Regulation Best Interest: The Broker-Dealer Standard of Conduct, 33318-33492 [2019-12164]

Download as PDF 33318 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 240 [Release No. 34–86031; File No. S7–07–18] RIN 3235–AM35 Regulation Best Interest: The BrokerDealer Standard of Conduct Securities and Exchange Commission. ACTION: Final rule. AGENCY: The Securities and Exchange Commission (the ‘‘Commission’’) is adopting a new rule under the Securities Exchange Act of 1934 (‘‘Exchange Act’’), establishing a standard of conduct for broker-dealers and natural persons who are associated persons of a broker-dealer (unless otherwise indicated, together referred to as ‘‘broker-dealer’’) when they make a recommendation to a retail customer of any securities transaction or investment strategy involving securities (‘‘Regulation Best Interest’’). Regulation Best Interest enhances the broker-dealer standard of conduct beyond existing suitability obligations, and aligns the standard of conduct with retail customers’ reasonable expectations by requiring broker-dealers, among other things, to: Act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker-dealer ahead of the interests of the retail customer; and address conflicts of interest by establishing, maintaining, and enforcing policies and procedures reasonably designed to identify and fully and fairly disclose material facts about conflicts of interest, and in instances where we have determined that disclosure is insufficient to reasonably address the conflict, to mitigate or, in certain instances, eliminate the conflict. The standard of conduct established by Regulation Best Interest cannot be satisfied through disclosure alone. The standard of conduct draws from key principles underlying fiduciary obligations, including those that apply to investment advisers under the Investment Advisers Act of 1940 (‘‘Advisers Act’’). Importantly, regardless of whether a retail investor chooses a broker-dealer or an investment adviser (or both), the retail investor will be entitled to a recommendation (from a broker-dealer) or advice (from an investment adviser) that is in the best interest of the retail investor and that does not place the interests of the firm or the financial jbell on DSK3GLQ082PROD with RULES2 SUMMARY: VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 professional ahead of the interests of the retail investor. DATES: Effective date: This rule is effective September 10, 2019. Compliance date: The compliance date is discussed in Section II.E of this final release. FOR FURTHER INFORMATION CONTACT: Lourdes Gonzalez, Assistant Chief Counsel—Office of Sales Practices; Emily Westerberg Russell, Senior Special Counsel; Alicia Goldin, Senior Special Counsel; John J. Fahey, Branch Chief; Daniel Fisher, Branch Chief; Bradford Bartels, Special Counsel; and Geeta Dhingra, Special Counsel, Office of Chief Counsel, Division of Trading and Markets, at (202) 551–5550, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549–8549. SUPPLEMENTARY INFORMATION: The Commission is adopting new rule 17 CFR 240.15l–1 under the Exchange Act to establish a standard of conduct for broker-dealers and natural persons who are associated persons of a broker-dealer when they make a recommendation to a retail customer of any securities transaction or investment strategy involving securities. The Commission is also adopting amendments to rules 17 CFR 240.17a–3 and 17 CFR 240.17a–4 to establish new record-making and recordkeeping requirements for brokerdealers with respect to certain information collected from or provided to retail customers. Table of Contents I. Introduction A. Background B. Overview of Regulation Best Interest C. Overview of Modifications to the Proposed Rule Text and Guidance Provided D. Overview of Key Enhancements II. Discussion of Regulation Best Interest A. General Obligation 1. Commission’s Approach 2. General Obligation To ‘‘Act in Best Interest’’ B. Key Terms and Scope of Best Interest Obligation 1. Natural Person Who Is an Associated Person 2. Recommendation of Any Securities Transaction or Investment Strategy Involving Securities 3. Retail Customer C. Component Obligations 1. Disclosure Obligation 2. Care Obligation 3. Conflict of Interest Obligation 4. Compliance Obligation D. Record-Making and Recordkeeping E. Compliance Date III. Economic Analysis A. Introduction and Primary Goals of the Regulation, Comments on Market Failure PO 00000 Frm 00002 Fmt 4701 Sfmt 4700 and Quantification, and Broad Economic Considerations 1. Introduction and Primary Goals of the Regulation 2. Broad Economic Considerations 3. Comments on Market Failure of the Principal-Agent Relationship and Quantification; Comments That the Broker-Dealer, Commission-Based Model Should Be Severely Restricted or Eliminated B. Economic Baseline 1. Providers of Financial Services 2. Regulatory Baseline and Current Market Practices 3. Investment Advice and Evidence of Potential Investor Harm 4. Trust, Financial Literacy, and the Effectiveness of Disclosure C. Benefits and Costs 1. General 2. Disclosure Obligation 3. Care Obligation 4. Conflict of Interest Obligation 5. Compliance Obligation 6. Record-Making and Recordkeeping 7. Approaches To Quantifying the Potential Benefits D. Efficiency, Competition, and Capital Formation 1. Competition 2. Capital Formation and Efficiency E. Reasonable Alternatives 1. Fiduciary Standard for Broker-Dealers 2. Prescribed Format for Disclosure 3. Disclosure-Only IV. Paperwork Reduction Act A. Respondents Subject to Regulation Best Interest and Amendments to Rule 17a– 3(a)(35) and Rule 17a–4(e)(5) 1. Broker-Dealers 2. Natural Persons Who Are Associated Persons of Broker-Dealers B. Summary of Collections of Information 1. Disclosure Obligation 2. Care Obligation 3. Conflict of Interest Obligation 4. Compliance Obligation 5. Record-Making and Recordkeeping Obligations V. Final Regulatory Flexibility Act Analysis A. Need for and Objectives of the Rule B. Significant Issues Raised by Public Comments C. Small Entities Subject to the Rule D. Projected Reporting, Recordkeeping, and Other Compliance Requirements 1. Disclosure Obligation 2. Care Obligation 3. Conflict of Interest Obligation 4. Compliance Obligation 5. Record-Making and Recordkeeping Obligations E. Agency Action To Minimize Effect on Small Entities VI. Statutory Authority and Text of the Rule I. Introduction We are adopting a new rule 15l–1 under the Exchange Act (‘‘Regulation Best Interest’’) that will improve investor protection by: (1) Enhancing the obligations that apply when a broker-dealer makes a recommendation to a retail customer and natural persons E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations who are associated persons of a brokerdealer (‘‘associated persons’’) (unless otherwise indicated, together referred to as ‘‘broker-dealer’’) and (2) reducing the potential harm to retail customers from conflicts of interest that may affect the recommendation. Regulation Best Interest enhances the broker-dealer standard of conduct beyond existing suitability obligations, and aligns the standard of conduct with retail customers’ reasonable expectations by requiring broker-dealers, among other things, to: (1) Act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker-dealer ahead of the interests of the retail customer; and (2) address conflicts of interest by establishing, maintaining, and enforcing policies and procedures reasonably designed to identify and fully and fairly disclose material facts about conflicts of interest, and in instances where we have determined that disclosure is insufficient to reasonably address the conflict, to mitigate or, in certain instances, eliminate the conflict. Regulation Best Interest establishes a standard of conduct under the Exchange Act that cannot be satisfied through disclosure alone. jbell on DSK3GLQ082PROD with RULES2 A. Background Broker-dealers play an important role in helping Americans organize their finances, accumulate and manage retirement savings, and invest toward other important long-term goals, such as buying a house or funding a child’s college education. Broker-dealers offer a wide variety of brokerage (i.e., agency) services and dealer (i.e., principal) services and products to both retail and institutional customers.1 Specifically, the brokerage services provided to retail customers range from execution-only services to providing personalized investment advice in the form of recommendations of securities transactions or investment strategies involving securities to customers.2 Investment advisers play a similarly important, though distinct, role. As described in the Fiduciary Interpretation, investment advisers 1 See Regulation Best Interest, Release No. 34– 83062 (Apr. 18, 2018) [83 FR 21574] (May 9, 2018) (‘‘Proposing Release’’) at 21574–75; see also Staff of the U.S. Securities and Exchange Commission, Study on Investment Advisers and Broker-Dealers As Required by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Jan. 2011) (‘‘913 Study’’) at 8–12, available at www.sec.gov/news/studies/2011/913studyfinal.pdf (discussing the range of brokerage and dealer services provided by broker-dealers). 2 See Proposing Release at 21574–21575; see also 913 Study. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 provide a wide range of services to a large variety of clients, from retail clients with limited assets and investment knowledge and experience to institutional clients with very large portfolios and substantial knowledge, experience, and analytical resources.3 As a general matter, broker-dealers and investment advisers have different types of relationships with investors, offer different services, and have different compensation models when providing investment recommendations or investment advisory services to customers. Broker-dealers typically provide transaction-specific recommendations and receive compensation on a transaction-bytransaction basis (such as commissions) (‘‘transaction-based’’ compensation or model). A broker-dealer’s recommendations may include recommending transactions where the broker-dealer is buying securities from or selling securities to retail customers on a principal basis or recommending proprietary products.4 Investment advisers, on the other hand, typically provide ongoing, regular advice and services in the context of broad investment portfolio management, and are compensated based on the value of assets under management (‘‘AUM’’), a fixed fee or other arrangement (‘‘feebased’’ compensation or model).5 This variety is important because it presents investors with choices regarding the types of relationships they can have, the services they can receive, and how they can pay for those services. It is also common for a firm to provide both broker-dealer and investment adviser services. Like many principal-agent relationships—including the investment adviser-client relationship—the relationship between a broker-dealer and a customer has inherent conflicts of interest, including those resulting from a transaction-based (e.g., commission) compensation structure and other broker-dealer compensation.6 These and other conflicts of interest may provide 3 See Commission Interpretation Regarding Standard of Conduct for Investment Advisers, Advisers Act Release No. 5248 (June 5, 2019) (‘‘Fiduciary Interpretation’’). 4 See Proposing Release at 21574–21575; see also 913 Study. 5 See 913 Study. 6 The investment adviser-client relationship also has inherent conflicts of interest, including those resulting from an asset-based compensation structure that may provide an incentive for an investment adviser to encourage its client to invest more money through an adviser in order increase its AUM at the expense of the client. See Fiduciary Interpretation at footnotes 53–72 and accompanying text for a discussion of how investment advisers satisfy their fiduciary duty when conflicts of interest are present. PO 00000 Frm 00003 Fmt 4701 Sfmt 4700 33319 an incentive to a broker-dealer to seek to increase its own compensation or other financial interests at the expense of the customer to whom it is making investment recommendations. Notwithstanding these inherent conflicts of interest in the broker-dealercustomer relationship, there is broad acknowledgment of the benefits of, and support for, the continuing existence of the broker-dealer business model, including a commission or other transaction-based compensation structure, as an option for retail customers seeking investment recommendations.7 For example, retail customers that intend to buy and hold a long-term investment may find that paying a one-time commission to a broker-dealer recommending such an investment is more cost effective than paying an ongoing advisory fee to an investment adviser merely to hold the same investment. Retail customers with limited investment assets may benefit from broker-dealer recommendations when they do not qualify for advisory accounts because they do not meet the account minimums often imposed by investment advisers. Other retail customers who hold a variety of investments, or prefer differing levels of services (e.g., both episodic recommendations from a broker-dealer and continuous advisory services including discretionary asset management from an investment adviser), may benefit from having access to both brokerage and advisory accounts. Nevertheless, concerns exist regarding (1) the potential harm to retail customers resulting from broker-dealer recommendations provided where conflicts of interest exist and (2) the insufficiency of existing broker-dealer regulatory requirements to address these conflicts when broker-dealers make recommendations to retail customers.8 More specifically, there are concerns that existing requirements do not require a broker-dealer’s recommendations to be in the retail customer’s best interest.9 B. Overview of Regulation Best Interest On April 18, 2018, we proposed enhancements to the standard of conduct that applies when brokerdealers make recommendations to retail customers.10 Specifically, the proposal would have established an express best interest obligation that would require all broker-dealers and associated persons, 7 See Proposing Release at 21579. at 21577–21579. 9 Id. See also Section I.C, Overview of Modifications to the Proposed Rule Text and Guidance Provided. 10 Proposing Release at 21575. 8 Id. E:\FR\FM\12JYR2.SGM 12JYR2 33320 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer, to act in the best interest of the retail customer at the time the recommendation is made without placing the financial or other interest of the broker-dealer or associated person making the recommendation ahead of the interest of the retail customer. The Commission received substantial comment on proposed Regulation Best Interest. We received over 6,000 comment letters in connection with the Proposing Release, of which approximately 3,000 are unique comment letters, from a variety of commenters including individual investors, consumer advocacy groups, financial services firms (including broker-dealers, investment advisers, and insurance companies), investment professionals, industry and trade associations, state securities regulators, bar associations, and others.11 The Commission also solicited individual investors’ input through a number of forums in addition to the traditional requests for comment in the Proposing Release. Among other things, seven investor roundtables were held in different locations across the country to solicit further comment on the proposed relationship summary,12 and the Commission and its staff received inperson feedback from almost 200 attendees in total.13 The Commission 11 Comments received in response to the Proposing Release are available at: https:// www.sec.gov/comments/s7-07-18/s70718.htm. 12 In a separate, concurrent rulemaking, the Commission proposed to, among other things, require broker-dealers and investment advisers to deliver to retail investors a short relationship summary (‘‘Relationship Summary’’). See Form CRS Relationship Summary; Amendments to Form ADV; Required Disclosures in Retail Communications and Restrictions on the use of Certain Names or Titles, Release No. 34–83063, IA–4888, File No. S7–08–18 (Apr. 18, 2018), 83 FR 23848 (May 23, 2018) (‘‘Relationship Summary Proposal’’). Along with adopting Regulation Best Interest, the Commission is adopting Exchange Act Rule 17a–14 (CFR 240.17a–14) and Form CRS (17 CFR 249.640) under the Exchange Act (‘‘Form CRS’’). See Form CRS Relationship Summary; Amendments to Form ADV Exchange Act Release No. 86032, Advisers Act Release No. 5247, File No. S7–08–18 (June 5, 2019) (‘‘Relationship Summary Adopting Release’’). The Commission is also providing interpretations: (1) Clarifying standards of conduct for investment advisers, and (2) regarding when a broker-dealer’s advisory services are solely incidental to the conduct of the business of a broker or dealer. See Fiduciary Interpretation; Commission Interpretation Regarding the Solely Incidental Prong of the BrokerDealer Exclusion to the Definition of Investment Adviser, Advisers Act Release No. 5249 (June 5, 2019) (‘‘Solely Incidental Interpretation’’). 13 The transcripts from the seven investor roundtables, which took place in Atlanta, Baltimore, Denver, Houston, Miami, Philadelphia, and Washington DC, are available in the comment file at https://www.sec.gov/comments/s7-08-18/ s70818.htm#transcripts. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 also received input and recommendations from a majority of its Investor Advisory Committee (‘‘IAC’’) on proposed Regulation Best Interest.14 After careful review and consideration of comments received and upon further consideration, the Commission is adopting Regulation Best Interest, with certain modifications as compared to the Proposing Release. As discussed below, while the Commission The Commission also used a ‘‘feedback form’’ designed specifically to solicit input from retail investors with a set of questions requesting both structured and narrative responses, and received more than 90 responses from individuals who reviewed and commented on the sample proposed relationship summaries published in the proposal. The feedback forms are available in the comment file at https://www.sec.gov/comments/s7-08-18/ s70818.htm. Finally, the Commission’s Office of the Investor Advocate engaged the RAND Corporation to conduct investor testing of the proposed relationship summary. Angela A. Hung, et al., RAND Corporation, Investor Testing of Form CRS Relationship Summary (2018), available at https:// www.sec.gov/about/offices/investorad/investortesting-form-crs-relationship-summary.pdf (‘‘RAND 2018’’). See also Investor Testing of the Proposed Relationship Summary for Investment Advisers and Broker-Dealers, Commission Press Release 2018– 257 (Nov. 7, 2018), available at https:// www.sec.gov/news/press-release/2018-257. As noted in the Relationship Summary Adopting Release, the amount of information available from the various investor surveys and investor testing described in this release is extensive. We considered all of this information thoroughly, using our decades of experience with investor disclosures, when evaluating changes to the disclosure required by Regulation Best Interest, as well as to the Relationship Summary. See Relationship Summary Adopting Release. 14 Recommendation of the Investor as Purchaser Subcommittee Regarding Proposed Regulation Best Interest, Form CRS, and Investment Advisers Act Fiduciary Guidance, Nov. 7, 2018, available at https://www.sec.gov/spotlight/investor-advisorycommittee-2012/iac110718-investor-as-purchasersubcommittee-recommendation.pdf (‘‘IAC 2018 Recommendation’’). Generally, a majority of the IAC made the following recommendations related to Regulation Best Interest: (1) That the meaning of the best interest obligation should be clarified to require both broker-dealers, investment advisers, and their associated persons to recommend the investments, investment strategies, accounts, or services, from among those they have reasonably available to recommend, that they reasonably believe represent the best available options for the investor; (2) that the best interest obligation be expanded to apply to the implicit ‘‘no recommendation’’ recommendation that a broker makes when reviewing an account and recommending no change, to rollover recommendations and recommendations by dual registrant firms regarding account types; and (3) that the best interest obligation should be explicitly characterized as the fiduciary duty that it is, while making clear that the specific obligations that flow from that duty will vary based on differences in business models. The Commission is statutorily obligated to respond to the recommendations of the IAC, which we are doing in this section and throughout the adopting release in the relevant sections, for example, in the discussion of the General Obligation in Section II.A.1, the discussion of recommendations in Section II.B.1, Recommendation of Any Securities Transaction or Investment Strategy Involving Securities, and the Care Obligation in Section II.C.2. PO 00000 Frm 00004 Fmt 4701 Sfmt 4700 is generally retaining the overall structure and scope set forth in the Proposing Release, we are making modifications to the text of the rule and also providing interpretations and guidance to address points raised during the comment process. The Commission has crafted Regulation Best Interest to draw on key principles underlying fiduciary obligations, including those that apply to investment advisers under the Advisers Act, while providing specific requirements to address certain aspects of the relationships between brokerdealers and their retail customers. Regulation Best Interest enhances the existing standard of conduct applicable to broker-dealers and their associated persons at the time they recommend to a retail customer a securities transaction or investment strategy involving securities. This includes recommendations of account types and rollovers or transfers of assets and also covers implicit hold recommendations resulting from agreed-upon account monitoring. When making a recommendation, a broker-dealer must act in the retail customer’s best interest and cannot place its own interests ahead of the customer’s interests (hereinafter, ‘‘General Obligation’’).15 The General Obligation is satisfied only if the brokerdealer complies with four specified component obligations. The obligations are: (1) Providing certain prescribed disclosure before or at the time of the recommendation, about the recommendation and the relationship between the retail customer and the broker-dealer (‘‘Disclosure Obligation’’); (2) exercising reasonable diligence, care, and skill in making the recommendation (‘‘Care Obligation’’); (3) establishing, maintaining, and enforcing policies and procedures reasonably designed to address conflicts of interest (‘‘Conflict of Interest Obligation’’), and (4) establishing, maintaining, and enforcing policies and procedures reasonably designed to achieve compliance with Regulation Best Interest (‘‘Compliance Obligation’’).16 15 See generally Section II.A, General Obligation. discussed in further detail below, although Regulation Best Interest identifies specified obligations with which a broker-dealer must comply in order to meet its General Obligation, compliance with each of the component obligations of Regulation Best Interest will be principles-based. In other words, whether a broker-dealer has acted in the retail customer’s best interest will turn on an objective assessment of the facts and circumstances of whether the specific components of Regulation Best Interest are satisfied at the time that the recommendation is made. 16 As E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations First, under the Disclosure Obligation,17 before or at the time of the recommendation, a broker-dealer must disclose, in writing, all material facts about the scope and terms of its relationship with the customer. This includes a disclosure that the firm or representative is acting in a brokerdealer capacity; the material fees and costs the customer will incur; and the type and scope of the services to be provided, including any material limitations on the recommendations that could be made to the retail customer. Moreover, the broker-dealer must disclose all material facts relating to conflicts of interest associated with the recommendation that might incline a broker-dealer to make a recommendation that is not disinterested, including, for example, conflicts associated with proprietary products, payments from third parties, and compensation arrangements. Second, under the Care Obligation,18 a broker-dealer must exercise reasonable diligence, care, and skill when making a recommendation to a retail customer. The broker-dealer must understand potential risks, rewards, and costs associated with the recommendation. The broker-dealer must then consider those risks, rewards, and costs in light of the customer’s investment profile and have a reasonable basis to believe that the recommendation is in the customer’s best interest and does not place the broker-dealer’s interest ahead of the retail customer’s interest. A broker-dealer should consider reasonable alternatives, if any, offered by the broker-dealer in determining whether it has a reasonable basis for making the recommendation. Whether a broker-dealer has complied with the Care Obligation will be evaluated as of the time of the recommendation (and not in hindsight). When recommending a series of transactions, the brokerdealer must have a reasonable basis to believe that the transactions taken together are not excessive, even if each is in the customer’s best interest when viewed in isolation. Third, under the Conflict of Interest Obligation,19 a broker-dealer must establish, maintain, and enforce reasonably designed written policies and procedures addressing conflicts of interest associated with its recommendations to retail customers. These policies and procedures must be reasonably designed to identify all such conflicts and at a minimum disclose or eliminate them. Importantly, the policies and procedures must be reasonably designed to mitigate conflicts of interests that create an incentive for an associated person of the broker-dealer to place its interests or the interest of the firm ahead of the retail customer’s interest. Moreover, when a broker-dealer places material limitations on recommendations that may be made to a retail customer (e.g., offering only proprietary or other limited range of products), the policies and procedures must be reasonably designed to disclose the limitations and associated conflicts and to prevent the limitations from causing the associated person or brokerdealer from placing the associated person’s or broker-dealer’s interests ahead of the customer’s interest. Finally, the policies and procedures must be reasonably designed to identify and eliminate sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sale of specific securities or specific types of securities within a limited period of time. Fourth, under the Compliance Obligation,20 a broker-dealer must also establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest as a whole. Thus, a broker-dealer’s policies and procedures must address not only conflicts of interest but also compliance with its Disclosure and Care Obligations under Regulation Best Interest. The enhancements contained in Regulation Best Interest are designed to improve investor protection by enhancing the quality of broker-dealer recommendations to retail customers and reducing the potential harm to retail customers that may be caused by conflicts of interest. Regulation Best Interest will complement the related rules, interpretations, and guidance that the Commission is concurrently issuing.21 Individually and collectively, these actions are designed to help retail customers better understand and compare the services offered by brokerdealers and investment advisers and make an informed choice of the relationship best suited to their needs and circumstances, provide clarity with respect to the standards of conduct applicable to investment advisers and broker-dealers, and foster greater consistency in the level of protections provided by each regime, particularly at 17 See generally Section II.C.1, Disclosure Obligation. 18 See generally Section II.C.2, Care Obligation. 19 See generally Section II.C.3, Conflict of Interest Obligation. 20 See generally Section II.C.4, Compliance Obligation. 21 See Relationship Summary Adopting Release; Fiduciary Interpretation; Solely Incidental Interpretation. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 PO 00000 Frm 00005 Fmt 4701 Sfmt 4700 33321 the point in time that a recommendation is made.22 At the time a recommendation is made, key elements of the Regulation Best Interest standard of conduct that applies to broker-dealers will be similar to key elements of the fiduciary standard for investment advisers.23 Importantly, regardless of whether a retail investor chooses a broker-dealer or an investment adviser (or both), the retail investor will be entitled to a recommendation (from a broker-dealer) or advice (from an investment adviser) that is in the best interest of the retail investor and that does not place the interests of the firm or the financial professional ahead of the interests of the retail investor. There are also key differences between Regulation Best Interest and the Advisers Act fiduciary standard that reflect the distinction between the services and relationships typically offered under the two business models. For example, an investment adviser’s fiduciary duty generally includes a duty to provide ongoing advice and monitoring,24 while Regulation Best Interest imposes no such duty and instead requires that a broker-dealer act in the retail customer’s best interest at the time a recommendation is made. In addition, the new obligations applicable to broker-dealers under Regulation Best Interest are more prescriptive than the obligations applicable to investment advisers under the Advisers Act fiduciary duty and reflect the characteristics of the generally applicable broker-dealer business model.25 The Commission has been studying and carefully considering the issues related to the standard of conduct for broker-dealers for many years, which led to the development of Regulation Best Interest.26 In designing Regulation Best Interest, we considered a number of options to enhance 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. There 22 We believe each rule and interpretation stands on its own and enhances the effectiveness of existing rules, and is reinforced by the other rules and interpretations being adopted contemporaneously. 23 Specifically, an investment adviser’s fiduciary duty under the Advisers Act comprises a duty of care and a duty of loyalty. This combination of care and loyalty obligations has been characterized as requiring the investment adviser to act in the ‘‘best interest’’ of its client at all times. See Fiduciary Interpretation. 24 See Fiduciary Interpretation, Section II.B.3 (Duty to Provide Advice and Monitoring over the Course of the Relationship). 25 See, e.g., Sections II.A and III.E. 26 Proposing Release at 21579–21583. E:\FR\FM\12JYR2.SGM 12JYR2 33322 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 were several options, including, among others: (1) Applying the fiduciary standard under the Advisers Act to broker-dealers; (2) adopting a ‘‘new’’ uniform fiduciary standard of conduct that would apply equally to both brokerdealers and investment advisers, such as that recommended by the staff in the 913 Study; 27 and (3) the path we ultimately chose, adopting a new standard of conduct specifically for broker-dealers, which draws from key principles underlying fiduciary obligations, including those that apply to investment advisers under the Advisers Act.28 The standard also provides specific requirements to address certain aspects of the relationships between broker-dealers and their retail customers, including certain conflicts related to compensation of associated persons.29 We have declined to subject brokerdealers to a wholesale and complete application of the existing fiduciary standard under the Advisers Act because it is not appropriately tailored to the structure and characteristics of the broker-dealer business model (i.e., transaction-specific recommendations and compensation), and would not properly take into account, and build upon, existing obligations that apply to broker-dealers, including under FINRA rules.30 Moreover, we believe (and our experience indicates), that this approach would significantly reduce retail investor access to differing types of investment services and products, reduce retail investor choice in how to pay for those products and services, and increase costs for retail investors of 27 One of the staff’s primary recommendations was that the Commission engage in rulemaking to adopt and implement a uniform fiduciary standard of conduct for broker-dealers and investment advisers when providing personalized investment advice about securities to retail customers. The staff’s recommended standard would require firms ‘‘to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer or investment adviser providing the advice.’’ The staff made a number of specific recommendations for implementing the uniform fiduciary standard of conduct, including that the Commission should: (1) Require firms to eliminate or disclose conflicts of interest; (2) consider whether rulemaking would be appropriate to prohibit certain conflicts, to require firms to mitigate conflicts through specific action, or to impose specific disclosure and consent requirements; and (3) consider specifying uniform standards for the duty of care owed to retail customers, such as specifying what basis a brokerdealer or investment adviser should have in making a recommendation to a retail customer by referring to and expanding upon broker-dealers’ existing suitability requirements. See generally 913 Study. 28 See supra footnote 23. 29 In addition to these alternatives, we also considered several other reasonable alternatives. See Section III.E. 30 See also 913 Study at 139–143. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 obtaining investment recommendations.31 We have also declined to craft a new uniform standard that would apply equally and without differentiation to both broker-dealers and investment advisers. Adopting a ‘‘one size fits all’’ approach would risk reducing investor choice and access to existing products, services, service providers, and payment options, and would increase costs for firms and for retail investors in both broker-dealer and investment adviser relationships. Moreover, applying a new uniform standard to advisers would mean jettisoning to some extent the fiduciary standard under the Advisers Act that has worked well for retail clients and our markets and is backed by decades of regulatory and judicial precedent. Our concerns about the ramifications for investor access, choice, and cost from adopting either of these approaches are not theoretical. With the adoption of the now vacated Department of Labor (‘‘DOL’’) Fiduciary Rule,32 there was a significant reduction in retail investor access to brokerage services,33 and we believe that the available alternative services were higher priced in many circumstances.34 Moreover, because key elements of the standard of conduct that Regulation Best Interest applies to broker-dealers at the time that a recommendation is made to a retail customer will be substantially similar to key elements of the standard of conduct that applies to investment advisers pursuant to their fiduciary duty under the Advisers Act, we do not believe that applying the existing fiduciary standard under the Advisers Act to broker-dealers or adopting a new uniform fiduciary standard of conduct applicable to both broker-dealers and investment advisers would provide any greater investor protection (or, in any case, that any benefits would justify the costs imposed on retail investors in terms of reduced access to services, products, and payment options, and increased costs for such services and products). We acknowledge certain commenters urged the Commission to take additional 31 See, e.g., Section 913 Study. at 143–159 for the study’s consideration of the potential costs, expenses, and impacts of various regulatory changes related to the provision of personalized investment advice to retail investors. See also Section II.A.1, Commission’s Approach. 32 As discussed in more detail in the Proposing Release, on April 8, 2016, the DOL adopted a new, expanded definition of ‘‘fiduciary’’ that treats persons who provide investment advice or recommendations for a fee or other compensation with respect to assets of a plan subject to the Employee Retirement Income Security Act of 1974 (‘‘ERISA’’) (an ‘‘ERISA plan’’) or individual retirement account (‘‘IRA’’) as fiduciaries in a wider array of advice relationships than under the previous regulation and issued certain related prohibited transaction exemptions (‘‘PTEs’’) (together, the ‘‘DOL Fiduciary Rule’’). The rule was subsequently vacated in toto by the United States Court of Appeals for the Fifth Circuit. See Chamber of Commerce v. U.S. Dep’t of Labor, 885 F.3d 360 (5th Cir. 2018). We understand that in the absence of a PTE, broker-dealers that would be considered to be a ‘‘fiduciary’’ for purposes of ERISA and the Internal Revenue Code (the ‘‘Code’’) would be prohibited from engaging in purchases and sales of certain investments for their own account (i.e., engaging in principal transactions) and would be prohibited from receiving common forms of broker-dealer compensation (notably, transaction-based compensation). See DOL, Best Interest Contract Exemption, 81 FR 21002 (Apr. 8, 2016) (‘‘BIC Exemption Release’’). To avoid this result, the DOL published, among other PTEs, the Best Interest Contract Exemption (‘‘BIC Exemption’’), which would have provided conditional relief for an ‘‘adviser,’’ as that term is used in the context of the BIC Exemption, and the adviser’s firm, to receive common forms of ‘‘conflicted’’ compensation, such as commissions and third-party payments (such as revenue sharing), provided that the adviser’s firm met certain conditions. See id. Generally, the BIC Exemption and other PTEs required that, among other things, the advice be provided pursuant to a written contract that commits the firm and the adviser to adhere to standards of impartial conduct, including providing advice in the investor’s best interest; charging only reasonable compensation; and avoiding misleading statements about fees and conflicts of interest) (‘‘Impartial Conduct Standards’’). See generally id. See also Proposing Release at 21580–21582. 33 While the full effects of the DOL Fiduciary Rule were not realized as it was vacated during the transition period, a number of industry studies indicated that, as a result of the DOL Fiduciary Rule, industry participants had already or were planning to alter services and products available to retail customers. For example, of the 21 members of the Securities Industry and Financial Markets Association (‘‘SIFMA’’) that participated in the SIFMA Study, 53% eliminated or reduced access to brokerage advice services and 67% migrated away from open choice to fee-based or limited brokerage services. See SIFMA & Deloitte, The DOL Fiduciary Rule: A Study on How Financial Institutions Have Responded and the Resulting Impacts on Retirement Investors (Aug. 9, 2017), available at https://www.sifma.org/wp-content/uploads/2017/ 08/Deloitte-White-Paper-on-the-DOL-FiduciaryRule-August-2017.pdf (‘‘SIFMA Study’’). Other studies also saw shifts from commission-based accounts to fee-based accounts. See infra footnote 1009. In addition, an industry study found that some customers were shifted from commissionbased brokerage accounts to self-directed accounts, while the same study observed that 29% of their survey participants expected to move clients, particularly those with low account balances, to robo-advisors. See infra footnote 1010. 34 It was widely reported that a number of firms responded to the DOL Fiduciary Rule by either requiring customers to enter into more expensive advice relationships or by passing through higher compliance costs to customers, which altered many retail customer relationships with their financial professionals. See infra footnote 1007. From the SIFMA Study, for those firms whose retail customers faced eliminated or reduced brokerage advice services, 63% of firms had customers that chose to move to self-directed accounts rather than fee-based accounts and cited the customers’ reasons as ‘‘not wanting to move to a fee-based model, not in the best interest to move to a fee-based model, did not meet account minimums, or wanted to maintain positions in certain asset classes prohibited by the fee-based models.’’ PO 00000 Frm 00006 Fmt 4701 Sfmt 4700 E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations or different regulatory actions than the approach we have adopted, including the alternatives discussed above. We do not believe that any rulemaking governing retail investor-advice relationships can solve for every issue presented. After careful consideration of the comments and additional information we have received,35 we believe that Regulation Best Interest, as modified, appropriately balances the concerns of the various commenters in a way that will best achieve the Commission’s important goals of enhancing retail investor protection and decision making, while preserving, to the extent possible, retail investor access (in terms of choice and cost) to differing types of investment services and products.36 The Commission’s staff will offer firms significant assistance and support during the transition period and thereafter with the aim of helping to ensure that the investor protections and other benefits of the final rule are implemented in an efficient and effective manner. Further, we will continue to monitor the effectiveness of Regulation Best Interest in achieving the Commission’s goals. C. Overview of Modifications to the Proposed Rule Text and Guidance Provided The vast majority of commenters supported the Commission’s rulemaking efforts to address the standards of conduct that apply to broker-dealers when making recommendations, but nearly all commenters suggested modifications to proposed Regulation Best Interest.37 These suggestions touch on almost every aspect of the proposal, as discussed in more detail below. A variety of commenters offered suggestions on the overall structure and 35 See supra footnotes 11–13 and accompanying jbell on DSK3GLQ082PROD with RULES2 text. 36 If any of the provisions of these rules, or the application thereof to any person or circumstance, is held to be invalid, such invalidity shall not affect other provisions or application of such provisions to other persons or circumstances that can be given effect without the invalid provision or application. 37 See, e.g., Letter from David Certner, Legislative Counsel and Legislative Policy Director, AARP (Aug. 7, 2018) (‘‘AARP August 2018 Letter’’); Letter from Christopher Gilkerson, Senior Vice President and General Counsel, and Tara Tune, Director and Corporate Counsel, Charles Schwab & Co., Inc. (Aug. 6, 2018) (‘‘Schwab Letter’’); Letter from Barbara Roper, Director of Investor Protection, and Micah Hauptman, Financial Services Counsel, Consumer Federation of America (‘‘CFA’’) (Aug. 7, 2018) (‘‘CFA August 2018 Letter’’); Letter from Joseph Borg, President, North American Securities Administrators Association, Inc. (‘‘NASAA’’) (Aug. 23, 2018) (‘‘NASAA August 2018 Letter’’); Letter from Kenneth E. Bentsen, Jr., President and Chief Executive Officer, SIFMA (Aug. 7, 2018) (‘‘SIFMA August 2018 Letter’’). VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 scope of the proposed rule, including: whether the standard should be a fiduciary standard; 38 whether the standard should apply to both investment advisers and brokerdealers; 39 whether the standard should be principles-based or more prescriptive; 40 whether the standard should define ‘‘best interest;’’ 41 whether 38 See, e.g., Letter from Jon Stein, Founder and CEO, Benjamin T. Alden, General Counsel, and Seth Rosenbloom, Associate General Counsel, Betterment (Aug. 7, 2018) (‘‘Betterment Letter’’); Letter from Kurt N. Schacht, Managing Director, James Allen, Head, Capital Markets Policy, and Linda L. Rittenhouse, Director, Capital Markets, CFA Institute (Aug. 7, 2018) (‘‘CFA Institute Letter’’); Letter from Jill I. Gross, Associate Dean for Academic Affairs, Professor of Law, Elisabeth Haub School of Law, Pace University (Mar. 11, 2019) (‘‘Pace March 2019 Letter’’); Letter from Sharon Cheever, Senior Vice President and General Counsel, Pacific Life Insurance Company (Aug. 3, 2018) (‘‘Pacific Life August 2018 Letter’’); Letter from Melanie Fein, Fein Law Offices (Jun. 6, 2018) (‘‘Fein Letter’’); Letter from Elizabeth Warren, U.S. Senator (Aug. 3, 2018) (‘‘Warren Letter’’); Letter from Dean P. McDermott, McDermott Investment Advisors (Jul. 7, 2018) (‘‘McDermott Letter’’); Letter from Brian Hamburger, President and CEO, MarketCounsel (Aug. 7, 2018) (‘‘MarketCounsel Letter’’). 39 See, e.g., AARP August 2018 Letter; Letter from Americans for Financial Reform et al. (Aug. 7, 2018) (‘‘Americans for Financial Reform Letter’’); Letter from Robert J. Moore, Chief Executive Officer, Cetera Financial Group (‘‘Cetera’’) (Aug. 7, 2018) (‘‘Cetera August 2018 Letter’’); Letter from L.A. Schnase, Individual Investor and Attorney at Law (Jul. 30, 2018) (‘‘Schnase Letter’’); Pacific Life August 2018 Letter; Pace March 2019 Letter; MarketCounsel Letter; Letter from Dennis M. Kelleher, President and CEO, Stephen Hall, Legal Director and Securities Specialist, Lev Bagramian, Senior Securities Policy Advisor, Better Markets (Aug. 7, 2018) (‘‘Better Markets August 2018 Letter’’); Letter from Attorneys General of New York, California, Connecticut, Delaware, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New Mexico, Oregon, Pennsylvania, Rhode Island, Vermont, Washington, and the District of Columbia (Aug. 7, 2018) (‘‘State Attorneys General Letter’’). 40 See, e.g., SIFMA August 2018 Letter; Letter from Mortimer J. Buckley, President and Chief Executive Officer, Vanguard (Aug. 7, 2018) (‘‘Vanguard Letter’’); Letter from Chris Lewis, General Counsel, Edward Jones (Aug. 7, 2018) (‘‘Edward Jones Letter’’); Letter from Joseph E. Sweeney, President, Advice & Wealth Management Products and Service Delivery, Ameriprise Financial (Aug. 6, 2018) (‘‘Ameriprise Letter’’); Letter from Sheila Kearney Davidson, Executive Vice President, Chief Legal Officer & General Counsel, New York Life Insurance Company (‘‘NY Life’’) (Aug. 7, 2018) (‘‘NY Life Letter’’); Letter from Keith Gillies, NAIFA President, National Association of Insurance and Financial Advisors (‘‘NAIFA’’) (Aug. 2, 2018) (‘‘NAIFA Letter’’); Letters from Tom Quaadman, Executive Vice President, Center for Capital Markets Competitiveness, U.S. Chamber of Commerce (‘‘CCMC’’) (Aug. 7, 2018) (supplemented by letter dated Sep. 5, 2018) (‘‘CCMC Letters’’); Letter from Dave Paulsen, Executive Vice President, Chief Distribution Officer, Transamerica (Aug. 7, 2018) (‘‘Transamerica August 2018 Letter’’). 41 See, e.g., Letter from Seth A. Miller, General Counsel, Senior Vice President, Chief Risk Officer, Cambridge (Aug. 7, 2018) (‘‘Cambridge Letter’’); SIFMA August 2018 Letter; Vanguard Letter; Edward Jones Letter; Ameriprise Letter; NY Life PO 00000 Frm 00007 Fmt 4701 Sfmt 4700 33323 the standard is or should be a safe harbor; 42 what should be considered a recommendation, including whether Regulation Best Interest should apply to recommendations to roll over or transfer assets or take plan distributions, and to recommendations of particular account types (i.e., brokerage or advisory); 43 whether Regulation Best Interest should apply to account monitoring services provided by a broker-dealer, or impose a continuing duty; 44 and whether Regulation Best Interest’s protections should apply to a broader or narrower set of ‘‘retail customers.’’ 45 Letter; NAIFA Letter; CCMC Letters; Letter from Aron Szapiro, Director of Policy Research, Morningstar (Aug. 7, 2018) (‘‘Morningstar Letter’’); Letter from David Kowach, Head of Wells Fargo Advisors, Wells Fargo (Aug. 7, 2018) (‘‘Wells Fargo Letter’’). 42 See, e.g., CFA August 2018 Letter; Letter from Anthony Chereso, President & CEO, Institute for Portfolio Alternatives (‘‘IPA’’) (Aug. 7, 2018) (‘‘IPA Letter’’); Letter from Heather Slavkin Corzo, AFL– CIO et al. (Apr. 26, 2019) (‘‘AFL–CIO April 2019 Letter’’). 43 See, e.g., Letter from Jason Bortz, Senior Counsel, Capital Research and Management Company (Aug. 7, 2018) (‘‘Capital Group Letter’’); Letter from Andrew Stoltmann, President, Public Investors Arbitration Bar Association (‘‘PIABA’’) (Aug. 7, 2018) (‘‘PIABA Letter’’); SIFMA August 2018 Letter; NASAA Letter; Letter from Robert K. Shaw, President, Individual Markets, Great-West Financial (Aug. 7, 2018) (‘‘Great-West Letter’’); NAIFA Letter; Transamerica August 2018 Letter; Letter from Tim Rouse, Executive Director, The SPARK Institute (Aug. 7, 2018) (‘‘SPARK Letter’’); Letter from Robin C. Swope, Director, Global Product Governance & Support, Invesco (Aug. 7, 2018) (‘‘Invesco Letter’’); Letter from R. Keith Overly, President, National Association of Government Defined Contribution Administrators (‘‘NAGDCA’’) (Aug. 7, 2018) (‘‘NAGDCA Letter’’); Letter from Kevin R. Keller, Chief Executive Officer, CFP Board, et al., Financial Planning Coalition (‘‘FPC’’) (Aug. 7, 2018) (‘‘FPC Letter’’); Letter from Dennis Simmons, Executive Director, Committee on Investment of Employee Benefit Assets, Committee on Investment of Employee Benefit Assets (‘‘CIEBA’’) (Aug. 6, 2018) (‘‘CIEBA Letter’’). 44 See, e.g., SIFMA August 2018 Letter; Letter from Lisa D. Crossley, Executive Director, National Society of Compliance Professionals (‘‘NSCP’’) (Aug. 7, 2018) (‘‘NSCP Letter’’); PIABA Letter; FPC Letter; Better Markets August 2018 Letter; Letter from Karen L. Barr, President and CEO, Investment Adviser Association (‘‘IAA’’) (Aug. 6, 2018) (‘‘IAA August 2018 Letter’’). We also received comments addressing when a broker-dealer’s advisory services are ‘‘solely incidental to the conduct of his business as a broker or dealer’’ under the ‘‘broker-dealer exclusion’’ from the definition of investment adviser—and thus from the application of the Advisers Act—provided in Section 202(a)(11)(C) of the Advisers Act. We have addressed these comments in the context of the Solely Incidental Interpretation. 45 See, e.g., Letter from Carl B. Wilkerson, Vice President and Chief Counsel, American Council of Life Insurers (‘‘ACLI’’) (Aug. 3, 2018) (‘‘ACLI Letter’’); Letter from Brian H. Graff, Executive Director and CEO, Craig P. Hoffman, General Counsel, Dough Fisher, Director of Retirement Policy, and Joseph A. Caruso, Government Affairs Counsel, American Retirement Association (‘‘ARA’’) (Aug. 3, 2018) (‘‘ARA August 2018 Letter’’); Letter from Anne Tennant, Managing E:\FR\FM\12JYR2.SGM Continued 12JYR2 33324 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 In addition, most commenters from both industry and consumer advocate groups requested modifications to each of the Disclosure, Care, and Conflict of Interest Obligations, and also called for more specific examples of conduct that would—or would not—satisfy these obligations. With respect to the Disclosure Obligation, most commenters generally sought greater clarity or made suggestions regarding what material facts and material conflicts would need to be disclosed, the form and manner (e.g., written versus oral, individualized versus standardized, and the use of electronic and/or layered) and the timing and frequency of the disclosure (e.g., whether the disclosure should be prior to, at the time of, or could be after a recommendation), as well as whether the Disclosure Obligation could be satisfied by complying with other existing disclosure requirements.46 In Director and General Counsel, Morgan Stanley (Aug. 7, 2018) (‘‘Morgan Stanley Letter’’); CCMC Letters; Letter from Thomas Roberts, Groom Law Group (Aug. 7, 2018) (‘‘Groom Letter’’); Letter from Catherine J. Weatherford, President and CEO, Insured Retirement Institute (‘‘IRI’’) (Aug. 7, 2018) (‘‘IRI Letter’’); NSCP Letter; Letter from Raymond J. Manista, Executive Vice President, Chief Legal Officer and Secretary, Northwestern Mutual (Aug. 7, 2018) (‘‘Northwestern Mutual Letter’’); State Attorneys General Letter; Letter from Mari-Anne Pisarri, Pickard Djinis and Pisarri LLP (Aug. 14, 2018) (‘‘Pickard Letter’’); SIFMA August 2018 Letter; Invesco Letter; Letter from Tom Clark, Managing Director, Sean Murphy, Vice President, Blackrock (Aug. 7, 2018) (‘‘Blackrock Letter’’). 46 See, e.g., Ameriprise Letter; Great-West Letter; Letter from Ram Subramaniam, Head of Brokerage and Investment Solutions, David Forman, Chief Legal Officer, Fidelity Investments (Aug. 7, 2018) (‘‘Fidelity Letter’’); Morgan Stanley Letter; CCMC Letters; Letter from Bret C. Hester, Senior Managing Director, Head of Regulatory Affairs, Teachers Insurance and Annuity Association of America (‘‘TIAA’’) (Aug. 7, 2018) (‘‘TIAA Letter’’); Letter from James Sonne, Assistant Vice President, Federal Government Relations, Mass Mutual (Feb. 19, 2019) (‘‘Mass Mutual Letter’’); Letter from Edmund F. Murphy III, President, Empower Retirement (Aug. 2, 2018) (‘‘Empower Retirement Letter’’); IRI Letter; Letter from Paul Schott Stevens, President and CEO, Investment Company Institute (‘‘ICI’’) (Aug. 7, 2018) (‘‘ICI Letter’’); SIFMA August 2018 Letter; Edward Jones Letter; Letter from Michelle Bryan Oroschakoff, Chief Legal Officer, LPL Financial (Aug. 7, 2018) (‘‘LPL August 2018 Letter’’); NASAA August 2018 Letter; AARP August 2018 Letter; PIABA Letter; Letter from Ann M. Kappler, Senior Vice President, Deputy General Counsel, Prudential Financial (Aug. 7, 2018) (‘‘Prudential Letter’’), CFA Institute Letter; State Attorneys General Letter; CFA August 2018 Letter; Letter from Jason Chandler, Group Managing Director, Co-Head Investment Platforms and Solutions, and Michael Crowl, Group Managing Director, General Counsel, UBS (Aug. 7, 2018) (‘‘UBS Letter’’), Letter from William F. Galvin, Secretary of the Commonwealth of Massachusetts (Aug. 7, 2018) (‘‘Galvin Letter’’); Letter from David T. Bellaire, Executive Vice President & General Counsel, Financial Services Institute (‘‘FSI’’) (Aug. 7, 2018) (‘‘FSI August 2018 Letter’’); Mass Mutual Letter; Schwab Letter; Letter from Michael F. Anderson, Senior Vice President and Chief Legal Officer, CUNA Mutual (Aug. 7, 2018) (‘‘CUNA Letter’’); Transamerica August 2018 Letter. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 particular, several commenters recommended that the Commission require broker-dealers provide ‘‘full and fair’’ disclosure.47 Regarding the Care Obligation, commenters from certain investor groups supported incorporating a ‘‘prudence’’ standard,48 while a number of industry commenters expressed concern about including this standard.49 Numerous commenters requested further clarity on what would be required to meet the Care Obligation, including what factors a broker-dealer should consider in developing a retail customer’s investment profile and when making a recommendation, and in particular the role of cost and other relevant factors when making a recommendation, and also asked for more specific examples of how to weigh costs against other factors when making a recommendation.50 A majority of the IAC and other commenters requested clarification on how to consider ‘‘reasonably available alternatives’’ when making a recommendation and suggested clarifying the scope of the inquiry into potential reasonably available alternatives when a brokerdealer offers a limited product menu versus when the broker-dealer has an ‘‘open architecture’’ model.51 Several industry commenters made recommendations regarding the application of proposed Regulation Best Interest to recommendations of specific categories of securities, such as variable annuities or leveraged exchange-traded products.52 47 See, e.g., CFA August 2018 Letter; Better Markets August 2018 Letter; Pace Letter. 48 See, e.g., AARP August 2018 Letter; CFA August 2018 Letter; FPC Letter. 49 See, e.g., Letter from Karen L. Sukin, Executive Vice President, Deputy General Counsel, Primerica (Aug. 7, 2018) (‘‘Primerica Letter’’); Transamerica August 2018 Letter; IPA Letter; Cetera August 2018 Letter. 50 See, e.g., Letter from Felice R. Foundos, Partner, Chapman and Cutler (Aug. 6, 2018) (‘‘Chapman Letter’’); Vanguard Letter; ICI Letter; Morgan Stanley Letter; Wells Fargo Letter; Primerica Letter; Great-West Letter; NASAA August 2018 Letter; Cambridge Letter; Blackrock Letter. 51 See, e.g., IAC 2018 Recommendation; Fidelity Letter; ICI Letter; SIFMA August 2018 Letter; Prudential Letter; LPL August 2018 Letter; Morningstar Letter. See also AFL–CIO April 2019 Letter (stating that the rule ‘‘must make clear that brokers are required to recommend the investments they reasonably believe are the best match for the investor from among the reasonably available investment options’’). 52 See, e.g., Letter from Brian Winikoff, Senior Executive Director and Head of U.S. Life, Retirement and Wealth Management, AXA (Aug. 7, 2018) (‘‘AXA Letter’’); Letter from Clifford Kirsch, Susan Krawczyk, Eversheds Sutherland, Committee of Annuity Insurers (Aug. 7, 2018) (‘‘Committee of Annuity Insurers Letter’’); Pacific Life August 2018 Letter; Letter from Angela Brickl, General Counsel, Rafferty Asset Management (‘‘Direxion’’) (Aug. 7, 2018) (‘‘Direxion Letter’’); Letter from Mark F. PO 00000 Frm 00008 Fmt 4701 Sfmt 4700 With respect to the Conflict of Interest Obligation, many commenters questioned the distinction between financial incentives that would have to be mitigated and other conflicts that would only need to be disclosed, and recommended generally that the distinction be eliminated.53 In addition, some commenters suggested that the obligation to establish policies and procedures to mitigate conflicts should apply to material conflicts at the level of the natural person who is an associated person (as opposed to the firm).54 Commenters also asked for more clarity and examples of what conflicts must be mitigated versus eliminated and more guidance on appropriate mitigation methods.55 Some commenters also expressed the view that by requiring mitigation of financial incentives, proposed Regulation Best Interest would require more of brokerdealers than what is required of investment advisers under their fiduciary duty, which could create a competitive disadvantage for brokerdealers that could further encourage migration from the broker-dealer to investment adviser business model and result in a loss of retail investor access (in terms of choice and cost) to differing types of investment services and products.56 In addition, a number of commenters agreed with the Commission’s statement that it was not intended to create a private right of action, but many requested that the Commission explicitly state in the final rule that Regulation Best Interest does not confer a private right of action.57 One Halloran, VP Managing Director, Business Development, Transamerica (Nov. 9, 2018) (‘‘Transamerica November 2018 Letter’’). 53 See, e.g., CFA August 2018 Letter; SIFMA August 2018 Letter; Primerica Letter; Letter from Jeff Hartney, Executive Director, Bank Insurance and Securities Association (‘‘BISA’’) (Aug. 7, 2018) (‘‘BISA Letter’’); Committee of Annuity Insurers Letter; IPA Letter; CFA Institute Letter; Morgan Stanley Letter; CCMC Letters. 54 See, e.g., Primerica Letter; TIAA Letter; ICI Letter; Letter from Craig D. Pfeiffer, President and CEO, Money Management Institute (Aug. 7, 2018) (‘‘Money Management Institute Letter’’). 55 See, e.g., AALU Letter; CFA August 2018 Letter; Letter from Quinn Curtis, Professor of Law, University of Virginia School of Law (‘‘UVA’’), (Aug. 3, 2018) (‘‘UVA Letter’’); Primerica Letter; Committee of Annuity Insurers Letter; Cetera August 2018 Letter; Wells Fargo Letter; NASAA August 2018 Letter; Morningstar Letter. 56 See, e.g., Letter from Craig S. Tyle, Executive Vice President and General Counsel, Franklin Templeton Investments, (Aug. 6, 2018) (‘‘Franklin Templeton Letter’’); Primerica Letter; LPL August 2018 Letter; CCMC Letters; UBS Letter; ICI Letter; Letter from Christopher A. Iacovella, Chief Executive Officer, American Securities Association (‘‘ASA’’) (Aug. 7, 2018) (‘‘ASA Letter’’); Schwab Letter. 57 See, e.g., Letter from Paul C. Reilly, Chairman and CEO, Raymond James Financial (Aug. 7, 2018) E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 commenter requested that the Commission elaborate and make clear the remedies available to investors when broker-dealers violate Regulation Best Interest and emphasize that scienter is not required to establish a violation of Regulation Best Interest.58 Finally, numerous commenters urged the Commission to coordinate with other regulators, in particular the DOL 59 and state securities and insurance regulators,60 and several commenters opined that the Commission should preempt (or avoid preempting) state law.61 After carefully reviewing the comments on the proposed rule, we have determined to retain its overall structure and scope. However, we have modified the proposed rule in a number of respects and are also providing additional interpretations and guidance to address and clarify issues raised by commenters. Summarized below are the key modifications from the proposal, as well as the interpretations and guidance provided. • Retail Customer Definition: We are modifying the definition of ‘‘retail (‘‘Raymond James Letter’’); NAIFA Letter; ASA Letter; CCMC Letters; UBS Letter; LPL August 2018 Letter; Cambridge Letter. Contra Letter from Elise Sanguinetti, President, American Association for Justice (Aug. 6, 2018) (‘‘American Association for Justice Letter’’). 58 NASAA August 2018 Letter. 59 See, e.g., ICI Letter; Franklin Templeton Letter; Morningstar Letter; Wells Fargo Letter; Edward Jones Letter; IRI Letter; Letter from Cynthia Lo Bessette, Executive Vice President and General Counsel, Letter from Oppenheimer Funds (Aug. 7, 2018) (‘‘Oppenheimer Letter’’); Vanguard Letter. 60 See, e.g., CCMC Letters; Letter from Robert Reynolds, President and CEO, Putnam Investments (Aug. 7, 2018) (‘‘Putnam Letter’’); Letter from Will H. Fuller, Executive Vice President, President, Annuity Solutions, Lincoln Financial Group (Nov. 13, 2018) (‘‘Lincoln Financial Letter’’); Cetera August 2018 Letter; Great-West Letter; Letter from Marc Cadin, Chief Operating Officer, Association of Advanced Life Underwriting (‘‘AALU’’) (Aug. 7, 2018) (‘‘AALU Letter’’); IRI Letter; Pacific Life August 2018 Letter; Vanguard Letter; Fidelity Letter; Letter from Andrew J. Bowden, Senior Vice President and General Counsel, Jackson National Life Insurance Company (Aug. 7, 2018) (‘‘Jackson National Letter’’); Invesco Letter; Lincoln Letter; CUNA Mutual Letter; Great-West Letter. 61 See, e.g., Cetera August 2018 Letter; ICI Letter; Franklin Templeton Letter; Putnam Investments Letter; but see NASAA August 2018 Letter; PIABA Letter; Letter from Teresa J. Verges, Director, Investor Rights Clinic, University of Miami School of Law (Aug. 2, 2018) (‘‘U. of Miami Letter’’); Letter from Kayla Martin, Legal Intern, Christine Lazaro, Director and Professor Clinical Legal Education, Securities Arbitration Clinic, St. John’s University School of Law (Aug. 7, 2018) (‘‘St. John’s U. Letter’’); Letter from Kevin M. Carroll, Managing Director & Associate General Counsel, SIFMA (Mar. 29, 2019) (‘‘SIFMA March 2019 Letter’’); Letter from Michael Pieciak, NASAA President and Commissioner, Vermont Department of Regulation, NASAA (Apr. 25, 2019); Letter from Tom Quaadman, Executive Vice President, CCMC (May 16, 2019) (‘‘CCMC May 2019 Letter’’); AFL–CIO April 2019 Letter. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 customer’’ to include any natural person who receives a recommendation from the broker-dealer for the natural person’s own account (but not an account for a business that he or she works for), including individual plan participants.62 We are interpreting ‘‘legal representative of such natural person’’ to include the nonprofessional legal representatives of such a natural person (e.g., nonprofessional trustee who represents the assets of a natural person). • Implicit Hold Recommendations: While broker-dealers will not be required to monitor accounts, in instances where a broker-dealer agrees to provide the retail customer with specified account monitoring services, it is our view that such an agreement will result in buy, sell or hold recommendations subject to Regulation Best Interest, even when the recommendation to hold is implicit.63 • Recommendations of account types, including recommendations to roll over or transfer assets from one type of account to another: We are modifying Regulation Best Interest to expressly apply to account recommendations including, among others, recommendations to roll over or transfer assets in a workplace retirement plan account to an IRA, recommendations to open a particular securities account (such as brokerage or advisory), and recommendations to take a plan distribution for the purpose of opening a securities account.64 We are also providing guidance under the Care Obligation on what factors a brokerdealer generally should consider when making such recommendations. • Dual-Registrants: We are providing additional guidance on how dualregistrants can comply with Regulation Best Interest, and confirming that Regulation Best Interest does not apply to advice provided by a broker-dealer that is dually registered as an investment adviser (‘‘dual-registrant’’) when acting in the capacity of an investment adviser, and that a dualregistrant is an investment adviser solely with respect to accounts for 62 As discussed in Section II.B.3.a, Retail Customer, Focus on Natural Persons and Legal Representatives of Natural Persons, to the extent a plan representative who decides service arrangements for a workplace retirement plan is a sole proprietor or other self-employed individual who will participate in the plan, the plan representative will be a retail customer to the extent that the sole proprietor or self-employed individual receives recommendations directly from a brokerdealer primarily for personal, family or household purposes. 63 See Section II.B.2.b, Interpretation of Any Securities Transaction or Investment Strategy Involving Securities. 64 See id. PO 00000 Frm 00009 Fmt 4701 Sfmt 4700 33325 which a dual-registrant provides advice and receives compensation that subjects it to the Advisers Act.65 We are also clarifying the relationship between the General Obligation and the specific component obligations, and in particular, what it means to ‘‘act in the best interest’’ of the retail customer. As is the case with the fiduciary duty applicable to investment advisers under the Advisers Act, we are not expressly defining in the rule text the term ‘‘best interest,’’ and instead are providing in Regulation Best Interest and through interpretations, what ‘‘acting in the best interest’’ means.66 Whether a brokerdealer has acted in the retail customer’s best interest in compliance with Regulation Best Interest will turn on an objective assessment of the facts and circumstances of how the specific components of Regulation Best Interest—including its Disclosure, Care, Conflict of Interest, and Compliance Obligations—are satisfied at the time that the recommendation is made (and not in hindsight). In response to commenters, we are addressing, among other things, what the General Obligation does and does not require (for example, that it does not impose a continuing duty beyond a particular recommendation), providing specific examples of what would violate Regulation Best Interest, and its application to certain scenarios, particularly in the context of satisfying the Care Obligation. We are also modifying and clarifying the component obligations that a brokerdealer would be required to satisfy in order to meet the General Obligation: Disclosure Obligation. We are refining the treatment of conflicts of interest by: (1) Defining in the rule text a ‘‘conflict of interest’’ for purposes of Regulation Best Interest (as opposed to interpreting the phrase ‘‘material conflict of interest’’ as in the Proposing Release) as an interest that might incline a brokerdealer—consciously or unconsciously— to make a recommendation that is not disinterested; and (2) revising the Disclosure Obligation to require disclosure of ‘‘material facts’’ regarding conflicts of interest associated with the recommendation.67 Similar to the proposal, all such conflicts of interest will be covered by Regulation Best 65 See Section II.B.3.d, Retail Customers, Treatment of Dual-Registrants. 66 In the investment adviser context, an investment adviser’s fiduciary duty under the Advisers Act comprises a duty of care and a duty of loyalty. This combination of care and loyalty obligations has been characterized as requiring the investment adviser to act in the ‘‘best interest’’ of its client at all times. See Fiduciary Interpretation. 67 See Section II.C.1.b, Disclosure Obligation, Material Facts Regarding Conflicts of Interest. E:\FR\FM\12JYR2.SGM 12JYR2 33326 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 Interest (e.g., subject to the Conflict of Interest Obligation), however, only ‘‘material facts’’ regarding these conflicts would be required to be disclosed under the Disclosure Obligation. Furthermore, we are modifying the Disclosure Obligation to explicitly require broker-dealers to provide ‘‘full and fair’’ disclosure of material facts, rather than requiring broker-dealers to ‘‘reasonably disclose’’ such information. We are providing the Commission’s view regarding what it means to provide ‘‘full and fair’’ disclosure to retail customers, including the level of specificity of disclosure required, and the form and manner and timing and frequency of such disclosure.68 We are explicitly requiring the disclosure of material facts relating to the scope and terms of the relationship that were specifically identified in the proposal (i.e., capacity, material fees and charges, and type and scope of services).69 In connection with disclosure requirements regarding the type and scope of services, we are also clarifying that at a minimum, a broker-dealer needs to disclose whether or not account monitoring services will be provided (and if so, the scope and frequency of those services), account minimums, and any material limitations on the securities or investment strategies involving securities that may be recommended to the retail customer.70 Also we conclude that the basis for a broker-dealer’s recommendations as a general matter (i.e., what might commonly be described as the firm’s investment approach, philosophy, or strategy) and the risks associated with a brokerdealer’s recommendations in standardized (as opposed to individualized) terms are material facts relating to the scope and terms of the relationship that should be disclosed.71 Below, we outline a method to address oral disclosure and written disclosure provided after the fact.72 Care Obligation. We are adopting the Care Obligation largely as proposed; however, we are expressly requiring that a broker-dealer understand and consider the potential costs associated with its recommendation, and have a reasonable basis to believe that the recommendation does not place the 68 See Section II.C.1.c, Disclosure Obligation, Full and Fair Disclosure. 69 See Section II.C.1.a, Disclosure Obligation, Material Facts Regarding Scope and Terms of the Relationship. 70 Id. 71 Id. 72 See Section II.C.1, Disclosure Obligation, Oral Disclosure or Disclosure After a Recommendation. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 financial or other interest of the brokerdealer ahead of the interest of the retail customer.73 Nevertheless, we emphasize that while cost must be considered, it should never be the only consideration. Cost is only one of many important factors to be considered regarding the recommendation and that the standard does not necessarily require the ‘‘lowest cost option.’’ Relatedly, we are emphasizing the need to consider costs in light of other factors and the retail customer’s investment profile. We are also providing additional guidance on what it means to make a recommendation in a retail customer’s ‘‘best interest.’’ As in the Proposing Release, determining whether a brokerdealer’s recommendation satisfies the Care Obligation will be an objective evaluation turning on the facts and circumstances of the particular recommendation and the particular retail customer. We recognize that a facts and circumstances evaluation of a recommendation makes it difficult to draw bright lines around whether a particular recommendation will meet the Care Obligation. Accordingly, we focus on how a broker-dealer could establish a reasonable basis to believe that a recommendation is in the best interest of its retail customer and does not place the broker-dealer’s interest ahead of the retail customer’s interest, and the circumstances under which a broker-dealer could not establish such a reasonable belief. We are clarifying that an evaluation of reasonably available alternatives does not require an evaluation of every possible alternative (including those offered outside the firm) nor require broker-dealers to recommend one ‘‘best’’ product, and what this evaluation will require in certain contexts (such as a firm with open architecture). Furthermore, we clarify that, when a broker-dealer materially limits its product offerings to certain proprietary or other limited menus of products, it must still comply with the Care Obligation—even if it has disclosed and taken steps to prevent the limitation from placing the interests of the brokerdealer ahead of the retail customer, as required by the Disclosure and Conflict of Interest Obligation—and thus could not use its limited menu to justify recommending a product that does not satisfy the obligation to act in a retail customer’s best interest. Conflict of Interest Obligation. We are revising the Conflict of Interest Obligation by: (1) Similar to the proposal, establishing an overarching obligation to establish written policies PO 00000 73 See generally Section II.C.2, Care Obligation. Frm 00010 Fmt 4701 Sfmt 4700 and procedures to identify and at a minimum disclose (pursuant to the Disclosure Obligation), or eliminate, all conflicts of interest associated with the recommendation; 74 and (2) setting forth explicit requirements to establish written policies and procedures reasonably designed to mitigate or eliminate certain identified conflicts of interest, specifically: • Mitigation of Associated Person Conflicts of Interest. We are revising the proposal’s mitigation requirement to: (1) Eliminate the distinction between financial incentives and all other conflicts of interest; and (2) focus on mitigating conflicts of interest associated with recommendations that create an incentive for the associated person of the broker-dealer to place the interest of the firm or the associated person ahead of the interest of the retail customer.75 We are providing further guidance regarding the types of incentives covered by this revised obligation, in particular focusing on compensation or employment related incentives and other incentives provided to the associated person (whether by the broker-dealer or thirdparties). We are also confirming, clarifying and expanding on the proposal’s guidance on potential mitigation methods to further promote compliance with this obligation. • Address Any Material Limitations on Recommendations to Retail Customers. To address the conflicts of interest presented when broker-dealers place any material limitations on the securities or investment strategies involving securities that may be recommended to a retail customer (i.e., only make recommendations of proprietary or other limited range of products), we are requiring brokerdealers to establish, maintain and enforce written policies and procedures reasonably designed to: (1) Identify and disclose any material limitations placed on the securities or investment strategies involving securities that may be recommended and any associated conflicts of interest; and (2) prevent the limitations and associated conflicts of 74 This obligation achieves greater consistency with the treatment of conflicts under the Advisers Act. As discussed in the Fiduciary Interpretation, in seeking to meet its duty of loyalty, an adviser must make full and fair disclosure to its clients of all material facts relating to the advisory relationship. An adviser must eliminate or at least expose through full and fair disclosure all conflicts of interest which might incline an investment adviser—consciously or unconsciously—to render advice which was not disinterested. See Fiduciary Interpretation. 75 See generally Section II.C.3.e, Conflict of Interest Obligation, Mitigation of Certain Incentives to Associated Persons. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 interest from causing the broker-dealer or their associated persons to make recommendations that place the interest of the broker-dealer or associated person ahead of the interest of the retail customer (for example, a broker-dealer could establish product review processes or establish procedures addressing which retail customers would qualify for the product menu).76 • Elimination of Certain Conflicts. We are requiring broker-dealers to establish written policies and procedures reasonably designed to identify and eliminate any sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sale of specific securities or the sale of specific types of securities within a limited period of time.77 By explicitly focusing on policies and procedures to eliminate these incentives, it does not mean that all other incentives are presumptively compliant with Regulation Best Interest. Rather, such other incentives and practices that are not explicitly prohibited are permitted provided that the broker-dealer establishes reasonably designed policies and procedures to disclose and mitigate the incentive created to the representative, and the broker-dealer and its associated persons comply with the Care Obligation and the Disclosure Obligation. General Compliance Obligation. We are establishing a new, general ‘‘Compliance Obligation’’ to require broker-dealers to establish policies and procedures to achieve compliance with Regulation Best Interest in its entirety.78 Books and Records. In addition to adopting Regulation Best Interest, we are also adopting the record-making and recordkeeping requirements largely as proposed, with certain explanations and clarifications regarding the scope of these requirements and the extent to which new obligations have been created.79 Interaction with Other Standards, Waivers and Private Right of Action. Compliance with Regulation Best Interest will not alter a broker-dealer’s obligations under the general antifraud provisions of the federal securities laws. Regulation Best Interest applies in addition to any obligations under the 76 See generally Section II.C.3.f, Conflict of Interest Obligation, Mitigation of Material Limitations on Recommendations to Retail Customers. 77 See generally Section II.C.3.g, Conflict of Interest Obligation, Elimination of Certain Conflicts of Interest. 78 See generally Section II.C.4, Compliance Obligation. 79 See generally Section II.D, Record-Making and Recordkeeping. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 Exchange Act, along with any rules the Commission may adopt thereunder, and any other applicable provisions of the federal securities laws and related rules and regulations.80 Scienter will not be required to establish a violation of Regulation Best Interest. We note that the preemptive effect of Regulation Best Interest on any state law governing the relationship between regulated entities and their customers would be determined in future judicial proceedings based on the specific language and effect of that state law. We believe that Regulation Best Interest, Form CRS, and the related rules, interpretations and guidance that the Commission is concurrently issuing will serve as focal points for promoting clarity, establishing greater consistency in the level of retail customer protections provided, and easing compliance across the regulatory landscape and the spectrum of investment professionals and products. In addition, under Section 29(a) of the Exchange Act, a broker-dealer will not be able to waive compliance with Regulation Best Interest, nor can a retail customer agree to waive her protections under Regulation Best Interest. Furthermore, we do not believe Regulation Best Interest creates any new private right of action or right of rescission, nor do we intend such a result. D. Overview of Key Enhancements With these modifications and clarifications, Regulation Best Interest is designed to improve investor protection by: • Requiring broker-dealers to have a reasonable basis to believe that recommendations are in the retail customer’s best interest, which enhances existing suitability obligations by: Requiring compliance not only with the explicit Care Obligation, but also with Disclosure, Conflict of Interest, and Compliance Obligations; expressly requiring consideration of cost in evaluating a recommendation as part of the Care Obligation; expressing our views regarding the consideration of reasonably available alternatives when making a recommendation as part of the Care Obligation; applying Regulation Best Interest to recommendations of account types and rollovers and to any 80 For example, any transaction or series of transactions, whether or not subject to the provisions of Regulation Best Interest, remain subject to the antifraud and anti-manipulation provisions of the securities laws, including, without limitation, Section 17(a) of the Securities Act of 1933 (‘‘Securities Act’’) [15 U.S.C. 77q(a)] and Sections 9, 10(b), and 15(c) of the Exchange Act [15 U.S.C. 78i, 78j(b), and 78o(c)] and the rules thereunder. PO 00000 Frm 00011 Fmt 4701 Sfmt 4700 33327 recommendations resulting from agreedupon account monitoring services (including implicit hold recommendations); and, applying the Care Obligation to a series of recommended transactions (currently referred to as ‘‘quantitative suitability’’) irrespective of whether a broker-dealer exercises actual or de facto control over a customer’s account; • requiring broker-dealers to establish, maintain, and enforce written policies and procedures reasonably designed to mitigate (and in some cases, eliminate) certain identified conflicts of interest that create incentives to make recommendations that are not in the retail customer’s best interest; these new requirements are a significant and critical enhancement as existing requirements under the federal securities laws largely center upon conflict disclosure rather than conflict mitigation; • requiring disclosure under the Disclosure Obligation of the material facts relating to the scope of terms of a broker-dealer’s relationship with the retail customer and the conflicts of interest associated with a brokerdealer’s recommendations, which will foster retail customers’ understanding of their relationship with the broker-dealer and help them to evaluate the recommendations received; and • requiring broker-dealers to establish, maintain and enforce written policies and procedures reasonably designed to achieve compliance with Regulation as a whole, which will further promote broker-dealer compliance with Regulation Best Interest. Through these new requirements, we believe that Regulation Best Interest will improve investor protection by enhancing the quality of broker-dealer recommendations to retail customers and reducing the potential harm to retail customers that may be caused by conflicted brokerage recommendations. We also believe Regulation Best Interest achieves these enhancements in a manner that is workable for the transaction-based relationship offered by broker-dealers, thus preserving, to the extent possible, retail investor access (in terms of choice and cost) to different types of quality investment services and products. As discussed above, Regulation Best Interest will complement Form CRS and related rules, interpretations, and guidance that the Commission is concurrently issuing. E:\FR\FM\12JYR2.SGM 12JYR2 33328 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations II. Discussion of Regulation Best Interest A. General Obligation As in the Proposing Release, Regulation Best Interest is set forth in two subparagraphs: (1) An overarching provision setting forth a general best interest obligation (‘‘General Obligation’’); and (2) a second provision requiring compliance with specific obligations in order to satisfy the overarching standard (discussed below in Section II.C).81 Specifically, as in the Proposing Release, the General Obligation requires that a broker-dealer ‘‘shall act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of [the broker-dealer] . . . ahead of the interest of the retail customer.’’ 82 Most commenters, including a majority of the IAC, expressed opinions on this approach, and in particular on the General Obligation, including whether the obligation should be a ‘‘fiduciary’’ standard, whether it should be a uniform standard for broker-dealers and investment advisers,83 and whether the standard should be more principlesbased or more prescriptive (in particular, whether to define ‘‘best interest’’).84 The views of commenters on the approach to an enhanced standard of conduct for broker-dealers varied widely. A number of commenters 81 See Proposing Release at 21585 et seq. Paragraph (a)(1) of Regulation Best Interest. 83 See IAC 2018 Recommendation; Letter from Rob Foregger, Co-Founder, NextCapital (Aug. 7, 2018) (‘‘NextCapital Letter’’) (recommending that the Commission adopt a uniform fiduciary standard of conduct applicable to both broker-dealers and investment advisers); Letter from Sharon Cheever, Senior Vice President and General Counsel, Pacific Life Insurance Company (May 28, 2019) (‘‘Pacific Life May 2019 Letter’’) (recommending that the Commission adopt a single ‘best interest’ standard of care for all financial professionals). See also Letter from R. Scott Henderson, Bank of America (Aug. 7, 2018) (‘‘Bank of America Letter’’); Letter from Christopher Jones, Chief Investment Officer, Financial Engines (Aug. 6, 2018) (‘‘Financial Engines Letter’’); State Attorneys General Letter; Letter from Jill I. Gross, Associate Dean, Academic Affairs, Elisabeth Haub School of Law, Pace University (Mar. 11, 2019) (‘‘Gross Letter’’). Relatedly, one commenter expressed concern that a court or arbitration panel would determine that Regulation Best Interest would control, rather than existing case law, which would apply a fiduciary duty in certain circumstances. See Gross Letter. See also AFL–CIO April 2019 Letter. 84 See, e.g., Ameriprise Letter; Cambridge Letter; CCMC Letters; Edward Jones Letter; NAIFA Letter; Morningstar Letter; NY Life Letter; Letter from Kevin T. Reynolds, Senior Vice President, Penn Mutual Life Insurance Company (Aug. 1, 2018) (‘‘Penn Mutual Letter’’); SIFMA August 2018 Letter; Vanguard Letter; Letter from Kent. A Mason, Davis & Harman LLP (Jul. 20, 2018) (‘‘Davis Harman Letter’’). supported a broker-dealer specific standard of conduct.85 Several of these commenters supported the Commission’s approach as proposed, with certain modifications to the specific component obligations discussed below.86 Some commenters urged the Commission to change the standard from what the commenters called ‘‘suitability-plus’’ to what the commenters called a ‘‘true best interest standard,’’ including the avoidance of certain conflicts,87 and urged the Commission to change the name of Regulation Best Interest unless it required firms to always be responsible for acting in the retail customer’s best interest (as opposed to at the time of the recommendation).88 Other commenters advocated for the adoption of a brokerdealer standard modeled after FINRA suitability rules,89 and some suggested that the Commission create a safe harbor from liability for compliance with Regulation Best Interest.90 By contrast, other commenters recommended that the Commission adopt a uniform standard of conduct for investment advisers and broker-dealers, in varying forms.91 Commenters expressed differing views on the form of such a uniform standard of conduct, including that the Commission should adopt: a fiduciary standard for brokerdealers similar to, or no less stringent than, the fiduciary duty under the Advisers Act; 92 a uniform fiduciary standard as articulated in Section 913(g) of the Dodd-Frank Act 93 and/or consistent with the recommendations of jbell on DSK3GLQ082PROD with RULES2 82 See VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 85 See, e.g., SIFMA August 2018 Letter; Cetera August 2018 Letter; Vanguard Letter; Edward Jones Letter; Ameriprise Letter; NY Life Letter; NAIFA Letter; CCMC Letters; Penn Mutual Letter; Cambridge Letter; PIABA Letter; Letter from Ronald J. Kruszewski, Chairman and Chief Executive Officer, Stifel Financial (Aug. 7, 2018) (‘‘Stifel Letter’’); Financial Engines Letter. 86 See, e.g., SIFMA August 2018 Letter; Vanguard Letter; Edward Jones Letter; Ameriprise Letter; NY Life Letter; NAIFA Letter; CCMC Letters; Penn Mutual Letter; Cambridge Letter; PIABA Letter. 87 See, e.g., CFA Institute Letter. 88 See, e.g., Letter from Jean-Luc Bourdon, CPA/ PFS, Chair, Personal Financial Planning Legislative and Regulatory Task Force, and Charles R. Kowal, Chair, Personal Financial Planning Executive Committee, AICPA (Aug. 7, 2018) (‘‘AICPA Letter’’); Betterment August 2018 Letter; NASAA August 2018 Letter. 89 See, e.g., National Society of Compliance Professionals Letter; Cetera August 2018 Letter. 90 See Cambridge Letter; BISA Letter; IPA Letter. 91 See, e.g., Betterment Letter; AARP August 2018 Letter; AFR Letter; Galvin Letter; State Attorneys General Letter. 92 See, e.g., Betterment Letter; Warren Letter; Fein Letter; Letter from Joseph M. Torsella, Pennsylvania State Treasurer, et al. (Aug. 7, 2018) (‘‘State Treasurers Letter’’); AARP August 2018 Letter. 93 See, e.g., FPC Letter; Letter from Maxine Waters, Ranking Member, Committee on Financial Services, U.S. House of Representatives, et al. (Sep. 12, 2018) (‘‘Waters Letter’’); Fein Letter. PO 00000 Frm 00012 Fmt 4701 Sfmt 4700 the staff’s Section 913 Study; 94 or a uniform standard similar to the DOL standard as reflected in the BIC Exemption; 95 harmonized requirements and guidance for broker-dealers and investment advisers offering services to retail customers; 96 or a new uniform best interest standard, with common core elements.97 In this vein, a number of commenters suggested specific revisions to the text of the General Obligation to clarify what the standard requires with respect to broker-dealer conflicts of interest, including that the Commission change the proposed ‘‘without placing the financial or other interest [of the brokerdealer] ahead’’ language to a standard that requires a recommendation be made ‘‘without regard to’’ a brokerdealer’s interest 98 and/or requires the broker-dealer to ‘‘place the customer’s interest first’’ or ahead of its own.99 These commenters stated that changing the proposed language to a ‘‘without regard to’’ and/or ‘‘place the customer’s interest first’’ phrasing would result in a stronger standard, whereas the proposed phrasing would allow a broker-dealer to act in its own interests as long as the broker-dealer does not put its interests ahead of its customers’ interest.100 These commenters stated that broker-dealers must put aside their own interest when determining what is best for the retail customer, that brokerdealers must ensure that conflicts do not taint recommendations.101 Some commenters challenged the Commission’s concern that the ‘‘without regard to’’ language ‘‘could be inappropriately construed to require a broker-dealer to eliminate all of its conflicts,’’ arguing that their position is supported by the plain meaning of the language and the context of 913(g) (which explicitly recognizes conflicts in certain areas), and the interpretations by others (such as the DOL) who have used it.102 Highlighting what commenters viewed as inconsistencies in the Proposing Release’s interpretation of the proposed ‘‘without placing . . . ahead’’ phrasing, such as statements that the obligation would require broker-dealers to ‘‘put aside their interests’’ when 94 See, e.g., ACLI Letter; Schwab Letter. e.g., Galvin Letter. See supra footnote 32. 96 See, e.g., AARP August 2018 Letter. 97 See, e.g., Pacific Life August 2018 Letter. 98 See, e.g., CFA August 2018 Letter; FPC Letter; PACE Letter; Better Markets August 2018 Letter. 99 See, e.g., Invesco Letter; Schwab Letter; Better Markets August 2018 Letter; CFA Institute Letter. 100 See, e.g., CFA August 2018 Letter; FPC Letter; Pace Letter. 101 See, e.g., CFA August 2018 Letter. 102 See, e.g., CFA August 2018 Letter; Waters Letter. 95 See, E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 making a recommendation versus others suggesting that a broker-dealer’s interests cannot ‘‘predominantly motivate’’ or be the ‘‘sole basis’’ for the recommendation, some commenters suggested we either adopt the ‘‘without regard to’’ phrasing or state that the proposed phrasing requires a brokerdealer to put aside its interests.103 Some commenters further stated that the ‘‘without regard to’’ phrasing, which is used in Section 913(g) of the DoddFrank Act, is the stronger standard of conduct that Congress intended, and challenged the Commission’s reliance on the authority provided in Section 913(f).104 In this vein, some commenters suggested that the Commission should adopt a uniform standard of conduct for broker-dealers and investment advisers that was authorized under Section 913(g), and recommended by the staff in the Section 913 Study.105 Other commenters, however, supported the proposal’s ‘‘without placing . . . ahead’’ formulation.106 These commenters expressed concern that a ‘‘without regard to’’ standard would require ‘‘conflict free’’ recommendations, which would limit compensation structures and the offering of certain products.107 Instead, commenters stated that the appropriate role of a best interest standard is to require disclosure and management of conflicts of interest.108 Others generally supported, or did not object to, the Commission’s decision not to proceed under its 913(g) authority in its current proposal.109 103 See, e.g., CFA August 2018 Letter. See also Waters Letter (stating that the proposal fails to adequately explain just what it would require of brokers that is different from the status quo, that the standard should clearly differ from the current ‘‘suitability’’ standard, and that any final rule must clearly explain the standard, what it requires and prohibits, and how it differs from the status quo). 104 See, e.g., CFA August 2018 Letter; State Attorneys General Letter; Waters Letter; FPC Letter; Better Markets August 2018 Letter. 105 See, e.g., Waters Letter; FPC Letter. 106 See, e.g., AALU Letter; Cetera August 2018 Letter; NAIFA Letter; Pickard Letter. 107 See, e.g., AALU Letter; Cetera August 2018 Letter; NAIFA Letter; Pickard Letter. 108 See, e.g., AALU Letter; Cetera August 2018 Letter. 109 See, e.g., Invesco Letter; IAC 2018 Recommendation (stating ‘‘we recognize that the Commission has chosen not to proceed under its 913(g) authority in its current proposal, and it is not our intent to derail that proposal by advocating that the Commission change the legal basis for its rulemaking. Moreover, we believe the clarifications we have outlined above to the meaning of best interest, if implemented, have the potential to deliver immediate benefits to customers of brokerdealers and investment advisers alike. Should the Commission determine, however, that it cannot enforce the clarified best interest standard under the Advisers Act, a majority of the Committee believes the Commission should reconsider rulemaking under its 913(g) authority to close that VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 A common theme across many comments was the need for additional guidance on what ‘‘best interest’’ means, with some commenters recommending that the Commission codify its interpretation of ‘‘best interest’’ or provide a more specific definition of what it means to act in the ‘‘best interest.’’ 110 Several commenters suggested that the ‘‘best interest’’ standard should require the ‘‘best’’ or most beneficial product available,111 while others (including a majority of the IAC) requested that the Commission clarify that there is no single ‘‘best’’ recommendation and that the obligation is to adhere to a professional standard of conduct when making a recommendation.112 Some commenters suggested defining ‘‘best interest’’ as including a duty of loyalty and care.113 Several also suggested that the Commission incorporate best execution and fair pricing and compensation as factors for determining compliance with the standard.114 Several commenters recommended that the Commission adopt a definition of best interest that is consistent with the best interest obligation described by the DOL in the BIC Exemption’s Impartial Conduct Standards,115 and supported a standard which would require a broker-dealer to act ‘‘solely’’ in the interest of the retail customer when making a recommendation.116 Conversely, other commenters recommended that the ‘‘best interest’’ standard could be satisfied even if the recommendations are in part influenced by ‘‘self-promotion.’’ 117 Finally, in lieu of a prescribed definition of ‘‘best interest,’’ a number of commenters advocated for a factsregulatory gap.’’). As noted above, Regulation Best Interest draws from key principles underlying fiduciary obligations, including those that apply to investment advisers under Advisers Act. Accordingly, as discussed below, the Commission has chosen to enhance existing obligations for broker-dealers when they make recommendations to a retail customer, while, in a separate interpretation, reaffirming and in some cases clarifying an investment adviser’s fiduciary duty. See Fiduciary Interpretation. 110 See, e.g., NASAA August 2018 Letter. 111 See, e.g., Financial Engines Letter; CFA August 2018 Letter. 112 See, e.g., Wells Fargo Letter; see also IAC 2018 Recommendation (‘‘[T]he Commission should recognize there will often not be a single best option and that more than one of the available options may satisfy this standard.’’). 113 See, e.g., TIAA Letter; Morningstar Letter. 114 See, e.g., CFA Institute Letter; Letter from Mark Heckert, Vice President, Pricing and Analytics, ICE Data Services, (Aug. 7, 2018) (‘‘ICE Letter’’); FPC Letter. 115 See, e.g., AARP August 2018 Letter; Wells Fargo Letter; Schwab Letter; NASAA August 2018 Letter. 116 See, e.g., Galvin Letter. 117 See, e.g., LPL August 2018 Letter. PO 00000 Frm 00013 Fmt 4701 Sfmt 4700 33329 and-circumstances or ‘‘totality of the circumstances approach’’ for determining compliance with the ‘‘best interest’’ standard.118 A majority of the IAC recommended that the meaning of the best interest obligation should be clarified to require ‘‘broker-dealers, investment advisers, and their associated persons to recommend the investments, investment strategies, accounts or services, from among those they have reasonably available to recommend, that they reasonably believe represent the best available options for the investor.’’ 119 After careful consideration of these comments, we continue to believe that our proposed approach for enhancing the standards of conduct that apply to broker-dealers’ recommendations to retail customers is the appropriate approach, and therefore we are adopting as proposed the structure and scope of Regulation Best Interest, including the phrasing of the General Obligation, and are not expressly defining ‘‘best interest’’ in the rule text.120 However, in consideration of these comments, we are providing our views on what the standard generally requires, what it is intended to achieve, and its alignment in many respects with fiduciary principles. 1. Commission’s Approach After extensive consideration, and for the reasons discussed in the Proposing Release and further below, we are adopting a rule to enhance the existing broker-dealer conduct obligations when they make recommendations to a retail customer.121 At the same time, we seek to preserve retail investor access (in terms of choice and cost) to differing types of investment services and products. The Commission is adopting Regulation Best Interest pursuant to the 118 See, e.g., AAJ Letter; CFA August 2018 Letter. 2018 Recommendation. 120 Another commenter stated that any modification to the proposed rules and guidance that would make them ‘‘more restrictive’’ should be reproposed for additional public comment. See ACLI Letter. Because we have provided notice and the changes we are making are based on comments we received, reproposal is not necessary. 121 See Proposing Release at 21575. In particular, we considered the recommendations made by our staff in 2011 and the recommendations of the IAC. See Staff of the U.S. Securities and Exchange Commission, Study on Investment Advisers and Broker-Dealers As Required by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Jan. 2011) (‘‘913 Study’’), at 9–10, available at www.sec.gov/news/studies/2011/ 913studyfinal.pdf; Recommendation of the Investor Advisory Committee: Broker-Dealer Fiduciary Duty (Nov. 2013) (‘‘IAC 2013 Recommendation’’), available at https://www.sec.gov/spotlight/investoradvisory-committee-2012/fiduciary-dutyrecommendation-2013.pdf; IAC 2018 Recommendation. 119 IAC E:\FR\FM\12JYR2.SGM 12JYR2 33330 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 express and broad grant of rulemaking authority in Section 913(f) of the DoddFrank Act.122 As some commenters noted, Section 913(g) expressly authorizes the Commission to adopt rules that would hold broker-dealers to the same standard of conduct as investment advisers. However, the availability of overlapping, yet distinct, rulemaking power under Section 913(g) does not negate the grant of authority under Section 913(f). The plain text of Section 913(f) authorizes the Commission to promulgate this rule addressing the legal and regulatory standards of care for broker-dealers, and their associated persons. The Commission is utilizing its authority under 913(f) in order to adopt an enhanced investor-protection standard for broker-dealers that maintains the availability of both the broker-dealer model and the investment adviser model. The Commission has chosen not to apply the existing fiduciary standard under the Advisers Act to broker-dealers in part because of concerns that such a shift would result in fewer broker-dealers offering transaction-based services to retail customers, which would in turn reduce choice and may raise costs for certain retail customers. Moreover, the Commission has chosen not to create a new uniform standard applicable to both brokerdealers and investment advisers which, among other things, would discard decades of regulatory and judicial precedent and experience with the fiduciary duty for investment advisers that has generally worked well for retail clients and our markets. We believe that adopting a ‘‘one size fits all’’ approach would not appropriately reflect the fact that broker-dealers and investment advisers play distinct roles in providing recommendations or advice and services to investors, and may ultimately harm retail investors. Instead, the Commission has chosen to enhance existing obligations for broker-dealers when they make recommendations to a retail customer, while, in a separate interpretation, reaffirming and in some 122 Section 913(f) of the Dodd-Frank Act provides the Commission discretionary authority to ‘‘commence a rulemaking, as necessary or appropriate to the public interest and for the protection of retail customers (and such other customers as the Commission may by rule provide), to address the legal or regulatory standards of care for brokers, dealers . . . [and] persons associated with brokers or dealers . . . for providing personalized investment advice about securities to such retail customers.’’ In addition to Section 913(f), the Commission is promulgating Regulation Best Interest pursuant to other provisions of the Exchange Act, including Section 15(c)(6) and Section 17. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 cases clarifying an investment adviser’s fiduciary duty.123 Regulation Best Interest considers and incorporates (to the extent appropriate) obligations that apply to investment advice in other contexts, with the goal of fostering greater consistency and clarity in the level of protection provided to retail customers at the time that a recommendation is made. We are tailoring these principles to the structure and characteristics of the broker-dealer relationship with retail customers and building upon existing 123 Although we are not adopting a uniform fiduciary standard of conduct, we note that our rules are designed to achieve many of the key goals advocated for by supporters of a uniform standard of conduct. For example, in advocating for a uniform standard of conduct former Commission Chair Elisse B. Walter (then a Commissioner) stated that (1) ‘‘[t]o appreciate fully what a fiduciary standard means, and what it really means to act in the best interest of an investor, it is absolutely necessary to drill down and determine what duties and obligations flow from a fiduciary standard,’’ (2) ‘‘a fiduciary standard is not a substitute for business practice rules . . . [r]ather, the two are complementary . . . and can be used by the Commission] to prohibit certain conflicted behavior or to require mitigation or management of the conflict,’’ (3) ‘‘what a fiduciary duty requires depends on the scope of the engagement,’’ and (4) ‘‘[m]ost important, whatever gloss and guidance the Commission provides, it should not deviate from the basic principle that financial professionals should always act in the best interests of investors, both large and small.’’ Commissioner Elisse B. Walter, Regulating Broker-Dealers and Investment Advisers: Demarcation or Harmonization? (May 5, 2009), available at https://www.sec.gov/news/ speech/2009/spch050509ebw.htm. In our Fiduciary Interpretation and in this release, we are providing our views on the duties and obligations that flow from the fiduciary duty and Regulation Best Interest. In this release, we discuss the specific obligations of broker-dealers under the Disclosure, Care and Conflicts of Interest Obligations, which include requirements to establish policies and procedures that comply with the Conflict of Interest Obligation, specifically to disclose and mitigate (i.e., reasonably reduce), or eliminate, certain conflicts. As discussed below, these specific obligations are tailored to address particular concerns that arise as a result of the broker-dealer model. For that reason, as well as the other reasons set forth above, the Commission does not believe that it is necessary to adopt a uniform standard in order to ensure that these specific obligations also apply to investment advisers, as the IAC suggests. See IAC 2018 Recommendation. In our Fiduciary Interpretation, we state that ‘‘the application of the investment adviser’s fiduciary duty will vary with the scope of the relationship,’’ and here we have noted that we are not expressly defining in the rule text the term ‘‘best interest,’’ and instead are providing in the rule and through interpretations what ‘‘best interest’’ means. Compliance with each of the specific component obligations will turn on an objective assessment of the facts and circumstances of how the specific components of Regulation Best Interest are satisfied at the time that the recommendation is made. Finally, regardless of whether a retail investor chooses a broker-dealer or an investment adviser (or both), the retail investor will be entitled to a recommendation (from a broker-dealer) or advice (from an investment adviser) that is in the best interest of the retail investor and that does not place the interests of the firm or the financial professional ahead of the interests of the retail investor. PO 00000 Frm 00014 Fmt 4701 Sfmt 4700 regulatory obligations. As a result, Regulation Best Interest protects investors who seek access to the services, products, and payment options offered by broker-dealers. Although we are not applying the existing fiduciary standard under the Advisers Act to broker-dealers, key elements of the standard of conduct that applies to broker-dealers under Regulation Best Interest will be substantially similar to key elements of the standard of conduct that applies to investment advisers pursuant to their fiduciary duty under the Advisers Act 124 at the time that a recommendation is made. Regulation Best Interest’s regulatory structure is unique to broker-dealers—and is tailored to the broker-dealer business model—but regardless of whether a retail investor chooses a broker-dealer or an investment adviser (or both), the retail investor will be entitled to a recommendation (from a broker-dealer) or advice (from an investment adviser) that is in the best interest of the retail investor and that does not place the interests of the firm or the financial professional ahead of the interests of the retail investor. As discussed in the proposal, and in the discussion below, Regulation Best Interest, as adopted, incorporates Care and Conflict of Interest Obligations substantially similar to the fiduciary duties of care and loyalty under Section 206(1) and (2) of the Advisers Act, even if not in the same manner as the 913 Study recommendations or identical to the duties under the Advisers Act.125 We extensively considered the 913 Study as part of developing Regulation Best Interest, as discussed in the Proposing Release, and believe that the enhancements to the broker-dealer standard of conduct incorporate, and in many aspects (such as the concept of mitigation, and the detailed Care Obligation), build upon and go beyond the recommendations in the 913 Study. Although key elements are substantially similar, the Commission notes that the obligations of a brokerdealer under Regulation Best Interest and the obligations of an investment adviser pursuant to its fiduciary duty under the Advisers Act differ in certain respects, taking into account the scope of the services and relationships typically offered by broker-dealers and 124 Specifically, an investment adviser’s fiduciary duty under the Advisers Act comprises a duty of care and a duty of loyalty. This combination of care and loyalty obligations has been characterized as requiring the investment adviser to act in the ‘‘best interest’’ of its client at all times. See Fiduciary Interpretation. 125 See Proposing Release at 21590. E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations investment advisers. For example, an investment adviser’s duty of care encompasses the duty to provide advice and monitoring at a frequency that is in the best interest of the client, taking into account the scope of the agreed relationship. This difference reflects the generally ongoing nature of the advisory relationship, and the Commission’s view that, within the scope of the agreed adviser-client relationship, investment advisers’ fiduciary duty generally applies to the entire relationship. In contrast, the provision of recommendations in a broker-dealer relationship is generally transactional and episodic, and therefore the final rule requires that broker-dealers act in the best interest of their retail customers at the time a recommendation is made and imposes no duty to monitor a customer’s account following a recommendation. As noted above, Regulation Best Interest also generally imposes more specific obligations on broker-dealers under the Disclosure, Care and Conflict of Interest Obligations (each of which is discussed in detail below) than the principles-based requirements of investment advisers’ fiduciary duty under the Advisers Act. This approach is intended to tailor the application of principles that have developed in the context of a different business model over the course of almost 80 years. Moreover, this more specific and tailored approach drawing on key fiduciary principles (1) is consistent with the generally rules-based regulatory regime that applies to brokerdealers, (2) acknowledges that certain relevant obligations may already be addressed by existing broker-dealer requirements (e.g., broker-dealers are already subject to a duty of best execution), (3) allows us to impose requirements that we are believe are more appropriately tailored to address the specific conflicts raised by the transaction-based nature of the brokerdealer model, and (4) recognizes that it would be inappropriate to apply to certain generally applicable obligations of investment advisers (e.g., duty to monitor) in the context of a transactionbased relationship. These specific obligations include express requirements relating to the Care Obligation, requiring that a brokerdealer exercise reasonable diligence, care, and skill to: (1) Understand the risks, rewards and costs of a recommendation; (2) have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer, based on the retail customer’s investment profile, and that the recommendation does not VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 place the broker-dealer’s interest ahead of the retail customer’s interest; and (3) have a reasonable basis to believe that a series of transactions is in the best interest of the retail customer and does not place the interest of the brokerdealer ahead of the retail customer’s interests. Regulation Best Interest imposes a duty of care that enhances existing suitability obligations (as discussed further below). It also includes a requirement under the Care Obligation to specifically address the risk that a broker-dealer’s transactionbased recommendations and compensation could result in a series of recommendations that are not in the best interest or a retail customer—a ‘‘churning’’ risk unique to the brokerdealer model of providing recommendations and resulting transaction-based compensation. Regulation Best Interest also includes a requirement under the Conflict of Interest Obligation for broker-dealers to establish, maintain, and enforce written policies and procedures reasonably designed to (1) mitigate conflicts of interest at the associated person level, (2) specifically address the conflicts of interest presented when broker-dealers place material limitations on the securities or products that may be recommended (i.e., only make recommendations of proprietary or other limited range of products), and (3) eliminate sales contests, bonuses, and non-cash compensation that are based on the sales of specific securities or specific types of securities within a limited period of time. The conflicts of interest associated with incentives at the associated person level and limitations on the securities or products that may be recommended to retail customers have raised particular concerns in the context of the broker-dealer, transactionbased relationship. Accordingly, the Commission believes specific disclosure and additional mitigation requirements are appropriate to address those conflicts. Sales contests, sales quotas, bonuses and non-cash compensation that are based on the sales of specific securities within a limited period of time create high-pressure situations for associated persons to increase the sales of specific securities or specific types of securities within a limited period of time and thus compromise the best interests of their retail customers. The Commission does not believe such conflicts of interest can be reasonably mitigated and, accordingly, they must be eliminated. Phrasing of Standard We are adopting the phrasing ‘‘act in the best interest of the retail customer at PO 00000 Frm 00015 Fmt 4701 Sfmt 4700 33331 the time the recommendation is made, without placing the financial or other interest of the [broker-dealer] ahead of the interest of the retail customer’’ as it was proposed.126 In response to comments, we are clarifying our views on what this standard entails and how it compares to the ‘‘without regard to’’ language of Section 913. By replacing the ‘‘without regard to’’ language of Section 913(g) and the 913 Study with the ‘‘without placing the financial or other interest of the [brokerdealer] . . . ahead of the interest of the retail customer’’ phrasing, we did not intend to create a ‘‘lower’’ or ‘‘weaker’’ standard compared to the language of Section 913(g) and the 913 Study. Rather, we are adopting a standard that reflects that a broker-dealer should not put its interests ahead of the retail customer’s interest, and thereby aligns with (and in certain areas imposes more specific obligations than) the investment adviser fiduciary duty, at the time a broker-dealer makes a recommendation to a retail customer. As discussed in the Proposing Release, we do not intend for our standard to require a broker-dealer to provide conflict-free recommendations. For example, under Regulation Best Interest, a broker-dealer could recommend a more expensive or more remunerative security or investment strategy if the broker-dealer has a reasonable basis to believe there are other factors about the security or investment strategy that make it in the best interest of the retail customer, based on that retail customer’s investment profile.127 We also agree with commenters that we do not believe that is the intent behind the ‘‘without regard to’’ phrase, as included in Section 913 of the DoddFrank Act or recommended in the 913 Study, as is evident both from other provisions of Section 913 that acknowledge and permit the existence of financial interests under that standard, and how our staff articulated the recommended uniform fiduciary standard in the 913 Study.128 126 See paragraph (a)(1) of Regulation Best Interest. As discussed in Section II.C.2, we are also adding the phrasing ‘‘does not place the financial or other interest of the broker, dealer, or such natural person . . . ahead of the retail customer’’ to certain provisions of the Care Obligation. 127 See Section II.C.2, Care Obligation. 128 See Proposing Release at 21590. As noted in the proposal, among other things, Dodd-Frank Act Section 913(g) expressly provides that the receipt of commission-based compensation, or other standard compensation, for the sale of securities shall not, in and of itself, violate any uniform fiduciary standard promulgated under that subsection’s authority as applied to a broker-dealer. Moreover, Section 913(g) does not itself require the imposition of the E:\FR\FM\12JYR2.SGM Continued 12JYR2 33332 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 Nevertheless, we are concerned that there is a risk that the ‘‘without regard to’’ language would be inappropriately construed to require a broker-dealer to eliminate all of its conflicts when making a recommendation (i.e., require recommendations that are conflict free), which we believe could ultimately harm retail investors by reducing their access to differing types of investment services and products and by increasing their costs. The potential for a range of different meanings to be given to the phrase ‘‘without regard to’’ was heightened by the DOL’s use of this same language for purposes of the Impartial Conduct Standards set forth in the BIC Exemption. We recognize, as noted by some commenters, that the DOL interpretation of this phrase does not require ‘‘conflict-free’’ recommendations. Nevertheless, because of the differences in the approach to the treatment of conflicts under ERISA and under the federal securities laws—ERISA starts by prohibiting conflicts and then through exemptions permits certain conflicts, whereas the federal securities laws generally start with disclosure and become more restrictive—we share commenters’ concerns that DOL’s use of the ‘‘without regard to’’ language could alter the way in which conflicts are viewed and cause a substantial portion of conduct that is currently permitted, and reasonably accepted and desired by retail customers, to be limited or eliminated. Based on market participant experience with the implementation of—and reaction to the subsequent overturning of—the DOL Fiduciary Rule, in particular the BIC Exemption,129 we continue to believe that it is better to use language that provides similar investor protections, but does not raise these legal ambiguities. The ‘‘without placing the financial or other interest . . . ahead of the interest of the retail customer’’ phrasing recognizes that while a broker-dealer will inevitably have some financial interest in a recommendation—the nature and magnitude of which will vary—the broker-dealer’s interests cannot be placed ahead of the retail principal trade provisions of Advisers Act Section 206(3) on broker-dealers. In addition, Dodd-Frank Act Section 913 provides that offering only proprietary products by a broker-dealer shall not, in and of itself, violate such a uniform fiduciary standard, but may be subject to disclosure and consent requirements. See Exchange Act Section 15(k)(1) and Advisers Act Section 211(g)(1). See also 913 Study at 113; Proposing Release at 21590. 129 See supra footnotes 33 and 34 (citing reduction in services and increase in costs following DOL). VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 customer’s interest.130 Accordingly, we believe this phrasing establishes a standard that enhances investor protection by prohibiting a brokerdealer from placing its interests ahead of the retail customer’s interests, and preserves investor access (in terms of both choice and cost) to differing types of investment services and products. The phrasing also aligns with an investment adviser’s fiduciary obligation. As discussed in the Fiduciary Interpretation, an investment adviser’s fiduciary duty under the Advisers Act comprises a duty of care and a duty of loyalty.131 The fiduciary duty requires that an adviser ‘‘adopt the principal’s goals, objectives, or ends.’’ 132 This means the adviser must, at all times, serve the best interest of its clients and not subordinate its client’s interest to its own. In other words, the investment adviser cannot place its own interests ahead of the interests of its client.133 This combination of care and loyalty obligations has been characterized as requiring the investment adviser to act in the ‘‘best interest’’ of its client at all times.134 Language that would require a brokerdealer to put the retail customer’s interest ‘‘first’’ arguably raises many of the same concerns as the ‘‘without regard to’’ language. Accordingly, we are adopting a formulation in Regulation Best Interest that is consistent with how we describe the duty of loyalty for investment advisers in the Fiduciary Interpretation—that is, a requirement 130 In this vein, we believe that a broker-dealer’s ‘‘financial interest’’ is broad, and that a brokerdealer is unlikely to have an ‘‘other interest’’ that is not a ‘‘financial interest.’’ See, e.g., Proposing Release at 21618 (noting ‘‘. . . our interpretation of the types of material conflicts of interest arising from financial incentives is broad. . .’’). 131 See, e.g., Proxy Voting by Investment Advisers, Advisers Act Release No. 2106 (Jan. 31, 2003) (‘‘Investment Advisers Release No. 2106’’). See also Fiduciary Interpretation. 132 Arthur B. Laby, The Fiduciary Obligations as the Adoption of Ends, 56 Buffalo Law Review 99 (2008); see also Restatement (Third) of Agency, § 2.02 Scope of Actual Authority (2006) (describing a fiduciary’s authority in terms of the fiduciary’s reasonable understanding of the principal’s manifestations and objectives). See Fiduciary Interpretation. 133 See Fiduciary Interpretation. 134 Id. See also Amendments to Form ADV, Advisers Act Release No. 3060 (Jul. 28, 2010) (adopting amendments to Form ADV and stating that ‘‘under the Advisers Act, an adviser is a fiduciary whose duty is to serve the best interests of its clients, which includes an obligation not to subrogate clients’ interests to its own,’’ citing Investment Advisers Act Release 2106). See SEC v. Tambone, 550 F.3d 106, 146 (1st Cir. 2008) (‘‘Section 206 imposes a fiduciary duty on investment advisers to act at all times in the best interest of the fund. . .’’); SEC v. Moran, 944 F. Supp. 286, 297 (S.D.N.Y 1996) (‘‘Investment advisers are entrusted with the responsibility and duty to act in the best interest of their clients.’’). PO 00000 Frm 00016 Fmt 4701 Sfmt 4700 not to place the adviser’s interests ahead of the interests of its client.135 While we are not revising this phrasing of the standard, we appreciate concerns raised by commenters about clarifying whether this standard permits broker-dealers to allow their conflicts to taint their recommendations or to allow broker-dealers to make recommendations that are motivated by their own interests or to put their interests first. We discuss below what it means to ‘‘act in the best interests,’’ particularly in the context of satisfying the Care and Conflict of Interest Obligations. Specifically, we clarify that the obligations set forth in Regulation Best Interest are intended to require broker-dealers to take steps to reduce the effect of (and in some cases eliminate) conflicts that create an incentive to place a broker-dealer’s or an associated person’s interest ahead of the retail customer’s interest when making a recommendation, and to make recommendations in the best interest of the retail customer even where conflicts continue to exist. We believe that this approach will result in a standard of conduct that is consistent with what a reasonable retail customer would expect.136 135 See Fiduciary Interpretation at footnote 54 (stating that, in practice, referring to putting a client’s interest first is a plain English formulation commonly used by investment advisers to explain their duty of loyalty in a way that may be more understandable to retail clients). 136 See, e.g., Brian Scholl, et al., SEC Office of the Investor Advocate and RAND Corporation, The Retail Market for Investment Advice (2018), available at https://www.sec.gov/comments/s7-0718/s70718-4513005-176009.pdf (‘‘OIAD/RAND’’). OIAD/RAND summarized the results of focus groups, indicating that in the context of discussing expectations for standards of conduct, ‘‘the groups typically expected that a financial professional who is acting in a client’s best interest’’ to, among other things, ‘‘disclose payments they receive that might influence their advice [and] avoid taking higher compensation for selling one product over a similar but less costly product.’’ Further, OIAD/RAND summarized focus group comments on professionals’ form of compensation, noting that ‘‘although many participants prefer that a professional be compensated by the client alone, some might not rule out using a professional who is receiving other compensation, for example if the compensation is openly disclosed and they are comfortable with the professional.’’ The SEC’s Office of Investor Advocate and the RAND Corporation prepared this research report regarding the retail market of investment advice prior to, and separate from, our rulemaking proposals. This report was included in the comment file at https:// www.sec.gov/comments/s7-07-18/s70718-4513005176009.pdf. See also, e.g., Washington, DC Roundtable at 49 (‘‘So it seems to me that there is a tight connection between the obligation that you have, and our obligations down below here to the conflicts of interest, that it’s really important that advisers or brokers spell out what conflicts of interest they have, and what that means in real terms to the person before they make a choice, for example’’). E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 Finally, although our standard draws from key fiduciary principles, for various reasons, including to emphasize that Regulation Best Interest is tailored to the broker-dealer relationship and distinct from the investment adviser fiduciary duty, we are not referring to Regulation Best Interest as a ‘‘fiduciary’’ standard, and we emphasize that Regulation Best Interest is separate from any common law analysis of whether a broker-dealer has fiduciary duties.137 As noted in the proposal, fiduciary standards vary, for example, for investment advisers, banks acting as trustees or fiduciaries, and fiduciaries to ERISA plans. As we have learned through our consideration of the Relationship Summary Proposal, and from various investor studies, using the term ‘‘fiduciary’’ to describe the standard may not sufficiently convey meaning regarding the specific substance of the standard.138 In addition, we appreciate commenters’ concerns that using the term in the context of a different relationship may introduce further legal or compliance ambiguity.139 As articulated in the Proposing Release, we appreciate the desire for clarity about the requirements imposed by Regulation Best Interest, and we have sought to provide such clarity by specifying by rule the specific components with which a broker-dealer is required to comply to satisfy its best interest obligation. The changes we are 137 In addition to the antifraud provisions of the federal securities laws, courts interpreting state common law have imposed fiduciary obligations on broker-dealers in certain circumstances. See Proposing Release at 21584. Generally, courts have found that broker-dealers that exercise discretion or control over customer assets, or have a relationship of trust and confidence with their customers, owe customers a fiduciary duty. Id. In developing proposed Regulation Best Interest, the Commission has drawn from principles that apply to investment advice under other regulatory regimes, including state common law fiduciary principles, among others. By doing so, we hope to establish greater consistency in the level of retail customer protections and to make it easier to comply with Regulation Best Interest where other legal regimes, such as state common law drawing upon comparable fiduciary principles, might also apply. 138 See, e.g., RAND 2018 (‘‘Some participants had never heard of the word, whereas others had heard it but did not know what it meant in this context. Others thought the word ‘‘fiduciary implies acting in best interest . . .’’). We have modified the standard of conduct disclosure required by Form CRS to eliminate technical words, such as ‘‘fiduciary,’’ and describe the standards of conduct of broker-dealers, investment advisers, or dualregistrants using similar terminology in a plainEnglish manner. In particular, Form CRS uses the term ‘‘best interest’’ to describe how broker-dealers, investment advisers, and dual-registrants must act regarding their retail customers or clients when providing recommendations as a broker-dealer or acting as an investment adviser. See Relationship Summary Adopting Release. 139 See, e.g., Stifel Letter. VerDate Sep<11>2014 20:12 Jul 11, 2019 Jkt 247001 making from the Proposing Release to this final Regulation Best Interest and the additional interpretations and guidance we are providing are intended to further clarify how a broker-dealer could comply with these requirements. As noted above and discussed in the Fiduciary Interpretation, an investment adviser’s fiduciary duty under the Advisers Act requires the adviser to act in the best interests of its clients. We have chosen to describe the standard by referring directly to what the standard requires at the time a recommendation is made.140 Furthermore, while key elements of the standard of conduct that applies to broker-dealers under Regulation Best Interest will be substantially similar to key elements of the standard of conduct that applies to investment advisers pursuant to their fiduciary duty under the Advisers Act at the time that a recommendation is made, we are concerned that using the term ‘‘fiduciary’’ to describe a brokerdealer’s obligations under Regulation Best Interest may create confusion by suggesting that the standards of conduct are identical in all respects, when there are key differences as noted above, including the scope of the of the duty (e.g., the application of the adviser’s fiduciary duty to the entire relationship versus Regulation Best Interest’s recommendation-specific application, and the application of an adviser’s fiduciary duty to all clients as opposed to Regulation Best Interest’s application to retail customers).141 Similarly, while we are not harmonizing the phrasing of the best interest standard with the DOL’s definition of ‘‘best interest’’ as reflected in the BIC Exemption’s Impartial Conduct Standards, as suggested by some commenters,142 or otherwise adopting some or all conditions of the BIC Exemption, we gave careful consideration to the DOL Fiduciary Rule in developing Regulation Best Interest.143 Regulation Best Interest takes into account both market participant experience with the implementation of—and reaction to the subsequent overturning of the DOL Fiduciary Rule, in particular the BIC Exemption. As discussed in the Proposing Release, we believe 140 As discussed in the Relationship Summary Adopting Release, we are adopting a requirement in Form CRS for a description of a firm’s applicable standard of conduct using prescribed wording. 141 See Fiduciary Interpretation. 142 See AARP August 2018 Letter; Wells Fargo Letter; Schwab Letter; NASAA August 2018 Letter. 143 On March 15, 2018, the DOL Fiduciary Rule was vacated by the United States Court of Appeals for the Fifth Circuit. Chamber of Commerce v. U.S. Dep’t of Labor, 885 F.3d 360 (5th Cir. 2018). PO 00000 Frm 00017 Fmt 4701 Sfmt 4700 33333 Regulation Best Interest is consistent with many of the key components of the DOL’s Impartial Conduct Standards. Regulation Best Interest incorporates principles underlying the DOL Fiduciary Rule—such as the concept of conflict mitigation—that, based on our expertise in regulating the broker-dealer industry, we believe would further our goal of reducing the effect of conflicts on recommendations and would promote recommendations in the best interest of the retail customer even where conflicts continue to exist. 2. General Obligation To ‘‘Act in Best Interest’’ We agree with commenters that further clarity should be provided on what it means to ‘‘act in the best interest’’ of a retail customer and particularly what it means to make a recommendation in a retail customer’s ‘‘best interest’’ under the Care Obligation. In the guidance that follows and in the detailed discussion of each of the Disclosure, Care, Conflict of Interest, and Compliance Obligations in Section II.C below, we provide further clarity on how a broker-dealer acts in a retail customer’s best interest when making a recommendation. First, in response to comments, we are clarifying the relationship between the General Obligation and the specific component obligations described in Section II.C. These specific component obligations expressly set forth what it means to ‘‘act in the best interest’’ of the retail customer in accordance with the General Obligation. As articulated in the proposal, and discussed in more detail in the relevant sections specifically addressing these obligations, these specific component obligations draw on principles underlying the fiduciary duties of care and loyalty interpreted under the Advisers Act and as recommended in the 913 Study. However, we believe that adopting specific regulatory obligations for broker-dealers appropriately reflects the structure and characteristics of brokerdealer relationships with retail customers and the extensive existing regulatory regime applicable to brokerdealers. Regulation Best Interest does not establish a ‘‘safe harbor.’’ The specific component obligations of Regulation Best Interest are mandatory, and failure to comply with any of the components would violate the General Obligation. By contrast, compliance with a safe harbor is optional, and failure to comply with the terms of the safe harbor does not necessarily violate the relevant legal requirement. Second, while we are declining to expressly define ‘‘best interest’’ in the E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 33334 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations rule text as suggested by some commenters, we are providing interpretations and guidance regarding the application of the specific component obligations and in particular what it means to make a recommendation in the retail customer’s ‘‘best interest.’’ Consistent with the proposal, compliance with each of the specific component obligations of Regulation Best Interest, including the ‘‘best interest’’ requirement in the Care Obligation, will be applied in a principles-based manner. This principles-based approach to determining what is in the ‘‘best interest’’ is similar to an investment adviser’s fiduciary duty, which has worked well for advisers’ retail clients and our markets. As proposed, whether a broker-dealer has acted in the retail customer’s best interest will turn on an objective assessment of the facts and circumstances of how the specific components of Regulation Best Interest are satisfied at the time that the recommendation is made (and not in hindsight). In particular, whether a broker-dealer’s recommendation satisfies the requirements of the Care Obligation is an objective evaluation that is not susceptible to a bright line test; rather it turns on the facts and circumstances of the particular recommendation and the particular retail customer, at the time the recommendation is made. This factsand-circumstances approach recognizes that one size does not fit all, and what is in the best interest of one retail customer may not be in the best interest of another. We understand that markets evolve and we encourage broker-dealers to have an open dialogue with the Commission and Commission’s staff as questions arise. As a general matter, however, in response to comments, we are changing guidance in the Proposing Release stating that under Regulation Best Interest, a broker-dealer’s financial interests cannot be the ‘‘predominant motivating factor behind’’ a recommendation, and that a ‘‘brokerdealer would violate proposed Regulation Best Interest’s Care Obligation and Conflict of Interest Obligations, if any recommendation was predominantly motivated by the brokerdealer’s self-interest.’’ 144 Many commenters expressed concerns regarding and requested removal of the ‘‘predominantly motivated’’ language, stating that it contradicted statements that there was no scienter requirement under Regulation Best Interest by 144 See Proposing Release at 21588. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 requiring a consideration of intent, creating ambiguity as to what extent a broker-dealer’s interests could influence its recommendations or requiring a weighing of the broker-dealer’s interests against the retail customer’s interests.145 Some commenters, however, indicated support for the ‘‘predominantly motivated language’’ in the context of agreeing with the Commission’s proposed ‘‘without placing the financial or other interest . . . ahead’’ phrasing of the best interest standard.146 In consideration of these comments, we are modifying these statements to remove this language and to clarify our intent. Specifically, Regulation Best Interest recognizes that while a brokerdealer will inevitably have some financial interest in a recommendation—the nature and magnitude of which will vary—the broker-dealer’s interests cannot be placed ahead of the retail customer’s interest.147 Accordingly, Regulation Best Interest will not per se prohibit a brokerdealer from making recommendations where conflicts of interest are present.148 Instead, Regulation Best Interest includes specific requirements for broker-dealers to address their conflicts of interest.149 These specific requirements are designed to promote recommendations that are in the best interest of the retail customer despite the existence of these conflicts of interest. In other words, recommendations involving conflicts of interest between the broker-dealer and the retail customer will be permissible under Regulation Best Interest only to the extent that the broker-dealer satisfies 145 See CFA August 2018 Letter; Better Markets August 2018 Letter; Wells Fargo Letter. 146 See AXA Letter; FSI August 2018 Letter. 147 See id. See infra Section II.C.2. 148 Such conflicts of interest may include: Charging commissions or other transaction-based fees; receiving or providing differential compensation based on the product sold; receiving third-party compensation; recommending proprietary products, products of affiliates or a limited range of products; recommending a security underwritten by the broker-dealer or a broker-dealer affiliate, including initial public offerings (‘‘IPOs’’); recommending a transaction to be executed in a principal capacity; allocating trades and research, including allocating investment opportunities (e.g., IPO allocations or proprietary research or advice) among different types of customers and between retail customers and the broker-dealer’s own account; considering cost to the broker-dealer of effecting the transaction or strategy on behalf of the customer (for example, the effort or cost of buying or selling a complex or an illiquid security); or accepting a retail customer’s order that is contrary to the broker-dealer’s recommendations. While these practices will not be per se prohibited by Regulation Best Interest, we are also not saying that these practices are per se consistent with Regulation Best Interest or other obligations under the federal securities laws. See also Proposing Release at 21587. 149 Id at 21588. PO 00000 Frm 00018 Fmt 4701 Sfmt 4700 the specific requirements of Regulation Best Interest. Further, for the reasons discussed in the proposal, we confirm that Regulation Best Interest is not intended to limit or eliminate recommendations that encourage diversity in a retail customer’s portfolio through investment in a wide range of products, including, when appropriate, products that may involve higher risks or cost to the retail customer, as these products may be in the best interest of certain retail customers at certain times or in certain circumstances.150 Regulation Best Interest will not necessarily obligate a broker-dealer to recommend the ‘‘least expensive’’ or the ‘‘least remunerative’’ security or investment strategy, provided the broker-dealer complies with the specific component obligations.151 In other words, Regulation Best Interest will allow a broker-dealer to recommend products that entail higher costs or risks for the retail customer, or that result in greater compensation to the broker-dealer, or that are more expensive, than other products, provided that the brokerdealer complies with the specific component obligations detailed below,152 including the requirement to make these recommendations exercising reasonable diligence, care, and skill to have a reasonable basis to believe that the recommendation is in the retail customer’s best interest and does not place the broker-dealer’s interest ahead of the retail customer’s interest. Finally, some commenters sought additional clarity whether Regulation Best Interest would extend beyond a particular recommendation, impose a duty to monitor the retail customer’s account, or apply to unsolicited orders.153 We confirm that, consistent with the Proposing Release and as discussed further below, Regulation Best Interest would not: (1) Extend beyond a particular recommendation 154 or generally require a broker-dealer to have a continuous duty to a retail customer or impose a duty to monitor; 155 (2) require the broker-dealer 150 Id. 151 See id. id. 153 See, e.g., SIFMA August 2018 Letter; Transamerica August 2018 Letter; see also generally CFA August 2018 Letter; Better Markets August 2018 Letter. 154 However, paragraph (a)(2)(iii)(C) of Regulation Best Interest addresses a series of recommended transactions. See Section II.C.2.d. 155 However, as discussed below, it is our position that when a broker-dealer agrees with a retail customer to provide account monitoring services: (1) The broker-dealer would be required to disclose the material facts (including scope and frequency) of those services pursuant to the 152 See E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations to refuse to accept a customer’s order that is contrary to the broker-dealer’s recommendation; or (3) apply to selfdirected or otherwise unsolicited transactions by a retail customer, whether or not she also receives separate recommendations from the broker-dealer. B. Key Terms and Scope of Best Interest Obligation 1. Natural Person Who Is an Associated Person In the Proposing Release, we stated that a ‘‘natural person who is an associated person’’ is a natural person who is an associated person as defined in Section 3(a)(18) of the Exchange Act: ‘‘any partner, officer, or director or branch manager of such broker or dealer (or any person occupying a similar status or performing similar functions); any person directly or indirectly controlling, controlled by, or under common control with such broker or dealer; or any employee of such broker or dealer, except that any person associated with a broker or dealer whose functions are solely clerical or ministerial shall not be included in the meaning of such term for purposes of Section 15(b) of this title (other than paragraph 6 thereof).’’ 156 In limiting the term to only a ‘‘natural person who is an associated person,’’ we sought to exclude affiliated entities of the brokerdealer that are not themselves brokerdealers, as they are not the intended focus of Regulation Best Interest.157 We solicited comment on whether the application of the definition was appropriate, alternative definitions should be considered, or the scope should be broadened or narrowed. We received no comments and, for the reasons discussed in the Proposing Release, are using the term ‘‘natural person who is an associated person,’’ consistent with the definition in Section 3(a)(18) of the Exchange Act.158 jbell on DSK3GLQ082PROD with RULES2 2. Recommendation of Any Securities Transaction or Investment Strategy Involving Securities We proposed to apply Regulation Best Interest to broker-dealer recommendations of any securities Disclosure Obligation, and (2) such agreed-upon account monitoring services involve an implicit recommendation to hold (i.e., an implicit recommendation not to buy, sell, or exchange assets pursuant to that securities account review) at the time agreed-upon monitoring occurs, which is a recommendation ‘‘of any securities transaction or investment strategy involving securities’’ covered by Regulation Best Interest. 156 Proposing Release at 21592–21593. 157 Id. 158 Id. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 transaction or investment strategy involving securities to a retail customer. We believed that by applying Regulation Best Interest to a ‘‘recommendation,’’ as that term is currently interpreted under broker-dealer regulation, we would make clear when the obligation applied and would maintain efficiencies for broker-dealers that have already established infrastructures to comply with suitability obligations, which are recommendation-based.159 Moreover, we believed that focusing on each recommendation would appropriately capture and reflect the various types of recommendations that broker-dealers make to retail customers, whether on an episodic, periodic, or more frequent basis and would help ensure that retail customers receive the protections that Regulation Best Interest is intended to provide. We received numerous comments supporting our general proposed approach to what is a ‘‘recommendation,’’ while several commenters suggested modifications regarding the scope of a recommendation or sought additional clarity regarding particular scenarios.160 As we indicated in the Proposing Release, in our view, the determination of whether a broker-dealer has made a recommendation that triggers application of Regulation Best Interest should turn on the facts and circumstances of the particular situation and therefore, whether a recommendation has taken place is not susceptible to a bright line definition. Factors considered in determining whether a recommendation has taken place include whether the communication ‘‘reasonably could be viewed as a ‘call to action’’’ and ‘‘reasonably would influence an investor to trade a particular security or group of securities.’’ 161 The more individually tailored the communication to a specific customer or a targeted group of customers about a security or group of securities, the 159 Id. 160 See generally SIFMA August 2018 Letter; Financial Engines Letter; IPA Letter; Putnam Letter; Cambridge Letter (recommending the Commission adopt FINRA’s approach to determining whether a communication is a ‘‘recommendation’’). But see NASAA August 2018 Letter; BlackRock Letter; FSI August 2018 Letter (recommending modifications or clarifications to ‘‘recommendation’’). 161 See Proposing Release at 21592–21593; see also NASD Notice to Members 01–23, Online Suitability—Suitability Rules and Online Communications (Apr. 2001); Notice of Filing Proposed Rule Change to Adopt FINRA Rule 2090 (Know Your Customer) and FINRA Rule 2111 (Suitability) in the Consolidated FINRA Rulebook, Exchange Act Release No. 62718 (Aug. 13, 2010), 75 FR 51310 (Aug. 19, 2010), as amended, Exchange Act Release No. 67218A (Aug. 20, 2010), 75 FR 52562 (Aug. 26, 2010) (discussing what it means to make a ‘‘recommendation’’). PO 00000 Frm 00019 Fmt 4701 Sfmt 4700 33335 greater the likelihood that the communication may be viewed as a ‘‘recommendation.’’ We continue to believe this general framework regarding what is a recommendation is appropriate, and for the reasons discussed in the Proposing Release, are taking this approach.162 While certain commenters recommended formally defining the term ‘‘recommendation,’’ including what does not come within that term,163 other commenters maintained there is no need to define ‘‘recommendation’’ and expressed support for harmonizing the term in accordance with existing broker-dealer guidance and case law.164 We agree with commenters that clarity is important, and we continue to believe that the current principles-based approach underlying existing Commission precedent and guidance will provide effective clarity. Being more prescriptive could result in a definition that is over inclusive, under inclusive, or both.165 We believe that what constitutes a recommendation is highly fact-specific and not conducive to an express definition in the rule text. Furthermore, we believe that the existing framework has worked well, that broker-dealers generally are familiar with the existing framework, and therefore, that this approach should continue. Accordingly, we are taking the approach as set forth in the Proposing Release, which we believe provides a workable framework and clarity for broker-dealers regarding the contours of a recommendation. To provide further clarity, in response to comments, we describe below the types of communications that we generally view 162 See Proposing Release at 21592–21593. e.g., Prudential Letter (recommending an express definition of ‘‘recommendation’’ that would codify guidance). 164 See, e.g., SIFMA August 2018 Letter (‘‘Similarly, the SEC refers to the FINRA concept of ‘recommendation’ rather than prescribing a specific definition. We believe this is appropriate, and we believe that a carve-out for educational materials would be consistent with that approach.’’); Edward Jones Letter (‘‘We do not believe it is necessary for the SEC to define the phrase ‘at the time the recommendation is made,’ because its meaning is plain.’’); Cambridge Letter (‘‘FINRA Rule 2111 sets forth an explicit standard for what constitutes a recommendation and recognizes ‘call to action’ as the hallmark. Cambridge believes this definition is fully understood and in use by the industry.’’ Cambridge also states that harmonizing the final rule with existing FINRA rules and guidance will provide clarity to firms, financial professionals, and investors). 165 See id.; Proposing Release at 21592–21593. Similarly, FINRA has stated that ‘‘defining the term ‘recommendation’ is unnecessary and would raise many complex issues in the absence of specific facts of a particular case.’’ Exchange Act Release No. 37588, 1996 SEC LEXIS 2285, at *29 (Aug. 20, 1996), 61 FR 44100, 44107 (Aug. 27, 1996). 163 See, E:\FR\FM\12JYR2.SGM 12JYR2 33336 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 as falling outside of the scope of a recommendation. We are also generally confirming our interpretation in the Proposing Release of the phrase ‘‘any securities transaction or investment strategy involving securities.’’ However, in response to comments regarding the coverage of certain securities or investment strategies, we are providing further clarity regarding our interpretation of this phrase, and in certain instances, refining our interpretation. For example, as discussed more fully below, we are confirming our interpretation that recommendations of ‘‘any securities transaction’’ (purchase, sale, or exchange) and any ‘‘investment strategy’’ involving securities (including an explicit hold recommendation) are recommendations ‘‘of any securities transaction or investment strategy involving securities.’’ In addition, we are generally confirming our interpretation that a broker-dealer may agree with a retail customer to take on additional obligations beyond those imposed by Regulation Best Interest, for example, by agreeing with a retail customer to provide monitoring of the retail customer’s investments on a periodic basis for purposes of recommending changes in investments.166 In response to comments, it is our position that when a broker-dealer agrees 167 with a 166 Proposing Release at 21594–21595. The Proposing Release referred to ‘‘ongoing’’ monitoring of the retail customer’s investments for purposes of recommending changes in investments. Id. In the discussion that follows and the Solely Incidental Interpretation, we are clarifying our views regarding broker-dealer account monitoring services, and the application of Regulation Best Interest to such services. As discussed in the Solely Incidental Interpretation, a broker-dealer that agrees to monitor a retail customer’s account on a periodic basis for purposes of providing buy, sell, or hold recommendations may still be considered to provide advice in connection with and reasonably related to effecting securities transactions. Brokerdealers may choose to adopt policies and procedures that, if followed, would help demonstrate that any agreed-upon monitoring is in connection with and reasonably related to the broker-dealer’s primary business of effecting securities transactions. See Solely Incidental Interpretation. 167 An agreement to provide account monitoring services to a retail customer is not required to be in writing (although whether or not the brokerdealer is providing account monitoring services, and, if so, the scope and frequency of such monitoring services, must be disclosed in writing pursuant to the Disclosure Obligation). For example, a broker-dealer’s oral undertaking that the broker-dealer will monitor the retail customer’s account on a periodic basis would create an agreement to monitor the account on the terms specified orally. Whether an agreement with the retail customer has been established in the absence of a written agreement or express oral undertaking will depend on an objective inquiry of the particular facts and circumstances, including reasonable retail customer expectations arising from VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 retail customer to monitor that customer’s account: (1) The brokerdealer is required to disclose the terms of such account monitoring services (including the scope and frequency of those services) pursuant to the Disclosure Obligation 168 and (2) such agreed-upon monitoring involves an implicit recommendation to hold (i.e., recommendation not to buy, sell, or exchange assets pursuant to that securities account review) at the time the agreed-upon monitoring occurs, which is a recommendation ‘‘of any securities transaction or investment strategy involving securities’’ covered by Regulation Best Interest.169 As discussed further below, in our view, a recommendation of ‘‘an investment strategy’’ includes implicit hold recommendations in this context, where the broker-dealer has agreed to monitor a retail customer’s account.170 We are interpreting the phrase ‘‘any security transaction or investment strategy’’ to include instances where there is an agreement to monitor because in this context there is an implicit recommendation to hold at the time the agreed-upon monitoring occurs when the broker-dealer’s course of conduct. In cases where a broker-dealer does not intend to create an implied agreement to monitor the retail customer’s account through course of conduct or otherwise, and to avoid ambiguity over whether an implied agreement has been formed, broker-dealers should take steps to ensure that all communications with the retail customer are consistent with its disclosures required under the Disclosure Obligation, which in this case would require the broker-dealer to clearly disclose that the brokerdealer does not monitor the retail customer’s account. 168 To avoid ambiguity over whether or when an implicit hold recommendation has been made, this disclosure should identify with specificity when the agreed upon monitoring will occur. See also FINRA Regulatory Notice 12–25 at Q14. 169 See IAC 2018 Recommendation; NAIFA Letter; AFL–CIO April 2019 Letter; see also FINRA Regulatory Notice 12–25, Suitability—Additional Guidance on FINRA’s New Suitability Rule (May 2012) at Q3 and accompanying footnotes. 170 See FINRA Rule 2111.03; FINRA Regulatory Notice 12–25. The Commission recognizes that its position with respect to Regulation Best Interest differs from that provided in FINRA guidance regarding whether implicit hold recommendations are subject to the suitability rule. This interpretation applies in the context of the protections of Regulation Best Interest, and does not change the scope of the application of the FINRA suitability rule. Further, while for purposes of Regulation Best Interest implicit hold recommendations are generally recommendations of ‘‘any securities transaction or investment strategy regarding securities’’ where a broker-dealer agrees to provide account monitoring services, we are not otherwise addressing the treatment of implicit hold recommendations in other contexts. In other words, except where a broker-dealer agrees to provide account monitoring services as described, consistent with existing FINRA guidance, Regulation Best Interest will only apply to explicit hold recommendations. See FINRA Regulatory Notice 12–25 at Q3 and accompanying footnotes. PO 00000 Frm 00020 Fmt 4701 Sfmt 4700 the broker-dealer does not provide an express recommendation to buy, sell, or hold.171 We recognize that a broker-dealer may voluntarily, and without any agreement with the customer, review the holdings in a retail customer’s account for the purposes of determining whether to provide a recommendation to the customer. We do not consider this voluntary review to be ‘‘account monitoring,’’ nor would it in itself create an implied agreement with the retail customer to monitor the customer’s account. Any explicit recommendation made to the retail customer as a result of any such voluntary review would be subject to Regulation Best Interest. Finally, in response to comments received, we have modified the rule text to provide that an ‘‘investment strategy involving securities’’ includes ‘‘account recommendations.’’ We interpret ‘‘account recommendations’’ to include recommendations of securities account types generally, as well as recommendations to roll over or transfer assets from one type of account to another (e.g., workplace retirement plan to an IRA). As discussed in more detail below, we believe that recommendations of securities account types are consistent with the types of recommendations that have been treated as investment strategies,172 because the 171 Our interpretation is generally consistent with commenters’ views regarding the application of Regulation Best Interest to implicit hold recommendations in the context of agreed-upon account monitoring services. See IAC 2018 Recommendation (‘‘we believe the best interest standard should be applied to the broker-dealer’s monitoring of the customer account, where brokers provide ongoing services to the account. In essence, this would apply the best interest standard to the implicit ‘‘no recommendation’’ recommendation that a broker makes when reviewing the account and recommending no change.’’); NAIFA Letter (asserting broker-dealers should be free to agree to, and define the nature of, any ongoing relationship via contract, such as including monitoring services). See also AFL–CIO April 2019 Letter (‘‘adopt a principles-based obligation to monitor the account, where the nature and extent of the monitoring follows the contours of the relationship’’). See also supra footnote 166 (encouraging broker-dealers to adopt policies and procedures that, if followed, would help demonstrate that any agreed-upon monitoring is in connection with and reasonably related to the broker-dealer’s primary business of effecting securities transactions in accordance with the Solely Incidental Interpretation). 172 Although FINRA has stated that a recommendation concerning the type of workplace retirement plan account in which a customer should hold his retirement investments typically involves a recommended securities transaction, and thus is subject to suitability requirements, FINRA did not address whether such a recommendation would be an investment strategy in the absence of such a recommended securities transaction. FINRA Regulatory Notice 13–45, Rollovers to Individual Retirement Accounts—FINRA Reminds Firms of Their Responsibilities Concerning IRA Rollovers E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations type of securities account recommended is an investment strategy that has the potential to greatly affect retail customers’ costs and investment returns.173 For example, different types of securities accounts can offer different features, products, or services, some of which may—or may not—be in the best interest of certain retail customers.174 Our interpretation is consistent with a majority of the IAC and other commenters that stated that such important recommendations relating to securities are ‘‘investment strategies involving securities’’ and thus within the scope of Regulation Best Interest.175 We note that, although we are specifically identifying ‘‘account recommendations’’ as an investment strategy involving securities in the rule text, an account recommendation is just one example of an investment strategy. jbell on DSK3GLQ082PROD with RULES2 a. Recommendation We interpret whether a ‘‘recommendation’’ has been made to a retail customer that triggers the best (Dec. 2013). Taking this approach is consistent with Commission precedent finding a recommendation of a margin strategy to be unsuitable under the NASD suitability rule, in light of the associated transactions costs and the impact the strategy could have on customer returns. See F.J. Kaufman & Co., 50 SEC. 164 (1989) (Commission Opinion) (stating that a broker-dealer recommending the purchase of securities using a margin strategy ‘‘at a minimum . . . had an obligation to understand that, in light of the applicable transaction costs, the two components of his recommended strategy, when combined, always would have produced returns inferior to those that could have been obtained from one of those components alone.’’). 173 See SEC Office of Investor Education and Advocacy, Updated Investor Bulletin: How Fees and Expenses Affect Your Investment Portfolio (Sep. 2016). 174 In addition to brokerage versus investment advisory accounts, there are also many options or account types within brokerage accounts. For example, brokerage accounts can include: Education accounts (e.g., 529 Plans and tax-free Coverdell accounts); retirement accounts (e.g., IRA, Roth IRA, or SEP–IRA accounts); and specialty accounts (e.g., cash or margin accounts, and accounts with access to Forex or options trading). Different brokerage accounts can also offer different levels of services, such as access to online trading, or can offer different products, for example, in higher dollar amount accounts (e.g., access to products with break-points). 175 See, e.g., IAC 2018 Recommendation (‘‘Decisions about which type of account to open have the potential to greatly affect their costs. Moreover, both rollover and account type recommendations are recommendations of an ‘investment strategy involving securities’ that can have substantial potential long-term impacts on investors. Both types of recommendations inherently involve potential conflicts of interest, making it critical that advisers and brokers put their clients’ interests ahead of their own in making such recommendations.’’); Capital Group Letter (‘‘Choosing between a brokerage and an advisory account is an incredibly impactful decision for investors. It is very important that these recommendations be made in the best interest of the retail [customer].’’). VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 interest obligation consistent with precedent under the anti-fraud provisions of the federal securities laws as applied to broker-dealers, and with how the term has been applied under the rules of self-regulatory organizations (‘‘SROs’’).176 Several commenters supported this approach, and specifically agreed with following the existing facts and circumstances approach as understood under federal securities laws and SRO rules.177 Commenters sought additional clarity regarding the scope of a recommendation and in particular whether certain activities or communications would constitute recommendations, and requested that the Commission incorporate or specifically identify exceptions or exclusions such as the exceptions recognized in FINRA Rule 2111.03 (Suitability) or acknowledged by the DOL.178 Some commenters also sought 176 See Proposing Release at 21592–21595. In this regard, Regulation Best Interest does not extend beyond a particular recommendation, for example, by imposing a general broker-dealer duty to monitor a customer’s account or by applying the duty to unsolicited orders. 177 See, e.g., AXA Letter; SIFMA August 2018 Letter; IPA Letter; Putnam Letter; FSI August 2018 Letter; Cetera August 2018 Letter. 178 See, e.g., Prudential Letter; Transamerica August 2018 Letter; SPARK Letter; see also FINRA Rule 2111.03 (excluding the following communications from the coverage of Rule 2111 as long as they do not include (standing alone or in combination with other communications) a recommendation of a particular security or securities: (a) General financial and investment information, including: (i) Basic investment concepts, such as risk and return, diversification, dollar cost averaging, compounded return, and tax deferred investment, (ii) historic differences in the return of asset classes (e.g., equities, bonds, or cash) based on standard market indices, (iii) effects of inflation, (iv) estimates of future retirement income needs, and (v) assessment of a customer’s investment profile; (b) Descriptive information about an employer-sponsored retirement or benefit plan, participation in the plan, the benefits of plan participation, and the investment options available under the plan; (c) Asset allocation models that are: (i) Based on generally accepted investment theory, (ii) accompanied by disclosures of all material facts and assumptions that may affect a reasonable investor’s assessment of the asset allocation model or any report generated by such model, and (iii) in compliance with Rule 2214 (Requirements for the Use of Investment Analysis Tools) if the asset allocation model is an ‘‘investment analysis tool’’ covered by Rule 2214; and (d) Interactive investment materials that incorporate the above). The DOL took a similar approach, excluding from the term ‘‘recommendation,’’ among other things, general communications and investment education (including plan information, general financial, investment and retirement information, asset allocation models and interactive investment materials). See DOL Interpretative Bulletin 96–1; Participant Investment Education, 29 CFR 2509.96– 1, 61 FR 29588 (Jun. 11, 1996) (IB 96–1). See also DOL, Definition of the Term ‘‘Fiduciary’’; Conflict of Interest Rule—Retirement Investment Advice, 81 FR 20945, 20975 (Apr. 8, 2016) (noting that the now vacated DOL Fiduciary Rule would have carved out investment education from the definition of investment advice, incorporating much of IB 96–1). PO 00000 Frm 00021 Fmt 4701 Sfmt 4700 33337 an explicit carve out or confirmation that certain communications, such as general education materials, general retirement planning materials, or general retirement communications, including ‘‘pure distribution recommendations,’’ are not ‘‘recommendations’’ subject to Regulation Best Interest.179 The treatment of certain communications as ‘‘education’’ rather than ‘‘recommendations’’ is well understood by broker-dealers. We generally view the following types of communications as not being recommendations of any securities transaction or investment strategy involving securities as long as they do not include, standing alone or in combination with other communications, a recommendation of a particular security or securities or particular investment strategy involving securities: 180 • General financial and investment information, including: Æ Basic investment concepts, such as risk and return, diversification, dollar cost averaging, compounded return, and tax deferred investment, Æ historic differences in the return of asset classes (e.g., equities, bonds, or cash) based on standard market indices, Æ effects of inflation, Æ estimates of future retirement income needs, and Æ assessment of a customer’s investment profile; • Descriptive information about an employer-sponsored retirement or benefit plan, participation in the plan, the benefits of plan participation, and the investment options available under the plan; 181 179 See SPARK Letter; NAGDCA Letter. Similarly, communications regarding participation in a plan and communications to make or increase plan contributions, without more, would generally not come within ‘‘recommendation.’’ 180 This concept also applies to investment strategies. See FINRA Regulatory Notice 11–25, Know Your Customer and Suitability—New Implementation Date for and Additional Guidance on the Consolidated FINRA Rules Governing KnowYour-Customer and Suitability Obligations (May 2011) at FAQ 9 (‘‘It is important to note, however, that the suitability rule would not apply to a firm’s explanation of a strategy falling outside the safeharbor provision if a reasonable person would not view the communication as a recommendation. Accordingly, the suitability rule would cover a firm’s recommendation that a customer purchase securities using margin, whereas the rule generally would not cover a firm’s brochure that simply explains the risks and benefits of margin without suggesting that the customer take action.’’). 181 While this descriptive information would be treated as ‘‘education’’ rather than a ‘‘recommendation,’’ we caution broker-dealers to ensure that communications by their associated persons intended as ‘‘education’’ do not cross the line into ‘‘recommendations.’’ See FINRA Regulatory Notice 13–45. E:\FR\FM\12JYR2.SGM 12JYR2 33338 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 • Asset allocation models that are: Æ Based on generally accepted investment theory, Æ accompanied by disclosures of all material facts and assumptions that may affect a reasonable investor’s assessment of the asset allocation model or any report generated by such model, and Æ in compliance with FINRA Rule 2214 (Requirements for the Use of Investment Analysis Tools) if the asset allocation model is an ‘‘investment analysis tool’’ covered by FINRA Rule 2214; 182 and • Interactive investment materials that incorporate the above. Thus, for example, a general conversation about retirement planning, such as providing a company’s retirement plan options to a retail customer, would not, by itself, rise to the level of a recommendation. Similarly, where a broker-dealer informs a retail customer that he or she needs to take a required minimum distribution under the Internal Revenue Code, we would not interpret such communication, by itself, to rise to the level of a recommendation. Such a communication would be considered investment education or descriptive information, provided it does not involve, for example, a recommendation regarding specific securities to be sold or a recommendation regarding specific securities to be purchased with the proceeds of any sale.183 We agree with commenters that Regulation Best Interest should not stifle investment education as a means to encourage financial wellness, or otherwise restrict broker-dealers from disseminating information about, for example, retirement plans, and the approach we are taking to what is or is not considered a ‘‘recommendation’’ achieves this goal.184 182 In this regard, as an allocation recommendation becomes narrower or more specific, the recommendation gets closer to becoming a recommendation of particular securities and, thus, subject to the suitability rule. See FINRA Regulatory Notice 12–25 at FAQ 8. 183 See, e.g., SPARK Letter (asking for confirmation that ‘‘pure ‘distribution recommendations’ involving retirement accounts, such as those required under Internal Revenue Code section 401(a)(9), are not a ‘recommendation of any securities transaction or investment strategy involving securities.’ ’’). However, informing a retail customer about a required minimum distribution may become a recommendation where a brokerdealer includes (standing alone or in combination with other communications) a recommendation of, or regarding, a particular security or securities or an investment strategy involving securities. See FINRA Rule 2111 (Suitability) FAQ. 184 See SPARK Letter (suggesting expressly excluding beneficial conversations about retirement savings and ‘‘ensuring that Regulation Best Interest does not discourage broker-dealers in any way from having these important conversations with VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 b. Interpretation of Any Securities Transaction or Investment Strategy Involving Securities As proposed, Regulation Best Interest would apply to recommendations of ‘‘any securities transaction’’ (purchase, sale, and exchange) and any ‘‘investment strategy’’ involving securities (including explicit recommendations to hold a security or regarding the manner in which it is to be purchased or sold). In addition, the Proposing Release stated that securities transactions or investment strategies involving securities might also include recommendations to roll over or transfer assets from one type of account to another, such as recommendations to roll over or transfer assets from a retirement plan.185 Finally, although we did not propose to cover account type recommendations generally, we noted that evaluating the appropriateness of the type of account is an issue that relates to both broker-dealers and investment advisers, and requested comment on whether and how we should address this type of recommendation. In response to the Proposing Release, several commenters supported the Commission’s approach; however, several commenters also requested modifications or clarifications regarding products or strategies covered under Regulation Best Interest. For example, a majority of the IAC and numerous commenters highlighted the conflicts of interest associated with account type recommendations, and urged the Commission to apply Regulation Best Interest to account type recommendations generally, and to IRA rollovers.186 Relatedly, several commenters sought clarity regarding whether and when a rollover or account type recommendation would be a ‘‘recommendation’’ under Regulation Best Interest.187 After careful consideration of comments and feedback, the Commission has modified the rule text retirement investors’’); see also Transamerica August 2018 Letter (suggesting the exclusion of various conversations designed to facilitate retirement savings). 185 See Proposing Release at 21595. 186 See, e.g., IAC 2018 Recommendation (supporting the ‘‘expan[sion] of the best interest obligation to cover rollover recommendations and recommendations by dual registrant firms regarding account types’’); see also NASAA August 2018 Letter; SPARK Letter; Financial Engines Letter; Cetera August 2018 Letter; AFL–CIO April 2019 Letter. But see SIFMA August 2018 Letter (viewing recommendations of an account type as not involving a recommendation of a securities transaction or investment strategy involving securities). 187 See, e.g., NAGDCA Letter; FPC Letter. PO 00000 Frm 00022 Fmt 4701 Sfmt 4700 to state that an ‘‘investment strategy involving securities’’ includes ‘‘account recommendations.’’ We interpret ‘‘account recommendations’’ to include recommendations by broker-dealers of securities account types generally,188 as well as recommendations to roll over or transfer assets from one type of account to another (e.g., workplace retirement plan account to an IRA).189 In addition, the Commission is stating its view that ‘‘any securities transaction or investment strategy involving securities’’ not only includes explicit hold recommendations, but also includes implicit hold recommendations that are the result of agreed-upon account monitoring between the broker-dealer and retail customer.190 Account Recommendations The Proposing Release indicated that securities transactions or investment strategies involving securities could include recommendations to roll over or transfer assets from one type of account to another, such as recommendations to roll over or transfer assets in a workplace retirement plan account to an IRA, and requested comment on whether and how to address account type recommendations. Several commenters suggested expanding Regulation Best Interest to explicitly cover rollover recommendations and recommendations by firms regarding account types. For example, a majority of the IAC explained that rollover recommendations ‘‘are frequently provided at a critical juncture in an investor’s life—retirement—and are often irrevocable decisions,’’ and further noted that ‘‘[d]ecisions about which type of account to open have the 188 In the discussion of the Care Obligation in Section II.C.2, we are also setting forth additional positions regarding the application of the Care Obligation to account type recommendations, as well as recommendations to roll over or transfer assets from one account to another. See also Fiduciary Interpretation (explaining that ‘‘[a]dvice about account type includes advice about whether to open or invest through a certain type of account (e.g., a commission-based brokerage account or a fee-based advisory account) and advice about whether to roll over assets from one account (e.g., a retirement account) into a new or existing account that the adviser or an affiliate of the adviser manages’’). 189 A majority of the IAC and numerous commenters expressed the importance of account rollovers and the need for rollovers to be covered under Regulation Best Interest. See, e.g., IAC 2018 Recommendation; Financial Engines Letter. 190 Several commenters stated that broker-dealers should be able to contract with retail customers to provide additional services, such as account monitoring, and that such agreed upon services should be subject to Regulation Best Interest. See, e.g., NAIFA Letter; IAA August 2018 Letter; AFL– CIO April 2019 Letter. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 potential to greatly affect [retail customers’] costs’’ and that both rollovers and account type recommendations can ‘‘have substantial potential long-term impacts on investors.’’ 191 Another commenter noted that ‘‘[r]etirees have no practical ability to recoup lost spending power by returning to work and setting aside additional retirement savings, so they are particularly vulnerable to the adverse consequences of poor advice and high expenses.’’ 192 Finally, a majority of the IAC and several commenters noted that broker-dealers and investment advisers alike have a strong economic incentive to recommend investors roll over plan assets into an IRA or otherwise transfer assets to open an account with the broker-dealer or investment adviser.193 After consideration of comments received, including concerns expressed about the conflicts associated with recommendations of account types, IRA rollovers and retirement advice more broadly, it is our view that Regulation Best Interest should apply broadly to recommendations of securities transactions and investment strategies involving securities. Accordingly, the Commission is including in the rule text account recommendations as recommendations that will be covered by Regulation Best. ‘‘Account recommendations’’ include recommendations of securities account types generally (e.g., to open an IRA or other brokerage account), as well as recommendations to roll over or transfer assets from one type of account to another (e.g., a workplace retirement plan account to an IRA). Although account recommendations, including recommendations of a securities account type generally, as well as recommendations to roll over assets from a workplace retirement plan account to an IRA or to open an IRA held at the broker-dealer, will almost always involve a ‘‘securities transaction’’ (such as a securities purchase, sale, or exchange), and thus would generally be subject to Regulation Best Interest, we are modifying the rule text to provide that such recommendations are ‘‘investment strategies involving securities’’ for purposes of Regulation Best Interest, 191 IAC 2018 Recommendation. See also Letter from Brian H. Graff, Executive Director and CEO, Craig P. Hoffman, General Counsel, Doug Fisher, Director of Retirement Policy, American Retirement Association (‘‘ARA’’) (Dec. 13, 2018) (‘‘ARA December 2018 Letter’’); Transamerica August 2018 Letter. 192 Fiduciary Benchmarks Letter. 193 See, e.g., IAC 2018 Recommendation; NASAA August 2018 Letter; Fiduciary Benchmarks Letter. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 regardless of whether they are tied to a specific securities transaction.194 Existing broker-dealer regulation and guidance stresses that the term ‘‘investment strategy’’ is to be interpreted broadly, and would include, among others, recommendations generally to use a bond ladder, day trading, ‘‘liquefied home equity,’’ or margin strategy involving securities, irrespective of whether the recommendations mention particular securities.195 This approach appropriately recognizes that customers may rely on firms’ and associated persons’ investment expertise and knowledge, and therefore the brokerdealer should be responsible for such recommendations, regardless of whether those recommendations result in transactions or generate transactionbased compensation.196 Account recommendations, including recommendations of securities account types generally (e.g., to open an IRA or other brokerage account), and recommendations to roll over or transfer assets into an IRA or another securities account, are consistent with the types of recommendations that have been treated as investment strategies under existing suitability rules.197 Specifically, like other investment strategies, account recommendations are recommendations of an approach or method (i.e., a ‘‘strategy’’) for how a retail customer should engage in transactions in securities, involve conflicts of interest, and can have long-term effects on investors’ costs and returns from their investments.198 In addition, we believe retail customers rely on broker-dealers’ and associated persons’ investment expertise and knowledge with respect to such recommendations. As a result, such recommendations must be made consistent with the retail customer’s objectives and needs (i.e., investment profile), irrespective of whether those recommendations are tied to a specific securities transaction. Consistent with a majority of the IAC’s and other commenters’ suggestions, we are modifying the rule text to state that the 194 A recommendation that a retail customer roll over or transfer assets to an IRA held at the brokerdealer, or open an IRA or another securities account with a broker-dealer, presumes that the recommendation would involve transactions in securities, even if the rollover or account recommendation does not result in transactions or transaction-based compensation. 195 See FINRA Rule 2111.03; FINRA Regulatory Notice 12–25 at Q7. 196 See FINRA Regulatory Notice 11–02, Know Your Customer and Suitability—SEC Approves Consolidated FINRA Rules Governing Know-YourCustomer and Suitability Obligations (Jan. 2011). 197 See supra footnotes 172 and 173. 198 See Capital Group Letter; see also IAC 2018 Recommendation; NASAA August 2018 Letter. PO 00000 Frm 00023 Fmt 4701 Sfmt 4700 33339 term ‘‘investment strategy involving securities’’ includes ‘‘account recommendations,’’ which we interpret to include recommendations of securities account types generally, as well as recommendations to roll over or transfer assets.199 Thus, such account recommendations will be subject to Regulation Best Interest even if there is not a recommendation of a securities transaction. Although we proposed only covering account type recommendations that are tied to securities transactions, and not account type recommendations generally, we agree with commenters and a majority of the IAC that consistent with other investment strategies involving securities, securities account type recommendations should be covered under Regulation Best Interest regardless of whether those recommendations result in transactions or generate transaction-based compensation.200 In addition, as discussed in the Fiduciary Interpretation, investment advisers’ fiduciary duty applies to advice to clients about account types, which satisfies the concerns about parity set forth in the Proposing Release and protects retail customers of brokerdealers and retail clients of investment advisers alike.201 Where a financial professional who is dually registered (i.e., an associated person of a broker-dealer and a supervised person of an investment adviser (regardless of whether the professional works for a dual-registrant, affiliated firm, or unaffiliated firm)) is making an account recommendation to a retail customer,202 whether Regulation Best Interest or the Advisers Act will apply will depend on the capacity in which the financial professional making 199 See, e.g., IAC 2018 Recommendation; Capital Group Letter (‘‘Choosing between a brokerage and an advisory account is an incredibly impactful decision for investors. It is very important that these recommendations be made in the best interest of the retail [customer].’’). 200 See, e.g., IAC 2018 Recommendation; NASAA August 2018 Letter. 201 See Fiduciary Interpretation. 202 As discussed in more detail below in Section II.B.3.b, Regulation Best Interest applies to a retail customer who receives a recommendation and uses the recommendation. Among other things, we interpret a retail customer to use a recommendation when: (1) The retail customer opens a brokerage account with the broker-dealer, regardless of whether the broker-dealer receives compensation; (2) the retail customer has an existing account with the broker-dealer and receives a recommendation from the broker-dealer, regardless of whether the broker-dealer receives or will receive compensation, directly or indirectly, as a result of that recommendation; or (3) the broker-dealer receives or will receive compensation, directly or indirectly as a result of that recommendation, even if that retail customer does not have an account at the firm. E:\FR\FM\12JYR2.SGM 12JYR2 33340 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations the recommendation is acting.203 As discussed further in the Care Obligation, if the individual is acting as a brokerdealer or associated person thereof, he or she must comply with Regulation Best Interest and will need to take into consideration all types of accounts offered by the financial professional (i.e., both brokerage and advisory accounts) when making the recommendation of an account that is in the retail customer’s best interest. In the case of an account recommendation by a financial professional who is only registered as an associated person of broker-dealer (regardless of whether that broker-dealer entity is a dual-registrant or affiliated with an investment adviser), Regulation Best Interest will apply to the recommendation. Further, the associated person can only recommend a brokerage account that the brokerdealer offers when the associated person has a reasonable basis to believe that the recommended brokerage account is in the best interest of the retail customer and the broker-dealer otherwise complies with Regulation Best Interest. Regulation Best Interest would apply to account recommendations by the dual-registrant firm, and consistent with the Conflict of Interest Obligation, the firm would need to, among other things, establish, maintain and enforce policies and procedures to identify, disclose, and mitigate, any incentives for an associated person of the broker-dealer to place the interest of the firm or the associated person ahead of the interests of the retail customer. In the discussion of the Care Obligation below, we discuss how a broker-dealer and associated persons of a broker-dealer can make recommendations of securities account types, including recommendations to open an IRA or to roll over assets into an IRA, in the best interest of the retail customer. Hold Recommendations jbell on DSK3GLQ082PROD with RULES2 The Proposing Release stated that Regulation Best Interest would apply to any securities transaction or investment strategy involving securities, including 203 See Section II.B.3.d, below for discussion of factors the Commission will consider in determining capacity. See also Fiduciary Interpretation at footnotes 42–44 and accompanying text. As discussed in the Fiduciary Interpretation, while advice to prospective clients about these matters is subject to the antifraud provisions under section 206 of the Advisers Act, the adviser must also satisfy its fiduciary duty with respect to any such advice (e.g., regarding account type) once a prospective client becomes a client. Thus, at the point in time at which the prospective client becomes a client of the investment adviser (e.g., at account opening), the fiduciary duty applies. Id. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 explicit recommendations to hold a security or regarding the manner in which it is to be purchased or sold to retail customers.204 The Proposing Release also recognized that brokerdealers may agree with a retail customer by contract to take on additional obligations beyond those imposed by Regulation Best Interest, for example, by agreeing with a retail customer to provide periodic or ongoing services, such as ongoing monitoring of the retail customer’s investments for purposes of recommending changes in investments.205 To the extent that a broker-dealer takes on such additional obligations, the Proposing Release indicated that Regulation Best Interest would apply to any recommendations about securities or investment strategies involving securities made to retail customers resulting from such services. Several commenters agreed that broker-dealers should be able to contract with retail customers for additional services and be able to expand the relationship on their own terms, while other commenters recommended that a duty to monitor apply to broker-dealers depending on the facts and circumstances.206 Other commenters suggested that the Commission not impose a duty to monitor brokerage accounts.207 We are confirming that, consistent with existing broker-dealer regulation, Regulation Best Interest will apply to explicit recommendations to hold a security or securities.208 We are also confirming that Regulation Best Interest does not impose a duty to monitor a retail customer’s account. We agree, however, with commenters that Regulation Best Interest should apply to any recommendations that result from the account monitoring services that a broker-dealer agrees to provide.209 We believe that any monitoring service agreed to by the broker-dealer, the scope and frequency of which would be required to be disclosed pursuant to the Disclosure Obligation, would be covered by Regulation Best Interest, as these activities will result in a recommendation to purchase, sell, or hold a security, or the manner in which to purchase, sell, or hold a security, at each time the agreed-upon monitoring occurs.210 Thus, by agreeing to perform account monitoring services, the brokerdealer is taking on an obligation to review and make recommendations with respect to that account (e.g., to buy, sell or hold) on that specified, periodic basis.211 For example, if a broker-dealer agrees to monitor the retail customer’s account on a quarterly basis, the quarterly review and each resulting recommendation to purchase, sell, or hold, will be a recommendation subject to Regulation Best Interest. This is the case even in instances where the brokerdealer does not communicate any recommendation to the retail customer. We believe that such an ‘‘implicit’’ recommendation to hold in this context should be covered under Regulation Best Interest in addition to ‘‘explicit’’ recommendations to hold.212 This position differs from FINRA guidance, which generally states that the FINRA suitability rule does not cover an implicit recommendation to hold.213 We believe that ‘‘implicit’’ hold 209 See NAIFA Letter; IAA August 2018 Letter. agreeing to provide any account monitoring services, broker-dealers need to consider whether the monitoring services fit within the broker-dealer exclusion from the Advisers Act. See Solely Incidental Interpretation. 211 The broker-dealer would also be required to disclose the existence, scope, and frequency of such account monitoring services pursuant to the Disclosure Obligation. To avoid ambiguity over whether or when an implicit hold recommendation has been made, this disclosure should identify with specificity when the agreed upon monitoring will occur. 212 See FINRA Rule 2111.03 (noting ‘‘[t]he phrase ‘investment strategy involving a security or securities’ used in this Rule is to be interpreted broadly and would include, among other things, an explicit recommendation to hold a security or securities.’’); see also NASAA August 2018 Letter. 213 FINRA Regulatory Notice 11–25 at Q7 (‘‘The rule, for instance, would not apply where an associated person remains silent regarding, or refrains from recommending the sale of, securities held in an account. That is true regardless of whether the associated person previously recommended the purchase of the securities, the customer purchased them without a recommendation, or the customer transferred them into the account from another firm where the same or a different associated person had handled the account.’’). See also id. at footnote 21 (‘‘To the extent that a customer account at a broker-dealer 210 In Release at 21593–21595. We also asked whether broker-dealers who provide ongoing monitoring should be considered investment advisers. Id. at 21592. 206 See, e.g., NAIFA Letter (‘‘Additionally, while the best interest standard applies to each recommendation and may not be waived or modified by contract as it applies to those recommendations, it should not be interpreted to create obligations with respect to other, expanded services (e.g., ongoing research and monitoring services, regular in-person meetings, etc.). Again, however, advisors and consumers may agree to expand the relationship in these ways on their own terms.’’); see also CFA August 2018 Letter; Better Markets August 2018 Letter (recommending the Commission establish a duty to monitor depending on the facts and circumstances); AFL–CIO April 2019 Letter. We note that additional commenters maintained that if broker-dealers agree with retail customers to provide ongoing monitoring for purposes of recommending changes in investments, they should be considered investment advisers. See NASAA August 2018 Letter; FPC Letter. We have addressed these comments in the context of the Solely Incidental Interpretation. See Solely Incidental Interpretation. 207 See IAA August 2018 Letter. 208 See FINRA Regulatory Notice 12–25. PO 00000 204 Proposing 205 Id. Frm 00024 Fmt 4701 Sfmt 4700 E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 recommendations in this context, where the broker-dealer agrees to provide specified account monitoring services, are similar to explicit hold recommendations that are considered ‘‘investment strategies’’ because they would constitute the type of recommendations that retail customers would be expected to rely upon and would be a ‘‘call to action’’ in the sense of a recommendation that the customer stay the course.214 We believe that, in this context, silence is tantamount to an explicit recommendation to hold, and should be viewed as a recommendation to hold the securities for purposes of Regulation Best Interest.215 Our interpretation that the term ‘‘investment strategy involving securities’’ includes implicit recommendations to hold that result from an agreement to monitor, at the time the agreed-upon monitoring occurs, is generally consistent with the treatment of similar broker-dealer communications as ‘‘investment strategies,’’ and applies the Regulation Best Interest protections to retail customers relying on a broker-dealer’s agreement to monitor the customer’s account.216 can be discretionary under applicable federal securities laws, the suitability rule generally would not apply where a firm refrains from selling a security. The rule states that it applies to explicit recommendations to hold. Unless the facts indicate that an associated person’s failure to sell securities in a discretionary account was intended as or tantamount to an explicit recommendation to hold, FINRA would not view the associated person’s inaction or silence in such circumstances as a recommendation to hold the securities for purposes of the suitability rule.’’). 214 See FINRA Regulatory Notice 11–25 at Q7 (‘‘The rule would apply, for example, when an associated person meets with a customer during a quarterly or annual investment review and explicitly advises the customer not to sell any securities in or make any changes to the account or portfolio.’’). While the FINRA guidance goes on to state that the rule generally would not cover an implicit recommendation to hold, it does not address the particular scenario in which a brokerdealer agrees to monitor an account (such as a quarterly review) and discloses the terms of that monitoring, and then during that review is silent on whether the customer should make any changes. Id.; see also FINRA Regulatory Notice 12–25 at Q3 and accompanying footnotes. 215 See FINRA Regulatory Notice 11–25 at footnote 21. 216 Our interpretation is generally consistent with a majority of the IAC’s and other commenters’ views regarding application of Regulation Best Interest to implicit hold recommendations in the context of agreed-upon account monitoring services. See IAC 2018 Recommendation (‘‘We believe the best interest standard should be applied to the broker-dealer’s monitoring of the customer account, where brokers provide ongoing services to the account. In essence, this would apply the best interest standard to the implicit ‘‘no recommendation’’ recommendation that a broker makes when reviewing the account and recommends no change.’’); NAIFA Letter (asserting broker-dealers should be free to agree to, and define the nature of, any ongoing relationship via contract, VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 Although for purposes of Regulation Best Interest, implicit hold recommendations will be considered a recommendation of ‘‘any securities transaction or investment strategy regarding securities’’ where a brokerdealer has agreed to provide account monitoring services, we are not otherwise changing the treatment of implicit hold recommendations in other contexts. In other words, unless the broker-dealer has agreed to provide account monitoring services as described, Regulation Best Interest would only apply to explicit—and not to implicit—hold recommendations regarding security positions in an account.217 This is consistent with the fact that Regulation Best Interest would not impose a duty to monitor customer accounts.218 Finally, although certain commenters stated that account monitoring services should only be performed by investment advisers,219 we reiterate that Regulation Best Interest does not change the scope of account monitoring that brokerdealers may agree to provide, nor does it change the scope of activities that would come within the ‘‘solely incidental’’ prong of the broker-dealer exclusion to the definition of ‘‘investment adviser’’ in the Advisers Act. We recognize that a broker-dealer may voluntarily, and without any agreement with the customer, review the holdings in a retail customer’s account for the purpose of determining whether to provide a recommendation to the customer. We view this voluntary review—and any subsequent recommendation to the customer—as in connection with and reasonably related to the broker-dealer’s primary business of effecting securities transactions.220 Recommendations Involving Retirement Accounts Furthermore, based on comments, our position is that recommendations to retail customers regarding retirement accounts would also be subject to such as including monitoring services); AFL–CIO April 2019 Letter. 217 FINRA Notice to Members 11–25 at Q7. 218 Our approach does not require broker-dealers to undertake account monitoring, unless they choose to do so. See Solely Incidental Interpretation. 219 See, e.g., NASAA August 2018 Letter; FPC Letter. 220 See Solely Incidental Interpretation. Absent an agreement with the customer (which would be required to be disclosed pursuant to the Disclosure Obligation), we do not consider this voluntary review to be ‘‘account monitoring’’ nor would it in itself create an obligation under Regulation Best Interest, provided of course that any recommendation made to the customer as a result of any such voluntary review would be subject to Regulation Best Interest. PO 00000 Frm 00025 Fmt 4701 Sfmt 4700 33341 Regulation Best Interest where they involve securities transactions or investment strategies involving securities. We agree with commenters that recommendations to retail customers to take distributions from proceeds of specific securities or to take in-service loans from an employersponsored plan are recommendations of a securities transaction, as they would involve a recommendation to sell a security.221 However, while such recommendations to take plan distributions are ‘‘recommendations’’ and thereby subject to Regulation Best Interest, we reiterate that general communications by broker-dealers relating to distributions in the context of a required minimum distribution or education regarding a plan’s options would not, by themselves, constitute recommendations that would be subject to Regulation Best Interest.222 3. Retail Customer We proposed to define retail customer as: ‘‘a person, or the legal representative of such person, who: (1) Receives a recommendation of any securities transaction or investment strategy involving securities from a broker, dealer, or a natural person who is an associated person of a broker or dealer, and (2) uses the recommendation primarily for personal, family or household purposes.’’ 223 The definition was generally intended to track the definition of ‘‘retail customer’’ under Section 913(a) of the Dodd-Frank Act with some differences, as described in the Proposing Release.224 In proposing the definition, we intended to exclude recommendations 221 See supra footnotes 185–189 and accompanying text. See, e.g., NASAA August 2018 Letter; Fiduciary Benchmarks Letter; IAC 2018 Recommendation. 222 For example, where a broker-dealer informs a retail customer that based on age and other relevant factors, he or she needs to take a required minimum distribution, but does not otherwise recommend specifics, such as what securities to sell, or where to place the proceeds, the communication would generally not be a ‘‘recommendation’’ subject to Regulation Best Interest. As with other communications subject to broker-dealer regulation, an inquiry of whether a ‘‘recommendation’’ was made would depend on the facts and circumstances relating to the communication, as discussed more fully above. See supra Section II.B.2.a. 223 As we stated in the Proposing Release, we believe that broker-dealers would generally be required to obtain sufficient facts about a customer to determine an account’s primary purpose for purposes of Regulation Best Interest. See Proposing Release at 21595. 224 See Proposing Release at Section II.C.4. Section 913(a) defines ‘‘retail customer’’ as a natural person, or the legal representative of such natural person who: (1) Receives personalized investment advice about securities from a broker or dealer or investment adviser; and (2) uses such advice primarily for personal, family, or household purposes. E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 33342 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations related to commercial or business purposes but for the definition to remain sufficiently broad to capture recommendations related to the various reasons retail customers may invest, such as saving for retirement, education expenses and other savings purposes. As such, the proposed definition applied to any persons who receive a recommendation from a broker or dealer or a natural person who is an associated person of a broker or dealer, provided that the recommendation is primarily for personal, family or household purposes. In the case of dual-registrants, the proposed definition was intended to apply only to recommendations made by broker-dealers in their brokerage capacity, based on a facts and circumstances analysis and consistent with existing guidance.225 The proposed definition differed from the definition of ‘‘retail investor’’ in the Relationship Summary Proposal as the Relationship Summary was intended for a broader range of investors.226 The Commission requested comment on the scope and definition of retail customer and received a range of comments requesting: modification of the definition to focus on natural persons; clarification of the ‘‘personal, family or household purposes’’ qualification; harmonization with the definition in Form CRS; and further guidance surrounding the treatment of dual-registrants. In consideration of the comments received, the Commission is modifying the definition of ‘‘retail customer’’ to mean a natural person, or the legal representative of such natural person, who: (A) Receives a recommendation of any securities transaction or investment strategy involving securities from a broker, dealer, or a natural person who is an associated person of a broker or dealer; and (B) uses the recommendation primarily for personal, family, or household purposes. The revised definition shifts the focus to natural persons, as opposed to any persons, but otherwise it is adopted largely as proposed. However, as discussed below, the Commission is providing additional interpretations, guidance and clarification regarding: The interpretation of the ‘‘personal, family, or household purposes’’ qualifier; the interaction of this definition with the definition of ‘‘retail investor’’ in Form CRS; what it means for a retail customer to ‘‘use’’ the recommendation; and the status of dualregistrants. Furthermore, we are providing guidance on who would be 225 Id. 226 Id. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 considered to be the legal representative of a natural person for purposes of this definition. a. Focus on Natural Persons and Legal Representatives of Natural Persons The Commission proposed to extend the definition of ‘‘retail customer’’ in Regulation Best Interest beyond natural persons to any persons to cover nonnatural persons (e.g., trusts that represent the assets of a natural person), which the Commission stated it believed would benefit from the protections of Regulation Best Interest. Commenters generally suggested that the definition of retail customer be modified to focus on natural persons.227 To that end, a number of commenters suggested eliminating the ‘‘personal, family or household purposes’’ qualifier from the definition under Dodd-Frank Section 913.228 Many commenters suggested excluding institutional investors and professional advisers or fiduciaries, including retirement plan representatives 229 and family offices,230 while a few stated that non-professional plan fiduciaries should have the same protections as retail customers.231 Many commenters suggested harmonizing the definition with FINRA’s definition,232 in particular, by excluding: (1) Institutional accounts that would be exempted from certain suitability protections under FINRA Rule 2111 (Suitability) 233 or (2) institutional investors as defined in Rule 2210 (Communications with the Public),234 227 See, e.g., Cetera August 2018 Letter; Invesco Letter. 228 See FPC Letter; SIFMA August 2018 Letter; BlackRock Letter. Contra ACLI Letter (supporting the provision in Section 913 and positing that Regulation Best Interest appropriately implements this foundational threshold). 229 See, e.g., SIFMA August 2018 Letter; Vanguard Letter; Prudential Letter; ICI Letter; Fidelity Letter. 230 See, e.g., TIAA Letter; SIFMA August 2018 Letter; Letter from Stuart J. Kaswell, Executive Vice President and Managing Director, Managed Funds Association, and Jiri Krol, Deputy CEO, Global Head of Government Affairs, Alternative Investment Management Association (Aug. 7, 2018) (‘‘Managed Funds Association Letter’’). 231 ARA August 2018 Letter; CFA August 2018 Letter. 232 See, e.g., UBS Letter; Bank of America Letter; Raymond James Letter; TIAA Letter; Letter from Joseph Giovanniello, Ladenburg Thalmann Financial Services Inc. (Jul. 30, 2018) (‘‘Ladenburg Letter’’). 233 FINRA Rule 2111(b). Institutional accounts include banks, savings and loan associations, insurance companies, registered investment companies, state and Federal Registered investment advisers, and other persons with total assets of at least $50 million. 234 FINRA Rule 2210(a)(4). Institutional investors include, in addition to persons with institutional accounts, government entities and their subdivisions, employee benefit plans, qualified plans as defined in Exchange Act Section 3(a)(12)(C), broker-dealers and registered PO 00000 Frm 00026 Fmt 4701 Sfmt 4700 which is broader 235 and would include, among others, certain workplace retirement plans. Conversely, a few commenters believed that Regulation Best Interest should apply to both retail and institutional customers.236 In response to comments, we are modifying the definition to focus on natural persons and their legal representatives, and are clarifying that we interpret ‘‘legal representatives’’ to mean non-professional legal representatives of a natural person, as we discuss below. We believe this change and clarification provides more certainty that institutions and certain professional fiduciaries are not covered for purposes of Regulation Best Interest. It would also retain, however, coverage of certain legal entities (i.e., trusts that represent the assets of a natural person) specifically identified in the Proposing Release as ‘‘retail customers’’ within the scope of Regulation Best Interest, but would not exclude certain high-networth natural persons, as was suggested by some commenters 237 to match the current FINRA exclusion of such natural persons from customer-specific suitability requirements.238 While the Commission recognizes commenters’ concerns regarding compliance costs and burdens if the definition of retail customer does not align with FINRA’s exclusion of certain institutional accounts and institutional investors, we have decided not to align our definition with FINRA’s exclusion because we believe conflicted recommendations can also result in harm to high net-worth individuals.239 representatives, and persons acting solely on behalf of such institutional investors. 235 See, e.g., SIFMA August 2018 Letter; TIAA Letter; IPA Letter. 236 NASAA August 2018 Letter, Better Markets August 2018 Letter; FPC Letter. But see Managed Funds Association Letter (suggesting that sophisticated investors should not be treated as retail customers). 237 See, e.g., Morgan Stanley Letter; FSI August 2018 Letter. 238 See FINRA Rule 4512(c), which includes within the definition of ‘‘institutional account’’ any person (whether a natural person, corporation, partnership, trust or otherwise) with total assets of at least $50 million. Currently, under FINRA rules, broker-dealers are exempt from the customerspecific suitability obligations with respect to these ‘‘institutional accounts’’ if certain conditions are met. FINRA Rule 2111(b). 239 The Commission has brought numerous enforcement actions against financial professionals engaged in schemes to defraud certain high networth individuals, in particular, professional athletes. See, e.g. SEC v. Charles A. Banks, IV, Civil Action No. 16–CV–3399–TWT (N.D. Ga. Nov. 2, 2018) (former investment adviser who fraudulently induced a former professional athlete to invest $7.5 million in a sports team and apparel merchandise company based on a series of misrepresentations); SEC v. Ash Narayan, The Ticket Reserve Inc. a/k/ a Forward Market Media, Inc., Richard M. Harmon, E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 We believe the benefits of Regulation Best Interest justify compliance costs as these individuals could benefit from the protections included in Regulation Best Interest regardless of their net worth, which may not necessarily correlate to a particular level of financial sophistication.240 In addition, we view a ‘‘legal representative’’ of a natural person to only cover non-professional legal representatives (e.g., a non-professional trustee that represents the assets of a natural person and similar representatives such as executors, conservators, and persons holding a power of attorney for a natural person),241 thereby excluding certain institutions from Regulation Best Interest’s coverage. In capturing nonprofessional legal representatives within the definition of retail customer, we are providing the protections of Regulation Best Interest to non-professional persons who are acting on behalf of natural persons but who are not regulated financial services industry professionals retained by natural persons to exercise independent professional judgment, such as registered investment advisers and broker-dealers, corporate fiduciaries (e.g., banks, trust companies and similar financial institutions) and insurance companies, and the employees or other regulated representatives of such advisers, broker-dealers, corporate fiduciaries and insurance companies.242 Our definition is intended to capture natural persons and their legal representatives who rely directly on the broker-dealer for the recommendation. Accordingly, such non-professional legal representatives would not include regulated financial industry professionals. We believe this responds to commenters who stated that it should and John A. Kaptrosky, Civil Action No. 16–CV– 1417–M (N.D. Tex. May 24, 2016) (investment adviser who misappropriated millions of dollars from accounts he managed for professional athletes and invested them in online sports and entertainment ticket business on whose board he served). In addition, reports indicate deficiencies in financial literary among the general population of retail investors. See Federal Research Division, Library of Congress, Financial Literacy Among Retail Investors in the United States (Dec. 30, 2011) at 25, available at https://www.sec.gov/news/ studies/2012/917-financial-literacy-study-part2.pdf (‘‘Library of Congress Report’’). 240 See Primerica Letter (noting challenges in using wealth and education as proxies for investment sophistication). In addition, the definition of ‘‘retail customer’’ under Section 913(a) of the Dodd-Frank Act did not make a distinction based on net worth. 241 A non-professional legal representative is covered pursuant to this rule even if another person is a trustee or managing agent of the trust. 242 See also Relationship Summary Adopting Release. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 not be necessary to provide the protections of Regulation Best Interest to regulated professionals.243 Importantly, however, this will not relieve firms or financial professionals retained to represent the assets of natural persons from their own obligations to retail customers.244 We retained the ‘‘personal, family, or household purposes’’ qualifier,245 but are providing additional guidance and clarification on our interpretation of this phrase to address comments received. In particular, we interpret ‘‘personal, family or household purposes’’ to mean that any recommendation to a natural person for his or her account would be subject to Regulation Best Interest, other than recommendations to natural persons seeking these services for commercial or business purposes. Accordingly, under this interpretation, ‘‘personal, family or household purposes’’ would not include, for example, an employee seeking services for an employer or an individual who is seeking services for a small business or on behalf of another non-natural person entity such as a charitable trust.246 As discussed above 247 and pursuant to the Care Obligation,248 we believe brokerdealers are able to obtain sufficient facts to determine the purpose for which a recommendation will be used. We also confirm that ‘‘personal, family or household purposes’’ would cover retirement accounts, as retirement savings is a personal, household or family purpose. Accordingly, the definition of retail customer will include a natural person receiving 243 See, e.g., Bank of America Letter; Invesco Letter; Letter from Bob Grohowski, Senior Legal Counsel, and Jon Siegel, Senior Legal Counsel, T. Rowe Price (Aug. 10, 2018) (‘‘T. Rowe Letter’’); Oppenheimer Letter; ICI Letter. 244 See also Relationship Summary Adopting Release. 245 Regulation Best Interest relies in part on the statutory authority provided in Section 913 of the Dodd-Frank Act which includes the statutory definition of ‘‘retail customer.’’ See Section 913(a) of the Dodd-Frank Act. 246 As discussed below, to the extent a plan representative who decides service arrangements for a workplace retirement plan is a sole proprietor or other self-employed individual who will participate in the plan, the plan representative will be a retail customer to the extent that the sole proprietor or self-employed individual receives recommendations directly from a broker-dealer primarily for personal, family or household purposes. 247 See supra footnote 223 and accompanying text. 248 Pursuant to the Care Obligation, a brokerdealer is required to ascertain the customer’s investment profile which considers, among other things, financial situation and needs and investment objectives, in evaluating a recommendation and whether it is in a retail customer’s best interest. PO 00000 Frm 00027 Fmt 4701 Sfmt 4700 33343 recommendations 249 for his or her own retirement account, including but not limited to IRAs and individual accounts in workplace retirement plans, such as 401(k) plans and other tax-favored retirement plans.250 For example, plan participants receiving recommendations about whether to take a distribution from a 401(k) plan or other workplace retirement plan and how to invest that distribution would be covered as retail customers. Similarly, a plan participant receiving recommendations for the participant’s individual account held in a 401(k) plan or other workplace retirement plan would be a retail customer for purposes of Regulation Best Interest.251 The Commission acknowledges concerns from some commenters that workplace retirement plans and their representatives (e.g., plan sponsors, trustees, other fiduciaries) and service providers should be included in the definition of retail customer.252 However, we understand that plan representatives of workplace retirement plans typically are not receiving recommendations for their own account for personal, family or household purposes when they engage a brokerdealer to provide services to a retirement plan established, maintained, 249 See Section II.C.2 (describing what constitutes a ‘‘recommendation’’ for purposes of Regulation Best Interest). 250 Such IRAs include, for example, individual retirement accounts and individual retirement annuities described by Internal Revenue Code section 408(a) and (b), ‘‘simplified employee pensions’’ (SEPs) described by Code section 408(k), and simple retirement accounts described by Code section 408(p) (SIMPLE IRAs). In response to commenters, we also clarify that workplace retirement plans include any arrangement available at a workplace that provides retirement benefits or allows saving for retirement, including, for example, any 401(k) plans or other plan that meet requirements for qualification under Code section 401(a), deferred compensation plans of state and local governments and tax-exempt organizations described by Code section 457, and annuity contracts and custodial accounts described by Code section 403(b). Likewise, the definition of retail investor includes natural persons seeking brokerage or advisory services for other tax-favored savings arrangements such as an Archer Medical Savings Account described by Code section 220(d), a Health Savings Accounts described by Code section 223(d) and any similar tax-favored health plan saving arrangement, a Coverdell education savings account described by Code section 530 and a qualified tuition program or ‘‘529 plan’’ established pursuant to Code section 529. 251 For example, we understand that, although not common, some 401(k) plans and other individual account plans provide participants total discretion to choose a broker-dealer to provide services for their individual plan account. See, e.g., 29 CFR 2550. 404c–1(f), Example 9. 252 See, e.g., ARA December 2018 Letter; FPC Letter. But see Empower Letter (‘‘It would be helpful if the SEC could confirm that the definition of ‘retail customer’ under RBI does not include advice to managers of retirement plans or to their fiduciaries or representatives.’’). E:\FR\FM\12JYR2.SGM 12JYR2 33344 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 and operated by an employer to provide pension or retirement savings benefits to employees; and further, as a legal representative of a plan participant, must comply with DOL rules.253 As such, the Commission does not believe that workplace retirement plans or their representatives and service providers generally fall within the definition of retail customer for purposes of Regulation Best Interest because the workplace retirement plan is not a natural person, and therefore the workplace retirement plan representatives are not a nonprofessional representative of a natural person that is receiving a recommendation directly from a broker253 It is our understanding that the investment responsibilities of plan representatives typically include, among other things, selecting and monitoring a menu of plan investment options and designating and monitoring ‘‘default’’ investments for investing account balances of participants who do not make their own investment elections, and that plan representatives typically make these investment selections for a workforce with diverse investment profiles. See ARA December 2018 Letter (describing obligations of plan fiduciaries selecting an investment menu and qualified default investment alternatives); Empower Letter (describing plan fiduciary obligations to select investment menus). We also understand that plan representatives may receive brokerage and advice services for plans together with or complimentary with, other services supporting the plan’s establishment, maintenance and operation, such as plan design, recordkeeping and other administrative services. See, e.g., Groom Letter (describing business models of firms offering brokerage and advice services together with other services); SPARK Letter (same). In this context, a plan representative would not be receiving recommendations from a broker-dealer for his or her own account and considerations material to the plan representative’s investment decisions differ from a situation in which a retail customer receives a recommendation from a broker-dealer for his or her own account. Further, we note that DOL has rules currently in place (not affected by the Fifth Circuit’s decision vacating the DOL Fiduciary Rule) that address how plan representatives operate participant-directed plans and select investment menus for such plans, see 29 CFR 2550.404c–1, what actions, including disclosures, plan representatives must take to be able to raise a defense or claim for investment losses by a participant or beneficiaries, see 29 CFR 2550.404c–5, and also generally require brokerdealers making investment alternatives available for a participant-directed plan to disclose in writing (among other things) all direct and indirect compensation received in connection with providing plan services. See 29 CFR 2550.408b– 2(c). See also Form 5500, Schedule C, requiring after-the-fact reporting by certain plans of information regarding direct and indirect compensation received by, among others, brokerdealers and investment advisers, in connection with services rendered or their position with the plan. Accordingly, we agree with those commenters who recommended that plan representatives should not be included in the definition of retail customer. See Empower Letter; Groom Letter; Letter from Nora M. Everett, President, Retirement and Income Solutions, Principal Financial Group (Aug. 7, 2018) (‘‘Principal Letter’’); SPARK Letter; T. Rowe Price Letter; Transamerica August 2018 Letter. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 dealer for ‘‘personal, family, or household purposes.’’ 254 We note, however, that some plan representatives may participate under their employer’s workplace plan, for example, in the case of a workplace IRA or other workplace retirement plan that is established and maintained by a sole proprietor or other self-employed individual that includes one or more employees in addition to the plan representative. To the extent that a plan representative who decides service arrangements for a workplace retirement plan is a sole proprietor or other selfemployed individual who will participate in the plan, the plan representative would be a retail customer for purposes of Regulation Best Interest to the extent the sole proprietor or self-employed individual receives recommendations directly from a broker-dealer primarily for personal, family or household purposes. b. Retail Customer Use of the Recommendation In the Proposing Release, the Commission did not specifically address whether recommendations subject to Regulation Best Interest needed to be for compensation, but did state that the proposed definition of retail customer would only apply to a person who ‘‘received a recommendation . . . from a broker or dealer or a natural person who is an associated person of a broker or dealer, and used the recommendation primarily for personal, family, or household purposes.’’ We stated that this approach was appropriate because it builds upon the guidance provided for FINRA’s suitability rule.255 In response, a few commenters recommended that the Commission limit the application of Regulation Best Interest to recommendations made to retail customers for compensation.256 Regulation Best Interest applies to a retail customer that both receives a recommendation of any securities transaction or investment strategy involving securities by a broker-dealer and that uses that recommendation primarily for personal, family, or 254 Although workplace retirement plans are not generally covered by the definition of retail customer in by Regulation Best Interest, based on preliminary discussions with DOL staff, we understand that the DOL is considering regulatory options in light of the Fifth Circuit’s decision vacating the DOL Fiduciary Rule, including the types of protections available to such workplace retirement plans and their representatives. Department of Labor Regulatory Agenda, Fiduciary Rule and Prohibited Transaction Exemptions, Fall 2018, available at https://www.reginfo.gov/public/ do/eAgendaViewRule?pubId=201810&RIN=1210AB82. 255 See Proposing Release at 21596, footnote 160. 256 See Morgan Stanley Letter; CCMC Letters. PO 00000 Frm 00028 Fmt 4701 Sfmt 4700 household purposes, and not simply those recommendations for which a broker-dealer receives compensation.257 In response to commenters, we interpret that a retail customer ‘‘uses’’ a recommendation of a securities transaction or investment strategy involving securities when, as a result of the recommendation: (1) The retail customer opens a brokerage account with the broker-dealer, regardless of whether the broker-dealer receives compensation,258 (2) the retail customer has an existing account with the brokerdealer and receives a recommendation from the broker-dealer, regardless of whether the broker-dealer receives or will receive compensation, directly or indirectly, as a result of that recommendation, or (3) the brokerdealer receives or will receive compensation, directly or indirectly as a result of that recommendation, even if that retail customer does not have an account at the firm.259 When a retail customer opens or has an existing account with a broker-dealer the retail customer has a relationship with the broker-dealer and is therefore in a position to ‘‘use’’ (i.e., accept or reject) the broker-dealer’s recommendation. In this context, tying ‘‘use’’ solely to a broker-dealer’s receipt of compensation would inappropriately result in Regulation Best Interest not applying to the broker-dealer’s recommendations to hold securities positions or to maintain an investment strategy (such as account type), recommendations to open an account, or recommendations that may 257 See paragraph (b)(1) of Regulation Best Interest. 258 As discussed in Section II.B.2.b below, account recommendations, including recommendations of a securities account type generally, and recommendations to open an IRA or to roll over or transfer assets into an IRA, are covered by Regulation Best Interest regardless of whether those recommendations result in transactions or generate transaction-based compensation. 259 See Proposing Release at 21596, footnote 160 and accompanying text. See also FINRA Regulatory Notice 12–55, Suitability—Guidance on FINRA’s Suitability Rule (Dec. 2012) at Q6(b) (‘‘The suitability rule would apply when a broker-dealer or registered representative makes a recommendation to a potential investor who then becomes a customer. Where, for example, a registered representative makes a recommendation to purchase a security to a potential investor, the suitability rule would apply to the recommendation if that individual executes the transaction through the broker-dealer with which the registered representative is associated or the broker-dealer receives or will receive, directly or indirectly, compensation as a result of the recommended transaction.’’); NASD Notice to Members 04–72, Transfers of Mutual Funds and Variable Annuities—Impermissible Use of Negative Response Letters for the Transfer of Mutual Funds and Variable Annuities (Changes in Broker-Dealer of Record) (Oct. 2004). E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations ultimately be rejected by the retail customer. Whether the recommendation complies with Regulation Best Interest will be evaluated based on the circumstances that existed at the time the recommendation was made to the retail customer. Accordingly, brokerdealers should carefully consider the extent to which associated persons can make recommendations to prospective retail customers (i.e., that have received, but not yet ‘‘used’’ the recommendation as noted above) in compliance with Regulation Best Interest, including having gathered sufficient information that would enable them to comply with Regulation Best Interest at the time the recommendation is made, should the prospective retail customer use the recommendation.260 c. Conformity With Form CRS The proposed definition of ‘‘retail customer’’ differed from the definition of ‘‘retail investor’’ proposed in the Relationship Summary Proposal, which was a prospective or existing client or customer who is a natural person (an individual), regardless of the individual’s net worth, including a trust or other similar entity that represents natural persons.261 The proposed definition was different from the definition of ‘‘retail investor’’ because the Relationship Summary was intended for an earlier state of the relationship between an investor and a financial professional, was intended to be required regardless of whether the investor would receive investment advice primarily for personal, family, or household purposes, and was designed to be delivered by investment advisers as well as broker-dealers.262 Many commenters recommended that we use the same definition to facilitate compliance for firms and avoid investor confusion.263 The Commission agrees with commenters that using a similar definition would provide consistency in the protections, and ease the compliance burden, of the package of rulemakings. Therefore, the definitions in Form CRS and Regulation Best Interest have been revised to generally conform to each other, consistent with our respective goals in each of these FINRA Regulatory Notice 12–55 at Q6(b). Relationship Summary Proposal. 262 See Relationship Summary Proposal, Section II, footnote 29. 263 See, e.g., Invesco Letter; BlackRock Letter; ICI Letter; Committee of Annuity Insurers Letter; Bank of America Letter; CFA August 2018 Letter; Cetera August 2018 Letter; Fidelity Letter; Morgan Stanley Letter; Oppenheimer Letter; Raymond James Letter; SIFMA August 2018 Letter; TIAA Letter; Transamerica August 2018 Letter. rulemakings.264 As discussed above, the definition of ‘‘retail customer’’ for purposes of Regulation Best Interest has been revised to apply only to natural persons, not all persons, in line with the definition of ‘‘retail investor’’ for purposes of Form CRS. In addition, the definition in Form CRS as adopted now includes the ‘‘personal, family or household purposes’’ qualifier. While the definitions have generally been harmonized across the package of rulemakings,265 they differ to reflect differences between the Relationship Summary delivery requirement and the obligations of broker-dealers under Regulation Best Interest, including that the Relationship Summary is required whether or not there is a recommendation and covers any prospective and existing clients and customers (i.e., a person who ‘‘seeks to receive or receives services’’) of investment advisers as well as brokerdealers.266 For the reasons discussed in the Proposing Release and in response to commenters who requested clarification on whether Regulation Best Interest applies to prospective customers,267 we would like to clarify that the definition of ‘‘retail customer’’ does not apply to prospective customers who do not receive and use recommendations from a brokerdealer,268 as discussed above. This distinction reflects differences between the point in time the Relationship Summary is delivered to an investor and when the obligations of broker-dealers pursuant to Regulation Best Interest attach. d. Treatment of Dual-Registrants In the Proposing Release, the Commission stated that Regulation Best Interest applies only in the context of a brokerage relationship with a brokerage customer, and specifically, when a broker-dealer is making a recommendation in the capacity of a broker-dealer. In particular, for dualregistrants (for purposes of this section, a broker-dealer that is dually registered as an investment adviser with the Commission), the obligations associated with Regulation Best Interest were intended to apply only when they are acting in the capacity as a brokerdealer.269 The Commission recognized 260 See 264 See jbell on DSK3GLQ082PROD with RULES2 261 See VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 Relationship Summary Adopting Release. 265 Id. 266 Id. 267 See, e.g., SIFMA August 2018 Letter; Prudential Letter; Money Management Institute Letter. 268 See Section II.B.3.b. 269 Although this discussion focuses on the treatment of broker-dealers that are dually registered with the Commission as investment PO 00000 Frm 00029 Fmt 4701 Sfmt 4700 33345 the issues surrounding the determination of whether a dualregistrant is acting in the capacity of a broker-dealer or an investment adviser, and asserted that such a determination requires a facts and circumstances analysis, with no one factor being determinative.270 Many commenters requested that the Commission clarify the treatment of dual-registrants and what is expected when offering products in both types of accounts.271 Some commenters asserted that dually registered financial professionals should be held to a fiduciary standard.272 A few commenters requested clarification on how Regulation Best Interest applies to particular scenarios, some of which involved dual-registrants.273 In response, the Commission is reaffirming the guidance provided in the proposal and providing further clarification on when and how Regulation Best Interest would apply to dual-registrants. As stated in the proposal, Regulation Best Interest would not apply to investment advice provided to a retail customer by a dual-registrant when acting in the capacity of an investment adviser, even if the retail customer has a brokerage relationship with the dual-registrant or the dualregistrant executes the transaction in its brokerage capacity.274 Similarly, as proposed, we are confirming that a dualregistrant is an investment adviser solely with respect to those accounts for which a dual-registrant provides investment advice or receives compensation that subjects it to the Advisers Act.275 While we acknowledge that some commenters believe all dual-registrants advisers, a broker-dealer should perform the same analysis when it is engaged in other financial services (such as, as a bank, a commodity trading advisor or a future commission merchant). 270 Proposing Release at 21596. 271 See, e.g., SIFMA August 2018 Letter; CCMC Letters; NASAA August 2018 Letter. 272 See PIABA Letter; AICPA Letter. 273 See SIFMA August 2018 Letter; Letter from Michael Pieciak, NASAA President, Commissioner Vermont Department of Financial Regulation, NASAA (Feb. 19, 2019) (‘‘NASAA February 2019 Letter’’). 274 This analysis would apply even if the dualregistrant receives transaction-based compensation for executing the transaction because the dualregistrant did not provide a recommendation in its capacity as a broker-dealer. While Regulation Best Interest would not apply in this situation, other provisions of the federal securities laws and SRO rules would apply to the actions taken or services provided by the broker-dealer. 275 See Proposing Release at 21596; see also Certain Broker-Dealers Deemed Not To Be Investment Advisers, Exchange Act Release No. 51523 (Apr. 12, 2005) at 8 (‘‘Release 51523’’); Interpretive Rule Under the Advisers Act Affecting Broker-Dealers, Advisers Act Release No. 2652 (Sep. 24, 2007). See also Fiduciary Interpretation. E:\FR\FM\12JYR2.SGM 12JYR2 33346 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations should be held to a fiduciary standard, for the reasons discussed in Section II.A, the Commission believes that Regulation Best Interest enhances the obligations that apply when a brokerdealer makes a recommendation to a retail customer by drawing from key principles underlying the fiduciary obligation that applies to investment advisers under the Advisers Act, while being tailored to the broker-dealer model.276 As stated in the proposal, determining the capacity in which a dual-registrant is making a recommendation is a facts and circumstances test, with no one factor being determinative, but the Commission considers, among other factors, the type of account, how the account is described, the type of compensation and the extent to which the dual-registrant made clear to the customer or client the capacity in which it was acting.277 In addition and in response to a commenter’s presentation 278 of particular scenarios in its comment letter,279 we would like to confirm or correct the commenter’s understanding of Regulation Best Interest in practice to provide further guidance to firms as it relates to their examples of dualregistrants.280 For example, in the commenter’s explanation of a scenario related to a recommendation to open a fee-based account, we agree that Regulation Best Interest would not apply when a dually registered financial professional of a dually registered broker-dealer and investment adviser, who is acting in the capacity of an investment adviser, recommends a feebased account. We note, however, that the dually registered financial professional would need to comply with the Advisers Act as well as the requirements with respect to Form CRS for the firm.281 In response to another scenario in which a financial professional who is dually registered provides a holistic review of the overall performance of a family’s accounts, 276 See Section I. Release at 21596. 278 See SIFMA August 2018 Letter. For purposes of the presented scenarios, SIFMA has assumed that the customer is a ‘‘retail customer.’’ 279 Id. 280 For purposes of this section, we have only addressed the scenarios applicable to dualregistrants and have not confirmed or rejected the commenter’s analysis of the other scenarios. 281 See Fiduciary Interpretation at Section II.B.1. In providing advice about account type, the adviser should consider both types of accounts (i.e., brokerage and advisory accounts) when determining whether the advice is in the client’s best interest. See also NASAA February 2019 Letter (stating that Regulation Best Interest would not apply but instead that the fiduciary duty under the Advisers Act would apply). jbell on DSK3GLQ082PROD with RULES2 277 Proposing VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 which are both brokerage and advisory, whether Regulation Best Interest applies depends on a facts and circumstances analysis. Regulation Best Interest would apply if the financial professional in her brokerage capacity (disclosed pursuant to the Disclosure Obligation), provides a recommendation of a securities transaction or investment strategy involving securities to the family in the course of the holistic review.282 C. Component Obligations As proposed Regulation Best Interest’s obligation to ‘‘act in the best interest of the retail customer . . . without placing the financial or other interest of the [broker-dealer] ahead of the retail customer’’ would have been satisfied by complying with four specified obligations: A Disclosure Obligation, a Care Obligation, and two Conflict of Interest Obligations.283 Failure to comply with any of these proposed requirements would have violated Regulation Best Interest.284 As discussed above, we have determined to retain the overall structure and scope of the proposed rule, but are modifying and clarifying the component obligations that a brokerdealer must satisfy in order to meet the General Obligation. As adopted, the General Obligation is satisfied only if the broker-dealer complies with four specified component obligations: (1) The Disclosure Obligation; (2) the Care Obligation; (3) the Conflict of Interest Obligation; and (4) the Compliance Obligation. Each of these component obligations is discussed below. Whether a broker-dealer has acted in the retail customer’s best interest under the General Obligation will turn on an objective assessment of the facts and circumstances of how these specific components of Regulation Best Interest are satisfied at the time that the recommendation is made (and not in hindsight). The specific component obligations of Regulation Best Interest are mandatory, and failure to comply with any of the components would violate Regulation Best Interest. 1. Disclosure Obligation We proposed a Disclosure Obligation that would require a broker-dealer ‘‘to, prior to or at the time of [a] recommendation, reasonably disclose to the retail customer, in writing, the material facts relating to the scope and 282 But see NASAA February 2019 Letter (stating that ‘‘a full fiduciary duty’’ should be imposed on the financial adviser as to all accounts in this case as the family has probably entrusted their entire financial well-being to one financial professional). 283 Proposing Release at 21598. 284 Id. PO 00000 Frm 00030 Fmt 4701 Sfmt 4700 terms of the relationship with the retail customer and all material conflicts of interest associated with the recommendation.’’ The Proposing Release states that, for purposes of the Disclosure Obligation, we would consider the following to be examples of material facts relating to the scope and terms of the relationship with the retail customer: (1) That the broker-dealer was acting in a broker-dealer capacity with respect to the recommendation; (2) fees and charges that would apply to the retail customer’s transactions, holdings, and accounts; and (3) type and scope of services provided by the broker-dealer, including, for example, monitoring the performance of the retail customer’s account. As stated in the Proposing Release, we understand that broker-dealers typically provide information about their services and accounts, which may include disclosures concerning the brokerdealer’s capacity, fees, services, and conflicts, on their firm websites and in their account opening agreements.285 Furthermore, while broker-dealers are subject to a number of specific disclosure obligations when they effect certain customer transactions, and are subject to the antifraud provisions of the federal securities laws, broker-dealers are not currently subject to an explicit and broad disclosure requirement under the Exchange Act regarding the scope and terms of the broker-dealer relationship.286 To promote brokerdealer recommendations that are in the best interest of retail customers, we determined it was necessary to impose a more explicit and broader disclosure obligation on broker-dealers than that which currently exists under the federal securities laws and SRO rules.287 We solicited comment on the Disclosure Obligation and commenters addressed several aspects of this proposed obligation, including the interpretation of each required element, as discussed in the relevant sections below.288 In consideration of these comments, we are revising the Disclosure Obligation to require a broker-dealer, prior to or at the time of the recommendation, to provide to the retail customer, in writing, full and fair disclosure 289 of all material facts related to the scope and terms of the 285 Proposing Release at 21599. Release at 21599–21600. 287 Proposing Release at 21600. 288 See, e.g., Better Markets August 2018 Letter; CCMC Letters; LPL August 2018 Letter; Schwab Letter; Morgan Stanley Letter; CFA August 2018 Letter; IPA Letter; NASAA Letter; SIFMA August 2018 Letter. 289 See Section II.C.1.c, Disclosure Obligation, Full and Fair Disclosure. 286 Proposing E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 relationship with the retail customer and all material facts relating to conflicts of interest that are associated with the recommendation.290 We are explicitly requiring in the rule text the disclosure of examples in the Proposing Release of the ‘‘material facts relating to the scope and terms of the relationship with the retail customer:’’ (1) That the broker, dealer or such natural person is acting as a broker, dealer or an associated person of a broker-dealer with respect to the recommendation; (2) the material fees and costs that apply to the retail customer’s transactions, holdings, and accounts; and (3) the type and scope of services provided to the retail customer, including: any material limitations on the securities or investment strategies involving securities that may be recommended to the retail customer. The Disclosure Obligation requires the disclosure of all material facts related to the scope and terms of the relationship with the retail customer. The material facts identified in Regulation Best Interest are the minimum of what must be disclosed. Similar to what was proposed, brokerdealers will need to disclose in writing prior to or at the time of a recommendation any material facts that relate to the ‘‘scope and terms of the relationship.’’ As to what constitutes a ‘‘material’’ fact related to the ‘‘scope and terms of the relationship,’’ the standard for materiality for purposes of the Disclosure Obligation is consistent with the one the Supreme Court articulated in Basic v. Levinson.291 Specifically, a fact is material if there is ‘‘a substantial likelihood that a reasonable shareholder would consider it important.’’ In the context of Regulation Best Interest, the standard is the retail customer, as defined in the rule. In response to comments, we are also refining and clarifying the treatment of conflicts of interest under Regulation Best Interest by: (1) Generally consistent with the fiduciary duty under the Advisers Act, adopting for purposes of Regulation Best Interest, the definition of ‘‘conflict of interest’’ associated with a recommendation as ‘‘an interest that might incline a broker, dealer, or a natural person who is an associated person of a broker or dealer— consciously or unconsciously—to make a recommendation that is not disinterested’’; 292 and (2) revising the 290 As discussed in more detail below, aspects of the Disclosure Obligation may be satisfied by other regulatory requirements. 291 Basic, Inc. v. Levinson, 485 U.S. 224 (1988). 292 This is the same as the definition of ‘‘material conflict of interest’’ discussed in the Proposing Release but eliminates ‘‘material’’ and ‘‘a reasonable VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 Disclosure Obligation to require disclosure of ‘‘material facts’’ relating to such conflicts of interest that are associated with the recommendation. Under this approach, all conflicts of interest as so defined will be covered by Regulation Best Interest (and thus, will be subject to the Conflict of Interest Obligation described below). However, only ‘‘material facts’’ regarding these conflicts of interest are required to be disclosed under the Disclosure Obligation.293 As discussed above, we are adopting a new set of disclosure requirements designed to reduce retail investor confusion in the marketplace for brokerage and advisory services and to assist retail investors with the process of deciding whether to engage a particular firm or financial professional and whether to establish an investment advisory or brokerage relationship.294 Specifically, we are requiring brokerdealers and investment advisers to deliver to retail investors a Relationship Summary.295 The Relationship Summary will provide succinct information about the relationships and services the firm offers to retail investors, fees and costs that retail investors will pay, specified conflicts of interest and standards of conduct, and disciplinary history, among other things.296 The Relationship Summary has a distinct purpose: It is intended to summarize information about a particular broker-dealer or investment adviser in a format that allows for comparability among the enumerated items, encourages investors to ask questions, and highlights additional sources of information. As a general matter, the Relationship Summary reflects an initial layer of disclosure, with the Disclosure Obligation reflecting more specific and additional, detailed layers of disclosure.297 We believe the Relationship Summary and the person would expect’’ for the reasons discussed below. 293 The Conflict of Interest Obligation requires, among other things, that a broker-dealer establish written policies and procedures reasonably designed to identify and disclose all conflicts of interest associated with a recommendation. Such disclosure is required to be provided in accordance with the Disclosure Obligation. See Section II.C.3.d. 294 See Relationship Summary Adopting Release. 295 See Relationship Summary Adopting Release. 296 See Relationship Summary Adopting Release at Section I. For purposes of Form CRS, ‘‘retail investor’’ is defined as ‘‘a natural person, or the legal representative of such natural person, who seeks to receive or receives services primarily for personal, family, or household purposes.’’ 297 Nevertheless, as discussed below where relevant, in some instances disclosures made pursuant to Form CRS may be sufficient to satisfy some aspects of the Disclosure Obligation. PO 00000 Frm 00031 Fmt 4701 Sfmt 4700 33347 Disclosure Obligation, while separate obligations with significant individual value, will complement each other and, consistent with our layered approach to disclosure, are designed to build upon each other to provide different levels of key information and may be required to be delivered at different times. In addition, we believe the Relationship Summary and Disclosure Obligation will improve the quality and consistency of disclosures and thus: (1) Reduce the information asymmetry that may exist between a retail customer and their broker-dealer, and (2) facilitate customer comparisons of different broker-dealers which we expect will, in turn, increase competition among broker-dealers, including with respect to fees and costs.298 As discussed below, we have identified those items of information that we consider to be ‘‘material facts’’ under the Disclosure Obligation. Though there are disclosures in the Relationship Summary that could satisfy the Disclosure Obligation, in most instances the Relationship Summary will not be sufficient.299 Moreover, as discussed below, we believe the Disclosure Obligation can be satisfied to varying degrees with existing documents provided to retail customers, such as account opening documents, with a standalone document, or by some combination. However, we encourage broker-dealers, in deciding whether to rely on such an existing disclosure document or whether to include or repeat information from existing disclosures, to consider the usefulness and ease of understanding for retail customers of any existing disclosure document. Oral Disclosure or Disclosure After a Recommendation As discussed in more detail below, a number of commenters highlighted practical difficulties associated with delivering disclosure either in writing, or prior to or at the time of a recommendation in some instances. Although Regulation Best Interest requires that the Disclosure Obligation be made ‘‘in writing,’’ we recognize the challenges associated with providing written disclosure in each instance that disclosure may be required. For example, a broker-dealer may need to supplement, clarify or update written disclosure it has previously made before 298 See infra footnote 1192 and accompanying text. 299 For example, as noted below, a standalone broker-dealer will be able to satisfy the Disclosure Obligation’s requirement to disclose the brokerdealer’s capacity by delivering the Relationship Summary to the retail customer. E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 33348 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations or at the time it provides a customer with a recommendation. As we stated in the Proposing Release, we recognized that broker-dealers may provide recommendations by telephone and may need to offer clarifying disclosure orally in some instances subject to certain conditions, such as a dual-registrant informing a retail customer of the capacity in which the dual-registrant is acting in conjunction with a recommendation. We stated that a broker-dealer could orally clarify the capacity in which it is acting at the time of the recommendation if it had previously provided written disclosure to the retail customer beforehand disclosing its capacity as well as the method it planned to use to clarify its capacity at the time of the recommendation. Similarly, although Regulation Best Interest requires a broker-dealer to disclose, prior to or at the time of a recommendation, all material facts relating to the scope and terms of the relationship with the retail customer and relating to conflicts of interest that are associated with the recommendation, we recognize that in some instances a broker-dealer may not have all the material facts at the time of the recommendation, or that such disclosure is provided to the retail customer pursuant to an existing regulatory obligation, such as the delivery of a product prospectus or a trade confirmation, after the execution of the trade.300 In the Proposing Release we stated that in circumstances where a broker-dealer determines to provide an initial, more general disclosure (such as a relationship guide) followed by specific information in a subsequent disclosure that is provided after the recommendation (e.g., a trade confirmation) the initial disclosure should address when and how a brokerdealer would provide more specific information regarding the material fact or conflict in a subsequent disclosure (e.g., after the trade in the trade confirmation). We noted also that whether there is sufficient disclosure in both the initial disclosure and any subsequent disclosure would depend on the facts and circumstances. We continue to believe that some flexibility with respect to the provision by broker-dealers of written and oral disclosure, as well as with respect to the timing that disclosure is made, is appropriate in certain circumstances, such as when a broker-dealer updates its written disclosures orally in order to reflect facts not reasonably known at the time the written disclosure is provided. 300 See infra footnote 525. VerDate Sep<11>2014 20:12 Jul 11, 2019 Jkt 247001 In such circumstances, a broker-dealer may satisfy its Disclosure Obligation by making supplemental oral disclosure not later than the time of the recommendation, provided that the broker-dealer maintains a record of the fact that oral disclosure was provided to the retail customer.301 In addition, in the limited instances where existing regulations permit disclosure after the recommendation is made (e.g., trade confirmation, prospectus delivery), a broker dealer may satisfy its Disclosure Obligation regarding the information contained in the applicable disclosure document by providing such document to the retail customer after the recommendation is made. Before supplementing, clarifying or updating written disclosures in the limited circumstances described above, brokerdealers must provide an initial disclosure in writing that identifies the material fact and describes the process through which such fact may be supplemented, clarified or updated. For example, with regard to productlevel fees, a broker-dealer could provide an initial standardized disclosure of product-level fees generally (e.g., reasonable dollar or percentage ranges), noting that further specifics for particular products appear in the product prospectus, which will be delivered after a transaction in accordance with the delivery method the retail customer has selected, such as by mail or electronically.302 Similarly, with regard to the disclosure of a brokerdealer’s capacity, a dual-registrant could disclose that recommendations will be made in a broker-dealer capacity unless otherwise expressly stated at the time of the recommendation, and that any such statement will be made orally. Or, a broker-dealer could disclose that its associated persons may have conflicts of interest beyond than those disclosed by the broker-dealer, and that associated persons will disclose, where appropriate, any additional material conflicts of interest not later than the time of a recommendation, and that any such disclosure will be made orally. 301 See Section II.D, Record-Making and Recordkeeping. 302 While using a percentage or dollar range to describe a fee can be appropriate, that range should be designed to reasonably reflect the actual fees to be charged. For example, if the firm offers in almost all instances funds with up-front sales charges of between 5% and 5.5%, but the disclosure states that mutual fund up-front sales charges may ‘‘range from 0.0% to 5.5%,’’ then the broker-dealer would need to evaluate whether the disclosure should be revised to more accurately describe the sales charge. See discussion in Section II.C.1.a, Disclosure Obligation, Material Facts Regarding Scope and Terms of the Relationship, Fees and Costs, Particularly of Fees and Costs Disclosed. PO 00000 Frm 00032 Fmt 4701 Sfmt 4700 We believe it is in the public interest and consistent with the protection of investors to permit such flexibility in the delivery of information pursuant to the Disclosure Obligation. Providing retail customers written summary information about material facts relating to a recommendation and indicating that additional information will be forthcoming, the point at which the additional information will be delivered, and the method by which it will be conveyed, highlights for retail customers a useful summary of information while allowing for the practical realities of the process by which securities recommendations are made and transactions are executed and leaving longstanding existing disclosure regimes, particularly those relating to product issuer disclosure, undisturbed. Other Liabilities Under the Federal Securities Laws Further, the requirements under Regulation Best Interest that particular information be disclosed is not determinative of a broker-dealer or associated person’s other potential liabilities under the general antifraud provisions of the federal securities laws for failure to disclose material information to a customer at the time of a recommendation.303 In addition, we 303 Broker-dealers are liable under the antifraud provisions for failure to disclose material information to their customers when they have a duty to make such disclosure. See Basic v. Levinson, 485 U.S. 224, 239 footnote 17 (1988) (‘‘Silence, absent a duty to disclose, is not misleading under Rule 10b–5.’’); Chiarella v. U.S., 445 U.S. 222, 228 (1980) (explaining that a failure to disclose material information is only fraudulent if there is a duty to make such disclosure arising out of ‘‘a fiduciary or other similar relation of trust and confidence’’); SEC v. Monarch Funding Corp., 192 F.3d 295, 308 (2d Cir. 1999) (explaining that defendant is liable under Section 10(b) and Rule 10b-5 for material omissions ‘‘as to which he had a duty to speak’’). Generally, under the antifraud provisions, a broker-dealer’s duty to disclose material information to its customer is based upon the scope of the relationship with the customer, which is fact intensive. See, e.g., Conway v. Icahn & Co., Inc., 16 F.3d 504, 510 (2d Cir. 1994) (‘‘A broker, as agent, has a duty to use reasonable efforts to give its principal information relevant to the affairs that have been entrusted to it.’’). For example, where a broker-dealer processes its customers’ orders, but does not recommend securities or solicit customers, then the material information that the broker-dealer is required to disclose is generally narrow, encompassing only the information related to the consummation of the transaction. See, e.g., Press v. Chemical Inv. Servs. Corp., 166 F.3d 529, 536 (2d Cir. 1999). However, courts have found that a broker-dealer’s duty to disclose material information under the antifraud provisions is broader when the broker-dealer is making a recommendation to its customer. See, e.g., Hanly, 415 F.2d 589, 597 (2d Cir. 1969). When recommending a security, broker-dealers generally are liable under the antifraud provisions if they do not give ‘‘honest and complete information’’ or disclose any material adverse facts or material conflicts of interest, including any economic self- E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations remind broker-dealers that even full and fair disclosure of the information required by the Disclosure Obligation is not sufficient, standing alone, to satisfy the Care Obligation, and that even sufficient disclosure cannot cure a violation of the Care Obligation. Disclosures by Natural Persons Associated With a Broker-Dealer jbell on DSK3GLQ082PROD with RULES2 The Disclosure Obligation applies to a broker, dealer, or natural person who is an associated person of a broker or dealer.304 As stated in the Proposing Release, we are requiring not only the broker-dealer entity, but also individuals who are associated persons of a broker-dealer (e.g., registered representatives) to comply with specified components of Regulation Best Interest when making recommendations to retail customers.305 One commenter requested guidance on how an associated person should comply with the Disclosure Obligation.306 In response, we believe that a natural person who is an associated person of a broker-dealer may in many instances rely on the disclosures provided by the broker-dealer with which he or she is associated to satisfy the Disclosure Obligation. However, when an associated person knows or should have known that the broker-dealer’s disclosure is insufficient to describe ‘‘all material facts,’’ the associated person must supplement that disclosure. For example, if an associated person of a broker-dealer that offers a full range of securities products is licensed solely as a Series 6 Registered Representative,307 and can sell only mutual funds, variable annuities and other enumerated products, that limitation on the scope of services provided by the particular associated person must be sufficiently clear in the broker-dealer’s disclosures; otherwise additional clarifying interest. See, e.g., De Kwiatkowski v. Bear, Stearns & Co., 306 F.3d 1293, 130 (2d Cir. 2002); Chasins v. Smith, Barney & Co., 438 F.2d 1167, 1172 (2d Cir. 1970). See Proposing Release at 21599 footnote 176. 304 Rule 15l–1(a)(2)(i). 305 Proposing Release at 21592. 306 See NASAA August 2018 Letter (recommending that the Commission provide specific instructions on how associated persons should disclose capacity in which they are acting). 307 A candidate who passes the Series 6 exam is qualified for the solicitation, purchase and/or sale of the following securities products: Mutual funds (closed-end funds on the initial offering only), Variable annuities, Variable life insurance, Unit investment trusts (UITs), Municipal fund securities (e.g., 529 savings plans, local government investment pools (LGIPs)). FINRA, Series 6— Investment Company and Variable Contracts Products Representative Exam, Permitted Activities, available at: https://www.finra.org/industry/series6 #permitted-activities. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 33349 disclosure by the associated person would be necessary. securities offered 312 and account monitoring services.313 As discussed below, in response to a. Material Facts Regarding Scope and comments, we have revised the Terms of the Relationship Disclosure Obligation to require disclosure of ‘‘all material facts relating As discussed above, the proposed to the scope and terms of the Disclosure Obligation would require a relationship with the retail customer, broker-dealer to, among other things, including: (i) That the broker, dealer or ‘‘prior to or at the time of such such natural person is acting as a recommendation, reasonably disclose to broker, dealer or an associated person of the retail customer, in writing, the a broker-dealer with respect to the material facts relating to the scope and recommendation; (ii) the material fees terms of the relationship with the retail and costs that apply to the retail customer.’’ We proposed to consider the customer’s transactions, holdings, and following to be examples of material accounts; and (iii) the type and scope of facts relating to the scope and terms of services provided to the retail customer, the relationship with the retail including any material limitations on customer: (i) That the broker-dealer was the securities or investment strategies acting in a broker-dealer capacity with involving securities that may be recommended to the retail respect to the recommendation; (ii) fees customer.’’ 314 In addition, we are and charges that would apply to the retail customer’s transactions, holdings, clarifying the scope of the obligation. As we did in the Proposing Release, and accounts; and (iii) the type and we emphasize that although we have scope of services provided by the explicitly identified the capacity in broker-dealer, including, for example, monitoring the performance of the retail which the broker-dealer is acting, material fees and costs, and the type and customer’s account. scope of services, as what would at a Commenters requested that we clarify minimum be required to be disclosed as which facts a broker-dealer would be ‘‘material facts relating to the scope and required to disclose about the scope and terms of the relationship with the retail terms of the relationship it has with a customer,’’ the Disclosure Obligation customer under Regulation Best requires broker-dealers and associated Interest.308 In particular, several persons to disclose ‘‘all material facts commenters recommended that the relating to the scope of the terms of the Commission clarify how a dualrelationship,’’ (emphasis added) and broker-dealers and such associated registrant should disclose its capacity regarding its recommendations.309 Other persons thus will need to consider, based on the facts and circumstances, commenters recommended that the whether there are other material facts Commission define the scope of fees a relating to the scope and terms of the broker-dealer must disclose 310 and the relationship with the retail customer form that disclosure should take.311 In that need to be disclosed. This analysis addition, some commenters requested generally should include consideration clarity on the types of services that a of whether information in the broker-dealer would be required to Relationship Summary constitutes a disclose, including limitations on ‘‘material fact’’ that could appropriately be expanded upon in satisfying the Disclosure Obligation. It would be possible, but would be unlikely for most 308 See, e.g., SIFMA August 2018 Letter; Edward Jones Letter; NASAA August 2018 Letter; AARP August 2018 Letter; PIABA Letter; Prudential Letter. 309 See, e.g., SIFMA August 2018 Letter; Edward Jones Letter. 310 See, e.g., Bank of America Letter (recommending that the Commission apply a ‘‘materiality’’ threshold to determine which fees should be disclosed). 311 See, e.g., SIFMA August 2018 Letter (stating that a broker-dealer’s disclosure of a range of customer costs per product should be sufficient); CFA August 2018 Letter (stating a broker-dealer’s disclosure of percentages or ranges of cost information would do little to enlighten investors about the true costs of brokers’ advice services). PO 00000 Frm 00033 Fmt 4701 Sfmt 4700 312 See, e.g., NY Life Letter (stating that an insurer may appropriately focus its career agents on the distribution of variable insurance products that the insurer manufactures, so long as limitations on the universe of available products are disclosed to consumers and supervisory procedures are in place to ensure that a variable insurance product is in the client’s best interest); CFA Institute Letter (stating that the Disclosure Obligation should complement the information presented in Form CRS and provide greater specificity about, among other things, the type and scope of services offered by the brokerdealer). 313 See, e.g., IAA August 2018 Letter (recommending that the Commission clarify that Regulation Best Interest would apply to all advisory activities that broker-dealers agree to provide (e.g., ongoing monitoring for purposes of recommending changes in investments)). 314 Rule 15l–1(a)(2)(i)(A). E:\FR\FM\12JYR2.SGM 12JYR2 33350 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations broker-dealers, for the abbreviated format of the Relationship Summary to sufficiently disclose ‘‘all material facts’’ regarding the scope and terms of the relationship such that no further information would be required to satisfy the Disclosure Obligation. Capacity In Which the Broker-Dealer Is Acting In the Proposing Release, the Commission identified that the capacity in which a broker-dealer is acting is a material fact relating to the scope and terms of a customer relationship subject to the Disclosure Obligation.315 In so identifying this critical element of information, we hoped to promote greater awareness among retail customers of the capacity in which their financial professional or firm acts with respect to recommendations. Several commenters requested additional guidance on how dualregistrants and their associated persons could comply with the proposed Disclosure Obligation in this respect.316 Some commenters stated that repeated disclosures of capacity would distract customers from more important disclosures related to a recommendation and could lead to confusion.317 While we received comments expressing concerns that our proposed approach might lead to investor confusion,318 many of these commenters were seeking clarity regarding this requirement and not its elimination.319 315 Proposing Release at 21601. e.g., NASAA August 2018 Letter (requesting that the Commission provide guidance to associated persons of dual-registrants explaining how they should disclose the capacity in which they are acting and whether they are providing a recommendation or advice); Better Markets August 2018 Letter; CFA August 2018 Letter; Fidelity Letter; IPA Letter; SIFMA August 2018 Letter; Edward Jones Letter; CCMC Letters. 317 See, e.g., Edward Jones Letter (recommending that the Commission not require repeated capacity disclosures to customers because it would be redundant and potentially confuse customers); SIFMA August 2018 Letter (stating that disclosure of capacity should not be required at the time of the recommendation as it would cause unnecessary delay and distract customers from more important disclosures regarding account features and recommendations); Better Markets August 2018 Letter (stating that one-time written disclosure about a dual-registrant’s advisory capacity, followed by future oral disclosures when they change roles when making recommendations would be confusing). 318 See, e.g., Better Markets August 2018 Letter; CFA August 2018 Letter (stating that flexibility in disclosure will result in disclosures that do not effectively convey key information especially for dual-registrants as customers will not understand the capacity the dual-registrant is acting in at the particular time or its significance). 319 See, e.g., SIFMA August 2018 Letter (requesting that the Commission clarify the application of the Disclosure Obligation to dually registered firms and personnel, including what, and jbell on DSK3GLQ082PROD with RULES2 316 See, VerDate Sep<11>2014 20:12 Jul 11, 2019 Jkt 247001 In response to commenters, we are revising Regulation Best Interest to explicitly require disclosure of capacity, which the Proposing Release addressed in guidance. Therefore, Rule 15l– 1(a)(2)(i)(A) requires that the broker, dealer, or natural person who is an associated person of a broker or dealer, prior to or at the time of the recommendation, provide the retail customer, in writing, full and fair disclosure of all material facts relating to the scope and terms of the relationship with the retail customer, including that the broker-dealer or such natural person is acting as a brokerdealer or an associated person of a broker-dealer with respect to the recommendation. This disclosure is designed to improve awareness among retail customers of the capacity in which their financial professional or broker-dealer acts when it makes recommendations so that the retail customer can more easily identify and understand their relationship, a goal shared with the Relationship Summary.320 Form CRS requires a firm to state the name of the broker-dealer or investment adviser and whether the firm is registered with the Commission as a broker-dealer, investment adviser, or both.321 A standalone broker-dealer (i.e., a brokerdealer not also registered as an investment adviser) will generally be able to satisfy the Disclosure Obligation’s requirement to disclose the broker-dealer’s capacity by delivering the Relationship Summary to the retail customer. For broker-dealers who are dually registered, and for associated persons who are either dually registered or, who are not dually registered but only offer broker-dealer services through a firm that is dually registered, the information contained in the Relationship Summary will not be sufficient to disclose their capacity in making a recommendation. Although some commenters expressed concerns about potential investor confusion caused by ‘‘additional’’ disclosure regarding a dual-registrant’s capacity, we believe that the Disclosure Obligation will not duplicate or confuse, but instead will provide clarifying detail on capacity to supplement the information contained in the Relationship Summary. Accordingly, we are clarifying that dually registered associated persons and associated persons who are not dually registered how frequently, disclosure is required to put customer on notice of their capacity); Edward Jones Letter; IPA Letter; CCMC Letters. 320 See Relationship Summary Proposal at 21420. 321 See Relationship Summary Adopting Release at Section II.C. PO 00000 Frm 00034 Fmt 4701 Sfmt 4700 but only offer broker-dealer services through a firm that is dually registered as an investment adviser with the Commission or with a state, must disclose whether they are acting (or, in the case of the latter, that they are only acting) as an associated person of a broker-dealer to satisfy the Disclosure Obligation.322 An associated person of a dual-registrant who does not offer investment advisory services must disclose that fact as a material limitation in order to satisfy the Disclosure Obligation. Furthermore, as discussed in greater detail below, we would presume the use of the terms ‘‘adviser’’ and ‘‘advisor’’ by (1) a broker-dealer that is not also registered as an investment adviser or (2) a financial professional that is not also a supervised person of an investment adviser to be a violation of the Disclosure Obligation under Regulation Best Interest. Disclosure of capacity may, in part, be made orally under the circumstances outlined in Section II.C.1, Oral Disclosure or Disclosure After a Recommendation. For example, a broker-dealer may disclose that: ‘‘All recommendations will be made in a broker-dealer capacity unless otherwise expressly stated at the time of the recommendation; any such statement will be made orally.’’ In this case, no further oral or written disclosure would be required until a recommendation is made in a capacity other than as a broker-dealer. Similarly, a broker-dealer may disclose that: ‘‘All recommendations regarding your brokerage account will be made in a broker-dealer capacity, and all recommendations regarding your advisory account will be in an advisory capacity. When we make a recommendation to you, we will expressly tell you orally which account we are discussing’’). In this instance, no further disclosure of capacity is necessary. Capacity in the Context of Names, Titles, and Marketing Practices The Relationship Summary Proposal included a proposed rule that would have restricted broker-dealers and their associated persons (unless they were registered as, or supervised persons of, an investment adviser), when communicating with a retail investor, 322 Financial professionals with registrations to offer services as a representative of a broker-dealer and investment adviser may offer services through a dual-registrant, affiliated firms, or unaffiliated firms, or only offer one type of service notwithstanding their dual licensing. Financial professionals who are not dually registered may offer one type of service through a firm that is dually registered. See Relationship Summary Adopting Release at Section II.B.4. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 from using the term ‘‘adviser’’ or ‘‘advisor’’ as part of a name or title (‘‘Titling Restrictions’’).323 After further consideration of our policy goals and the comments we received, and in light of the disclosure requirements under Regulation Best Interest, we do not believe that adopting a separate rule restricting these terms is necessary, because we presume that the use of the term ‘‘adviser’’ and ‘‘advisor’’ in a name or title by (1) a broker-dealer that is not also registered as an investment adviser or (2) an associated person that is not also a supervised person of an investment adviser, to be a violation of the capacity disclosure requirement under the Disclosure Obligation as discussed further below.324 We received several comments on the proposed Titling Restrictions, which we have also considered when determining to presume use of such names and titles to be a violation of the capacity disclosure.325 Some commenters supported a restriction on the terms ‘‘adviser’’ and ‘‘advisor,’’ noting, for 323 See Relationship Summary Proposal, supra footnote 12, at 21461–63. We also requested comment on whether we should explicitly restrict other terms, including ‘‘wealth manager’’ and ‘‘financial consultant.’’ Additionally, we requested comment on whether we should restrict terms that are synonymous with ‘‘adviser’’ or ‘‘advisor.’’ 324 We recognize that, in adopting the fee-based brokerage rule in 2005, we declined to place any limitations on how a broker-dealer may hold itself out or the titles it may employ. Certain BrokerDealers Deemed Not to Be Investment Advisers, Advisers Act Release No. 2376 (Apr. 12, 2005). However, as we noted in the Relationship Summary Proposal, comments we received in response to Chairman Clayton’s request for comment and our experience prompted us to revisit our approach from 2005. In addition, given that the new disclosure requirements under Regulation Best Interest and Form CRS will and should necessitate a reassessment of a broker-dealer’s names, titles, and communications with its customers, we believe it is necessary to re-evaluate the appropriateness of these practices in light of these new obligations. See also generally Relationship Summary Proposal, supra footnote 12, at 21459–61 (citing commenters and studies by the Siegel and Gale Consulting Group and the RAND Corporation that document investor confusion in the marketplace, all of which were conducted subsequent to the 2005 fee-based brokerage rule); Public Comments from Retail Investors and Other Interested Parties on Standards of Conduct for Investment Advisers and BrokerDealers, Chairman Jay Clayton (Jun. 1, 2017), available at https://www.sec.gov/news/publicstatement/statement-chairman-clayton-2017-05-31. We also proposed rules (the ‘‘Affirmative Disclosures’’) that would have required a brokerdealer and an investment adviser to prominently disclose that it is registered as a broker-dealer or investment adviser, as applicable, with the Commission in print or electronic retail investor communications. As we discuss in a concurrent rulemaking, we are not adopting the Affirmative Disclosures. See Relationship Summary Adopting Release, supra footnote 12, at Section III. 325 See, e.g., CFA August 2018 Letter; IAA August 2018 Letter; LPL August 2018 Letter; Letter from Dennis M. Kelleher, President and CEO, et al., Better Markets (Aug. 7, 2018) (‘‘Better Markets CRS Letter’’). VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 example, that these particular terms are often associated with the statutory term ‘‘investment adviser,’’ 326 or that investors ‘‘typically associate’’ these terms with registered investment advisers.327 A few commenters generally noted that the title ‘‘financial advisor’’ prevents investors from understanding whether they are engaging a financial professional who provides advisory services or who sells brokerage services.328 Moreover, other commenters generally stated that names and titles containing ‘‘adviser’’ or ‘‘advisor’’ create investor confusion and/or could mislead investors about the differences between broker-dealers and investment advisers including the applicable standard of care 329 and the services to be provided.330 Other commenters did not support the proposed Titling Restrictions, believing that the terms ‘‘adviser’’ and ‘‘advisor’’ are more generically used and understood, and refer to financial professionals who provide advice and financial services more generally.331 Several of these commenters stated that the restriction adds little additional investor protection when taken together with Regulation Best Interest and Form CRS (i.e., it is duplicative).332 326 See Letter from Lexie Pankratz, Owner, Trailhead Consulting, LLC (Aug. 7, 2018) (‘‘Trailhead Letter’’). 327 See, e.g., Letter from Kurt N. Schacht, Managing Director, et al., CFA Institute (Aug. 7, 2018) (‘‘CFA Institute CRS Letter’’); Pickard Letter. 328 See, e.g., Letter from Gerald Lopatin (Jul. 30, 2018) (‘‘Lopatin Letter’’); Letter from Paula Hogan (Aug. 6, 2018) (‘‘Hogan Letter’’); Letter from Arlene Moss (Jul. 31, 2018) (‘‘Moss Letter’’); Letter from Daniel Wrenne (Jul. 31, 2018) (‘‘Wrenne Letter’’). 329 See, e.g., FSI August 2018 Letter; Schwab Letter; CFA Institute CRS Letter; Betterment Letter. 330 See, e.g., NASAA August 2018 Letter (stating that ‘‘[t]his rule change will help forestall retail investors’ confusion about the different roles and duties owed by broker-dealers/agents and investment advisers/investment adviser Representatives’’); CFA Institute CRS Letter (stating that ‘‘[i]nvestor confusion about the roles and duties of different financial services providers who use ‘‘adviser/advisor’’ in their titles has become problematic from both an investor protection and trust standpoint. Use of the proposed CRS, alone, will not allay the substantial investor confusion in the marketplace about the differences between broker-dealers and investment advisers.’’) 331 See LPL August 2018 Letter (stating that ‘‘restricting use of ‘advisor’ and ‘adviser’ is contrary to the plain English meaning the average investor associates with those terms . . . regardless of the legal contours of the service relationship.’’); NAIFA Letter (stating that ‘‘[m]any financial professionals are recognized as and/or refer to themselves as ‘advisors/advisers’ or ‘financial advisors/advisers.’ These words are (aptly) used by professionals who offer advice on any number of financial topics.’’); Letter from Investments & Wealth Institute (‘‘IWI’’) (Aug. 6, 2018) (‘‘IWI August 2018 Letter’’) (stating that an outright ban on the use of the terms ‘‘adviser’’ and ‘‘advisor’’ by broker-dealers would raise First Amendment concerns). 332 See, e.g., Letter from Robert D. Oros, Chief Executive Officer, HD Vest Financial Services (Aug. PO 00000 Frm 00035 Fmt 4701 Sfmt 4700 33351 Additionally, some commenters stated that Form CRS alone provides similar investor protections that alleviate the need for the restriction.333 Along similar lines, one commenter stated that certain fraud-based securities laws and FINRA rules provide the same protections that the proposed restriction seeks to add, making it unnecessary.334 We also received several comments on the following alternative approaches to the Titling Restrictions on which we sought comment: (i) A broker-dealer that used the terms ‘‘adviser’’ or ‘‘advisor’’ as part of a name or title would not be considered to provide investment advice solely incidental to the conduct of its business as a broker-dealer, and (ii) a broker-dealer would not be providing investment advice solely incidental to its brokerage business if it ‘‘held itself out’’ as an investment adviser to retail investors.335 This second alternative approach would have resulted in a restriction generally broader in scope than the Titling Restrictions, as it would also have encompassed communications and sales practices in addition to the use of names and titles. In response to these alternatives, several commenters stated that the Titling Restrictions were too narrow in meeting the Commission’s intended objective of mitigating the risk that investors could be misled by the use of certain names and titles because the Titling Restrictions did not address other confusing names or titles,336 and, 7, 2018) (‘‘HD Vest Letter’’); LPL August 2018 Letter; SIFMA August 2018 Letter. But see Pickard Letter (supporting the restriction and our proposed alternative holding out approach by noting that ‘‘[w]e do not think that Reg BI or Form CRS as currently proposed is sufficient.’’) 333 See, e.g., LPL August 2018 Letter; Morgan Stanley Letter; Raymond James Letter. 334 See Cambridge Letter. 335 See Relationship Summary Proposal, supra footnote 12, at 21463–64. We are not adopting the proposed alternative approach that would have restricted a broker-dealer from availing itself of the solely incidental exclusion if it ‘‘held itself out’’ as an investment adviser. Use of the terms ‘‘adviser’’ or ‘‘advisor,’’ however, could support a conclusion depending on other facts and circumstances, that the primary business of the firm is advisory in nature, in which case the advice provided by the broker-dealer would not be solely incidental to the conduct of its brokerage business. See Solely Incidental Interpretation, supra footnote 12, at Section II.B (providing the Commission’s interpretation of the solely incidental prong of the broker-dealer exclusion from the Advisers Act). 336 See e.g., Letter from Barbara Roper, Director of Investor Protection, and Micah Hauptman, Financial Services Counsel, (Dec. 7, 2018) (‘‘CFA December 2018 Letter’’); State Treasurers Letter; Waters Letter (noting that the Titling Restrictions are too narrow of a fix for investor confusion because they fail ‘‘to address the numerous other titles professionals use. . . . As a result, most retail investors cannot easily distinguish between E:\FR\FM\12JYR2.SGM Continued 12JYR2 33352 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations more specifically, because the Titling Restrictions did not address the brokerdealers who ‘‘hold themselves out’’ as investment advisers.337 Several of these commenters instead advocated for precluding reliance on the solely incidental prong by any broker-dealer that holds itself out as an investment adviser.338 Some commenters stated that certain marketing practices indicate that advice is the main function of the broker-dealer’s service.339 Additionally, one commenter stated that ‘‘the potential for investor confusion is at its greatest when dealing with brokerdealers and dual-registrants that routinely market their services as advisory in nature. . . .’’ 340 jbell on DSK3GLQ082PROD with RULES2 Use of Terms ‘‘Adviser’’ or ‘‘Advisor’’ Financial firms and their professionals, including broker-dealers and investment advisers, seek to acquire new customers and to retain existing customers by marketing their services, financial advisers who are mere salespeople and those that are investment advisers that must provide advice that is in the best interests of the investor.’’). See also NAIFA Letter (noting that restricting these terms for broker-dealers and their financial professionals only ‘‘and not for numerous other professionals using those words and delivering advice on a wide variety of financial topics creates more consumer confusion and does not enhance consumers’ understanding of the specific obligations and standards that apply to their advisor(s).’’) Additionally, several of the commenters who supported the restriction recommended modifications such as broadening the restriction to include other terms, including ‘‘wealth manager’’ and ‘‘financial consultant.’’ See, e.g., Financial Engines Letter; Comment Letter of Altruist Financial Advisors LLC (Aug. 7, 2018) (‘‘Altruist Letter’’); Letter from David John Marotta (April 22, 2018) (‘‘Marotta Letter’’); Galvin Letter; Letter from Pamela Banks, Senior Policy Counsel, Consumers Union (Oct. 19, 2018) (‘‘Consumers Union Letter’’). 337 See, e.g., CFA August 2018 Letter; FPC Letter; IAA August 2018 Letter; Letter from Michael Kitces (Aug. 2, 2018) (‘‘Kitces Letter’’); LPL August 2018 Letter; MarketCounsel Letter; Waters Letter. 338 See, e.g., IAA August 2018 Letter (noting that ‘‘[w]hile names or titles are contributing factors to investor confusion and the potential for investors to be misled, we believe that other factors should be considered as well. In particular, previous studies noted the confusion arising from ‘we do it all’ advertisements and ‘marketing efforts which depicted an ongoing relationship between the broker-dealer and the investor.’ ’’); Betterment Letter; CFA August 2018 Letter; LPL August 2018 Letter. 339 See CFA August 2018 Letter (citing to Micah Hauptman and Barbara Roper, Financial Advisor or Investment Salesperson? Brokers and Insurers Want to Have it Both Ways, January 18, 2017). See also Better Markets CRS Letter (stating that titles present a professional as not ‘‘only an expert in financial matters but also someone who will offer advice and recommendations’’); Letter from Michael Palumbo (Aug. 7, 2018) (‘‘Palumbo Letter’’); Kitces Letter. 340 See CFA August 2018 Letter. See also CFA Institute CRS Letter (stating that the proposal should address ‘‘those who may not expressly refer to themselves as ‘adviser/[advis]or’ but through their actions convey that meaning to investors. . . .’’). VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 including through the use of particular terms in names and titles. Firms often spend time and money to market, brand, and create intellectual property by using these terms in an effort to shape investor expectations.341 A name or title is generally used, and is designed to have significance, on its own without any additional context as to what it means. Given that the titles ‘‘adviser’’ and ‘‘advisor’’ are closely related to the statutory term ‘‘investment adviser,’’ their use by broker-dealers can have the effect of erroneously conveying to investors that they are regulated as investment advisers, and have the business model, including the services and fee structures, of an investment adviser.342 Such potential effect undermines the objective of the capacity disclosure requirement under Regulation Best Interest to enable a retail customer to more easily identify and understand their relationship. As discussed above, the Disclosure Obligation requires broker-dealers to make full and fair disclosure of all material facts relating to the scope and terms of the relationship with a retail customer, including the capacity in which they are acting with respect to a recommendation. The capacity disclosure requirement is designed to improve awareness among retail customers of the capacity in which their firm and/or financial professional acts when it makes recommendations so that a retail customer can more easily identify and understand their relationship.343 We believe that in most cases broker-dealers and their financial professionals cannot comply with the capacity disclosure requirement by disclosing that they are a broker-dealer while calling themselves an ‘‘adviser’’ or ‘‘advisor.’’ Under the Disclosure 341 See, e.g., Letter from Barbara Roper, Director of Investor Protection, and Micah Hauptman, Financial Services Counsel, CFA (Sep. 14, 2017) (‘‘CFA September 2017 Letter’’) (‘‘[O]ur study documents how everything from the titles brokers use to the way they describe their services is designed to send the message that they are in the business of ‘providing expert investment advice, comprehensive financial planning, and retirement planning that is based on their clients’ needs and goals and that is designed to serve their best interests.’ ’’) 342 See Relationship Summary Proposal, supra footnote 12, at 21461. 343 Similarly, Form CRS is designed to reduce retail investor confusion in the marketplace for brokerage and investment advisory services and to assist retail investors with the process of deciding whether to engage, or to continue to engage, a particular firm or financial professional and whether to establish, or to continue to maintain, an investment advisory or brokerage relationship. A broker-dealer firm or financial professional’s use of ‘‘adviser’’ or ‘‘advisor’’ in its name or title would inhibit a customer’s full understanding of the contours of his or her relationship with the firm and financial professional, undermining Form CRS. PO 00000 Frm 00036 Fmt 4701 Sfmt 4700 Obligation, a broker-dealer, or an associated person, must, prior to or at the time of the recommendation, disclose that the broker-dealer or that associated person is acting as a broker or dealer with respect to the recommendation.344 When a brokerdealer or an associated person uses the name or title ‘‘adviser’’ or ‘‘advisor’’ there are few circumstances 345 in which that broker-dealer or associated person would not violate the capacity disclosure requirement because the name or title directly conflicts with the information that the firm or professional would be acting in a broker-dealer capacity.346 Therefore, use of the titles ‘‘adviser’’ and ‘‘advisor’’ by brokerdealers and their financial professionals would undermine the objectives of the capacity disclosure requirement by potentially confusing a retail customer as to type of firm and/or professional they are engaging, particularly since ‘‘investment adviser’’ is defined by statute separately from ‘‘broker’’ or ‘‘dealer.’’ As a result,347 we presume that the use of the terms ‘‘adviser’’ and ‘‘advisor’’ in a name or title by (i) a broker-dealer that is not also registered as an investment adviser or (ii) an associated person that is not also a supervised person of an investment adviser to be a violation of the capacity disclosure requirement under Regulation Best Interest.348 344 See Rule 15l–1(a)(2)(i)(A)(i). infra footnotes 349–351 and accompanying text. 346 In the Relationship Summary Proposal, we stated that our proposed restriction on the terms ‘‘adviser’’ and ‘‘advisor’’ would not have applied to broker-dealers when communicating with institutions. See Relationship Summary Proposal, supra footnote 12, at 21462. Given that Regulation Best Interest and the Relationship Summary apply only to retail customers and retail investors, respectively, our presumption would only apply to the use of ‘‘adviser’’ and ‘‘advisor’’ in such contexts. Therefore, we do not believe that further clarification of communications by non-retail focused broker-dealers is necessary. 347 Specifically, in the Proposing Release we stated that a standalone broker-dealer would satisfy the capacity disclosure by complying with the proposed Relationship Summary and Affirmative Disclosure requirements. We provided this proposed guidance in the context of concurrently proposing the Titling Restrictions. For the reasons discussed herein, we believe a presumption against the use of these titles by standalone broker-dealers is more appropriate than a restriction. 348 If a financial professional is a registered representative of a broker-dealer that is a dualregistrant but the professional is not also a supervised person of an investment adviser, this professional would similarly be presumptively in violation of the capacity disclosure requirement if the financial professional uses the title ‘‘adviser’’ or ‘‘advisor.’’ However, this financial professional may continue to use either the dual-registrant’s materials or may use the firm’s name in the financial professional’s communications even if the firm’s name includes the title ‘‘adviser’’ or ‘‘advisor’’ 345 See E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 Although using these names or titles creates a presumption of a violation of the Disclosure Obligation in Regulation Best Interest, we are not expressly prohibiting the use of these names and titles by broker-dealers because we recognize that some broker-dealers use them to reflect a business of providing advice other than investment advice to retail clients. A clear example is a broker-dealer (or associated person) that acts on behalf of a municipal advisor 349 or commodity trading adviser,350 or as an advisor to a special entity,351 as these are distinct advisory roles specifically defined by federal statute that do not entail providing investment advisory services. We also recognize that a broker-dealer may provide advice in other capacities outside the context of investment advice to a retail customer that would present a similarly compelling claim to the use of these terms. In these circumstances, firms and their financial professionals may in their discretion use the terms ‘‘adviser’’ or ‘‘advisor.’’ 352 In most instances, however, when a broker-dealer uses these terms in its name or title in the context of providing investment advice to a retail customer, they will generally violate the capacity disclosure requirement under Regulation Best Interest. because such firm is dually registered as an investment adviser and broker-dealer and is not presumptively violating the capacity disclosure requirement under Regulation Best Interest. Moreover, we believe it would be consistent for dual-registrants and dually registered financial professionals to use these terms as they would be accurately describing their registration status as an investment adviser. 349 15 U.S.C. 78o–4(e)(4). 350 15 U.S.C. 80b–2(a)(29). 351 15 U.S.C. 78o–8(h)(2)(A). 352 Some commenters raised concerns that the proposed restriction would not permit financial professionals to indicate that they maintain particular certifications that include in the name or title ‘‘adviser’’ or ‘‘advisor.’’ See, e.g., IWI August 2018 Letter; Letter from IWI (Oct. 9, 2018) (‘‘IWI October 2018 Letter’’). Cf. Letter from John Robinson (Aug. 6, 2018) (‘‘Robinson Letter’’) (suggesting that the Commission limit the use of the term ‘‘financial planner’’ to investment adviser representatives); FPC Letter (suggesting that the Commission clarify which certifications or professional designations may be used for financial planners). We recognize that these designations are intended to convey adherence to particular standards that financial professionals have met. However, these designations are not rooted in any statutory construct (as are the titles ‘‘commodity trading advisor’’ and ‘‘municipal advisor’’) and given that the terms ‘‘adviser’’ and ‘‘advisor’’ are still associated with the statutory term ‘‘investment adviser,’’ even if used in a designation, a brokerdealer or associated person that uses these designations would similarly be in presumptive violation of the capacity disclosure requirement in Regulation Best Interest. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 Marketing Communications As discussed above, several commenters on the Titling Restrictions raised concerns that restricting the use of names and titles would be insufficient to address what they viewed as the larger issue of broker-dealer marketing communications where a broker-dealer and/or its financial professional appears to be holding itself out as an investment adviser. Marketing communications provide additional context to investors and are designed to persuade potential customers to obtain and pay for the firm’s services and products.353 They communicate to customers what services firms understand themselves to be providing—including, for brokerdealers, recommendations in connection with and reasonably related to effecting securities transactions. The way in which a broker-dealer markets itself may have regulatory consequences. As noted above, Form CRS requires, among other items, broker-dealers (and investment advisers) to state clearly key facts about their relationship, including their registration status and the services they provide.354 Broker-dealers (and investment advisers) will also be required through Form CRS to provide information to assist retail investors in deciding whether to engage in an investment advisory or brokerage relationship.355 Additionally and as discussed above, we are adopting the capacity disclosure requirement under Regulation Best Interest, which requires broker-dealers and their financial professionals to affirmatively disclose the capacity (e.g., brokerage) in which they are acting with respect to their recommendations.356 These obligations are designed to 353 Affiliated firms may market advisory and brokerage services in a single set of communications. A dually registered firm also may seek to market the primary services provided by its advisory and brokerage business lines in a single set of communications. We believe this combined approach to providing customers with information about investment services enhances customer choice, and we understand that many such firms market in this way in an effort to provide a comprehensive picture of the firm’s services. See also Instructions to Form CRS, General Instruction 5. (Encouraging dual-registrants to prepare one relationship summary discussing both its brokerage and investment advisory services, but stating that they may prepare two separate relationship summaries for brokerage services and investment advisory services. Whether the firm prepares one relationship summary or two, the firm must present the brokerage and investment advisory information with equal prominence and in a manner that clearly distinguishes and facilitates comparison of the two types of services.). 354 See Relationship Summary Adopting Release, supra footnote 12. 355 Id. 356 See Rule 15l–1(a)(2)(i)(A)(i). PO 00000 Frm 00037 Fmt 4701 Sfmt 4700 33353 improve awareness among retail customers of the capacity in which their firm or financial professional acts when it makes recommendations so that the retail customer can more easily identify and understand their relationship. As noted above, we are not adopting the Commission’s proposed alternative holding out approach that would have addressed broker-dealer marketing communications through the lens of the solely incidental exclusion.357 However, under our interpretation of the solely incidental prong of the broker-dealer exclusion from the definition of investment adviser, a broker-dealer’s investment advisory services do not fall within that prong if the broker-dealer’s primary business is giving investment advice or if its investment advisory services are not offered in connection with and are not reasonably related to the broker-dealer’s business of effecting securities transactions.358 By more clearly delineating when a brokerdealer’s performance of advisory activities renders it an investment adviser, this interpretation provides guidance that may be informative to broker-dealers when designing marketing communications that accurately reflect their activities. Broker-dealers, dual-registrants, and affiliated broker-dealers of investment advisers that market their services together should consider whether modifications are needed in their marketing communications in light of these new obligations. As we noted in the Relationship Summary Proposal, broker-dealers can, and do, provide investment advice so long as such advice comports with the broker-dealer exclusion under Advisers Act section 202(a)(11)(C). While broker-dealers and their financial professionals may state that they provide ‘‘advice’’ in their marketing communications, those and other statements should not be made in a manner that contradicts the disclosures made pursuant to Regulation Best Interest and Form CRS, and should be reviewed in light of the Solely Incidental Interpretation.359 We believe that the combination of new disclosure obligations and requirements and firms’ implementation of these new obligations will appropriately address commenters’ concerns regarding brokerdealers that hold themselves out as 357 See supra footnote 335 and accompanying text. 358 See Solely Incidental Interpretation, supra footnote 12, Section II.B (providing the Commission’s interpretation of the solely incidental prong of the broker-dealer exclusion from the Advisers Act.) 359 See Relationship Summary Proposal, supra footnote 12, at 21461. E:\FR\FM\12JYR2.SGM 12JYR2 33354 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations investment advisers, particularly those who can change capacities when serving retail investors in a dual capacity.360 In addition to these new obligations, FINRA Rule 2210 (regarding its members’ communications with the public) is designed to ensure that broker-dealer communications with the public are fair, balanced, and not misleading.361 This rule includes general standards, such as a requirement to not make any false or misleading statements, and specific content standards, such as requirements on how to disclose the broker-dealer’s name in marketing communications.362 Accordingly, we anticipate that FINRA will be reviewing the application of these rules in light of these new disclosure obligations. The Commission staff also will evaluate broker-dealer marketing communications to consider whether additional measures may be necessary. jbell on DSK3GLQ082PROD with RULES2 Fees and Costs In the Proposing Release, we stated that fees and charges applicable to the retail customer’s transactions, holdings, and accounts would also be examples of ‘‘material facts relating to the terms and scope of the relationship’’ 363 As such, these fees and charges would generally have needed to be disclosed in writing prior to, or at the time of, the recommendation. While we did not propose to mandate the form, specific content, or method for delivering fee disclosure, we stated that we would generally expect that, to meet the Disclosure Obligation, broker-dealers would build upon the proposed Relationship Summary by disclosing, among other things, additional detail regarding the types of fees and charges described in the proposed Relationship Summary.364 We received a number of comments on the proposed Disclosure Obligation relating to fees and charges. As discussed in more detail in the relevant sections below, these comments generally sought clarity on the scope of fees and charges to be disclosed, including the particularity of the fees and charges to be disclosed (i.e., whether standardized or individualized disclosure would be required). In 360 See, e.g., IAA August 2018 Letter; FPC Letter; Better Markets CRS Letter. 361 See FINRA Rule 2210. Additionally, broker-dealers and their financial professionals should keep in mind the applicability of the antifraud provisions of the federal securities laws, including section 17(a) of the Securities Act, and Exchange Act Section 10(b) and Rule 10b–5 thereunder, to their marketing practices. 362 See, e.g., FINRA Rule 2210(d)(1) and (d)(3). 363 See Proposing Release at 21601. 364 See Proposing Release at 21600. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 consideration of the comments received, and in light of the obligations being imposed by the Relationship Summary, we are revising Regulation Best Interest to explicitly require the disclosure of fees and costs, and are providing additional clarifying guidance. In addition, we are revising the Regulation Best Interest rule text to refer to ‘‘fees and costs’’ instead of ‘‘fees and charges,’’ consistent with the approach taken in the Relationship Summary. Specifically, we are revising the Disclosure Obligation to require disclosure of ‘‘all material facts relating to the scope and terms of the relationship with the retail customer, including [. . .] the material fees and costs that apply to the retail customer’s transactions, holdings and accounts.’’ 365 We are also providing additional guidance addressing the scope of fees and costs to be disclosed. Namely, the Disclosure Obligation requires disclosure of material fees and costs relating to the retail customer’s transactions, holdings and accounts. This obligation would not require individualized disclosure for each retail customer. Rather, the use of standardized numerical and other nonindividualized disclosure (e.g., reasonable dollar or percentages ranges) is permissible, as discussed below.366 Scope of Fees and Costs To Be Disclosed Several commenters asked for clarification about whether all fees and charges must be disclosed, or only those that are ‘‘material.’’ 367 In response, we are revising Regulation Best Interest to make explicit that a material fact regarding the scope and terms of the relationship includes material fees and costs that apply to the retail customer’s transactions, holdings and accounts. As noted above, the standard for materiality for purposes of the Disclosure Obligation is consistent with the one the Supreme Court articulated in Basic v. Levinson; fees and costs are material and must be disclosed, if there is ‘‘a substantial likelihood that a reasonable shareholder would consider it important.’’ 368 As noted above, in the context of this Regulation Best Interest, the standard of materiality is based on 15l–1(a)(2)(i)(A)(ii). Section II.C.1.a, Disclosure Obligation, Fees and Costs, Particularity of Fees and Costs Disclosed; Individualized Disclosure. 367 See, e.g., Bank of America Letter (recommending that the Commission: (i) Provide greater specificity regarding the fees to be disclosed under Regulation Best Interest, and (ii) apply a ‘‘materiality’’ threshold to those fees). 368 Basic, Inc. v. Levinson, 485 U.S. 224, 224 (1988). PO 00000 365 Rule 366 See Frm 00038 Fmt 4701 Sfmt 4700 the retail customer, as defined in the rule. We would generally expect that, to satisfy the Disclosure Obligation, broker-dealers would build upon the material fees and costs identified in the Relationship Summary, providing additional detail as appropriate. These descriptions could include, for example, an explanation of how and when the fees are deducted from the customer’s account (e.g., such as on a pertransaction basis or quarterly). Although the fees and costs identified in the Relationship Summary may provide a useful starting point for the identification of the material fees and costs that may be disclosed pursuant to the Disclosure Obligation, there may be other categories of fees and costs that are material under the facts and circumstances of a broker-dealer’s business model that must be disclosed pursuant to the Disclosure Obligation. Particularity of Fees and Costs Disclosed; Individualized Disclosure Several commenters recommended that the Commission not require that broker-dealers provide individualized fee disclosures to retail customers. Specifically, they recommended that the Commission clarify that broker-dealers could meet the Disclosure Obligation if they provide a range of fees and costs or use standardized and hypothetical amounts rather than requiring disclosure of actual dollar amounts based on proposed amounts to be invested (i.e., individualized fees).369 These commenters cited concerns about cost and practicality associated with generating individualized disclosures.370 With regard to productlevel fees in particular, several commenters expressed concern that 369 See, e.g., Vanguard Letter (recommending that the Disclosure Obligation could be satisfied by relaying the types and ranges of costs associated with a recommendation, or by using standardized and hypothetical investments, rather than requiring computation of actual dollar amounts based on proposed amounts to be invested); Capital Group Letter (stating that customized mutual fund fee and expense disclosures for investors at the time of the recommendation would be impractical); SIFMA August 2018 (recommending the Commission permit disclosure of a range of customer costs per product); NASAA August 2018 Letter (suggesting that the Commission mandate its Model Fee Table along with disclosure of other fees paid for services and any other third party remuneration). 370 See, e.g., TIAA Letter (stating that brokerdealers would need to expend significant resources to build new systems and new compliance programs in order to provide individualized fee disclosure); ICI Letter (recommending that the Commission confirm that the Disclosure Obligation would not require a broker-dealer to separately calculate fund fees and expenses); Capital Group Letter (stating that individualized disclosures raise significant operational burdens and compliance issues in exchange for, at best, inconsistent utility). E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 broker-dealers could not easily calculate individualized fees and charges associated with the securities about which they provide recommendations and that doing so might lead to inadvertently providing inconsistent or inaccurate fee estimates to their retail customers.371 In this vein, several commenters recommended that brokerdealers should be able to satisfy the Disclosure Obligation regarding product-level fees by providing retail customers with or referring them to an issuer’s offering materials, such as a prospectus.372 Other commenters, on the other hand, stated that the Commission should not allow the use of percentages or ranges because such a presentation does not adequately inform investors of the fees and charges they will incur.373 As adopted, the Disclosure Obligation does not mandate individualized fee disclosure particular to each retail customer. Instead, broker-dealers may disclose ‘‘material facts’’ about material fees and costs in terms of more standardized numerical and narrative disclosures, such as standardized or hypothetical amounts, dollar or percentage ranges, and explanatory text where appropriate. The disclosure should accurately convey why a fee is being imposed and when the fee is to be charged. Further, as discussed below,374 a broker-dealer will need to supplement this standardized disclosure with more particularized information if the brokerdealer concludes that such information is necessary to fully and fairly disclose the material facts associated with the fee or charge. For example, a broker-dealer might initially disclose a range of 371 See, e.g., TIAA Letter (stating that calculating individualized fee information for any retail customer would be difficult and might lead to inadvertently providing inconsistent or inaccurate fee estimate); Capital Group Letter. 372 See TIAA Letter (stating that broker-dealers should not be obligated to provide fund-level fee disclosure outside of a fund prospectus or to provide individualized fee disclosure to retail customers); ICI Letter (stating that when making a recommendation of a fund, a broker-dealer should be permitted to direct customers to the fund’s prospectus as the source of information about fund fees and expenses); Oppenheimer Letter (stating that the fund, not the broker-dealer, is in a better position to provide these disclosures, in a manner that is accurate, consistent and complete). 373 See, e.g., CFA August 2018 Letter (stating that the Commission should not allow for percentages or ranges because it would do little to inform investors); PIABA Letter (stating that broker-dealers should disclose the specific charges that their customers will incur as a result of the particular recommendation); UMiami Letter (stating that customers should be provided with clear and concise information that fully and fairly discloses the specific charges the customer will incur as a result of a particular recommendation). 374 See Section II.C.1.c, Disclosure Obligation, Full and Fair Disclosure, Layered Disclosure. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 product fees, and later supplement that information with more particularized information by delivering the product prospectus.375 Consistent with this approach, and also in response to comments, we are further clarifying that a broker-dealer recommending a securities transaction or an investment strategy involving securities can meet the Disclosure Obligation regarding fees and costs assessed at the product level by describing those fees and costs in initial, standardized terms and providing subsequent particularized disclosure as necessary. To the extent that such subsequent information regarding product-level fees and costs appears in a currently mandated disclosure document, such as a trade confirmation or a prospectus, delivery of that information in accordance with existing regulatory obligations will be deemed to satisfy the Disclosure Obligation, even if delivery occurs after the recommendation is made, under the circumstances outlined in Section II.C.1. Although it is not required by Regulation Best Interest, broker-dealers may refer the customer to any issuer disclosure of the security being recommended, such as a prospectus, private placement memorandum, or offering circular, where more particular information may be found. We acknowledge that the desire for greater fee transparency was a consistent theme of our investor engagement and we believe that the Disclosure Obligation, in conjunction with the Relationship Summary, significantly advances that goal. Individualized fee disclosure may be helpful to some retail customers, but it can also be costly, prone to errors, and cause delays in trade execution. In addition, in some cases the precise amount of the fee may be based on the dollar value of the transaction, and would not be known prior to or at the time of the recommendation, meaning that it could only be expressed in more general terms, such as a percentage value or range, as an initial matter. We believe that adopting the Disclosure Obligation that allows for the use of standardized disclosure furthers our goal of informing investors about fees and costs by the time of a recommendation in a workable manner. Nothing in Regulation Best Interest prevents a broker-dealer from providing such individualized disclosure to its customers should it wish to do so, and we encourage firms to assist retail customers in understanding the specific fees and costs that apply, and to provide PO 00000 375 See supra footnote 302. Frm 00039 Fmt 4701 Sfmt 4700 33355 more individualized disclosure where appropriate, or in response to a retail customer’s request. As a best practice, firms may also consider reviewing with their retail customers the effect of fees and costs on the retail customer’s account(s) on a periodic basis.376 The costs, errors, delays, and other practical obstacles to individualized fee disclosure are likely to fall over time. We will continue to consider whether to require more personalized fee disclosure, particularly as technology evolves to address operational and technological costs. With regard to the disclosure of product-level fees in particular, while we support the goal of bringing greater transparency to all fees incurred, we are seeking to supplement, not supplant, the existing regulatory regime currently applicable to product-level fees with the adoption of Regulation Best Interest. We acknowledge that if a broker-dealer highlights such fees with particularity, it may raise a customer’s awareness of them, and we encourage as a best practice that broker-dealers do so.377 We acknowledge also that the nature and extent of product-level disclosures may vary. However, we do not believe that requiring broker-dealers to deliver product disclosures earlier than is currently required, to generate fee disclosure not currently required of issuers, or to recalculate or highlight specific product-level fees already disclosed in an issuer’s offering materials will meaningfully improve fee disclosure and it may, in fact, be unduly burdensome and raise the possibility of errors if broker-dealers were to be obligated to project or calculate product fees based on product issuer information. Accordingly, we believe that allowing broker-dealers to meet the Disclosure Obligation with regard to product-level fees by describing those fees in standardized terms with further detailed, particularized information related to the recommendation provided either prior to or at the time of the recommendation or afterwards under the circumstances outlined in Section II.C.1, Oral Disclosure or Disclosure After a Recommendation, strikes an 376 Although we encourage firms to have this conversation with their retail customers, we are not suggesting that engaging in such a best practice would, by itself, create any implied or explicit obligation to monitor such fees and costs. 377 With regard to product-level fees, in particular, broker-dealers may wish to highlight certain categories of fees such as distribution fees, platform fees, shareholder servicing fees and subtransfer agency fees, in order to enhance retail customers’ understanding of these fees to the extent applicable to the customer’s transactions, holdings, and accounts. E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 33356 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations appropriate balance between costs to firms and benefits to retail customers.378 We believe this approach is bolstered by the existence of complementary obligations protective of retail customers that are imposed by Regulation Best Interest. For example, to the extent fees and costs incurred related to these products create conflicts of interest associated with a recommendation, we believe they are appropriately highlighted and addressed in the context of the conflicts and incentives they create to make a recommendation, and must be addressed as part of the obligation to disclose material facts about conflicts of interest associated with a recommendation, as discussed below.379 Moreover, under the Care Obligation, a broker-dealer recommending a securities transaction or investment strategy involving securities to a retail customer must consider costs associated with that recommendation when determining whether it is in the best interest of that retail customer. As a result, disclosure of product-level fees and costs to satisfy the Disclosure Obligation will be supplemented by other aspects of Regulation Best Interest. While the Disclosure Obligation provides broker-dealers with flexibility in describing the material fees and costs that apply, the disclosure should accurately convey why the fee or charge is being imposed and when the fee or charge is to be assessed. For example, describing a commission or markup as a fee for ‘‘handling services’’ could inappropriately disguise the fee’s true nature. Furthermore, while using a percentage or dollar range to describe a fee can be appropriate, that range should be designed to reasonably reflect the actual fee to be charged. For example, a statement that a charge may be ‘‘between 5 and 100 basis points’’ would not be accurate if the fee is in almost all instances between 85 and 100 basis points. However, in this case, a broker-dealer could accurately describe the fee, for example, as ‘‘generally being between 85 and 100 basis points, sometimes lower, but never above.’’ In some cases, actual dollar values based on a hypothetical transaction may facilitate customer understanding. A material fact about fees and costs could also include informing a retail customer of a fee’s triggering event, such as a fee imposed because an account minimum falls below a threshold and whether fees are negotiable or waivable. 378 See Section II.C.1, Disclosure Obligation, Oral Disclosure or Disclosure After a Recommendation. 379 See Section II.C.1.b, Disclosure Obligation, Material Facts Regarding Conflicts of Interest. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 Type and Scope of Services Provided In the Proposing Release, we provided guidance that the type and scope of services a broker-dealer provides its retail customers would also be an example of what typically would be ‘‘material facts relating to the terms and scope of the relationship,’’ that would require disclosure pursuant to the Disclosure Obligation.380 Specifically, we stated that broker-dealers should build upon their disclosure in the Relationship Summary, and provide additional information regarding the types of services that will be provided as part of the relationship with the retail customer and the scope of those services.381 In particular, we noted that under proposed Form CRS broker-dealers would provide high-level disclosures concerning services offered to retail investors, including, for example, recommendations of securities, assistance with developing or executing an investment strategy, monitoring the performance of the retail investor’s account, regular communications, and limitations on selections of products.382 We recognized that a broker-dealer that offers different account types, or offers varying additional services to the retail customer may not be able, within the content and space constraints of the Relationship Summary, to provide ‘‘all material facts relating to the scope and terms of the relationship’’ with the retail customer.383 Thus, we stated that pursuant to the proposed Disclosure Obligation, we would have generally expected broker-dealers to disclose these types of material facts concerning the actual services offered as part of the relationship with the retail customer separately from the Relationship Summary. Commenters generally agreed that it was important for broker-dealers to disclose to their customers material facts about the type and scope of services they provide to their customers.384 However, commenters sought clarity regarding the application of this proposed guidance, and raised questions about whether firms would be specifically required to disclose certain services (e.g., monitoring account performance and providing financial education) pursuant to Regulation Best 380 See Proposing Release at 21602. 381 Id. 382 See Relationship Summary Proposing Release at 31426. 383 See Section II.C.1.a, Disclosure Obligation, Standard of Conduct. 384 See, e.g., Pacific Life August 2018 Letter; Cetera August 2018 Letter. PO 00000 Frm 00040 Fmt 4701 Sfmt 4700 Interest,385 as discussed below, and the level of disclosure required under Regulation Best Interest.386 Consistent with our approach in the Proposing Release, we continue to believe that the type and scope of services a broker-dealer provides to its retail customers are ‘‘material facts relating to the scope and terms of the relationship.’’ Accordingly, we are revising the rule text to explicitly require the disclosure of the ‘‘type and scope of services provided to the retail customer, including any material limitations on the securities or investment strategies involving securities that may be recommended to the retail customer,’’ as part of the ‘‘material facts relating to the scope and terms of the relationship’’ that must be disclosed pursuant to the Disclosure Obligation.387 We are interpreting the Disclosure Obligation to only require disclosure of material facts relating to the type of services provided (e.g., the fact that the broker-dealer monitors securities transactions and investment strategies) and the scope of services (e.g., information about the frequency and duration of the services). In response to comments, we are also specifically addressing the disclosure of information regarding whether or not the brokerdealer provides account monitoring services and whether the broker-dealer has account minimums or similar requirements. In addition, in response to comments, we are clarifying that pursuant to the Disclosure Obligation, broker-dealers need to disclose only material information relating to the ‘‘type and scope of services provided.’’ As discussed in the context of the disclosure of fees and costs above, the standard for materiality of the type and scope of services to be disclosed is consistent with the standard articulated in Basic v. Levinson: Information related to the type and scope of services provided is material, and must be disclosed, if there is ‘‘a substantial likelihood that a reasonable shareholder 385 See, e.g., Betterment Letter (recommending that the Commission ensure that dual-registrants communicate which of their services are advisory in nature); Northwestern Mutual Letter. 386 See, e.g., Cetera August 2018 Letter (stating that a best interest standard should include a requirement to deliver a summary description of the relationship between the firm and customer, including the scope of services); Committee of Annuity Insurers Letter (recommending the Commission clarify that a broker-dealer could satisfy the Disclosure Obligation by disclosing the products and services available to its retail customers and does not need to disclose information particularized to a recommendation). 387 Rule 15l–1(a)(2)(i)(A)(iii). E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations would consider it important.’’ 388 As noted above, in the context of Regulation Best Interest, this standard would apply in the context of retail customers, as defined. We believe the information included in the Relationship Summary may provide a useful starting point for the identification of the type and scope of services that must be disclosed pursuant to the Disclosure Obligation. For example, in the Relationship Summary a broker-dealer must describe its principal brokerage services offered, including buying and selling securities, and whether or not it offers recommendations to retail investors.389 Additionally, in the Relationship Summary, if applicable, the brokerdealer must address whether or not the firm offers monitoring of investments. We believe that broker-dealers will generally need to build upon the disclosures made in the Relationship Summary as appropriate, and to provide additional information regarding the types of services that will be provided as part of the relationship with the retail customer and the scope of those services (e.g., the frequency and duration of the services), as necessary, in order to meet the Disclosure Obligation’s requirement to disclose ‘‘all material facts’’ regarding the type and scope of services provided. Broker-dealers may be able to satisfy this aspect of the Disclosure Obligation by relying on their existing disclosures about the type and scope of their services, typically reflected in their account opening agreement or other account opening related documentation, so long as the disclosure as a whole addresses the material facts relating to the type and scope of services offered to the retail customer. jbell on DSK3GLQ082PROD with RULES2 Disclosure of Material Limitations on Securities and Investment Strategies In the Proposing Release, we included any limitations on the products and services offered as an example of a material fact relating to the terms and scope of the relationship that would need to be disclosed pursuant to the Disclosure Obligation. We agree with commenters who advocated for helping investors to understand whether a broker-dealer limits its product offerings, and to what extent, before entering into a relationship with a broker-dealer.390 We continue to believe 388 Basic, Inc. v. Levinson, 485 U.S. 224, 224 (1988). 389 See Form CRS, Item 2.B. (Description of Services). 390 See CFA Institute Letter (stating that if a broker-dealer only offers proprietary products, it should clearly call attention to the higher product cost and the potential cost to the investor of such VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 that broker-dealers that place material limitations on the securities or investment strategies involving securities that may be recommended to retail customers—such as recommending only proprietary products or a specific asset class—need to describe the material facts relating to those limitations.391 Therefore, in response to comments, we are revising Regulation Best Interest to explicitly require that, as part of the disclosure of the type and scope of services provided to the retail customer, a broker-dealer must include ‘‘any material limitations on the securities or investment strategies involving securities that may be recommended to the retail customer.’’ 392 For purposes of this requirement, a ‘‘material limitation’’ placed on the securities or investment strategies involving securities could include, for example, recommending only proprietary products (e.g., any product that is managed, issued, or sponsored by the broker-dealer or any of its affiliates), a specific asset class, or products with third-party arrangements (e.g., revenue sharing, mutual fund service fees).393 Similarly, the fact that the broker-dealer recommends only products from a select group of issuers, or makes IPOs available only to certain clients, could also be considered a material limitation. To cite another example, if an associated person of a dually registered broker-dealer only offers brokerage services, and is not able to offer advisory services, the fact that the associated person’s services are materially narrower than those offered by the broker-dealer would constitute a material limitation. We recognize that, as a practical matter, all broker-dealers limit their offerings of securities and investment strategies to a greater or lesser degree. We do not believe that disclosing the fact that a broker-dealer does not offer a limited offering); SIFMA August 2018 Letter (stating that a firm should be able to limit its offerings to a particular subset of its customers to proprietary product or revenue sharing products as long as: (1) The broker-dealer discloses that it is limiting its recommendation to a specific set of securities and (2) the specific set of securities contains appropriate securities to meet the customer’s needs); SPARK Letter (recommending that the Commission permit broker-dealers that only offers proprietary products or a limited menu of investments to satisfy the conflict mitigation requirements by: (1) Disclosing any material limitations on the investment products being offered and (2) reasonably concluding that the limitations will not violate the Care Obligation). 391 See Form CRS, Item 2.B.(iii). 392 Rule 15l–1(a)(2)(A). See also Section II.C.1 for a discussion of the materiality standard under Basic, Inc. v. Levinson, 485 U.S. 224 (1988). 393 This is consistent with the approach we are taking in the Relationship Summary Adopting Release. PO 00000 Frm 00041 Fmt 4701 Sfmt 4700 33357 the entire possible range of securities and investment strategies would convey useful information to a retail customer, and therefore we would not consider this fact, standing alone, to constitute a material limitation.394 In addition, we believe that there are a number of reasonable practices by which appropriate limitations are determined, including processes for the selection of a ‘‘menu’’ of products that will be available for recommendations to retail customers. We further recognize that these limitations can be beneficial, such as by helping ensure that a brokerdealer and its associated persons understand the securities they are recommending, as required by paragraph (a)(2)(ii)(A) of the Care Obligation. We have also explicitly stated that Regulation Best Interest would not prohibit a broker-dealer from recommending, for example, a limited range of products, or only proprietary products, provided the broker-dealer satisfies the component obligations of Regulation Best Interest. Nonetheless, because these firm-wide threshold decisions have such a significant effect on the subsequent recommendations ultimately made to a retail customer, we are requiring disclosure of the material limitations on the securities or investment strategies involving securities that may be recommended— by the broker-dealer and its associated persons—as well as any associated conflicts of interest. Explicitly requiring disclosure of these limitations is also consistent with our approach in the Care and Conflict of Interest Obligations. As discussed below, despite the potential beneficial aspects of some limitations, we are concerned that such limitations and any associated conflicts of interest can negatively affect the securities or investment strategies recommended to a retail customer.395 In recognition of this concern, we have revised the Conflict of Interest Obligation to specifically require the establishment of policies and procedures to identify, disclose, and address that risk.396 Furthermore, we reiterate that even if a broker-dealer discloses and addresses any material limitations on the securities or investment strategies involving securities recommended to a retail customer, and any associated conflicts of interest, as required by the Disclosure 394 See Basic, Inc. v. Levinson, 485 U.S. 224, 224 (1988). 395 See Section II.C.3, Conflicts of Interest. See Proposing Release at 21608 (asking commenters to comment on whether, and, if so why, the Commission should require specific disclosure on product limitations). 396 See Section II.C.4. E:\FR\FM\12JYR2.SGM 12JYR2 33358 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations and Conflict of Interest Obligations, it would nevertheless need to satisfy the Care Obligation in recommending such products.397 Account Monitoring Services In the Proposing Release, we identified as a material fact relating to the scope and terms of the relationship with the retail customer the type and scope of services provided by the broker-dealer, including, for example, monitoring the performance of the retail customer’s account.398 Additionally, the Proposing Release stated that to the extent that the broker-dealer agrees with a retail customer by contract to provide periodic or ongoing monitoring of the retail customer’s investments for purposes of recommending changes in investments, Regulation Best Interest would apply to, and a broker-dealer would be liable for not complying with the proposed rule with respect to, any recommendations about securities or investment strategies made to retail customers resulting from such services.399 Commenters suggested that brokerdealers should be required to clearly define the nature of account monitoring services offered, with some commenters pointing to retail customer confusion on this topic.400 One commenter stated that disclosure will not help a retail customer of a dual-registrant who has both brokerage and advisory accounts, who is unlikely to remember which accounts his or her financial advisor is responsible for monitoring, and for which accounts the customer bears that responsibility. Accordingly, the commenter recommends that we require broker-dealers to monitor all retail customers’ accounts.401 As discussed in the Solely Incidental Interpretation, we disagree with commenters who suggested that any monitoring of customer accounts would require a broker-dealer to register as an investment adviser and we believe that it is important for retail customers to understand: (1) The types of account monitoring services (if any) a particular broker-dealer provides, and (2) whether or not the broker-dealer will be 397 See Section II.C.2. Release at 21600. 399 Id. at 21594. 400 See, e.g., NAIFA Letter (asserting brokerdealers should be free to agree to, and define the nature of, any ongoing relationship via contract, such as including monitoring services); see also RAND 2018 (stating that participants demonstrated a lack of clarity on how a financial professional would monitor an account); OIAD/RAND (stating that some participants perceived that continuous monitoring of a client’s account is consistent with acting in the client’s best interest). 401 AFL–CIO April 2019 Letter. jbell on DSK3GLQ082PROD with RULES2 398 Proposing VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 providing monitoring services for the particular retail customer’s account. Accordingly, we believe that whether or not the broker-dealer will monitor the retail customer’s account and the scope and frequency of any account monitoring services that a broker-dealer agrees to provide are material facts relating to the type and scope of services provided to the retail customer and must be disclosed pursuant to the Disclosure Obligation. This disclosure could indicate, for example, that the broker-dealer will monitor the account or investments at a stated frequency in light of the retail customer’s investment objectives for the purpose of recommending an asset reallocation where appropriate, or that the brokerdealer will monitor the account periodically to determine whether a brokerage account continues to be in the retail customer’s best interest. Or, broker-dealers that offer no account monitoring services could disclose that they will not monitor the account or consider whether any recommendations may be appropriate unless the retail customer specifically requests that they do so.402 The Relationship Summary requires broker-dealers to explain whether or not they monitor retail investors’ investments, including the frequency and any material limitations.403 However, as noted above, because the Relationship Summary provides highlevel disclosure, in most cases it generally would not be sufficiently specific to inform investors about the scope and frequency of any account monitoring services applicable to the particular retail customer’s account. The Disclosure Obligation is designed to provide investors with an expanded description of the material information relating to such services. Furthermore, as discussed in Section 2.B.2.b., Regulation Best Interest applies to recommendations resulting from agreedupon account monitoring services (including implicit hold recommendations). Requiring disclosure of whether or not the broker-dealer will monitor the retail customer’s account, and the scope and frequency of such 402 As discussed in footnote 167, we recognize that a broker-dealer may voluntarily, and without any agreement with the customer, review the holdings in a retail customer’s account for the purposes of determining whether to provide a recommendation to the customer. We do not consider this voluntary review to be ‘‘account monitoring,’’ nor would it in and of itself on its own to create an implied agreement with the retail customer to monitor the customer’s account. Any explicit recommendation made to the retail customer as a result of any such voluntary review would be subject to Regulation Best Interest. 403 See Form CRS, Item 2.B.(i). PO 00000 Frm 00042 Fmt 4701 Sfmt 4700 monitoring, will help retail customers understand the terms applicable to the particular retail customer’s account. While retail customers with multiple accounts will have to keep track of the accounts for which their broker-dealer has agreed to monitor, we believe that requiring disclosure of this service will provide those retail customers with sufficient clarity about the monitoring services they may expect. Requiring all broker-dealers to monitor all retail customer accounts, as one commenter suggested, would diminish the options available to retail customers, who may wish to have their accounts monitored to a greater or lesser degree (including not at all). Account Balance Requirements The Proposing Release did not address whether a broker-dealer offering brokerage accounts subject to account balance requirements is a ‘‘material fact relating to the scope and terms of the relationship.’’ However, several commenters to the Form CRS proposal suggested that the Commission require firms to disclose any account balance requirements in the Relationship Summary.404 We believe that account balance requirements are a material fact relating to the terms and scope of the relationship. Consequently, we are interpreting the Disclosure Obligation to include disclosure of whether a brokerdealer has any requirements for retail customers to open or maintain an account or establish a relationship, such as a minimum account size. We believe that if a broker-dealer will only open a brokerage account for a retail customer with a specific account minimum, such a basic operational aspect of the account is a material fact relating to the type and scope of services provided. If dollar thresholds or other requirements apply to a retail customer’s ability to maintain an existing account, or to avoid additional fees when the threshold is crossed (for example, a ‘‘low account balance’’ fee), such requirements also would likely be of importance to a retail customer.405 We further believe retail customers can use facts about different account size requirements for both current and future planning and decision-making purposes. Accordingly, 404 See, e.g., NASAA Letter (stating that ‘‘Form CRS should specify minimum account size and include information on miscellaneous fees different categories of investors can expect to pay.’’); Cetera August 2018 Letter (stating that Form CRS should include ‘‘[w]hether or not the firm has established standards for the minimum or maximum dollar amount of various account types;’’ and submitting mock-up form that include disclosures of account minimums); Primerica Letter. See Relationship Summary Adopting Release. 405 See Relationship Summary Adopting Release. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations the Commission believes this information constitutes a ‘‘material fact’’ that must be disclosed pursuant to the Disclosure Obligation. Other Material Facts Related to the Scope and Terms of the Relationship In the Proposing Release, although we identified the broker-dealer’s capacity, fees and charges, and type and scope of services provided as examples of what would generally be considered ‘‘material facts relating to the scope and terms of the relationship with the retail customer,’’ we noted that the Disclosure Obligation would also require brokerdealers and their associated persons to determine, based on the facts and circumstances, whether there are other material facts relating to the scope and terms of the relationship that would need to be disclosed.406 We also asked for comment on whether examples of other information relating to scope and terms of the relationship should be highlighted by the Commission as likely to be considered a material fact relating to the scope and terms of the relationship that would need to be disclosed.407 A number of commenters provided suggestions of additional examples of such material facts that the Commission should highlight or explicitly require to be disclosed as a ‘‘material fact relating to the scope and terms of the relationship.’’ Specifically, commenters raised whether a broker-dealer’s basis for,408 and risks associated with,409 a recommendation, or the standard of conduct applicable to a broker-dealer making a recommendation,410 should be material facts relating to the scope and terms of the relationship. Basis for and Risks Associated With the Recommendation The Proposing Release did not address whether a broker-dealer’s basis for a recommendation is a ‘‘material fact relating to the scope and terms of the relationship.’’ However, several commenters requested that the Commission treat a broker-dealer’s basis for a recommendation as a ‘‘material fact relating to the scope and terms of the relationship’’ that would likely need to be disclosed prior to, or at the time of the recommendation, pursuant to the Disclosure Obligation.411 Similarly, jbell on DSK3GLQ082PROD with RULES2 406 See Proposing Release at 21600–21601. Proposing Release at 21607. 408 See infra footnote 411. 409 See infra footnote 412. 410 See infra footnote 417. 411 See, e.g., PIABA Letter (recommending that broker-dealers be required to provide a clear and understandable explanation as to the other lower cost investments which are available, and why the 407 See VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 several commenters suggested that the Commission should treat risks associated with a broker-dealer’s recommendation as ‘‘material facts relating to the scope and terms of the relationship’’ that would likely need to be disclosed prior to, or at the time of the recommendation.412 Other commenters opposed requiring particularized disclosure of the basis of individual recommendations, stating that it is sufficient to disclose that different products are available with different features rather than require firms specify why the broker-dealer recommended one product over another.413 Our view is that the general basis for a broker-dealer’s or an associated person’s recommendations (i.e., what might commonly be described as the firm’s or associated person’s investment approach, philosophy, or strategy) is a material fact relating to the scope and terms of the relationship with the broker-dealer that must be disclosed pursuant to the Disclosure Obligation. The process by which a broker-dealer and an associated person develop their recommendations to retail customers is of fundamental importance to the retail customer’s understanding of what services are being provided, and whether those services are appropriate to the retail customer’s needs and goals. We believe that such a description can be made in standardized or summary form; however the disclosure should also address circumstances of when the higher cost investment is being recommended); Morningstar Letter (recommending that the Commission require a firm to disclose its analysis of the reasons it is recommending a rollover from an ERISA-covered retirement plan to an IRA and why it is in the participant’s best interest). 412 See, e.g., PIABA Letter (recommending that the Commission extend the Disclosure Obligation to include the risks, benefits, and ramifications of a recommendation). 413 See, e.g., LPL August 2018 Letter (stating that a broker-dealer could satisfy the Care Obligation if it recommends a more expensive investment product so long as it discloses that the recommended product is not the least expensive among the alternatives and is otherwise in the investor’s best interest); Committee of Annuity Insurers Letter (recommending that the Commission clarify that a broker-dealer could satisfy the Disclosure Obligation through the use of a disclosure describing the products and services available to its retail customers and related conflicts of interest, and that a broker-dealer or associated person need not provide a disclosure particularized to a recommendation). See also CCMC Letters (requesting that the SEC confirm that it is sufficient to disclose that different products are available with different features rather than require firms to also document why the firm recommended one product over another); IPA Letter (requesting additional guidance regarding specificity of disclosure needed to demonstrate why a broker-dealer recommended one of multiple different products (with different terms, cost structures and conditions) that each meet the customer’s investment objective). PO 00000 Frm 00043 Fmt 4701 Sfmt 4700 33359 standardized disclosure does not apply and how the broker-dealer will notify the customer when that is the case. For example, if an associated person has a distinct investment approach, as may be the case with persons associated with an independent contractor broker-dealer, the broker-dealer’s standardized disclosure should indicate how its associated persons will notify retail customers of their own investment approach. While the general basis for the recommendation is a material fact for purposes of the Disclosure Obligation, we decline to require disclosure of the basis for each recommendation, an approach that could involve significant costs and in many cases may simply repeat the more standardized disclosure that we are already requiring. With regard to how conflicts of interest may affect the basis for a particular recommendation, we note that the Disclosure Obligation requires disclosure of the material facts relating to the conflicts of interest associated with the recommendation, which will help retail customers evaluate the incentives a broker-dealer or associated person may have in making a recommendation; and the Conflict of Interest Obligation requires a brokerdealer to have policies and procedures to mitigate, and in certain instances, eliminate, specified conflicts of interest. Accordingly, to the extent the basis for any recommendation is subject to any conflicts of interest, the Commission believes that the Care Obligation’s substantive requirement to have a reasonable basis for the recommendation, combined with the Disclosure, Conflict of Interest and Compliance Obligations, provides sufficient protections to broker-dealers’ retail customers. Similarly, we are interpreting disclosure of the risks associated with a broker-dealer’s or associated person’s recommendations in standardized terms as a material fact related to the scope and terms of the relationship that needs to be disclosed. For example, a brokerdealer could disclose: ‘‘While we will take reasonable care in developing and making recommendations to you, securities involve risk, and you may lose money. There is no guarantee that you will meet your investment goals, or that our recommended investment strategy will perform as anticipated. Please consult any available offering documents for any security we recommend for a discussion of risks associated with the product. We can provide those documents to you, or help you to find them.’’ This example is purely illustrative. Whether any E:\FR\FM\12JYR2.SGM 12JYR2 33360 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 particular disclosure by a broker-dealer is sufficient to meet the Disclosure Obligation will depend on the facts and circumstances. The risks associated with a particular recommendation would be relevant to a retail customer. However, we believe that broker-dealers may rely on the existing disclosure regime governing securities issuers to disclose the risks associated with any issuer, security or offering,414 and it is not our intent to require the broker-dealer to duplicate or expand on those disclosures. Consistent with our approach, discussed above, to disclosure of product-level fees and costs, we believe that describing product-level risks in standardized terms, with additional information in any available issuer disclosure documents delivered in accordance with existing regulatory requirements would satisfy the Disclosure Obligation. As noted above, we are not seeking to supplant the developed regulatory regime currently applicable to offering disclosure with the adoption of Regulation Best Interest. While we believe that a standardized discussion of risks is a material fact that must be disclosed to satisfy the Disclosure Obligation, we decline to impose a disclosure requirement specific to each recommendation. As with regard to the disclosure of the individualized basis for each recommendation, we believe that such specific disclosure could involve significant costs and in many cases simply repeat the more standardized disclosure that we are requiring, which we believe will sufficiently inform retail customers, in broad terms, of the nature of the risks associated with a recommendation. In addition, under the Care Obligation, a broker-dealer making a recommendation of a securities transaction or investment strategy involving securities to a retail customer must consider the risks when determining whether it has a reasonable 414 See, e.g., Item 503(c) of Reg. S–K (requiring disclosure of the ‘‘most significant’’ factors that make an offering ‘‘speculative or risky,’’ as well as an explanation of how each risk ‘‘affects the issuer or the securities being offered.’’ See also Form 10– K (requiring a description of the 503(c) risk factors that are ‘‘applicable to the registrant’’). In some cases, SRO Rules applicable to recommendations of particular securities may also require disclosure of risks. See, e.g., FINRA Rule 2330 (requiring a FINRA member or its associated persons recommending deferred variable annuity to have a reasonable belief that the customer has been informed of, among other things, market risk). See also FINRA Rule 2210(d), requiring, among other things, that statements in member communications ‘‘are clear and not misleading within the context in which they are made, and that they provide balanced treatment of risks and potential benefits.’’ VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 basis for believing that the recommended transaction or investment strategy could be in the best interest of at least some retail customers, and is in the best interest of a particular retail customer. Moreover, under paragraph (a)(2)(B) of Regulation Best Interest, discussed below, broker-dealers need to disclose ‘‘all material facts relating to conflicts of interest that are associated with the recommendation,’’ which will require disclosure of what we believe to be a significant risk associated with a broker-dealer’s recommendations—the broker-dealer’s conflicts of interest. For these reasons, we believe that standardized written disclosure of this information in general terms is sufficient. Consistent with the Compliance Obligation, broker-dealers should consider developing policies and procedures that address the circumstances under which the basis for a particular recommendation would be disclosed to a retail customer. As a best practice, firms also should encourage their associated persons to discuss the basis for any particular recommendation with their retail customers, including the associated risks, particularly where the recommendation is significant to the retail customer. For example, the decision to roll over a 401(k) into an IRA may be one of the most significant financial decisions a retail investor could make. Thus, a broker-dealer should discuss the basis of such recommendations with the retail customer. Similarly, we encourage broker-dealers to record the basis for their recommendations, especially for more complex, risky or expensive products and significant investment decisions, such as rollovers and choice of accounts, as a potential way a brokerdealer could demonstrate compliance with the Care Obligation. Standard of Conduct 415 As stated in the Proposing Release, the Commission intended the Relationship Summary to touch on issues that are also contemplated under the Disclosure Obligation, such as facilitating greater awareness of key aspects of a relationship with a firm or financial professional, such as the applicable standard of conduct.416 Several commenters on Regulation Best Interest also requested that the Commission treat the standard of conduct applicable to a broker-dealer making the recommendation to its retail customer as a ‘‘material fact relating to 415 See Section II.C.1.a, Disclosure Obligation, Capacity in Which the Broker-Dealer is Acting. 416 See Proposing Release at 21600. PO 00000 Frm 00044 Fmt 4701 Sfmt 4700 the scope and terms of the relationship’’ that would likely need to be disclosed prior to, or at the time of the recommendation under the Disclosure Obligation.417 Specifically, these commenters requested that the Commission require a firm to disclose whether it is providing a recommendation subject to Regulation Best Interest or advice subject to a fiduciary duty.418 The Commission also carefully considered numerous comments concerning the standard of conduct disclosure in proposed Form CRS, along with the results of investor testing and the Commission’s Feedback Form.419 As discussed more fully in the Relationship Summary Adopting Release, we are adopting a requirement in Form CRS for a description of a firm’s applicable standard of conduct using prescribed wording.420 This ‘‘standard of conduct’’ disclosure (as modified from proposed Form CRS) both eliminates technical words, such as ‘‘fiduciary,’’ and describes the legal obligations of brokerdealers, investment advisers, or dualregistrants using similar terminology in plain English. The prescribed wording 417 See, e.g., NASAA 2018 Letter (recommending that the Commission provide specific instructions on how associated persons of dually registered firms should disclose capacity in which they are acting and whether the information they are providing is a recommendation subject to ‘‘best interest’’ or advice subject to a fiduciary duty). See also Betterment Letter (recommending that the Commission require broker-dealers to disclose that they are ‘‘salespeople who are providing sales recommendations and not advice’’ in lieu of the adoption of a fiduciary duty on broker-dealers). 418 Id. 419 Most commenters did not object to the proposal’s requirement that broker-dealers and investment advisers provide disclosure regarding their standards of conduct or that such disclosure be standardized. See, e.g., CFA Institute Letter (urging the Commission to require disclosure of the standard of conduct under which broker-dealers operate); IAA August 2018 Letter. In addition, results of investor studies and surveys indicate that retail investors view this information as helpful. See RAND 2018 (almost one third of survey respondents selected this section as one of the two most useful; Letter from Mark Quinn, Director of Regulatory Affairs, Cetera (Nov. 19, 2018) (‘‘Cetera November 2018 Letter’’) (88% of survey respondents somewhat or strongly agreed ‘‘the firm’s obligations to you’’ is an important topic’’). See also Schwab Letter I (Hotspex) (‘‘obligations the firm and its representatives owe me’’ ranked third where survey participants were asked to identify four topics as most important for a firm to communicate’’). Similarly, commenters on Feedback Forms found this information to be useful. See Feedback Forms Comment Summary (38% of commenters on Feedback Forms graded the ‘‘Our Obligations to You’’ section of the relationship summary as ‘‘very useful’’ and 46% graded this section as ‘‘useful’’). 420 Form CRS, Item 3.B.(i).a (stating that ‘‘If you are a broker-dealer that provides recommendations subject to Regulation Best Interest, include: ‘When we provide you with a recommendation, we have to act in your best interest and not put our interest ahead of yours’ ’’). E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations also highlights when a firm must satisfy its legal obligation—specifically, in the case of a broker-dealer, when making a recommendation. We believe the standard of conduct owed to a retail customer under Regulation Best Interest is a material fact relating to the scope and terms of the relationship. However, given that Form CRS requires firms to disclose in prescribed language the applicable standard of conduct and, as discussed above, the Disclosure Obligation requires broker-dealers to disclose the capacity (i.e., brokerage) in which they are acting with respect to a recommendation, we believe this disclosure to be sufficient and thus requiring any additional disclosure would be duplicative. b. Material Facts Regarding Conflicts of Interest As noted above, in addition to requiring disclosure of the ‘‘material facts relating to the scope and terms of the relationship,’’ the proposed Disclosure Obligation would have required a broker-dealer to disclose ‘‘all material conflicts of interest associated with the recommendation.’’ We proposed to interpret a ‘‘material conflict of interest’’ as a conflict of interest that a reasonable person would expect might incline a broker-dealer— consciously or unconsciously—to make a recommendation that is not disinterested.’’ 421 We generally modeled this proposed interpretation on the Advisers Act approach to identifying conflicts of interest for which investment advisers may face antifraud liability in the absence of full and fair disclosure.422 We expressed our preliminary belief that a material conflict of interest that generally should be disclosed would include material conflicts associated with recommending: Proprietary products, products of affiliates, or a limited range of products, or one share class versus another share class of a mutual fund; securities underwritten by the brokerdealer or an affiliate; the rollover or transfer of assets from one type of account to another (such as a recommendation to roll over or transfer assets in an ERISA account to an IRA); and allocation of investment jbell on DSK3GLQ082PROD with RULES2 421 Proposing Release at 21602. id. (citing Capital Gains (stating that as part of its fiduciary duty, an adviser must fully and fairly disclose to its clients all material information in accordance with Congress’s intent ‘‘to eliminate, or at least expose, all conflicts of interest which might incline an investment adviser—consciously or unconsciously—to render advice which was not disinterested’’)). 422 See VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 opportunities among retail customers (e.g., IPO allocation).423 While commenters supported the disclosure of conflicts of interest, some sought clarity on the standard for determining which conflicts should be disclosed,424 and others requested clarity on whether conflicts involving certain actions (e.g., rollovers) 425 and products (e.g., proprietary products) 426 should be disclosed.427 Several commenters urged the Commission to define ‘‘conflicts of interest’’ without a reference to the terms ‘‘consciously or unconsciously.’’ 428 These commenters claim that discerning a broker’s conscious or unconscious state of mind is ‘‘confusing and inherently unknowable.’’ 429 Similarly, one commenter stated that a broker-dealer would be unable to draft adequate policies and procedures that address an individual’s mindset, noting that it would be impossible for a broker-dealer to anticipate an individual’s unconscious conflicts.430 Instead, these commenters suggested revised language that eliminates the notion of conscious or unconscious inclination.431 Proposing Release at 21603. e.g., SIFMA August 2018 Letter, Edward Jones Letter (requesting clarity on the definition of materiality with regards to conflicts); Ameriprise Letter (stating that the definition of ‘‘material conflicts of interest’’ should follow well known and understood principles); Fidelity Letter (stating that the Commission should not distinguish between conflicts of interest based on financial incentives and all other conflicts of interest); Morgan Stanley Letter; CCMC Letters; TIAA Letter; Mass Mutual Letter; Empower Letter. See also IRI Letter (stating that requiring a registered representative to predict what a hypothetical reasonable person might think is confusing); ICI Letter (stating that rather than focusing on what a ‘‘reasonable person would expect . . .’’ the standard should focus on that nature of the incentive and its effect on a brokerdealer’s conduct). 425 See, e.g., CFA Institute Letter. 426 See, e.g., SIFMA August 2018 Letter; State Attorneys General Letter; CFA Institute Letter. 427 See, e.g., Ameriprise Letter; State Attorneys General Letter; CFA August 2018 Letter. 428 See, e.g., Edward Jones Letter (urging the Commission to articulate a definition of materiality that does not refer to a person’s unconscious activity); Empower Letter; Ameriprise Letter. 429 Id. 430 See Great-West Letter. 431 See, e.g., Edward Jones Letter (suggesting that the Commission define ‘‘material conflict’’ as an activity that: (i) Affects financial compensation of a person making a recommendation; and (ii) a reasonable investor would likely view as important to the total mix of information available when considering that recommendation); Ameriprise Letter (suggesting that the Commission define ‘‘material conflict of interest’’ as a conflict of interest that a reasonable person might conclude has the potential to influence the recommendation); Pacific Life August 2018 Letter (suggesting the Commission define ‘‘material conflict of interest’’ as a financial interest of the financial professional making a recommendation that a reasonable person would expect to affect the impartiality of such recommendation). PO 00000 423 See 424 See, Frm 00045 Fmt 4701 Sfmt 4700 33361 Similarly, several commenters opposed the Commission’s use of the term ‘‘not disinterested.’’ 432 These commenters believe that the term is not clear and could, among other things, suggest the elimination of all conflicts.433 One of these commenters recommended that the Commission eliminate the term ‘‘not disinterested’’ 434 while another suggested that the Commission clarify whether ‘‘material’’ and ‘‘not disinterested’’ are intended to be identical or different standards for brokers and advisers.435 Other commenters opposed the proposed standard, arguing that it was not as broad as the disclosure obligation applicable to investment advisers. In particular, some commenters urged the Commission to apply the standard for disclosure applicable to investment advisers as articulated by the Supreme Court in SEC. v. Capital Gains Research Bureau.436 Specifically, commenters requested that the Commission require disclosure of not only material conflicts but also the material facts related to a recommendation.437 We are adopting the obligation to disclose conflicts of interest, with several modifications and clarifications to the Proposing Release. Specifically, Paragraph (a)(2)(i)(B) of Regulation Best Interest requires that broker-dealers disclose ‘‘material facts relating to conflicts of interest that are associated with the recommendation.’’ 438 432 See, e.g., IPA Letter (stating that the use of the term ‘‘not disinterested’’ may require unnecessary legal interpretation); Empower Letter. 433 See, e.g., Empower Letter. 434 See id. 435 See IPA Letter. 436 375 U.S. 180 (1963). See, e.g., CFA August 2018 Letter; Schnase Letter. 437 See, e.g., CFA August 2018 Letter. 438 This supplements the disclosure required in the Relationship Summary regarding ways in which the broker-dealer and its affiliates make money from brokerage or investment advisory services they provide to retail investors, and about the related material conflicts of interest. The Relationship Summary requires firms to disclose, if applicable, conflicts related to compensation it could receive from proprietary products, third-party payments, revenue sharing, or principal trading. If firms do not have any of these conflicts, the firm must disclose at least one other material conflict of interest that affects retail investors. As described in the Relationship Summary Adopting Release, we declined to make a change pursuant to comments that suggested that Regulation Best Interest’s and Form CRS’s conflicts disclosures be coordinated, and that any conflict disclosure obligations under Regulation Best Interest should be satisfied upon delivery of the Relationship Summary. We recognize that broker-dealers may need to disclose additional conflicts at a point in time other than at the beginning of the relationship with a retail investor. Broker-dealers also may need to include additional information about conflicts of interest summarized in the Relationship Summary. The Relationship Summary will provide a high-level E:\FR\FM\12JYR2.SGM Continued 12JYR2 33362 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 However, as discussed in more detail below, in response to comments and in the light of the Relationship Summary, we are: (1) Adopting for purposes of Regulation Best Interest a definition of ‘‘conflict of interest’’ associated with a recommendation ‘‘as an interest that might incline a broker, dealer, or a natural person who is an associated person of a broker or dealer— consciously or unconsciously—to make a recommendation that is not disinterested;’’ and (2) revising the Disclosure Obligation to require disclosure of ‘‘material facts’’ regarding such conflicts of interest. Under this approach, all conflicts of interest as interpreted under the Proposing Release will be covered by Regulation Best Interest. We believe distinguishing between ‘‘conflicts of interest’’ and ‘‘material facts’’ regarding such conflicts that would be disclosed would make the Disclosure Obligation more consistent with the proposal’s intent. In the Proposing Release, the Commission discussed limiting the disclosure of conflicts under the Disclosure Obligation ‘‘consistent with case law under the antifraud provisions, which limit disclosure obligations to ‘‘material facts.’’ After considering the comments, we have determined to retain the proposed approach to conflicts of interest as described in Capital Gains. In particular, we acknowledge commenter concerns about discerning a broker’s conscious or unconscious state of mind. However, the description of conflicts of interest in Capital Gains is well established, familiar to many in the industry, particularly dual-registrants, and guidance already exists regarding what constitutes a conflict of interest under this standard. To provide clarity that this interpretation is limited to Regulation Best Interest, however, we are revising Regulation Best Interest to explicitly provide that a ‘‘conflict of interest’’ ‘‘means an interest that might incline a, broker, dealer, or natural person who is an associated person of a broker-dealer—consciously or unconsciously—to make a recommendation that is not disinterested,’’ 439 consistent with the scope of the meaning of ‘‘conflict of summary for retail investors so that they can engage in a conversation with their financial professional about investment advisory or brokerage services, and so that the retail investors can choose the type of service that best meets their needs, but will not necessarily include all material facts related to a particular conflict of interest. We believe many firms may not be able to capture all of the necessary disclosures about their conflicts in this short standardized disclosure. 439 Rule 15l–1(b)(3). VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 interest’’ for investment advisers under Capital Gains.440 Several commenters also made suggestions regarding the Commission’s interpretation of the term ‘‘material’’ as used in the proposed Disclosure Obligation (i.e., the proposed requirement to disclose ‘‘all material conflicts of interest that are associated with the recommendation’’).441 Many commenters agreed with the Commission’s decision to use a ‘‘materiality’’ standard to determine those facts about conflicts of interest that must be disclosed.442 However, several other commenters asked the Commission to clarify the meaning of ‘‘material.’’ 443 These latter commenters stated, among other things, that the term ‘‘material’’ in proposed Regulation Best Interest was not clearly defined and would be subjectively interpreted.444 Accordingly, many of these commenters recommended that the Commission adopt a materiality standard based on the standard articulated in Basic v. Levinson.445 The Supreme Court in Basic articulated a standard for materiality, stating that information is material if there is ‘‘a substantial likelihood that a reasonable shareholder would consider it important.’’ 446 This definition of ‘‘material’’ is well established and thus limiting disclosure to material facts in the Disclosure Obligation will eliminate confusion and reduce the compliance burden on broker-dealers in fulfilling the Disclosure Obligation. It will also help focus the information made available to retail customers.447 Accordingly, we interpret ‘‘material facts’’ consistent with the Basic standard. Moreover, while the Regulation Best Interest definition of ‘‘conflict of interest’’ is modeled on the regulatory regime applicable to investment advisers, and is not by its terms explicitly limited to ‘‘material’’ conflicts of interest, it would be difficult to envision a ‘‘material fact’’ that must be disclosed pursuant to the Disclosure Obligation that is not related to a conflict of interest that is also material under the Basic standard.448 Interpretation of Disclosure of Material Facts Relating to Conflicts of Interest In response to comments, we are providing our view regarding what we would consider ‘‘material facts relating to conflicts of interest that are associated with a recommendation’’ that would need to be disclosed under the Disclosure Obligation. We believe the conflicts of interest identified in the Relationship Summary may provide a useful starting point for the identification of material facts that need to be disclosed pursuant to the Disclosure Obligation.449 In addition, we also view how a broker-dealer’s investment professionals are compensated, and the conflicts associated with those arrangements, as material facts relating to conflicts of interest that are associated with a recommendation.450 While these conflicts of interest must be summarized in the Relationship Summary to the extent they are applicable, we believe that additional details regarding many of these conflicts need to be disclosed under the Disclosure Obligation as ‘‘material facts’’ relating to conflicts of interest associated with a recommendation. Disclosure of Compensation the same reasons, we have eliminated the phrase ‘‘a reasonable person would expect’’ that was included in the definition of ‘‘material conflict of interest’’ discussed in the Proposing Release at 21602. 441 See, e.g., Transamerica August 2018 Letter; Fidelity Letter; SIFMA August 2018 Letter; Morgan Stanley Letter; IPA Letter; Great-West Letter. 442 See, e.g., Morgan Stanley Letter; Great-West Letter. 443 See, e.g., FSI August 2018 Letter (recommending the Commission publish examples of when a conflict is material); Wells Fargo Letter; Cetera August 2018 Letter; IPA Letter. 444 See, e.g., Great-West Letter (stating that the Commission appears to have created a very subjective standard to determine materiality). 445 See, e.g., Mass Mutual Letter; SIFMA August 2018 Letter; Bank of America Letter; CCMC Letters; TIAA Letter; Cetera August 2018 Letter; Fidelity Letter. 446 Basic v. Levinson. 447 As stated in the Proposing Release, we are sensitive to the potential that broker-dealers could adopt an approach that results in lengthy disclosures that undermine the Commission’s goal of facilitating meaningful disclosure to assist retail customers in making informed investment decisions. Proposing Release at 21604. PO 00000 440 For Frm 00046 Fmt 4701 Sfmt 4700 Broker-dealers receive compensation that typically varies depending on what securities transaction or investment strategy involving securities is being recommended. The source of the compensation may also vary, for example being paid directly by the investor, or by a product sponsor, or a combination of both. A broker-dealer may also pay its associated persons different rates of compensation depending on the type of security they sell.451 Similarly, broker-dealers can receive different payments from 448 See Fiduciary Interpretation. e.g., Form CRS, Item 3 (Fees, Costs, Conflicts, and Standard of Conduct). 450 See Form CRS, Item 3.C.(i) (‘‘Description of How Financial Professionals Make Money: Summarize how your financial professionals are compensated, including cash and non-cash compensation, and the conflicts of interest those payments create.’’). 451 See NASD NTM 03–54. 449 See, E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations different product providers (e.g., mutual funds) for a variety of reasons, such as payments for inclusion on a brokerdealer’s menu of products offered (sometimes referred to as shelf space). These compensation arrangements create a variety of conflicts of interest that must be addressed under both Form CRS and the Disclosure Obligation. We believe that compensation associated with recommendations to retail customers and related conflicts of interest—whether at the broker-dealer or the associated person level—is a conflict of interest about which material facts must be disclosed as part of the Disclosure Obligation. This disclosure should summarize how the brokerdealer and its financial professionals are compensated for their recommendations and, as importantly, the conflicts of interest that such compensation creates. This summary should include the sources and types of compensation received, and may include the fact that fees and costs disclosed pursuant to Paragraph (a)(2)(i)(A) of Regulation Best Interest that a retail customer may pay directly or indirectly are a source of compensation, if that is the case. For example, if a broker-dealer receives compensation derived from the sale of securities or other investment products held by retail customers of the firm, including asset-based sales charges or service fees on mutual funds, that fact and the conflicts associated with the receipt of such compensation should be fully and fairly described. Broker-dealers could meet the Disclosure Obligation by making certain required disclosures of information regarding conflicts of interest to their customers at the beginning of a relationship, and this form of disclosure may be standardized. However, if standardized disclosure, provided at such time, does not sufficiently identify the material facts relating to conflicts of interest associated with any particular recommendation, the disclosure would need to be supplemented so that such disclosure is tailored to the particular recommendation. For example, with regard to mutual fund transactions and holdings, a broker-dealer might disclose broadly that it is compensated by funds out of product fees or by the funds’ sponsors, and that such compensation gives it an incentive to recommend certain products over other products for which the broker-dealer receives less compensation; later, when a brokerdealer recommends a particular fund, it could provide more specific detail about compensation arrangements, for example revenue sharing associated with the fund family. In the alternative, so long as the ‘‘material facts’’ regarding VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 the conflicts associated with a recommendation of a mutual fund were disclosed at the outset of the relationship, no further disclosure need be made at the time of recommendation; we are not requiring that information regarding conflicts be disclosed on a recommendation-by-recommendation basis. The Disclosure Obligation also does not require specific written disclosure of the amounts of compensation received by the broker-dealer or the financial representative. For example, we are not requiring broker-dealers to disclose the amount, if any, they compensate their financial professionals per transaction, or for year-end bonuses. We believe that disclosure of the material facts regarding conflicts of interest associated with a recommendation need not entail such individualized numerical disclosure, and that in any event such a level of detail may be difficult and costly to calculate with accuracy, and also confusing to investors in many instances. Instead, disclosure regarding conflicts must reasonably inform investors so that the investor may use the information to evaluate the recommendation, and that can be done without specific disclosure of the amount of the compensation. Although disclosure of specific compensation amounts is not required, depending on facts and circumstances, full and fair disclosure may require disclosure of the general magnitude of the compensation.452 We are also clarifying that while product fees and costs can be a significant source of compensation received by broker-dealers and associated persons, no disclosure regarding the particular amounts of these fees and costs is required under Regulation Best Interest with regard to conflicts of interest. Instead, what must 452 See, e.g., Advantage Investment Management, Advisers Act Release No. 4455 (Jul. 18, 2016) (settled order) (the Commission brought an enforcement action against an adviser for failing to disclose the existence, nature and magnitude of a forgivable loan from a broker-dealer that the adviser had engaged to provide services to the adviser’s clients); Taberna Capital Management LLC, Advisers Act Release No. 4186 (Sep. 2, 2015) (settled order) (the Commission brought an enforcement action against an adviser for failing to disclose the existence, nature, and extent of a conflict of interest raised by the adviser’s receipt of certain fees from issuers); BISYS Fund Services, Inc., Advisers Act Release No. 2554 (Sep. 26, 2006) (settled order) (the Commission brought an enforcement action against a mutual fund administrator for failure to disclose information concerning the existence or magnitude of the conflicts of interest created by a marketing arrangement that called for BISYS to rebate a portion of its administrative fees to 27 mutual fund advisers so that the fund advisers would continue to recommend BISYS as an administrator). PO 00000 Frm 00047 Fmt 4701 Sfmt 4700 33363 be disclosed under Paragraph (a)(2)(i)(B) of Regulation Best Interest are the ‘‘material facts relating to conflicts of interest’’ created by compensation sourced from product fees and costs, rather than the fees and costs themselves. Differences in Compensation and Proprietary Products Several commenters recommended that required conflict disclosure address recommendations where a less expensive alternative is available, or condition the ability to recommend a more expensive product on the adequacy of a broker-dealer’s conflict disclosures.453 Similarly, several commenters expressed differing views on how payment of varying compensation should be handled under the ‘‘best interest’’ standard of Regulation Best Interest and how related conflicts should be disclosed.454 For example, one commenter identified compensation differences within product lines as an example of a conflict that should be disclosed.455 Several commenters also recommended that the Commission require disclosure of conflicts of interest related to use of proprietary products, and whether the broker-dealer offers alternatives to proprietary products.456 Similarly, several commenters requested that the Commission clarify that broker-dealers can limit their offerings to proprietary products or products that make revenue sharing payments if, among other 453 See PIABA Letter (stating that where less expensive alternatives are available, disclosure should include an explanation of why the recommendation is nevertheless in the best interest given other factors associated with the recommendation); LPL August 2018 Letter (recommending that the Commission clarify that a broker-dealer can recommend a product involving costs and charges that are within a range of reasonableness that has been disclosed to the investor in advance provided the recommendation is otherwise in the investor’s best interest); UMiami Letter; SIFMA August 2018 Letter. 454 See, e.g., CFA August 2018 Letter (recommending that the Commission include compensation differences within product lines as an example of a conflict that should be disclosed); Ameriprise (stating that differential compensation for diverse products aligns with Regulation Best Interest provided the firm mitigates the potential related conflicts); Pacific Life August 2018 Letter (stating that the definition of ‘‘material conflicts of interest’’ must encompass, among other things, the types of compensation received by the person making the recommendation). 455 See CFA August 2018 Letter. 456 See, e.g., Money Management Institute Letter (recommending the SEC allow firms to meet the Conflict of Interest Obligation with respect to their preference for proprietary products through disclosure); CFA Institute Letter; IRI Letter; SIFMA August 2018 Letter. E:\FR\FM\12JYR2.SGM 12JYR2 33364 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 things, appropriate disclosure is made.457 As discussed above, we agree with commenters who stated that it may be compatible with the Care Obligation to recommend a more expensive product that is otherwise in a retail customer’s best interest when there are less expensive alternatives available, to receive compensation that varies among products, and to recommend proprietary products.458 However, we also believe that the conflicts of interest associated with such practices constitute ‘‘material facts’’ relating to conflicts of interest that must be disclosed under the Disclosure Obligation. The receipt of higher compensation for recommending some products rather than others, whether received by the broker-dealer, the associated person, or both, is a fundamental and powerful incentive to favor one product over another.459 While we are requiring firms to establish policies and procedures reasonably designed to mitigate the conflicts of interest that create an incentive for financial professionals to place the interest of the professional or broker-dealer ahead of the interest of the retail customer, we believe also that full and fair disclosure of the material facts concerning conflicts raised by variable compensation schemes is of particularly critical importance for an investor seeking to evaluate a recommendation under such circumstances, a concern further underscored by our approach under the Conflict of Interest Obligation of requiring policies and procedures to mitigate or eliminate certain conflicts.460 The benefits that accrue to a brokerdealer and its financial professionals from recommending proprietary products also raise conflicts of interest that must be disclosed. Material facts relating to the conflicts of interest 457 See, e.g., SIFMA August 2018 Letter (stating that a firm should be allowed to limit its offerings to proprietary products or revenue sharing products, as long as: (a) The broker-dealer discloses to its customer that it is limiting the recommendation to a specific set of securities, and (b) the specific set of securities contains appropriate securities to meet the customer’s needs); CFA Institute Letter (stating that when a firm only offers proprietary products it should disclose not only the higher product cost, but the potential cost to the investor of such a limited offering). 458 See generally Section II.A.1, Commission’s Approach. 459 See Proposing Release at 21578 (referencing the Commission’s long-held concerns about the incentives that commission-based compensation provides to churn accounts, recommend unsuitable securities, and engage in aggressive marketing of brokerage services); FINRA Report on Conflicts of Interest (Oct. 2013), available at https:// www.finra.org/sites/default/files/Industry/ p359971.pdf (‘‘FINRA Conflicts Report’’) at p. 4. 460 See generally Section II.C.3. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 associated with recommending proprietary products could include, as relevant, that the broker-dealer owns the product, and that in addition to any commission associated with purchasing the product, the broker-dealer or an affiliate may receive additional fees and compensation 461 related to that product.462 c. Full and Fair Disclosure As proposed, the Disclosure Obligation would have required brokerdealers to ‘‘reasonably disclose’’ material facts relating to the scope and terms of the relationship with the retail customer, including all material conflicts of interest associated with the recommendation. The Commission used this formulation in order to give flexibility to broker-dealers in determining the most appropriate way to meet the proposed Disclosure Obligation depending on their individual business practices. The Commission also provided preliminary guidance on what it believed would be to ‘‘reasonably disclose’’ in accordance with the Disclosure Obligation by setting forth the aspects of effective disclosure, including the form and manner of disclosure and the timing and frequency of disclosure. In this regard, the Commission requested comment on whether brokerdealers should be required to ‘‘reasonably disclose’’ and whether additional guidance as to how brokerdealers could meet this standard should be provided. The Commission also requested comment on whether disclosure should explicitly be required to be ‘‘full and fair.’’ In response, some commenters raised questions about using the term ‘‘reasonably disclose’’ 463 and whether broker-dealers should be subject to less rigorous disclosure obligations for recommendations made to retail customers than investment advisers.464 These commenters 461 For example, a broker-dealer’s sale of proprietary products potentially generates a compensation stream for the broker-dealer, in addition to commissions, which may need to be disclosed under paragraph (a)(2)(i)(A). 462 As discussed further in Section II.C.3, in addition to disclosure of such conflicts, brokerdealers are also required under the Conflict of Interest Obligation to establish, maintain, and enforce written policies and procedures reasonably designed to mitigate or address the conflicts presented. 463 See, e.g., CFA August 2018 Letter (stating that a ‘‘reasonable’’ disclosure standard gives firms too much discretion to determine how the disclosures will be presented); Galvin (arguing that the proposed standard would give broker-dealers more opportunities to argue that they acted ‘‘reasonably’’ under the rules). 464 See, e.g., CFA August 2018 Letter (stating that ‘‘[t]he Commission offers no explanation for why PO 00000 Frm 00048 Fmt 4701 Sfmt 4700 recommended that the Commission explicitly require broker-dealers to provide full and fair disclosure of material facts.465 One commenter reasoned that the Commission should not make Regulation Best Interest any more stringent than in the Proposing Release, stating that ‘‘full and fair’’ is both inapplicable and unnecessary given the proposed standard under the Disclosure Obligation.466 After careful consideration of the comments received, the Commission is adopting the Disclosure Obligation with revisions to require ‘‘full and fair disclosure’’ of all material facts relating to the scope and terms of the relationship with the retail customer and all material facts relating to conflicts of interest associated with the recommendation for the reasons described below. While we do not believe that adopting a ‘‘full and fair disclosure’’ standard is significantly different from the proposed requirement to ‘‘reasonably disclose,’’ we believe that the Regulation Best Interest serves the Commission’s goal of facilitating disclosure to assist retail customers in making informed investment decisions.467 In addition, broker-dealers should be subject to less rigorous disclosure obligations than investment advisers’’). 465 See, e.g., Pace Investor Rights Clinic August 2018 Letter (urging the Commission to require broker-dealers to provide full and fair disclosure of any conflicts that are not eliminated or mitigated); Better Markets August 2018 Letter (urging the Commission to further enhance the Disclosure Obligations by requiring broker-dealers to make full and fair disclosure of all information required to be disclosed); State Attorneys General Letter; NASAA August 2018 Letter. 466 See SIFMA August 2018 Letter. 467 This approach is consistent with the rationale articulated in the Fiduciary Interpretation. See Fiduciary Interpretation at Section II.C (stating, ‘‘In order for disclosure to be full and fair, it should be sufficiently specific so that a client is able to understand the material fact or conflict of interest and make an informed decision whether to provide consent. For example, it would be inadequate to disclose that the adviser has ‘other clients’ without describing how the adviser will manage conflicts between clients if and when they arise, or to disclose that the adviser has ‘conflicts’ without further description. Similarly, disclosure that an adviser ‘may’ have a particular conflict, without more, is not adequate when the conflict actually exists.’’ [However,] ‘‘[t]he word ‘may’ could be appropriately used to disclose to a client a potential conflict that does not currently exist but might reasonably present itself in the future.’’). See also In the Matter of The Robare Group, Ltd., et al., Advisers Act Release No. 4566 (Nov. 7, 2016) (Commission Opinion) (finding, among other things, that adviser’s disclosure that it may receive a certain type of compensation was inadequate because it did not reveal that the adviser actually had an arrangement pursuant to which it received fees that presented a potential conflict of interest); aff’d in part and rev’d in part on other grounds Robare Group, Ltd., et al. v. SEC, 922 F.3d 468 (D.C. Cir. 2019); SEC v. Blavin, 760 F.2d 706, 711 (6th Cir. 1985) (disclosure that investment adviser ‘‘may’’ trade in recommended securities for its own E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 Regulation Best Interest will more closely align the Disclosure Obligation with existing requirements for investment advisers 468 and is consistent with disclosure standards in other contexts under the federal securities laws.469 The full and fair disclosure standard that the Commission is adopting for broker-dealers under the Disclosure Obligation is generally similar to the disclosure standard applicable to investment advisers under the Advisers Act.470 Similar to the Proposing Release’s interpretation of the phrase ‘‘reasonably disclose,’’ broker-dealers’ obligation to provide full and fair disclosure should give sufficient information to enable a retail investor to make an informed decision with regard to the recommendation.471 We disagree with commenters who believe the ‘‘full and fair’’ standard is too stringent. While the general standard for broker-dealers under the Disclosure Obligation will be generally similar to the disclosure requirements applicable to investment advisers, the scope of the required disclosure is not as broad. For example, the Disclosure Obligation only requires disclosure of material facts relating to the scope and terms of the relationship with the broker-dealer, and material facts relating account was false and misleading where the adviser actually invested in 10%–25% of the publicly available stock of the companies it recommended); ICI Letter (commenting on the Fiduciary Interpretation proposing release). 468 See Fiduciary Interpretation at Section II.A (stating that ‘‘[t]he [investment adviser’s] fiduciary duty follows the contours of the relationship between the adviser and its client, and the adviser and its client may shape that relationship by agreement provided that there is full and fair disclosure and informed consent’’ (emphasis added)). 469 For instance, the Municipal Securities Rulemaking Board requires that municipal advisors provide full and fair disclosure of material conflicts of interest and material legal or disciplinary events. See MSRB Rule G–42. In addition, the registration and disclosure requirements of the Securities Act of 1933 (‘‘Securities Act’’) are based on the concept that investors in a public offering should be provided with full and fair disclosure of material information needed for an informed investment decision. See Securities Act Concepts and Their Effects on Capital Formation, Securities Act Release No. 7314 (Jul. 25, 1996); 61 FR 40044 (Jul. 31, 1996) at text accompanying footnote 13; see also SEC v. Ralston Purina Co., 346 U.S. 119, 124 (1953). Finally, Regulation FD under the Securities Act was ‘‘designed [in part] to promote the full and fair disclosure of information by issuers.’’ See Selective Disclosure and Insider Trading, Securities Act Release No. 7881 (Aug. 15, 2000), 65 FR 51715 (Aug. 24, 2000). 470 See supra footnote 468. See also Fiduciary Interpretation, stating that the disclosure ‘‘should be sufficiently specific so that a client is able to understand the material fact or conflict of interest and make an informed decision whether to provide consent.’’ 471 See Proposing Release at 21604, footnote 208. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 to conflicts of interest associated with a broker-dealer’s recommendations, and not of all material facts relating to the relationship. In addition, the Disclosure Obligation only applies to retail customers. In contrast, the disclosure requirements imposed by the fiduciary duty under the Advisers Act generally and Form ADV in particular are broader (e.g., Form ADV requires disclosure of the adviser’s principal owner(s) and certain financial industry activities and affiliations, which are not explicitly required under the Disclosure Obligation; Form ADV and the fiduciary duty also go to disclosure of the entire relationship while the Disclosure Obligation is tailored to the recommendation and also given at relevant points in time). We designed our approach to avoid having retail customers receive overwhelming amounts of information.472 Some commenters suggested that disclosure and informed consent should be required in order to comply with the obligations under Regulation Best Interest, similar to the approach taken under the fiduciary duty under the Advisers Act.473 We have carefully considered these comments. As noted above, under the Disclosure Obligation, broker-dealers are required to provide full and fair disclosure such that a retail customer can make an informed decision with regard to the recommendation (i.e., whether to accept (or reject) that recommendation). In making such an informed decision after being provided with full and fair disclosure, we believe that the retail customer has provided ‘‘informed consent’’ in a manner that is analogous to the informed consent required to be provided by a client in the context of an investment adviser-client relationship.474 An investment advisory 472 Commenters pointed out that requiring too much information regarding conflicts of interest would go beyond the standard of materiality set forth under Basic. See, e.g., SIFMA August 2018 Letter; Cetera August 2018 Letter (citing Basic at 231, noting that ‘‘an avalanche of trivial information’’ would not be ‘‘conducive to informed decision making.’’). See also Letter from David Schwartz, President and CEA, Florida International Bankers Association (‘‘FIBA’’) (Feb. 8, 2019) FIBA (‘‘February 2019 Letter’’) (stating that ‘‘the amount of required disclosure may overwhelm rather than educate’’). 473 See, e.g., ASA Letter (stating that the Commission should reaffirm that broker-dealers can address conflicts of interest by disclosing them and obtaining informed consent); Primerica Letter (suggesting that the Commission clarify that brokerdealers can effectively address all material conflicts by providing full and fair disclosure and obtaining customer consent); Morgan Stanley Letter. 474 As discussed in the Fiduciary Interpretation, a client’s informed consent can be either explicit or, depending on the facts and circumstances, implicit. See Fiduciary Interpretation at Section II.C. Under PO 00000 Frm 00049 Fmt 4701 Sfmt 4700 33365 client must provide informed consent to the adviser’s conflicts of interest in the context of the entire relationship, which can be broader than the informed consent provided by a retail customer when making an informed decision to accept or reject a particular recommendation by a broker-dealer. We believe this is appropriate because the investment-adviser client relationship is generally broader and can include, for example, unlimited investment discretion by the investment adviser to conduct securities transactions on behalf of the client. The broker-dealer customer relationship on the other hand is generally transaction-based and the retail customer must accept (or reject) each recommendation by a brokerdealer after the broker-dealer has provided full and fair disclosure as required under the Disclosure Obligation. Thus, in this regard, Regulation Best Interest will more closely align the Disclosure Obligation with the existing requirements for investment advisers, as noted above, but is tailored to the broker-dealer relationship.475 The Commission believes that the final Disclosure Obligation along with the protections provided by the requirements of Regulation Best Interest, including the Care Obligation and Conflict of Interest Obligation, will further serve to enhance the protections available to retail customers. One commenter recommended that the Commission clarify what a brokerdealer is required to deliver to a retail customer in order to permit the retail customer to make an ‘‘informed decision,’’ and asked the Commission to confirm that it does not require a caseby-case analysis of what is reasonable to permit the retail customer to make an informed decision.476 In addition, other commenters underscored the importance of providing retail customers with sufficient time to review and comprehend the disclosed information prior to making an informed decision about a recommendation.477 Other commenters Regulation Best Interest, however, assuming the retail customer has been provided with full and fair disclosure, the retail customer will be considered to have provided informed consent by affirmatively accepting a recommendation. 475 See Fiduciary Interpretation (describing an investment adviser’s obligation to provide disclosure designed to put a reasonable client in a position to be able to understand and provide informed consent). 476 See, e.g., CCMC Letters. 477 See, e.g., Financial Planning Coalition Letter (stating that disclosures should be made prior to the recommendation so a retail customer has sufficient time to review and understand them, as well as to E:\FR\FM\12JYR2.SGM Continued 12JYR2 33366 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 questioned whether providing ‘‘sufficient information’’ to enable a retail customer to make an informed decision broadens the Disclosure Obligation beyond ‘‘material facts’’ and ‘‘material conflicts.’’ 478 We have considered the issues raised by the commenters and in the sections that follow are providing guidance on what we believe constitutes ‘‘full and fair disclosure’’ for purposes of the Disclosure Obligation, including the form and manner, and the timing and frequency, of the disclosure. Similar to the proposal, in lieu of setting explicit requirements by rule for what constitutes full and fair disclosure of all material facts, we are providing brokerdealers flexibility in determining the most appropriate way to meet the Disclosure Obligation depending on each broker-dealer’s specific business practices. As we noted in the Proposing Release, while we are providing flexibility to broker-dealers to meet the Disclosure Obligation, we continue to be sensitive to the potential that broker-dealers could opt to disclose all facts, including those that do not meet the materiality threshold.479 We are cognizant of the likelihood that some broker-dealers could provide lengthy disclosures that do not meaningfully convey the material facts regarding the scope and terms of the relationship and material facts regarding conflicts of interest, an outcome that could undermine the Commission’s goal of facilitating disclosure to assist retail customers in making an informed investment decision. To this end, broker-dealers will only be required to disclose material facts about the scope and terms of the relationship or conflicts of interest. Although we are adopting the requirement with revisions to require full and fair disclosure of all material facts, we still believe it is important to clarify that broker-dealers’ compliance with the Disclosure Obligation will be measured against a negligence standard, not against a standard of strict liability, consistent with the Proposing Release. The Commission has taken this position in other contexts where full and fair disclosure is required, including under ask questions); CFA August 2018 Letter (stating that if the Commission wants to give investors time to consider the information and make an informed choice disclosure should be provided as soon as reasonably feasible and, when possible, no later than the point of recommendation). 478 See, e.g., IPA Letter (requesting clarification on whether providing sufficient information to enable a retail investor to make an informed decision broadens the disclosure obligation beyond material facts); CCMC Letters. 479 Id. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 the fiduciary duty under the Advisers Act.480 Form and Manner In the Proposing Release, the Commission noted that it was not proposing to specify by rule the form (e.g., narrative v. graphical/tabular) or manner (e.g., relationship guide or other written communications) of disclosure required under the Disclosure Obligation. The Commission stated that disclosure should be concise, clear and understandable to promote effective communication between a broker-dealer and a retail customer.481 We also stated that broker-dealers would be able to deliver disclosure required pursuant to Regulation Best Interest consistent with the Commission’s guidance regarding electronic delivery of documents.482 Although we preliminarily believed that broker-dealers should have the flexibility to make disclosures by any means, as opposed to requiring a standard written document at the outset of the relationship, we stated our belief that any such disclosure should be provided in writing.483 Commenters sought further guidance in a number of areas relating to disclosure, including the extent to which the Relationship Summary or other disclosures may satisfy the Disclosure Obligation,484 the circumstances under which standardized disclosure could be sufficient, as well as how, and the extent to which, disclosures made pursuant to the Disclosure Obligation 480 While establishing scienter is a requirement to establish violations of Section 206(1) of the Advisers Act, it is not required to establish a violation of Section 206(2); a showing of negligence is adequate. See SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 195 (1963); see also SEC v. Steadman, 967 F.2d at 643 and footnote 5; Steadman v. SEC, 603 F.2d 1126, 1132–34 (5th Cir. 1979), aff’d on other grounds, 450 U.S. 91 (1981). See also Prohibition of Fraud by Advisers to Certain Pooled Investment Vehicles, Advisers Act Release No. 2628 (Aug. 3, 2007). In its adoption of Rule 206(4)–8 under the Advisers Act, the Commission stated that it would not need to demonstrate that an adviser violating the rule acted with scienter. 481 See Proposing Release at 21604, footnote 211. 482 Id. at 21604 and footnote 214. 483 Id. at 21604 and footnote 213. 484 See, e.g., Cambridge Letter (arguing that the Relationship Summary and Disclosure Obligation are duplicative requirements); CUNA Mutual Letter (seeking greater clarification regarding the extent to which information provided in other documents could satisfy the Disclosure Obligation); Financial Services Institute August 2018 Letter (arguing that providing the Relationship Summary should be deemed to satisfy the requirements of the brokerdealer’s Disclosure Obligation); Morningstar Letter (arguing that due to the brevity of the Relationship Summary, additional broker-dealer disclosures would be necessary); Wells Fargo Letter (recommending that the requirements of the Disclosure Obligation be incorporated into Form CRS). PO 00000 Frm 00050 Fmt 4701 Sfmt 4700 should be made in writing.485 In response to comments we are providing additional guidance. We are also reaffirming guidance that we provided in the Proposing Release. Prescribed Form of Disclosure As noted in the Proposing Release, we believe it is important to provide brokerdealers with flexibility in determining the most appropriate and effective way to meet the Disclosure Obligation to reflect the structure and characteristics of their relationships with retail customers.486 Many commenters agreed with this reasoning, arguing that there was a need to preserve flexibility for broker-dealers to comply with the Disclosure Obligation as proposed.487 Other commenters believed, however, that the proposed Disclosure Obligation gave broker-dealers too much discretion.488 After careful consideration of these comments, the Commission has decided not to require any standard written disclosures (other than the Relationship Summary) at this time. Although we recognize the potential value to retail customers of standardizing the disclosures required pursuant to the Disclosure Obligation, we believe that retail customers can derive value from disclosures that accommodate the structure and characteristics of the particular broker-dealer. On balance, we recognize the wide variety of business models and practices and we continue to believe it is important to provide broker-dealers with flexibility to enable them to better tailor disclosure and information that their retail customers can understand and may be more likely to read at relevant points in time, rather 485 See, e.g., Schwab Letter (arguing that because most recommendations occur over the phone and through various digital means, the Commission should remove the ‘‘in writing’’ requirement and allow firms to determine the best method for disclosure depending on the situation); SIFMA August 2018 Letter (seeking clarification that oral disclosure at the time of the recommendation may be sufficient to satisfy the Disclosure Obligation in certain circumstances). But see AARP August 2018 Letter (stating that oral disclosures should never be permitted). 486 See Proposing Release at 21604. 487 See, e.g., Prudential Letter; SIFMA August 2018 Letter; TIAA Letter; UBS Letter. 488 See, e.g., Better Markets August 2018 Letter (arguing that proving broker-dealer discretion in this area will virtually assure a failure to communicate helpfully with investors); CFA August 2018 Letter (arguing that the flexibility the Commission provides will result in disclosure that does not effectively convey key information). See also Morningstar Letter (supporting the expansion of disclosures, but arguing that ‘‘publicly available disclosures with a standard taxonomy work best because they empower third parties such as ‘‘fintech’’ and ‘‘reg-tech’’ firms to analyze and contextualize critical information and amplify a call to action for ordinary investors’’). E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations Relying on Other Disclosures and Standardized Documents In the Proposing Release, we described how the Disclosure Obligation builds upon the requirements of Form CRS and the disclosures in the Relationship Summary.490 We also stated that we anticipated that brokerdealers may elect to use other documents to satisfy elements of the Disclosure Obligation, such as an account agreement, a relationship guide, or a fee schedule.491 Several commenters requested guidance on their ability to use other documents to meet the requirements of the Disclosure Obligation. For example, some commenters recommended that the Commission harmonize the Disclosure Obligation with the broad, firm-level disclosure obligations of Form CRS so that firms can use the Relationship Summary to help satisfy the Disclosure Obligation.492 Commenters also recommended that broker-dealers should be permitted to satisfy the Disclosure Obligation by using standardized language generally to describe the broker-dealer’s products and services available to their retail customers and related conflicts of interest, including the ranges of remuneration payable to a broker-dealer in connection with its recommendation of different products.493 Several commenters also suggested that the Commission should clarify that the Disclosure Obligation should not apply where an existing disclosure regime already exists.494 Similarly, other commenters recommended that the Commission clarify whether brokerdealers could meet the Disclosure Obligation by referencing information required to be disclosed pursuant to other regulatory requirements such as FINRA disclosure rules.495 After careful consideration of the comments, the Commission is providing guidance to permit a broker-dealer to utilize existing disclosures and standardized documents, such as a product prospectus, relationship guide, account agreement, or fee schedule to help satisfy the Disclosure Obligation. The Commission recognizes that brokerdealers are subject to disclosure requirements other than the Disclosure Obligation and Form CRS, and believes utilizing such existing disclosures 489 With respect to the length of disclosure documents, investor testing of proposed Form CRS examined retail investors’ likelihood of reading only longer documents (such as Form ADV Part II or an account opening agreement), only a short document (Form CRS), both, or neither when choosing a financial professional, account type or firm. Although the context was specific to Form CRS and the retail investor’s initial determination regarding a financial professional, account type or firm, the survey suggests that retail investors may be more likely to read either both longer and shorter disclosures or just shorter disclosures. See RAND 2018 (‘‘Whereas Figure 2.20 shows that half of all investors reported having reviewed neither a Form ADV nor an account opening agreement in the past and another 20 percent reported not knowing whether they had ever done so, Figure 2.21 shows that about 70 percent of all respondents and of all investors reported that they would be likely to read either both types of documents or only the Relationship Summary when choosing a financial professional in the future. Just 2 percent of investors and 1 percent of noninvestors reported being likely to read only the longer documents, whereas 29 percent of investors and 13 percent of noninvestors were likely to read only the Relationship Summary.’’ More specifically, Figure 2.21 shows that over 40% of all respondents indicated they would read both and under 30% indicated that they would read only the Relationship Summary.) 490 See Proposing Release at 21600. 491 See id. at 21605. 492 See, e.g., Cambridge Letter (recommending that providing the Form CRS should fulfill the broker-dealer’s Disclosure Obligation under Regulation Best Interest); ACLI Letter (noting that a single disclosure fulfilling Regulation Best Interest and Form CRS would reduce the disclosure burdens and increase the likelihood consumers will read the required information); FSI August 2018 Letter; Mutual of America Letter; Northwestern Mutual Letter; IPA Letter; Transamerica August 2018 Letter; NAIFA Letter. 493 See, e.g., LPL August 2018 Letter (recommending that all investors be provided with general disclosures setting forth the ranges of remuneration payable to broker-dealers in connection with its recommendations of different products); Committee of Annuity Insurers (urging the Commission to clarify that a broker-dealer can satisfy the Disclosure Obligation through disclosure describing products and services available to its retail customers and need not provide a disclosure particularized to a recommendation). 494 See, e.g., SIFMA August 2018 Letter (asking the Commission to clarify that the Disclosure Obligation does not apply in contexts where there is an existing regime, such as for equity and debt research); Transamerica August 2018 Letter (recommending that the Commission recognize that existing disclosure regimes suffice to meet certain disclosure requirements). 495 See, e.g., Transamerica August 2018 Letter (stating that the disclosure obligation should expressly take into consideration existing disclosures). jbell on DSK3GLQ082PROD with RULES2 than, for example, mandating a standardized all-inclusive (and likely lengthy) disclosure.489 We disagree that flexibility will prevent investors from obtaining information necessary to make an informed investment decision and do not believe that requiring a standard written disclosure beyond the Relationship Summary is necessary at this time. We emphasize, however, that the adequacy of the disclosure will depend on the facts and circumstances. We intend to evaluate broker-dealer disclosure practices in response to Regulation Best Interest over time to determine whether additional disclosure initiatives may be appropriate. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 PO 00000 Frm 00051 Fmt 4701 Sfmt 4700 33367 where appropriate is a reasonable and cost-effective way to satisfy the requirements of the Disclosure Obligation, and can also help avoid duplicative or voluminous disclosure by not requiring the creation of new disclosure documents.496 We recognize also that in many instances, information necessary to satisfy the Disclosure Obligation may be broadly applicable to a broker-dealer’s retail customers, and therefore the use of standardized disclosure may be appropriate. However, while broker-dealers may choose to standardize certain forms of their disclosure, whether such materials would be sufficient to satisfy the Disclosure Obligation will depend on the facts and circumstances.497 For example, disclosures may need to be tailored to a particular recommendation if the standardized disclosure does not sufficiently identify the material facts about a conflict of interest presented by a particular recommendation. Accordingly, a broker-dealer remains responsible for disclosing all material facts relating to the scope and terms of the relationship with the retail customer (as discussed above), as well as all material facts relating to conflicts of interest that are associated with a recommendation whether or not the firm relies on other materials to fulfill that obligation. With regard to commenters’ request that the Relationship Summary be considered sufficient to satisfy the Disclosure Obligation, we note that the Relationship Summary will provide succinct information and is designed to assist retail investors with the process of deciding whether to engage, or to continue to engage, a particular firm or financial professional, deciding whether to establish or continue to maintain a brokerage or investment advisory relationship, and asking questions and easily finding additional information. 496 See Proposing Release at 21599, footnotes 175 and 176. For example, broker-dealers must disclose information about a transaction on trade confirmations pursuant to Exchange Act Rule 10b– 10. 17 CFR 240.10b–10. See also Morgan Stanley Letter (noting that the securities laws and FINRA rules already require firms to provide significant disclosures to clients at natural touchpoints in the client relationship). 497 Similarly, we also note that a number of broker-dealers are modeling their disclosure of fees other than transaction-based fees on the NASAA Schedule of Miscellaneous Account and Service Fees. See NASAA August 2018 Letter. A brokerdealer may use this schedule to comply in part with its obligation to disclose fees and costs pursuant to the Disclosure Obligation. We note, however, that the NASAA Schedule may recommend the disclosure of certain fees that may not be required under the Disclosure Obligation depending on the facts and circumstances, for example those that are not ‘‘material facts’’ for purposes of Regulation Best Interest. E:\FR\FM\12JYR2.SGM 12JYR2 33368 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations We recognize that additional details regarding many of the topics (e.g., services, fees and conflicts of interest) would in many cases be necessary to satisfy the Disclosure Obligation. Thus, although a broker-dealer could use a Relationship Summary and other standardized disclosures about its products and services to help satisfy the Disclosure Obligation, these disclosures may not be sufficient to satisfy the Disclosure Obligation. Whether the Relationship Summary standing alone, or any additional or existing disclosures, satisfy any of these required disclosures in full would depend on the facts and circumstances. In most instances, broker-dealers will need to provide additional information beyond that contained in the Relationship Summary in order to satisfy the Disclosure Obligation. In Writing We proposed requiring that disclosures be provided in writing.498 We also stated that requiring written disclosures would help facilitate investor review of the disclosure, promote compliance by firms, facilitate effective supervision, and facilitate more effective regulatory oversight to help ensure and evaluate whether the disclosure complies with the requirements of Regulation Best Interest.499 We also stated that the ‘‘in writing’’ requirement could be satisfied either through paper or electronic means consistent with existing Commission guidance on electronic delivery of documents. We also provided guidance on how brokerdealers could comply with the ‘‘in writing’’ requirement when recommendations are given over the telephone.500 A number of commenters supported the ‘‘in writing’’ requirement.501 Other commenters, however, recommend that the Commission also permit the use of oral disclosure.502 For example, several commenters recommend that the Commission permit broker-dealers to orally disclose information to their customers provided they later follow-up 498 See Proposing Release at 21604. 499 Id. jbell on DSK3GLQ082PROD with RULES2 500 Id. 501 See, e.g., Vanguard Letter (recommending that the Commission require a consolidated written disclosure of all material conflicts); CFA August 2018 Letter. 502 See Schwab Letter (recommending that the Commission eliminate the ‘‘in writing’’ requirement and allow firms to design and document the best method depending on the situation); SIFMA August 2018 Letter; TIAA Letter. But see AARP August 2018 Letter (stating that oral disclosures should never be permitted). VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 in writing.503 Other commenters highlighted concerns associated with such oral disclosure.504 After carefully considering the comments, we are adopting the ‘‘in writing’’ requirement as proposed, subject to discussion in Section II.C.1, Oral Disclosure or Disclosure After a Recommendation. As stated above, we believe that retail customers would benefit from receiving a written disclosure to assist their investment decisions and form the basis of an informed investment decision.505 However, we also believe that brokerdealers require flexibility to make proper written disclosures to their customers. Accordingly, the Commission is not requiring a specific form or method of written disclosure. Although we are requiring that disclosure be made ‘‘in writing,’’ we recognize that a broker-dealer may need to supplement, clarify or update written disclosure it has previously made before it provides a retail customer with a recommendation. For instance, as we stated in the Proposing Release, we recognized that broker-dealers may provide recommendations by telephone and offer clarifying disclosure orally in some instances subject to certain conditions,506 such as a dual-registrant 503 See PIABA Letter (recommending that the Commission allow broker-dealers to discharge their disclosure obligations by: (i) Orally explaining the relationship, any conflicts, how the broker-dealer is paid, and the features, benefits and risks of the recommendation; and (ii) confirming the discussion by letter or email, which is signed or confirmed as being accurate by the customer, and retained in customer’s file); SIFMA August 2018 Letter (recommending that the Commission clarify that oral disclosure at the time of the recommendation may satisfy the Disclosure Obligation if: (1) The associated person documents that the oral disclosure was made, or (2) the firm provides written disclosure after the trade); USAA Letter (suggesting that the Commission could allow oral product-level disclosures, while providing the client the choice to request confirming disclosure in writing at her option). 504 See Edward Jones Letter (expressing concern that the Commission is implying that a dualregistrant would need to provide an oral point of sale disclosure regarding the capacity in which it is acting when it makes a recommendation, and that such oral disclosure would be difficult to supervise and of little value); CCMC Letters (stating that a dual-registrant should not have to make an oral disclosure of the capacity for each and every conversation it has with retail customers). 505 One commenter stated that certain foreign laws do not permit firms to provide their customers with written materials prior to entering into a contractual relationship. See FIBA February 2019 Letter. In response, we note that the Disclosure Obligation requires disclosure to be provided prior to or at the time of the recommendation and is not tied to a contractual relationship. In addition, the staff will continue to evaluate the application of the Disclosure Obligation in circumstances such as the one raised by this commenter. Interested parties are invited to provide further feedback on issues involving non-U.S.- resident retail customers. 506 See Proposing Release at 21604, footnote 213. PO 00000 Frm 00052 Fmt 4701 Sfmt 4700 informing a retail customer of the capacity in which the dual-registrant is acting in conjunction with a recommendation.507 In such instances, we believe that it may be necessary as a practical matter to provide oral disclosure of a material fact to supplement, clarify, or update written disclosure made previously.508 Therefore, firms may make oral disclosures under the circumstances outlined in Section II.C.1, Oral Disclosure or Disclosure After a Recommendation.509 When making such an oral disclosure, firms must maintain a record of the fact that oral disclosure was provided to the retail customer.510 We are not explicitly requiring broker-dealers to create a record documenting the substance of the oral disclosure itself, but rather a record of the fact that such oral disclosure was made.511 This record should include documentation sufficient to demonstrate that disclosure was made to the retail customer, which could include, for example, recordings of telephone conversations or contemporaneous written notations. Nonetheless, although it is not required by Regulation Best Interest, as a best practice we encourage broker-dealers that make oral disclosures to subsequently provide to their retail customers in a timely manner written disclosure summarizing the information conveyed orally. Plain English In the Proposing Release, we stated that broker-dealers should apply plain English principles to written disclosures including, among other things, the use of short sentences and active voice, and avoidance of legal jargon, highly technical business terms, or multiple negatives.512 Similarly, several commenters recommended that whatever format broker-dealers use for their disclosure, they should be written in plain English and easy to understand.513 Accordingly, although it 507 See id. at 21605, footnote 216. We stated that a broker-dealer could orally clarify the capacity in which it is acting at the time of the recommendation if it had previously provided written disclosure to the retail customer beforehand disclosing its capacity as well as the method it planned to use to clarify its capacity at the time of the recommendation. 508 For more discussion on guidance relating to updating disclosures, see Section II.C.1.d, Disclosure Obligation, Updating Disclosure. 509 See Section II.C.1, Disclosure Obligation, Oral Disclosure or Disclosure After a Recommendation. 510 See Section II.D. 511 See Section II.C.1, Disclosure Obligation, Oral Disclosure or Disclosure After a Recommendation. 512 Proposing Release at 21604, footnote 213. 513 See State Attorneys General Letter (stating that all disclosures must be in plain language and easily E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations is not required, the Commission encourages broker-dealers to use plain English in preparing any disclosures they make in satisfaction of the Disclosure Obligation. jbell on DSK3GLQ082PROD with RULES2 disclosure and recommended various methods (e.g., hyperlinks to web-based documents) but recommended paper delivery as the default option.518 Other commenters recommended permitting electronic delivery for required Electronic Delivery disclosures.519 While investor testing on In the Proposing Release, we took the the proposed Relationship Summary position that broker-dealers could indicated that some retail investors deliver written disclosures required by generally support some form of Regulation Best Interest in accordance electronic copies, most participants in with the Commission’s existing the study ‘‘generally liked having a guidance regarding electronic delivery paper version of the Relationship of documents.514 This framework Summary.’’ 520 Similarly, as stated in consists of the following elements: (1) the Form CRS adopting release, the IAC Notice to the investor that information has cited one study indicating that is available electronically; (2) access to nearly half of investors (49%) still prefer information comparable to that which to receive paper disclosures through the would have been provided in paper mail, compared with only 33% who form and that is not so burdensome that prefer to receive disclosures the intended recipients cannot electronically, either through email effectively access it; and (3) evidence to (27%) or accessing them online (6%).521 show delivery (i.e., reason to believe After considering investor testing that electronically delivered information results and commenters’ concerns and will result in the satisfaction of the recommendations, the Commission delivery requirements under the federal reaffirms the application of existing securities laws).515 We have furthermore Commission guidance relating to paper clarified that one method to satisfy the and electronic delivery of disclosure evidence of delivery element is to obtain documents to broker-dealers in meeting informed consent from investors.516 the Disclosure Obligation. Specifically, Several commenters agreed with this we believe that broker-dealers should be approach.517 These commenters able to satisfy the Disclosure Obligation typically supported the use of electronic by using electronic delivery.522 understood by investors); CFA Institute (recommending that the Commission require a clear English listing of all conflicts of interest in which a broker-dealer engages). One commenter requested that the Commission consider clarifying that the Plain English standard in the Disclosure Obligation is not an English-only requirement to address the needs of certain non-U.S. customers. See FIBA February 2019 Letter. In response, we note that any disclosure should be made consistent with Plain English principles. 514 See Proposing Release at 21604. We cited to a number of prior Commission releases on electronic delivery in the Proposing Release, including Use of Electronic Media by BrokerDealers, Transfer Agents, and Investment Advisers for Delivery of Information, Exchange Act Release No. 37182 (May 9, 1996), 61 FR 24644 (May 15, 1996) (‘‘1996 Release’’) (providing Commission views on electronic delivery of required information by broker-dealers, transfer agents and investment advisers) and Use of Electronic Media, Exchange Act Release No. 42728 (Apr. 28, 2000), 65 FR 25843 (May 4, 2000) (‘‘2000 Release’’) (providing updated interpretive guidance on the use of electronic media to deliver documents on matters such as telephonic and global consent; issuer liability for website content; and legal principles that should be considered in conducting online offerings). 515 See 1996 Release at 24646–47; see also Relationship Summary Proposing Release at 21454. 516 See 2000 Release at 25845–46 (clarifying how market intermediaries and other market participants can obtain consent for electronic delivery). 517 See, e.g., CFA August 2018 Letter (stating that giving firms discretion to choose the delivery mechanism would all but ensure that many investors would never see the disclosures); AARP August 2018 Letter (recommending that the Commission prohibit firms from solely providing electronic access to disclosures and require delivery of paper copies). VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 518 Id. See also LPL August 2018 Letter (noting that modern communication practices underscore the need for the Commission to provide more flexibility to broker-dealers to satisfy their document delivery obligations; and requesting that the Commission confirm that broker-dealers can deliver disclosures in compliance with existing guidance regarding electronic delivery of documents (which requires paper delivery as a default)). 519 See, e.g., IPA Letter (urging the Commission to confirm that all required disclosures may be delivered electronically); see also AXA Letter (urging the Commission to encourage the use of appropriate electronic disclosures, which can make information available to consumers more quickly and in a more digestible format); Prudential Letter (recommending that electronic delivery be deemed to comply with the Disclosure Obligation). 520 See RAND 2018. 521 Relationship Summary Adopting Release at Section II.D.3.a (citing Investor Advisory Committee, Recommendation of the Investor as Purchaser Subcommittee: Promotion of Electronic Delivery and Development of a Summary Disclosure Document for Delivery of Investment Company Shareholder Reports (Dec. 7, 2017), available at https://www.sec.gov/spotlight/investor-advisorycommittee-2012/recommendation-promotion-ofelectronic-delivery-and-development.pdf (citing FINRA Investor Education Foundation, ‘‘Investors in the United States 2016,’’ December 2016, available at https://bit.ly/2hMrppX). 522 See 1996 Release (stating that ‘‘the Commission believes that broker-dealers . . . similarly should have reason to believe that electronically delivered information will result in the satisfaction of the delivery requirements under the federal securities laws. Thus, whether using paper or electronic media, broker-dealers . . . should consider the need to establish procedures to ensure that applicable delivery obligations are met’’); see also 2000 Release. PO 00000 Frm 00053 Fmt 4701 Sfmt 4700 33369 However, if a broker-dealer is providing its customers with electronic delivery (upon their consent) it cannot solely offer electronic delivery and must make paper delivery available, upon request. Both Regulation Best Interest and Form CRS require firms to provide electronic delivery of documents within the framework of the Commission’s existing guidance regarding electronic delivery.523 d. Timing and Frequency We proposed requiring broker-dealers to provide the disclosures required by the Disclosure Obligation ‘‘prior to or at the time of’’ the recommendation. We noted the importance of determining the appropriate timing and frequency of disclosure that may be effectively provided ‘‘prior to or at the time of’’ the recommendation.524 In cases where a broker-dealer determines that disclosure may be more effectively be provided in an initial, more general disclosure (such as a relationship guide) followed by specific information in a subsequent disclosure that is provided at a later time, the initial disclosure would address when and how a broker-dealer would provide more specific information regarding the material fact or conflict in a subsequent disclosure. We stated also that in circumstances where a broker-dealer determines to provide an initial, more general disclosure (such as a relationship guide) followed by specific information in a subsequent disclosure that is provided after the recommendation (such as a trade confirmation), the initial disclosure must address when and how a broker-dealer would provide more specific information regarding the material fact or conflict in a subsequent disclosure (e.g., after the trade in the trade confirmation).525 We also stated 523 See Relationship Summary Adopting Release, Section II.C.3. 524 See Proposing Release at 21605. 525 The Commission has granted exemptions to certain dual-registrants, subject to a number of conditions, from the written disclosure and consent requirements of Advisers Act Section 206(3) (which makes it unlawful for an adviser to engage in a principal trade with an advisory client, unless it discloses to the client in writing before completion of the transaction the capacity in which the adviser is acting and obtains the consent of the client to the transaction). The exemptions are subject to several conditions, including conditions to provide disclosures at multiple points in the relationship, including disclosure that the entity may be acting in a principal capacity in a written confirmation at or before completion of a transaction. See, e.g., In the matter of Merrill Lynch Pierce Fenner & Smith, Incorporated, Investment Advisers Act Release No. 4595; (Dec. 28, 2016); In the matter of Robert W. Baird & Co., Incorporated, Advisers Act Release No. 4596 (Dec. 28, 2016); In the matter of UBS Financial Services, Inc., Advisers Act Release No. 4597 (Dec. E:\FR\FM\12JYR2.SGM Continued 12JYR2 33370 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 that disclosure after the recommendation, such as in a trade confirmation for a particular recommended transaction would not, by itself, satisfy the Disclosure Obligation, because the disclosure would not be ‘‘prior to, or at the time of the recommendation.’’ We noted also that whether there is sufficient disclosure in both the initial disclosure and any subsequent disclosure would depend on the facts and circumstances.526 Several commenters supported the Commission’s proposal to require broker-dealers to make disclosure prior to or at the time of the recommendation, but disagreed about the precise timing with which disclosure should be provided.527 For example, some commenters recommended that the Commission require or allow brokerdealers to meet the Disclosure Obligation prior to or at account opening.528 Similarly, several commenters recommended that the Commission require broker-dealers to provide disclosure prior to a recommendation or investment decision.529 Specifically, commenters recommended that the Commission require disclosures to be made with enough time prior to a recommendation that a retail customer has sufficient time to review and understand them, as well as ask questions.530 28, 2016); In the matter of Wells Fargo Advisors, LLC, Wells Fargo Advisors Financial Network, LLC, Advisers Act Release No. 4598 (Dec. 28, 2016). 526 See Proposing Release at 21605. 527 See, e.g., CFA August 2018 Letter (stating that any information that can be provided before the transaction is entered into should be provided to give investor time to consider it); AARP August 2018 Letter (stating that all key disclosures should be made significantly in advance of an investment decision; disclosure made at the time of or immediately prior to investing is not adequate); Bank of America Letter (stating that disclosure of material conflicts of interest can be satisfied in advance of a particular recommendation on a onetime basis); Pacific Life August 2018 Letter (stating that disclosure of material conflicts of interest must be disclosed at or prior to the point of sale or at the time the recommendation is made); FPC Letter. 528 See, e.g., TIAA Letter (recommending that the Commission require firms to meet their Regulation Best Interest and CRS disclosure obligations at or before the point the investor: (i) Opens a brokerage account; or (ii) engages the broker-dealer to provide advice services (including for recommendations provided by phone)). 529 See, e.g., Better Markets August 2018 Letter (stating that disclosure should be provided in a timely fashion so investors have a meaningful opportunity to read, digest, understand, and discuss them); FPC Letter; AARP August 2018 Letter. 530 See, e.g., NAIFA Letter (recommending that disclosure be provided at or before the time of a recommendation because it helps consumers better understand and evaluate the recommendations they receive and preserves flexibility for professionals who may be interacting with clients of various levels of financial sophistication, duration of relationship, and investment history); CFA August 2018 Letter (recommending that transaction-specific VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 Several other commenters, however, recommended that the Commission clarify whether broker-dealers could meet the Disclosure Obligation at the point of sale 531 or after a recommendation is made.532 Conversely, several commenters recommended that the Commission clarify that it will not require point of sale or point of recommendation disclosure obligations.533 After carefully considering the comments received, we are providing our view on what it means for brokerdealers to provide the required disclosures in writing ‘‘prior to or at the time of’’ the recommendation. As with the ‘‘form and manner’’ of making disclosures, the Commission continues to believe that broker-dealers should have flexibility with respect to the ‘‘timing and frequency’’ of providing disclosure to determine the most information should be provided, whenever possible, at the point of recommendation rather than at the point of sale); Groom Letter (recommending that the Commission require disclosure of material conflicts of interest related to investing plan distribution proceeds at the inception of any discussions of the matter); PIABA Letter (recommending that the Commission require firms to provide specific charges prior to or at the time the recommendation is made); FPC Letter (stating that disclosures should be made prior to the recommendation so the retail customer has sufficient time to review and understand them, as well as to ask questions); Better Markets August 2018 Letter; AARP August 2018 Letter; Bank of America Letter. 531 See Pacific Life August 2018 Letter (stating that material conflicts of interest must be disclosed at or prior to the point-of-sale or at the time the recommendation is made). 532 See, e.g., LPL August 2018 Letter (suggesting that the Commission permit a broker-dealer to satisfy the Disclosure Obligation by directing an investor in writing to review the recommended product’s offering documents, along with hyperlinks to those documents, prior to the recommendation or shortly thereafter via a trade confirmation); SIFMA August 2018 Letter (recommending that the Commission confirm that firms would be permitted to provide disclosures on a website or on a post-trade basis, provided customers have been informed in advance of the timing of those disclosures). 533 See, e.g., SIFMA August 2018 Letter (requesting the Commission clarify that there is no requirement for a point of sale or point of recommendation disclosure, as such a requirement would be unworkable for the industry); Morgan Stanley Letter (noting that point-of-sale disclosures pose operational issues and may not afford clients sufficient time to adequately consider and understand them); HD Vest Letter (recommending that the Commission not mandate written point of recommendation or point of sale disclosure); Prudential Letter (requesting that the Commission clarify that it is not mandating a point of sale or point of recommendation disclosure obligation). But see NASAA August 2018 Letter (stating that only a transaction-by-transaction disclosure obligation will ensure that broker-dealers are meeting their ‘‘best interest’’ duties and provide investors the level of protection they deserve); AARP August 2018 Letter (recommending that the Commission require firms to disclose their fees any time a recommendation is made). PO 00000 Frm 00054 Fmt 4701 Sfmt 4700 appropriate and effective way to meet the Disclosure Obligation. Accordingly, the Commission has decided not to provide any prescriptive requirements for the timing and frequency of written disclosures, other than requiring disclosure prior to or at the time of the recommendation. In order to make an informed decision about a securities recommendation, retail customers must have appropriate information at the time or before a recommendation is made. Being in possession of relevant information gives investors the tools with which to judge the merits of acting on a particular recommendation. As stated in the Proposing Release, the Commission believes that broker-dealers should provide retail customers information early enough in the process to give them adequate time to consider the information and promote the investor’s understanding in order to make informed investment decisions.534 Similarly, the Commission believes that broker-dealers should not provide information so early that the disclosure fails to provide meaningful information (e.g., does not sufficiently identify material conflicts presented by a particular recommendation, or overwhelms the retail customer with disclosures related to a number of potential options that the retail customer may not be qualified to pursue).535 Nevertheless, in order to provide broker-dealers the flexibility to determine how and when to make relevant disclosures pursuant to the Disclosure Obligation, we are not mandating a requirement that disclosures be made within a certain timeframe preceding a recommendation. However, we continue to encourage broker-dealers to consider whether it would be helpful to repeat or highlight disclosures already made pursuant to the Disclosure Obligation at the time of the recommendation. We are also clarifying the ability of a broker-dealer to supplement, clarify, or update information after making a recommendation.536 In particular, if a broker-dealer determines to disclose information, in part, after the recommendation, such as in a prospectus or trade confirmation, that disclosure may be used to supplement, clarify, or update the initial, general disclosure. For example, any necessary 534 Proposing Release at 21605. 535 Id. 536 See id. In the proposal, we noted that there may be material information that the broker-dealer may not be in a position to disclose at or prior to the recommendation that may be revealed following the transaction, such as the final transaction information contained in a trade confirmation. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations information in a product offering document, such as information about product risks or fees, may be provided in accordance with existing disclosure mechanisms that occur after a transaction, such as the delivery of a trade confirmation or a prospectus, private placement memorandum, or offering circular.537 However, the broker-dealer must comply with the circumstances outlined in Section II.C.1, Oral Disclosure or Disclosure After a Recommendation, in order to make any such disclosure after the recommendation. jbell on DSK3GLQ082PROD with RULES2 Layered Disclosure We proposed to require broker-dealers to provide disclosure prior to or at the time of the recommendation but gave guidance on a number of approaches they could take to achieve this requirement, including providing layered disclosure, in which more general information is supplemented by more detailed information provided either at the same time or subsequently.538 We received a number of comments supporting our proposed guidance concerning a layered approach to the Disclosure Obligation.539 In addition, investor testing illustrates that many retail investors support a layered approach as well.540 537 In instances where a recommended transaction is not acted upon by the retail customer, and therefore there is no subsequent delivery of disclosure otherwise required by the transaction, the fact that such information is not provided would not be a violation of the Disclosure Obligation. 538 See Proposing Release at 21605 (suggesting the Disclosure Obligation could be satisfied, for example, at multiple points in the relationship or through a layered approach to disclosure, such as an initial disclosure conveying more general information regarding the material fact or conflict followed by more specific information in a subsequent disclosure). 539 See, e.g., Commonwealth Letter (supporting a layered disclosure approach that includes (i) the Relationship Summary at the inception of the relationship; (ii) the traditional disclosures included in account-opening agreements; (iii) product-specific point-of-sale disclosures (e.g., prospectuses and alternative investment offering documents); and (iv) more detailed disclosures on the firm’s website); IRI Letter (supporting a principles-based disclosure regime, which leverages the benefits of layered disclosure to combat information overload); Morgan Stanley Letter (concurring with the Commission’s proposed layered approach to disclosure of material facts regarding the scope of the relationship with the client and fees, as well as material conflicts of interest associated with the recommendation); Stifel Letter; Mass Mutual Letter; Triad Advisors Letter; Investacorp Letter; Ladenburg Letter. 540 See, e.g., Study Regarding Financial Literacy Among Investors As Required by Section 917 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, August 2012 at iv. A key finding of the SEC staff’s 917 study was that Investors favor ‘‘layered’’ disclosure and, wherever possible, the use of a summary document containing key information about an investment product or service. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 We have considered these comments and results of investor testing and will continue to permit broker-dealers to use a layered approach to disclosure. We acknowledge that different investors have different preferences for the type and length of disclosures they receive, and that some investors may not read additional information provided in any particularized disclosure that supplements initial, standardized disclosure. Nonetheless, we believe that permitting broker-dealers to provide their retail customers with a standardized summary of information supplemented by more particularized information will help avoid the likelihood that retail customers receive a single, potentially voluminous disclosure document, and enable the many investors who prefer a shorter, summary document to have it available to them, with additional information available should they wish to have it. This approach to layering information is also consistent with our concurrent effort in Form CRS to provide retail investors with high level information and context concerning key material facts, supplemented by additional layers of information regarding their relationship. We also continue to believe that broker-dealers should have flexibility in determining when to make disclosures and whether, in light of their retail customer base, certain material facts That study described layered disclosure as an ‘‘approach to disclosure in which key information is sent or given to the investor and more detailed information is provided online and, upon request, is sent in paper or by email.’’ See Enhanced Disclosure and New Prospectus Delivery Option for Registered Open-End Management Investment Companies, Securities Act Release No. 8998 (Jan. 13, 2009). This layered approach is ‘‘intended to provide investors with better ability to choose the amount and type of information to review, as well as the format in which to review it (online or paper).’’ Id. Other studies that considered the use of hyperlinks for layered disclosure in proposed Form CRS suggested that retail investors are generally interested in receiving additional information, but recognized the possibility that retail investors may not click on a hyperlink. See, e.g., RAND 2018 (finding 58% of participants selecting ‘‘very likely’’ and another 32% selecting ‘‘somewhat likely’’ to click on a hyperlink relating to fees; although no other potential hyperlink generated a majority with ‘‘very likely’’ usage, other potential hyperlinks concerning services, conflicts and investor education generated a majority when combining responses of ‘‘very likely’’ and ‘‘somewhat likely’’ to click on the hyperlink). See also Kleimann Communication Group, Inc., Report on Development and Testing of Model Client Relationship Summary, Presented to AARP and Certified Financial Planner Board of Standards, Inc. (Dec. 5, 2018), available at https://www.sec.gov/ comments/s7-07-18/s70718-4729850-176771.pdf (indicating that while some participants were interested in additional information, others admitted they would not follow the links because it was extra effort, they were uninterested, or the link did not itself suggest what would be there). PO 00000 Frm 00055 Fmt 4701 Sfmt 4700 33371 would be more effectively conveyed in a more general manner in an initial written disclosure accompanied or followed by more specific information in a separate disclosure. Similarly, we believe that providing broker-dealers with flexibility to best target their disclosures to their particular retail customer base will increase the likelihood that investors will view them. The Commission is not prescribing specific procedures obligating brokerdealers to fulfill the Disclosure Obligation in a particular way. Rather, Regulation Best Interest as adopted provides broker-dealers with flexibility to provide disclosures that are consistent with the various ways in which broker-dealers may already provide disclosure to their customers.541 This could include, for example, providing multiple or ‘‘layered’’ disclosures either initially or over time, but that in total constitute full and fair disclosure of the information required by the Disclosure Obligation. While we are not setting forth a prescriptive approach regarding exactly when disclosures should be made as suggested by some commenters, we believe that a broker-dealer may determine that certain disclosures are most effective if they are made at multiple points of the relationship, or alternatively, certain material facts may be conveyed in a more general manner in an initial written disclosure accompanied or followed by more specific information.542 Updating Disclosures Several commenters recommend that the Commission clarify under what circumstances a broker-dealer would be required to update prior disclosures made pursuant to the Disclosure Obligation.543 Among the suggestions are to only require broker-dealers to update their disclosures when there are material changes to the disclosed 541 See Proposing Release at 21605. id. 543 See, e.g., LPL August 2018 Letter (recommending that the Commission provide additional guidance with respect to the updating and amendment requirements that apply to the Disclosure Obligation); CFA Institute Letter (recommending that the Commission require broker-dealers to provide updated disclosures at least 30 days before raising or imposing new fees); Bank of America Letter (recommending that the Commission require firms to update existing disclosures when there are changes to material conflicts of interest, as well as annually); NAIFA Letter (recommending that the Commission not require regular disclosure (e.g., quarterly, annual, etc.) of any new information items, unless the information has materially changed). 542 See E:\FR\FM\12JYR2.SGM 12JYR2 33372 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations information; 544 require broker-dealers to update their disclosures at least 30 days before raising or imposing new fees; 545 and require broker-dealers to update their disclosures when changes are made, as well as annually.546 The Commission has carefully considered the commenters’ suggestions and is providing guidance on a brokerdealer’s duty to update disclosures made to customers under Regulation Best Interest. The Disclosure Obligation requires broker-dealers to provide their retail customers with full and fair disclosure of material facts related to several aspects of their relationship with their customers. Therefore, a brokerdealer cannot provide customers with full and fair disclosure if the disclosures contain materially outdated, incomplete, or inaccurate information. Additional disclosure will be necessary when any previously provided information becomes materially inaccurate, or when there is new relevant material information (e.g., a new material conflict of interest has arisen that is not addressed by the standardized disclosure).547 Therefore, a broker-dealer’s duty to update disclosures made to its customers under Regulation Best Interest is based on the facts and circumstances. While we are not prescribing an explicit timeframe in which required updates must be made, generally the Commission encourages broker-dealers to update their disclosures to reflect material changes or inaccuracies as soon as practicable, and thus generally should be no later than 30 days after the material change; in the meantime, broker-dealers are encouraged to provide, supplement, or correct any written disclosure with oral disclosure as necessary prior to or at the time of the recommendation.548 However, if updated information is to be provided either orally, or after a recommendation, such disclosure must be made under the circumstances outlined in Section II.C.1, Oral Disclosure or Disclosure After a Recommendation. 544 See NAIFA Letter. CFA Institute Letter. 546 See Bank of America Letter. 547 See Proposing Release at 21605. 548 The 30-day period aligns with other requirements to update disclosures in similar contexts. For instance, NASD Notice to Members 92–11, Fees and Charges for Services (Feb. 1992) states that its member firms need to provide written notification to customers of all service charges when accounts are opened, and . . . written notification at least 30 days prior to the implementation or change of any service charge. Failure to do so could be construed as conduct inconsistent with just and equitable principles of trade under FINRA Rule 2010 (Standards of Commercial Honor and Principles of Trade). jbell on DSK3GLQ082PROD with RULES2 545 See VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 2. Care Obligation We proposed the Care Obligation to require a broker-dealer, when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer, to exercise reasonable diligence, care, skill, and prudence to: (1) Understand the potential risks and rewards associated with the recommendation, and have a reasonable basis to believe that the recommendation could be in the best interest of at least some retail customers; (2) have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer based on that retail customer’s investment profile and the potential risks and rewards associated with the recommendation; and (3) have a reasonable basis to believe that a series of recommended transactions, even if in the retail customer’s best interest when viewed in isolation, is not excessive and is in the retail customer’s best interest when taken together in light of the retail customer’s investment profile. As we indicated in the Proposing Release, the Care Obligation was intended to incorporate and enhance existing suitability requirements applicable to broker-dealers under the federal securities laws by, among other things, imposing a ‘‘best interest’’ requirement that will require a broker-dealer to not place its own interest ahead of the retail customer’s interest, when making recommendations.549 Commenters generally supported the proposed Care Obligation, including its principles-based approach, but many commenters requested additional guidance or clarification on how a broker-dealer could satisfy the Care Obligation under different circumstances and regarding specific products.550 Relatedly, several commenters requested further guidance regarding the role of costs and other relevant factors when making a best interest determination,551 while other commenters expressed concern over the usage of the term ‘‘prudence’’ 552 or expressed concern that Regulation Best Interest is not a major change from FINRA’s suitability rule.553 Numerous 549 As discussed in the Fiduciary Interpretation, the duty of care of the investment adviser’s fiduciary duty includes a duty to provide investment advisory services that are in the best interest of the client. See Fiduciary Interpretation at footnote 34. 550 See, e.g., NASAA August 2018 Letter; Cambridge Letter; BlackRock Letter. 551 See, e.g., Wells Fargo Letter; Primerica Letter; CFA Institute Letter. 552 See, e.g., BISA Letter; Raymond James Letter; Transamerica August 2018 Letter. 553 See, e.g., CFA August 2018 Letter (stating ‘‘[n]owhere does the Commission explain how the PO 00000 Frm 00056 Fmt 4701 Sfmt 4700 commenters also requested clarification on the meaning and scope of ‘‘reasonably available alternatives’’ and ‘‘otherwise identical securities,’’ including how the phrase ‘‘reasonably available alternatives’’ would apply in situations where a broker-dealer operated in an open architecture environment,554 or maintained a limited product menu such as where brokerdealers limited available offerings to proprietary products.555 Finally, several commenters recommended the Commission include other factors in building a retail customer’s investment profile, such as longevity risk,556 market risk,557 or income profile.558 We are adopting the Care Obligation substantially as proposed, but with certain modifications and additional guidance to address comments. As discussed in more detail below, in response to comments, we are revising the Care Obligation to remove the term ‘‘prudence,’’ as we have concluded that its inclusion creates legal uncertainty and confusion, and it is redundant of what we intended in requiring a brokerdealer to exercise ‘‘diligence, care, and skill,’’ and its removal does not change the requirements under the Care Obligation. Accordingly, the Care Obligation will require broker-dealers to ‘‘exercise reasonable diligence, care, and skill’’ to meet the three components of the Care Obligation. In addition, after careful consideration of the comments received, we are expressly adding cost to the rule text as a factor that a broker-dealer must consider in fulfilling the Care Obligation. While certain commenters expressed concerns about the prominence of cost and how cost would be balanced against other factors under the Care Obligation,559 other standard differs from, or even whether it improves upon, the existing suitability standard under FINRA rules’’); AFL–CIO April 2019 Letter (stating ‘‘that the intent of [proposed Regulation Best Interest] is to codify, rather than enhance, protections investors currently receive under FINRA’s suitability standard’’). 554 For purposes of this requirement, we use the term ‘‘open architecture’’ to mean a firm’s product menu that includes both third-party and proprietary products, or as a concept wherein a firm offers a large range of products to their retail customers that are not limited, for example, to a small list of approved managers or funds (i.e., a product menu that is not limited to proprietary products or otherwise constrained to certain retail customers or registered representatives). See generally FINRA 2013 Conflicts Report; Morgan Stanley Letter. 555 See, e.g., Fidelity Letter; ICI Letter; LPL August 2018 Letter; SIFMA August 2018 Letter; Prudential Letter; Morningstar Letter. 556 See, e.g., CCMC Letters; Lincoln Financial Letter; Pacific Life August 2018 Letter. 557 See, e.g., Jackson National Letter. 558 See, e.g., Lincoln Financial Letter. 559 See, e.g., ICI Letter; Putnam Letter; Morgan Stanley Letter; Letter from Eric R. Dinallo, E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 commenters supported incorporating cost into the rule text.560 As noted in the Relationship Summary Adopting Release, participants in investor testing and roundtables also overwhelmingly supported including fees in the Relationship Summary, and believed that the ‘‘fees and costs’’ section was the most important for determining which type of investment accounts and services are right for that person.561 We believe that while the factors that a broker-dealer should understand and consider when making a recommendation may vary depending upon the particular product or strategy recommended, cost—along with potential risks and rewards—will always be a relevant factor that will bear on the return of the security or investment strategy involving securities.562 This would include, for example, both costs associated with the purchase of the security, as well as any costs that may apply to the future sale or exchange of the security, such as deferred sales charges or liquidation costs. Elevating cost to the rule text clarifies that this factor must always be considered when making a recommendation. Thus, a broker-dealer, in fulfilling its obligation to make a recommendation in the best interest of its retail customer, must exercise reasonable diligence, care, and skill to understand the ‘‘potential risks, rewards, and costs’’ associated with the recommendation and have a reasonable basis to believe that the recommendation is in the best interest of the retail customer based on these factors. Importantly, however, while cost, like potential risks and rewards, is always a Executive Vice President, General Counsel, Guardian Life (Aug. 7, 2018) (‘‘Guardian August 2018 Letter’’) (cautioning against inclusion of ‘‘costs’’ into rule text or overemphasizing its importance). 560 See, e.g., AFL–CIO April 2019 Letter (stating ‘‘If, as has been suggested, one goal is to ensure that brokers give greater consideration to costs in determining what investments to recommend, [Regulation Best Interest] should incorporate an explicit requirement to consider costs in the rule text.’’); NASAA August 2018 Letter; U. of Miami Letter (supporting addition of ‘‘costs’’ into rule text). See also CFA August 2018 Letter (supporting the Commission’s emphasis of cost and associated financial incentives as more important factors, and stating ‘‘[t]his requirement would be clearer, however, if it were incorporated into the rule text, which requires the broker to consider the ‘potential risks and rewards associated with the recommendation,’ rather than the material characteristics, including costs, of the recommended investment or investment strategy.’’). 561 See Relationship Summary Adopting Release. 562 See Vanguard Letter (‘‘We agree that costs and remuneration should play a central role in meeting the revise best interest standards. Cost is a critical factor because of its compounding effect upon performance.’’). VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 factor that a broker-dealer must consider in making a recommendation, it is not a dispositive factor and its inclusion in the rule text is not meant to limit or foreclose the recommendation of a more costly or complex product that a brokerdealer has a reasonable basis to believe is in the best interest of a particular retail customer.563 Moreover, we are reiterating that the standard does not necessarily require the lowest cost option, and that while cost is an important factor that always needs to be taken into consideration in making a recommendation, it is not the only one.564 Rather, as explained more fully below, the evaluation of cost would be more analogous to a broker-dealer’s best execution analysis, which does not require the lowest possible cost, but rather looks at whether the transaction represents the best qualitative execution for the customer using cost as one factor.565 Several commenters expressed concern over the emphasis of ‘‘cost’’ and suggested that, for example, more emphasis be placed on additional or subjective factors beyond specific product attributes.566 Those commenters stated that the emphasis on cost may discourage certain products or investment strategies. Our intent is not to discourage or otherwise limit the recommendation of products or investment strategies where a brokerdealer concludes that the recommendation is in the best interest of the retail customer. Instead, we believe that cost will always be relevant to a recommendation and accordingly should be a required consideration as 563 See Proposing Release at 21587–21589; 21610–21612. 564 See Proposing Release at 21610. 565 Under the antifraud provisions of the federal securities laws and SRO rules, broker-dealers have a legal duty to seek to obtain best execution of customer orders. See Regulation NMS, Exchange Act Release No. 51808 (Jun. 9, 2005) (‘‘Regulation NMS Release’’); FINRA Rule 5310 (Best Execution and Interpositioning). A broker-dealer’s duty of best execution requires a broker-dealer to seek to execute customers’ trades at the most favorable terms reasonably available under the circumstances. See Regulation NMS Release at 160; see also Proposing Release at 21615. Certain commenters pointed to best execution analysis as an example of a rule or guidance that is facts-and-circumstancesbased. See, e.g., CFA August 2018 Letter (‘‘Just as compliance with the best execution standard will not always be met by sending trades to the exchange where the lowest cost is displayed, compliance with a best interest standard will not always be satisfied by recommending the lowest cost option.’’). 566 See, e.g., ICI Letter; BlackRock Letter; Putnam Letter; Transamerica August 2018 Letter; Northwestern Mutual Letter; see also Vanguard Letter (recognizing the importance of cost, but urging the Commission to maintain a principlesbased approach recognizing the importance of ‘‘holistic advice that necessarily contemplates factors beyond cost.’’). PO 00000 Frm 00057 Fmt 4701 Sfmt 4700 33373 set forth in the rule text. It should never be the only consideration. Additional factors such as those cited by commenters also should be taken into consideration as the broker-dealer formulates a recommendation consistent with the best-interest standard.567 Though we are declining to expressly define ‘‘best interest’’ in the rule text, as discussed above,568 we are providing guidance regarding the application of the Care Obligation and in particular what it means to make a recommendation in the retail customer’s ‘‘best interest.’’ In addition, to emphasize the importance of determining that each recommendation is in the best interest of the retail customer and that it does not place the broker-dealer’s interests ahead of the retail customer’s interests, we are expressly incorporating into the rule text of Paragraph (a)(2)(ii)(B) and Paragraph (a)(2)(ii)(C) of Regulation Best Interest that a broker-dealer must have a reasonable basis to believe that the recommendation ‘‘does not place the financial or other interest of the [brokerdealer] . . . ahead of the interest of the retail customer.’’ While we acknowledge that a broker-dealer and an associated person can and will have some financial interest in a recommendation, as noted above, this addition to the Care Obligation makes clear these interests cannot be placed ahead of the retail customer’s interests when making a recommendation.569 Finally, we believe that by explicitly requiring in the rule text that the brokerdealer have a reasonable basis to believe that a recommendation is both in the retail customer’s ‘‘best interest’’ and 567 See, e.g., BlackRock Letter (citing consideration of investors’ needs and desired outcomes relative to service offerings of several different managers); Vanguard Letter (‘‘considerations include important factors such as product structure, investment features, liquidity, volatility, issuer reputation, brand and business practices (securities lending activities, portfolio tracking error, or usage of derivatives in a portfolio)’’); ICI Letter (citing several subjective factors, such as the ‘‘nature and quality of a provider’s services (including advantages to the investor of consolidating investments as a single firm, such as higher levels of service that may be offered), minimum initial investments, and firm reputation’’); FIBA February 2019 Letter (citing ‘‘highly personalized non-economic reasons underlying cross-border investment’’). 568 See Section II.A.2. 569 See id. See also AFL–CIO April 2019 Letter (noting ‘‘Adopting a standard that explicitly states that brokers are prohibited form placing their own interests ahead of the retail customer’s interests reinforces [investors’ reasonable expectations that the financial professionals they rely on for investment advice will put their interests first]’’ and asserting that ‘‘a requirement to place the customer’s interests ahead of the brokers’ interests must be included in the operational provisions of Reg BI. . . .’’). E:\FR\FM\12JYR2.SGM 12JYR2 33374 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 does ‘‘not place the financial or other interest’’ of the broker-dealer ahead of the retail customer’s interests, we are enhancing the Care Obligation by imposing obligations beyond existing suitability obligations. Under existing suitability requirements, a broker-dealer is required to make recommendations that are ‘‘suitable’’ for the customer. While certain cases and guidance have interpreted FINRA’s suitability rule to require that ‘‘a broker’s recommendations must be consistent with his customers’ best interests,’’ and FINRA has further interpreted the requirement to be ‘‘consistent with the customer’s best interest’’ to prohibit a broker-dealer from placing his or her interests ahead of the customer’s interests, this obligation is not explicitly required by FINRA’s rule (or its supplementary material), nor does the interpretation require recommendations to be in the best interest (as opposed to ‘‘consistent with the best interest’’) of a retail customer.570 We believe that requiring recommendations to be in the best interest is declarative of what must be done, and therefore stronger than, requiring recommendations to be ‘‘consistent with’’ the best interest of the retail customer, which we believe at a minimum creates ambiguity as to whether the recommendation must be in the retail customer’s best interest or something less.571 The Care Obligation significantly enhances the investor protection provided as compared to current suitability obligations by: (1) Explicitly requiring in Regulation Best Interest that recommendations be in the best interest of the retail customer and do not place the broker-dealer’s interests ahead of the retail customer’s interests; (2) explicitly requiring by rule the consideration of costs when making a recommendation; 570 See FINRA Regulatory Notice 12–25 at Q1. See also FINRA Letter to Senators Warren, Brown, and Booker (Aug. 3, 2018) (‘‘FINRA 2018 Letter’’) (stating that ‘‘[w]hile FINRA’s suitability rule implicitly requires a broker-dealer’s recommendations to be consistent with customer’s best interests, the SEC’s proposed best interest standard explicitly establishes the customer’s best interest as an overarching standard of care for broker-dealers.’’ (internal citations omitted)). Some commenters have also made this point. See, e.g., CFA August 2018 Letter (‘‘In enforcing that standard, however, FINRA has only rarely and very narrowly enforced the obligation to do what is best for the customer—typically in cases that involve recommending the most appropriate share class of a particular mutual fund. . . . Indeed, as we detailed in our July 2015 comment letter to the Department of Labor, most of the cases in which FINRA and the Commission have asserted an obligation for brokers to act in customers’ best interest have involved egregious frauds rather than questions of whether customers’ best interests were being served.’’). 571 See, e.g., CFA August 2018 Letter. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 and (3) applying the obligations relating to a series of recommended transactions (currently referred to as ‘‘quantitative suitability’’) irrespective of whether a broker-dealer exercises actual or de facto control over a customer’s account.572 In addition, it is our view that a broker-dealer should consider ‘‘reasonably available alternatives’’ as part of having a ‘‘reasonable basis to believe’’ that the recommendation is in the best interest of the retail customer, which we also believe is an enhancement beyond existing suitability expectations.573 a. Exercise Reasonable Diligence, Care, and Skill A broker-dealer is required to ‘‘exercise reasonable diligence, care, and skill’’ to satisfy the three components of the Care Obligation set forth in Regulation Best Interest. In the Proposing Release, we included ‘‘prudence,’’ and explained that ‘‘prudence’’ ‘‘conveys the fundamental importance of conducting a proper evaluation of any securities or investment strategy recommendation in accordance with an objective standard of care.’’ 574 Further, we solicited comment on all aspects of the Care Obligation, and also asked specifically whether there was adequate clarity and understanding regarding the term ‘‘prudence,’’ or whether other terms were more appropriate in the context of broker-dealer regulation. Several commenters supported adopting a principles-based obligation, thus requiring the broker-dealer to assess the adequacy of a recommendation based on the facts and circumstances of each 572 See FINRA 2018 Letter (noting that proposed Regulation Best Interest augments and enhances current requirements by, among other things: ‘‘explicitly impos[ing] a ‘best interest’ standard, making clear that a broker-dealer cannot put its interests ahead of the interests of its customers. While FINRA’s suitability rule implicitly requires a broker-dealer’s recommendations to be consistent with customers’ best interests, the SEC’s proposed best interest standard explicitly establishes the customer’s best interest as an overarching standard of care for broker-dealers;’’ ‘‘explicitly requir[ing] broker-dealers to consider ‘reasonably available alternatives’ to a recommended security and justify any choice of a more costly product. . . . Although case law and FINRA guidance establish cost and available alternatives as factors to consider as part of a FINRA suitability assessment, particularly regarding mutual fund share classes, proposed Reg Bl expressly establishes the significance of these factors’’; and ‘‘remov[ing] the ‘control’ element for purposes of quantitative suitability, which would make this obligation more enforceable.’’) (internal citations omitted). 573 See infra Section II.C.2.c, Application of the Care Obligation—Reasonably Available Alternatives and Otherwise Identical Securities. 574 Proposing Release at 21609. PO 00000 Frm 00058 Fmt 4701 Sfmt 4700 recommendation.575 We also received numerous comments asking for further guidance relating to recommendations of specific securities or asking how the Care Obligation applies to certain factual scenarios.576 With respect to the term ‘‘prudence,’’ a number of comments requested removal of the term, stating that such language is unnecessary given the other requirements to satisfy the Care Obligation, as well as the fact that the term introduces legal confusion and uncertainty.577 Other commenters supported the use of the term ‘‘prudence’’ because they believed that Regulation Best Interest’s component obligations generally rested on a ‘‘prudence’’ standard or maintained that the Care Obligation ‘‘echoes elements found in the common law ‘prudent person rule,’ ’’ and thus thought its addition was appropriate to capture, or describe, these obligations.578 After careful consideration of comments, we are revising the Care Obligation to remove the term 575 See, e.g., SIFMA August 2018 Letter; Vanguard Letter; Morningstar Letter; Edward Jones Letter. 576 See, e.g., SIFMA August 2018 Letter; Direxion Letter; Chapman Letter. 577 See, e.g., Primerica Letter (stating ‘‘. . . . the term [prudence] raises numerous interpretative issues and compliance risks. Regulatory and judicial interpretations of ERISA ‘prudence’ and its requirements abound, but these are exclusive to employee benefit plan duties and do not address duties with respect to retail accounts for individual customers.’’); Transamerica August 2018 Letter (‘‘The term ‘prudence’ is one used primarily in the ERISA context and is not generally used in the federal securities laws. We believe inclusion of the term ‘prudence’ in describing the care obligation is unnecessary and could lead to confusion in interpretation of the care obligation set forth in the Proposal’’); IPA Letter (‘‘ ‘Prudence’ is an ERISA term based on trust law that is not generally used under the federal securities laws’’). See also Fein Letter (discussing that the ‘‘duties of loyalty and care are the core fiduciary standards that apply across all fiduciary fields, including trust law, agency law, and employee benefits law;’’ that ‘‘[b]oth of these duties are reflected in the existing regulation of broker-dealers and investment advisers when they give investment advice to retail customers;’’ and that the ‘‘duty of care—also called ‘prudence’—requires a fiduciary to act with care, skill and diligence in fulfilling his designated functions.’’) (internal citations omitted). 578 See LPL August 2018 Letter (‘‘We believe that each of the four component obligations identified in Regulation BI generally rests on a ‘prudence’ standard that is the foundation of the common law principles and the Federal law that have governed the activities of financial services providers for decades. The obligation to provide prudent recommendations that are appropriate for an investor’s circumstances is a principal component of the suitability obligations that apply to investment advisers under the [Advisers Act]’’ (internal citations omitted); FPC Letter (stating that ‘‘the duty of care, as described by both Reg BI and CFP Board Standards, echoes elements found in the common law ‘prudent person rule’ which can serve to measure the reasonableness of a prudent professional’s actions. . . .’’); see also CFA August 2018 Letter; NAIFA Letter. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations ‘‘prudence.’’ Accordingly, the Care Obligation will require broker-dealers to ‘‘exercise reasonable diligence, care, and skill’’ to meet the three components of the Care Obligation. We are persuaded by commenters that its inclusion in the proposed rule text to satisfy the components of the Care Obligation is superfluous and unnecessarily presents the possibility for confusion and legal uncertainty.579 We believe requiring broker-dealers ‘‘to exercise reasonable diligence, care, and skill’’ conveys ‘‘the fundamental importance of conducting a proper evaluation of any securities recommendation in accordance with an objective standard of care’’ 580 that was intended by the inclusion of ‘‘prudence.’’ Removing ‘‘prudence’’ does not lessen nor otherwise change the requirements or our expectations under the Care Obligation, or Regulation Best Interest more broadly as it was duplicative of the phrase ‘‘diligence, care, and skill.’’ 581 The revised obligation, in requiring the brokerdealer to ‘‘exercise[ ] reasonable diligence, care and skill’’ and to have a ‘‘reasonable basis to believe that the recommendation is in the best interest . . . and does not place’’ the interest of the broker-dealer ahead of the interest of the retail customer, will continue to require an analysis that is comparable to the notion of ‘‘prudence’’ as described in other regulatory frameworks,582 but does so using the terms ‘‘diligence, skill, and care’’—terminology with which broker-dealers are familiar and that is well understood under the federal securities laws.583 As such, we believe that the revised language will minimize the potential confusion and legal uncertainty created by using a term that is predominantly interpreted in other 579 See supra footnote 577. Release at 21609. 581 See, e.g., LPL August 2018 Letter (noting that the component obligations of Regulation Best Interest generally rest on ‘‘prudence’’ concepts); Fein Letter. 582 See Fein Letter (stating that the ‘‘duty of care—also called ‘prudence’—requires a fiduciary to act with care, skill and diligence in fulfilling his designated functions’’) (citing Restatement 3d of Agency, § 8.08 Duties of Care, Competence, and Diligence (‘‘[s]ubject to any agreement with the principal, an agent has a duty to the principal to act with care, competence, and diligence normally exercised by agents in similar circumstances. . . .’’)). The DOL interpreted ‘‘prudence’’ to represent ‘‘an objective standard of care that requires investment advice fiduciaries to investigate and evaluate investments, make recommendations, and exercise sound judgment in the same way that knowledgeable and impartial professionals would.’’ BIC Exemption Release, 81 FR 21208 at 21028–21029. 583 See, e.g., Proposing Release at 21595, 21609– 21613. The discussion that follows addresses what it means to ‘‘exercise reasonable diligence, care, and skill’’ in the context of each aspect of the Care Obligation. jbell on DSK3GLQ082PROD with RULES2 580 Proposing VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 legal regimes,584 and will aid brokerdealers in achieving compliance with Regulation Best Interest as well as permit broker-dealers to utilize existing compliance and supervisory systems that already rely on this language. Moreover, we note that certain commenters’ support for the term ‘‘prudence’’ was based on our interpretation of the Care Obligation in the Proposing Release.585 As noted above, the removal of the term ‘‘prudence’’ does not change the obligations or our interpretation of the Care Obligation, which we believe are addressed by the ‘‘diligence, care, and skill’’ language and through Regulation Best Interest more broadly. In light of concerns regarding legal uncertainty associated with the term ‘‘prudence,’’ and our view that its inclusion or removal would not change the requirements or expectations of Regulation Best Interest, we have determined to remove it from the rule text. Finally, in response to comments, we are retaining the facts-andcircumstances determination for the reasons set forth in the Proposing Release,586 and providing additional guidance on the application of the components of the Care Obligation with respect to certain securities and under certain scenarios. As we noted in the Proposing Release, such an approach is consistent with how broker-dealers are currently regulated with respect to the suitability of their recommendations and would allow broker-dealers to utilize and incorporate pre-existing compliance systems. In addition, this approach is generally consistent with the principles-based approach applicable to the duty of care of investment advisers.587 b. Understand Potential Risks, Rewards, and Costs Associated With Recommendation, and Have a Reasonable Basis To Believe That the Recommendation Could Be in the Best Interest of at Least Some Retail Customers Under the proposed ‘‘reasonable basis’’ component of the Care Obligation, broker-dealers would be required to understand the potential supra footnote 577. e.g., NAIFA Letter. 586 Proposing Release at 21587 (‘‘[W]e preliminarily believe that whether a broker-dealer acted in the best interest of the retail customer when making a recommendation will turn on the facts and circumstances of the particular recommendation and the particular retail customer, along with the facts and circumstances of how the four specific components of Regulation Best Interest are satisfied.’’). 587 See Fiduciary Interpretation. PO 00000 584 See 585 See, Frm 00059 Fmt 4701 Sfmt 4700 33375 risks and rewards of the recommendation and have a reasonable basis to believe that the recommendation could be in the best interest of at least some retail customers. Although potential costs were not specifically included in the proposed rule text as a factor to be considered as part of a recommendation, the Proposing Release identified potential costs associated with a recommendation as an important factor to understand and consider as part of making a recommendation, and likewise as a key factor to consider when evaluating whether or not a broker-dealer had a reasonable basis to believe it was acting in the best interest of the retail customer when making the recommendation.588 After careful consideration of comments, the Commission is adopting, for the reasons set forth in the Proposing Release, Paragraph (a)(2)(ii)(A) of the Care Obligation substantially as proposed. However, as discussed above, in addition to requiring broker-dealers to understand the potential risks and rewards associated with the recommendation, we are also expressly requiring them to understand and consider the potential costs associated with a recommendation. Elevating costs to the rule text is consistent with a number of commenters’ recommendations and, importantly, stresses that cost will always be a salient factor to be considered when making a recommendation.589 Additionally, this requirement that the broker-dealer understands and considers costs is a distinct enhancement over existing reasonable basis suitability obligations, which do not expressly require this consideration.590 Nevertheless, we recognize—and emphasize—that cost is one important factor among many factors, and thus provide additional guidance below regarding the importance of weighing and considering costs in light of other relevant factors and the retail customer’s investment profile. Paragraph (a)(2)(ii)(A) of Regulation Best Interest is intended to incorporate and build upon broker-dealer’s existing ‘‘reasonable-basis suitability’’ obligations and would relate to the broker-dealer’s understanding of the particular security or investment strategy recommended, rather than to any particular retail customer. Without establishing such a threshold understanding of its particular 588 See Proposing Release at 21609–21612. See also supra footnote 572. 589 See, e.g., AFL–CIO April 2019 Letter; NASAA August 2018 Letter; U. of Miami Letter. 590 See supra footnote 572. E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 33376 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations recommended security or investment strategy involving securities, we do not believe that a broker-dealer could, as required by Regulation Best Interest, have a reasonable basis to believe that it is acting in the best interest of a retail customer when making a recommendation.591 In order to meet the requirement under Paragraph (a)(2)(ii)(A), a brokerdealer would need to undertake reasonable diligence, care, and skill to understand the nature of the recommended security or investment strategy involving a security or securities, as well as the potential risks, rewards—and now costs—of the recommended security or investment strategy, and have a reasonable basis to believe that the recommendation could be in the best interest of at least some retail customers based on that understanding. A broker-dealer must adhere to both components of Paragraph (a)(2)(ii)(A). For example, a brokerdealer could violate the obligation by not understanding the potential risks, rewards, or costs of the recommended security or investment strategy, even if the security or investment strategy could have been in the best interest of at least some retail customers. Conversely, even if a broker-dealer understands the recommended security or investment strategy, the broker-dealer must still have a reasonable basis to believe that the security or investment strategy could be in the best interest of at least some retail customers. What would constitute reasonable diligence, care, and skill under Paragraph (a)(2)(ii)(A) will vary depending on, among other things, the complexity of and risks associated with the recommended security or investment strategy and the brokerdealer’s familiarity with the recommended security or investment strategy.592 While every inquiry will be specific to the particular broker-dealer and the recommended security or investment strategy, broker-dealers generally should consider important factors such as the security’s or investment strategy’s investment objectives, characteristics (including any special or unusual features), liquidity, volatility, and likely performance in a variety of market and economic conditions; the expected return of the security or investment strategy; as well as any financial incentives to recommend the security or investment strategy. Together, this inquiry should allow the broker-dealer 591 See Proposing Release at 21609–21610 (for further discussion regarding this requirement). 592 See FINRA Rule 2111.05(a). VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 to develop a sufficient understanding of the security or investment strategy and to be able to reasonably believe that it could be in the best interest of at least some retail customers. This ‘‘reasonable-basis’’ component of the Care Obligation is especially important when broker-dealers recommend securities and investment strategies that are complex or risky.593 For example, in recent years, the Commission staff and FINRA have addressed broker-dealer sales practice obligations under existing law relating to complex products, such as inverse or leveraged exchange-traded products.594 These products, which may be useful for some sophisticated trading strategies, are highly complex financial instruments and are typically designed to achieve their stated objectives on a daily basis.595 However, because of the effects of compounding, the performance of these products over longer periods of time can differ significantly from their stated daily objectives. Thus, broker-dealers recommending such products should understand that inverse and leveraged exchange-traded products that are reset daily may not be suitable for, and as a consequence also not in the best interest of, retail customers who plan to hold them for longer than one trading session, particularly in volatile markets.596 Without understanding the terms, features, and risks of inverse and leveraged exchange-traded products—as with the potential risks, rewards, and 593 See FINRA Rule 2111 (Suitability) FAQ at Q5.1 (‘‘The reasonable-basis obligation is critically important because, in recent years, securities and investment strategies that brokers recommend to customers, including retail investors, have become increasingly complex and, in some cases, risky.). See also SEC v. Hallas, No. 17–cv–02999 (S.D.N.Y. filed Apr. 25, 2017). 594 See FINRA Regulatory Notice 09–31, NonTraditional ETFs—FINRA Reminds Firms of Sales Practice Obligations Relating to Leveraged and Inverse Exchange-Traded Funds (June 2009); SEC staff and FINRA, Investor Alert, Leveraged and Inverse ETFs: Specialized Products with Extra Risks for Buy-and-Hold Investors (Aug. 1, 2009); SEC Office of Investor Education and Advocacy, Investor Bulletin: Exchange-Traded Funds (ETFs) (Aug. 2012). 595 See id. See also Exchange-Traded Funds, Securities Act Release No. 10515 (Jun. 28, 2018); Use of Derivatives by Registered Investment Companies and Business Development Companies, Investment Company Act Release No. 31933 (Dec. 11, 2015) [80 FR 80883 (Dec. 28, 2015)] (‘‘Derivatives Proposing Release’’); Direxion Letter (recognizing that leveraged ETFs are not appropriate for all customers, and thus the importance for broker-dealers to perform sufficient diligence to adequately ‘‘understand the terms and features of such funds, including how they are designed to perform, how they achieve that objective, and the impact that market volatility, the ETF’s use of leverage, and the customer’s intended holding period will have on their performance’’). 596 See supra footnotes 593–595. PO 00000 Frm 00060 Fmt 4701 Sfmt 4700 costs of any security or investment strategy—a broker-dealer could not establish a reasonable basis to recommend these products to retail customers.597 Further, these products may not be in the best interest of a retail customer absent an identified, shortterm, customer-specific trading objective. Similarly, when a brokerdealer recommends a potentially high risk product to a retail customer—such as penny stocks or other thinly-traded securities—the broker-dealer should generally apply heightened scrutiny to whether such investments are in a retail customer’s best interest.598 Finally, several commenters expressed concern about the applicability of Regulation Best Interest to variable annuities and variable life insurance products.599 Variable annuities and variable life insurance products have generated special attention from regulators and their staff, such as statements regarding sales practice obligations and specific FINRA rules relating to the recommendation of variable annuities.600 These variable insurance products are often unique and have different features depending on the company providing the product, as well as depending on the chosen investment options, benefits, fees and expenses, liquidity restrictions, and other considerations.601 Consistent with 597 See id. e.g., FINRA Regulatory Notice 17–32, Volatility-Linked Exchange Traded Products— FINRA Reminds Firms of Sales Practice Obligations for Volatility-Linked Exchange-Traded Products (Oct. 2017) (explaining that ‘‘The level of reasonable diligence that is required will rise with the complexity and risks associated with the security or strategy. With regard to a complex product such as a volatility-linked ETP, an associated person should be capable of explaining, at a minimum, the product’s main features and associated risks.’’); FINRA Regulatory Notice 12–03, Complex Products—Heightened Supervision of Complex Products (Jan. 2012) (stating that ‘‘Reasonable diligence must provide the firm or registered representative ‘with an understanding of the potential risks and rewards associated with the recommended security or strategy.’ This understanding should be informed by an analysis of likely product performance in a wide range of normal and extreme market actions. The lack of such an understanding when making the recommendation could violate the suitability rule.’’) (internal citations omitted). 599 See related discussion in Section II.C.2.c, Retail Customer Investment Profile. 600 See, e.g., FINRA Rule 2330, Members Responsibilities Regarding Deferred Variable Annuities; FINRA Rule 2320, Variable Contracts of Insurance Companies; FINRA Regulatory Notice 10–05, Deferred Variable Annuities—FINRA Reminds Firms of Their Responsibilities Under FINRA Rule 2330 for Recommended Purchases or Exchange of Deferred Variable Annuities (Jan. 2010); SEC Updated Investor Bulletin: Variable Annuities (Oct. 30, 2018); SEC Investor Bulletin: Variable Life Insurance (Oct. 30, 2018). 601 See id. See also Updated Disclosure Requirements and Summary Prospectus for Variable 598 See, E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations existing FINRA rules and existing suitability obligations under the federal securities laws and SRO rules, regulators and their staffs have stated that recommendations of these products would require careful attention and a specific understanding of certain factors, such as whether the product provides tax-deferred growth, or a death or living benefit, before a broker-dealer could establish an understanding of the product, and apply that understanding to a retail customer’s investment profile in making a recommendation. While we stress the importance of understanding the potential risks, rewards, and costs associated with a recommended security or investment strategy, as well as other factors depending on the facts and circumstances of each recommendation, we do not intend to limit or foreclose broker-dealers from recommending complex or more costly products or investment strategies where the brokerdealer has a reasonable basis to believe that a recommendation could be in the best interest of at least some retail customers and the broker-dealer has developed a proper understanding of the recommended product or investment strategy. As discussed below, once a broker-dealer develops an appropriate understanding of a securities product or investment strategy, including its potential costs, and believes it could be in the best interest of at least some retail customers, the broker-dealer will then need to apply that understanding to reasonably determine that the recommended product or investment strategy is in the particular retail customer’s best interest at the time of the recommendation. jbell on DSK3GLQ082PROD with RULES2 c. Have a Reasonable Basis To Believe the Recommendation Is in the Best Interest of a Particular Retail Customer Based on That Retail Customer’s Investment Profile and the Potential Risks, Rewards, and Costs Associated With the Recommendation and Does Not Place the Interest of the BrokerDealer Ahead of the Interest of the Retail Customer In the Proposing Release, we stated that beyond establishing an understanding of the recommended securities transaction or investment strategy, in order to act in the best interest of the retail customer, a brokerdealer would be required to have a reasonable basis to believe that a specific recommendation is in the best Annuity and Variable Life Insurance Contracts, Investment Advisers Act Release No. 10569 (Oct. 30, 2018) [83 FR 61730 (Nov. 30, 2018)] (‘‘VA Summary Prospectus Proposal’’). VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 interest of the particular retail customer based on its understanding of the investment or investment strategy under Paragraph (a)(2)(ii)(A), and in light of the retail customer’s investment objectives, financial situation, and needs. Accordingly, under proposed paragraph (a)(2)(ii)(A), the second subcomponent of the Care Obligation would require a broker-dealer to ‘‘exercise reasonable diligence, care, skill, and prudence to . . . have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer based on that retail customer’s investment profile and the potential risks and rewards associated with the recommendation.’’ In the Proposing Release, the Commission further articulated that under this standard, a broker-dealer could not have a reasonable basis to believe that the recommendation is in the ‘‘best interest’’ of the retail customer, if the broker-dealer put its interest ahead of the retail customer’s interest. This was intended to incorporate a broker-dealer’s existing well-established obligations under ‘‘customer-specific suitability,’’ but also to enhance these obligations by requiring that the broker-dealer have a reasonable basis to believe that the recommendation is in the ‘‘best interest’’ of (rather than ‘‘suitable for’’) the retail customer. Commenters largely supported the Commission’s proposed approach, but several commenters requested clarifying guidance regarding the importance of costs and other specific factors in a ‘‘best interest’’ evaluation, as well as more broadly how ‘‘best interest’’ was to be determined.602 For example, several commenters requested additional guidance on the role of costs and other ‘‘relevant factors,’’ including subjective and qualitative factors such as shareholder support services, redemption procedures, or qualifications of the investment adviser.603 Similarly, several commenters asked for clarification that ‘‘best interest’’ does not necessarily mean the lowest cost option or require the broker-dealer to look at every single possible security.604 Commenters also requested further direction regarding guidance in the Proposing Release related to the consideration of ‘‘reasonably available alternatives’’ and ‘‘otherwise identical securities,’’ and 602 See, e.g., Wells Fargo Letter; Primerica Letter; Great-West Letter; NASAA August 2018 Letter; Cambridge Letter; BlackRock Letter. 603 See Chapman Letter; BlackRock Letter; Vanguard Letter; ICI Letter; Morgan Stanley Letter. 604 See Great-West Letter; SIFMA August 2018 Letter. PO 00000 Frm 00061 Fmt 4701 Sfmt 4700 33377 requested certain modifications to the definition of ‘‘Retail Customer Investment Profile.’’ 605 After careful consideration of these comments, for the reasons set forth in the Proposing Release, the Commission is adopting the ‘‘customer specific’’ component of the Care Obligation substantially as set forth in the Proposing Release. However, as included under the reasonable basis component of the Care Obligation and for the reasons discussed above, the Commission is expressly incorporating ‘‘costs’’ into the rule text to emphasize that broker-dealers must consider the potential costs associated with a recommendation to a particular retail customer. As noted above, the Commission is also incorporating into the rule text that broker-dealers must have a reasonable basis to believe that the recommendation ‘‘does not place the financial or other interest of the brokerdealer ahead of the interest of the retail customer.’’ 606 This addition is intended to make clear that while a broker-dealer typically will have some interest in a recommendation, the broker-dealer cannot put that interest ahead of the retail customer’s interest when making the recommendation. To address feedback from commenters, the Commission is also providing further interpretations and guidance regarding the application of the Care Obligation, and in particular, what it means to make a recommendation in a retail customer’s best interest and not place the brokerdealer’s interest ahead of the retail customer’s interest. Specifically, recognizing that a facts and circumstances evaluation of a recommendation makes it difficult to draw bright lines around whether a particular recommendation would meet the Care Obligation, the Commission is providing further interpretations and guidance on how a broker-dealer could have a ‘‘reasonable basis to believe’’ that a recommendation is in the best interest of its retail customer and does not place the broker-dealer’s interest ahead of the retail customer’s interest, as well as circumstances when we believe that a broker-dealer could not have such a reasonable belief. 605 See, e.g., Committee of Annuity Insurers Letter; Guardian August 2018 Letter; IPA Letter; Morgan Stanley Letter; Invesco Letter; CFA August 2018 Letter. 606 See related discussion in Section II.A.2; see also Fiduciary Interpretation. E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 33378 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations Factors To Consider Regarding a Recommendation to a Particular Retail Customer and Relevance of Cost Consistent with paragraph (a)(2)(ii)(A) of the Care Obligation, we are incorporating ‘‘costs’’ in the rule text of paragraph (a)(2)(ii)(B) of Regulation Best Interest as a relevant factor that, in addition to risks and rewards, must always be understood and considered by the broker-dealer prior to recommending a particular securities transaction or investment strategy involving securities to a particular retail customer. As discussed above, under paragraph (a)(2)(ii)(A) of the Care Obligation, a broker-dealer will be required to exercise reasonable diligence, care, and skill to understand the potential risks, rewards, and costs of a recommended security or investment strategy and have a reasonable basis to believe that it could be in the best interest of at least some retail customers.607 Paragraph (a)(2)(ii)(B) of the Care Obligation builds on this obligation and will require a brokerdealer to have a reasonable basis to believe, based on its understanding of the potential risks, rewards, and costs of the recommendation, and in light of the retail customer’s investment profile, that the recommendation is in the best interest of a particular retail customer and does not place the broker-dealer’s interest ahead of the retail customer’s interest. Accordingly, when making a recommendation to a particular retail customer, broker-dealers must weigh the potential risks, rewards, and costs of a particular security or investment strategy, in light of the particular retail customer’s investment profile. As discussed above,608 a broker-dealer’s diligence, care, and skill to understand the potential risks, rewards, and costs of a security or investment strategy should generally involve a consideration of factors, depending on the facts and circumstances of the particular recommendation and the particular retail customer’s investment profile, as discussed below. While the factors noted above are examples of important factors to consider based on the particular security or investment strategy, this list is not exhaustive and additional factors, including those raised by commenters, could be relevant depending on the particular security or investment strategy being recommended and depending on the particular retail customer’s investment profile. For example, prior to recommending a 607 See Proposing Release at 21610–21611. related discussion in Section II.C.2.a and Section II.C.2.b. 608 See VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 variable annuity to a particular retail customer, broker-dealers should generally develop a reasonable basis to believe that the retail customer will benefit from certain features of deferred variable annuities, such as tax-deferred growth, annuitization, or a death or living benefit.609 As stated in the Proposing Release, the importance of each factor in determining the customer-specific component of the Care Obligation will depend on the facts and circumstances of each recommendation. Thus, one or more factors may have more or less relevance—or may not be obtained or analyzed at all—if the broker-dealer has a reasonable basis for determining that the factors are not relevant. Regardless of which factors are evaluated—and equally important, which factors are not evaluated—a broker-dealer must have a reasonable basis to believe that the particular recommendation is in the best interest of the particular retail customer and does not place the broker-dealer’s interest ahead of the retail customer’s interest, consistent with the interpretations and guidance provided. For example, recommendations of the ‘‘lowest cost’’ security or investment strategy, without consideration of other factors, could violate Regulation Best Interest. In the same vein, it is important to consider that a recommendation may be considered to be in a retail customer’s best interest when viewed in the context of the retail customer’s portfolio even if seemingly not in a retail customer’s best interest when viewed in isolation (e.g., inclusion of what otherwise might be seen as a risky investment in the portfolio of a riskadverse customer, such as including hedging instruments in a conservative portfolio). The customer-specific component of the Care Obligation will rest on whether a broker-dealer had a reasonable basis to believe that the recommendation was in the best interest of the particular retail customer at the time of the recommendation, based on that retail customer’s investment profile and the potential risks, rewards, and costs associated with the recommendation, and did not place the financial or other interest of the broker, dealer, or such natural person ahead of the interest of the retail customer. Thus, as discussed further below, the importance of each factor, and which factors to consider, will depend on the facts and circumstances of each recommendation, 609 Cf. also FINRA Rule 2330, Members’ Responsibilities Regarding Deferred Variable Annuities. See Transamerica November 2018 Letter. PO 00000 Frm 00062 Fmt 4701 Sfmt 4700 as well as the specific security or investment strategy. While the Care Obligation does not require broker-dealers to document the basis for a recommendation, brokerdealers may choose to take a risk based approach when deciding whether or not to document certain recommendations. For example, broker-dealers may wish to document an evaluation of a recommendation and the basis for the particular recommendation in certain contexts, such as the recommendation of a complex product, or where a recommendation may seem inconsistent with a retail customer’s investment objectives on its face.610 Similarly, broker-dealers may consider using existing compliance measures, such as generating and reviewing exception reports that identify transactions that fall outside of firm-specified parameters to help evaluate and review for compliance with the Care Obligation. These measures are not meant to be exhaustive, but rather are examples of the sorts of compliance tools and methods broker-dealers should generally consider using in evaluating whether recommendations are consistent with a retail customer’s best interests. Retail Customer Investment Profile The Proposing Release would have required a ‘‘Retail Customer Investment Profile’’ to include, but not be limited to, ‘‘the retail customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the retail customer may disclose to the broker, dealer, or a natural person who is an associated person of a broker or dealer in connection with a recommendation.’’ 611 The Proposing Release also explained that brokerdealers would be required to exercise ‘‘reasonable diligence’’ to ascertain the 610 See FINRA Regulatory Notice 11–25 at FAQ 2 (explaining that FINRA Rule 2111 (Suitability) permits firms to take a risk-based approach with respect to documenting suitability determinations). Regulation Best Interest similarly does not require documentation; however, as noted above, we encourage broker-dealers to take a risk-based approach when deciding whether or not to document certain recommendations. 611 Proposing Release at 21611 (noting the proposed definition of Retail Customer Investment Profile was consistent with FINRA Rule 2111(a) (Suitability), which provides that ‘‘A customer’s investment profile includes, but is not limited to, the customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer may disclose to the member or associated person in connection with such recommendation’’). E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 retail customer’s investment profile as part of satisfying proposed paragraph (a)(2)(i)(B), and that when retail customer information is unavailable despite a broker-dealer’s reasonable diligence to obtain such information, a broker-dealer should consider whether it has sufficient understanding of the retail customer to properly evaluate whether the recommendation is in the retail customer’s best interest.612 Furthermore, under the proposed rule, a broker-dealer would not meet its Care Obligation if it made a recommendation to a retail customer for whom it lacks sufficient information to have a reasonable basis to believe that the recommendation is in the best interest of that retail customer based on such customer’s investment profile. In response to this definition and the related discussion, commenters identified several additional factors that they believed should be included or discussed as part of a retail customer’s investment profile. For example, several commenters suggested adding ‘‘longevity risk,’’ ‘‘retirement income needs,’’ or ‘‘lifetime income needs’’ as factors that should be included as part of an investor’s investment profile.613 Other commenters suggested additional factors, such as, for trust accounts, considering the profile of trust beneficiaries and not the trustee, or adding a retail customer’s ‘‘income profile.’’ 614 While we agree that many of these factors will likely be relevant to a broker-dealer’s recommendation of various securities or investment strategies involving securities, we are adopting the definition of ‘‘retail customer investment profile’’ as proposed. We believe that the list of factors under ‘‘retail customer investment profile’’ is widely understood and importantly, offers 612 Id. This is similar to the approach articulated below, as well as in FINRA Regulatory Notice 12– 25, which outlines what constitutes ‘‘reasonable diligence’’ under FINRA’s suitability rule in attempting to obtain customer-specific information and that the reasonableness of the effort also will depend on the facts and circumstances. See FINRA Regulatory Notice 12–25 at Q16. Moreover, under Regulation Best Interest, as with the approach under FINRA’s suitability rule, broker-dealers may generally rely on a retail customer’s responses absent ‘‘red flags’’ indicating that the information is inaccurate. Id. 613 See, e.g., IRI Letter, The Committee of Annuity Insurers Letter, CCMC Letters, Jackson National Letter, Pacific Life August 2018 Letter, Lincoln Financial Letter, AXA Letter, Principal Letter; Transamerica November 2018 Letter; Letter from Mark F. Halloran, VP Managing Director, Business Development, Transamerica (Dec. 14, 2018) (‘‘Transamerica December 2018 Letter’’). 614 See, e.g., Jackson National Letter, Lincoln Financial Letter; Transamerica December 2018 Letter. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 broker-dealers the flexibility to consider additional factors as deemed necessary.615 Although many of the additional factors cited by commenters may be relevant to securities or investment strategy recommendations under certain facts and circumstances, we are not persuaded that we should add any specific factor or factors to the existing list of profile factors, particularly given that the list of factors is non-exhaustive and broker-dealers can consider additional factors as appropriate under the unique facts and circumstances of each recommendation. Thus, for example, where a brokerdealer making a variable annuity recommendation believes that longevity risk is an important factor for a particular retail customer and that such factor is necessary to develop a reasonable basis to believe that the product is in the best interest of that retail customer, that broker-dealer should consider and utilize that factor.616 We believe that this approach appropriately provides broker-dealers with a well-understood starting framework, but also gives broker-dealers the ability to consider additional factors based on the unique nature of its particular securities products, investment strategies, and retail customers. Broker-dealers must obtain and analyze enough customer information to have a reasonable basis to believe that the recommendation is in the best interest of the particular retail customer. The significance of specific types of customer information generally will depend on the facts and circumstances of the particular case, including the nature and characteristics of the product or strategy at issue. Where retail customer information is unavailable despite a broker-dealer’s reasonable diligence, the broker-dealer should carefully consider whether it has a sufficient understanding of the retail customer to properly evaluate whether the recommendation is in the best interest of that retail customer.617 In addition, a broker-dealer generally should make a reasonable effort to ascertain information regarding an existing customer’s investment profile prior to the making of a recommendation on an ‘‘as needed’’ basis—that is, where a broker-dealer knows or has reason to believe that the customer’s investment profile has 615 See, e.g., CCMC Letters; Jackson National Letter; Pacific Life August 2018 Letter; Committee of Annuity Insurers Letter; AXA Letter. 616 See, e.g., AXA Letter; Committee of Annuity Insurers Letter; Pacific Life August 2018 Letter. 617 See supra footnotes 611–612 and accompanying text. PO 00000 Frm 00063 Fmt 4701 Sfmt 4700 33379 changed.618 The reasonableness of a broker-dealer’s efforts to collect information regarding a customer’s investment profile information depends on the facts and circumstances of a given situation, and the importance of each factor may vary depending on the facts and circumstances of the particular case.619 Under Regulation Best Interest, as with the approach under FINRA’s suitability rule, broker-dealers may generally rely on a retail customer’s responses absent ‘‘red flags’’ indicating that the information is inaccurate.620 Moreover, as noted in the Proposing Release, one or more factors may have more or less relevance, or may not be obtained or analyzed at all if the brokerdealer has a reasonable basis for determining that the factor is irrelevant to that particular best interest determination. However, consistent with existing obligations, where a broker-dealer determines not to obtain or analyze one or more of the factors specifically identified in the definition of ‘‘Retail Customer Investment Profile,’’ the broker-dealer should document its determination that the factor(s) are not relevant components of a retail customer’s investment profile in light of the facts and circumstances of the particular recommendation.621 Regulation Best Interest, as noted above, does not require documentation of the basis for believing a particular recommendation was in a particular retail customer’s best interest.622 Nevertheless, broker-dealers may wish to consider documenting the basis for determining that the recommendation is in the best interest of the retail customer when it is not evident from the recommendation itself.623 Documentation by itself will not cure a recommendation in circumstances in which a broker-dealer could not have reasonably believed the recommendation was in the best interest of the retail customer at the time the recommendation was made.624 618 See id.; see also Proposing Release at 21611– 21612. 619 See id.; see also FINRA Regulatory Notice 12– 25 at Q16. 620 See supra footnote 612. 621 FINRA Rule 2111.04. 622 As discussed in Section II.C.1, we believe that the basis for and risks associated with a brokerdealer’s recommendations in standardized terms (as opposed to individualized disclosure of the basis for each recommendation made) is a material fact relating to the scope and terms of the relationship that is required to be disclosed under the Disclosure Obligation. 623 See supra footnote 610 and accompanying text. 624 See FINRA Rule 2111 (Suitability) FAQ. E:\FR\FM\12JYR2.SGM 12JYR2 33380 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations Application of the Care Obligation— Reasonably Available Alternatives and Otherwise Identical Securities In the Proposing Release, we provided guidance on what types of recommendations would or would not be in the best interest of a particular retail customer. In particular, the Proposing Release stated that where a broker-dealer is choosing among identical securities available to the broker-dealer, it would be inconsistent with the Care Obligation to recommend the more expensive alternative for the customer.625 Similarly, in the Proposing Release, we noted our belief that it would be inconsistent with the Care Obligation if the broker-dealer made a recommendation to a retail customer in order to: Maximize the broker-dealer’s compensation, further the brokerdealer’s business relationships, satisfy firm sales quotas or other targets, or win a firm-sponsored sales contest.626 We also stated that under the Care Obligation a broker-dealer generally should consider reasonable alternatives, if any, offered by the broker-dealer in determining whether it has a reasonable basis for making the recommendation.627 The Proposing Release explained that this approach would not require a broker-dealer to analyze all possible securities, all other products, or all investment strategies to recommend the single ‘‘best’’ security or investment strategy for the retail customer, nor necessarily require a broker-dealer to recommend the least expensive or least remunerative security or investment strategy. Further, the Proposing Release indicated that under the Care Obligation, when a brokerdealer recommends a more expensive security or investment strategy over another reasonably available alternative offered by the broker-dealer, the broker dealer would need to have a reasonable basis to believe that the higher cost is justified (and thus nevertheless is in the retail customer’s best interest) based on other factors (e.g., the product’s or strategy’s investment objectives, characteristics (including any special or unusual features), liquidity, risks and potential benefits, volatility and likely performance in a variety of market and economic conditions), in light of the retail customer’s investment profile.628 625 Proposing Release at 21612. jbell on DSK3GLQ082PROD with RULES2 626 Id. 627 Proposing Release at 21608–21610. Release at 21612 (emphasis in original). We similarly noted that ‘‘when a brokerdealer recommends a more remunerative security or investment strategy over another reasonably available alternative offered by the broker-dealer, the broker-dealer would need to have a reasonable basis to believe that—putting aside the broker628 Proposing VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 Relatedly, we stated that a broker-dealer could not meet the Care Obligation through disclosure alone.629 The Commission received numerous comments relating to the Proposing Release’s discussion of ‘‘reasonably available alternatives’’ and regarding recommendations of ‘‘otherwise identical securities.’’ 630 For example, commenters sought clarification regarding what factors need to be considered in the evaluation, and also how the evaluation could be performed in certain contexts, such as where a broker-dealer operates with an open architecture framework, recommends only a limited menu of products, or recommends only proprietary products.631 A majority of the IAC recommended that Regulation Best Interest should be clarified to require recommendations of ‘‘the investments, investment strategies, accounts, or services, from among those that [the broker-dealers, investment advisers, and their associated persons] have reasonably available to recommend, that they reasonably believe represent the best available options for the investor’’ and that a ‘‘determination regarding the best reasonably available options should be based on a careful review of the investor’s needs and goals, as well as the full range of the reasonably available products’, strategies’, accounts’, or services’ features, including, but by no dealer’s financial incentives—the recommendation was in the best interest of the retail customer based on the factors noted [therein], in light of the retail customer’s investment profile. Nevertheless, this does not mean that a broker-dealer could not recommend the more remunerative of two reasonably available alternatives, if the brokerdealer determines the products are otherwise both in the best interest of—and there is no material difference between them from the perspective of— the retail customer, in light of the retail customer’s investment profile.’’ Id. (emphasis in original). 629 Id. at 21612–21613 (further explaining that ‘‘where a broker-dealer is choosing among identical securities with different cost structures, we believe it would be inconsistent with the best interest obligation for the broker-dealer to recommend the more expensive alternative for the customer, even if the broker-dealer had disclosed that the product was higher cost and had policies and procedures reasonably designed to mitigate the conflict under the Conflict of Interest Obligation, as the brokerdealer would not have complied with the Care Obligation. Such a recommendation, disclosure aside, would still need to be in the best interest of a retail customer, and we do not believe it would be in the best interest of a retail customer to recommend a higher-cost product if all other factors are equal.’’) (internal citations omitted). 630 See, e.g., Fidelity Letter; Vanguard Letter; MMI Letter; BlackRock Letter. 631 See, e.g., CFA August 2018 Letter; Wells Fargo Letter; Fidelity Letter; Morgan Stanley Letter. See also LPL August 2018 Letter (suggesting that its representatives could not conduct a meaningful comparison across ‘‘all similar available securities’’ and that, such recommendations would be subject to legal challenges in hindsight). PO 00000 Frm 00064 Fmt 4701 Sfmt 4700 means limited to cost.’’ 632 Several other commenters recommended that the Commission confirm that Regulation Best Interest will not require brokerdealers to offer an unlimited number of securities or investment strategies.633 Commenters also expressed concern over whether the consideration of ‘‘reasonably available alternatives’’ would effectively require a brokerdealer to document the basis of any recommendation, as well as concerns about disclosure’s role in satisfying the Care Obligation.634 Finally, a majority of the IAC and other commenters sought clarification on whether broker-dealers were required to recommend only the single ‘‘best’’ product.635 The Care Obligation will require a broker-dealer to have a reasonable basis to believe, based on its understanding of the potential risks, rewards, and costs of the recommended security or investment strategy involving securities, and in light of the retail customer’s investment profile, that the recommendation is in the best interest of a particular retail customer and does not place the broker-dealer’s interest ahead of the retail customer’s interest. As noted above, determining what is in a retail customer’s best interest is an objective evaluation turning on the facts and circumstances of the particular recommendation and the particular retail customer at the time the recommendation is made.636 Accordingly, as noted above, a brokerdealer would not satisfy the Care Obligation by simply recommending the least expensive or least remunerative 632 IAC 2018 Recommendation (emphasis in original). 633 See LPL August 2018 Letter (recommending that the Commission clarify that a financial professional can satisfy his or her obligations under Regulation Best Interest, even if he or she limits recommendations to a smaller number of product sponsors because financial professionals participating on large platforms may, in practice, be discouraged from conducting focused analysis of product offerings, instead opting for a more cursory review of a few high-level cost, risk, and performance metrics across all available products). See also Fidelity Letter; Cetera August 2018 Letter; SIFMA August 2018 Letter; Guardian August 2018 Letter; Prudential Letter. 634 See, e.g., Fidelity Letter; Wells Fargo Letter. 635 See 2018 IAC Recommendation (‘‘The Commission should recognize that there will often not be a single best option and that more than one of the available options may satisfy this standard,’’ and that ‘‘compliance should be measured based on whether the broker or adviser had a reasonable basis for the recommendation at the time it was made, and not on how the recommendation ultimately performed for the investor. . . .’’); see also SIFMA August 2018 Letter. 636 As noted and further reiterated below, a broker-dealer will not be required to recommend the single ‘‘best’’ of all possible alternatives that might exist, in part because many different options may in fact be in the retail customer’s best interest. See infra footnote 640 and accompanying text. E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations security without any further analysis of these other factors and the retail customer’s investment profile. A brokerdealer could recommend a more expensive security or investment strategy if there are other factors about the product that reasonably allow the broker-dealer to believe it is in the best interest of the retail customer, based on that retail customer’s investment profile. Similarly, a broker-dealer could recommend a more remunerative security or investment strategy if the broker-dealer has a reasonable basis to believe that there are other factors about the security or investment strategy that make it in the best interest of the retail customer, in light of the retail customer’s investment profile. We also continue to have the view that, as part of determining whether a broker-dealer has a reasonable basis to believe that a recommendation is in the best interest of the retail customer, a broker-dealer generally should consider reasonably available alternatives offered by the broker-dealer. It is our view that such a consideration is an inherent aspect of making a ‘‘best interest’’ recommendation, and is a key enhancement over existing brokerdealer suitability obligations, which do not necessarily require a comparative assessment among such alternatives.637 Similarly, this concept has been applied in the context of guidance regarding suitability and heightened supervision of complex products, stating that when broker-dealers are recommending complex or costly products, they should first consider whether less complex or costly products could achieve the same objectives for their retail customers.638 In terms of conducting such an evaluation, a broker-dealer does not have to conduct an evaluation of every possible alternative, either offered outside of the firm (such as where the firm offers only proprietary or other limited range of products) or available on the firm’s platform. We appreciate commenter concerns about the impracticality and potential impossibility of such a comparative evaluation, particularly where the firm offers numerous different products, many of which may have similar strategies but with other varying characteristics, including cost structures, that may apply differently based on the particular retail customer.639 We also recognize that different products are rarely perfectly equal, and that differences will be both quantitative and qualitative in nature. A broker-dealer will not be required to recommend the single ‘‘best’’ of all possible alternatives that might exist, in part because many different options may in fact be in the retail customer’s best interest.640 We are sensitive to commenters’ concern that this determination, to the extent it can be made at all, may be judged in hindsight even though Regulation Best Interest applies at the time of the recommendation.641 In particular, we are not requiring a natural person who is an associated person of the broker-dealer to be familiar with every product on a brokerdealer’s platform, particularly where a broker-dealer operates in an open architecture framework or otherwise operates a platform with a large number of products or options.642 Such a 637 While enforcement actions and related guidance may be construed as interpreting the suitability obligation to include a consideration of available alternatives, it is generally limited to certain circumstances, such as recommendations of mutual funds with different share classes or recommendations of complex or costly products. See In re Application of Raghavan Sathianathan, Exchange Act Release No. 54722 at 21 (Nov. 8, 2006); In the Matter of Wendell D. Belden, 56 S.E.C. 496 (2003); FINRA Regulatory Notice 12–03. See also FINRA 2018 Letter; MSRB Rule G–42 (requiring a municipal advisor to inform its municipal entity or obligated person client whether it has investigated or considered other reasonably feasible alternatives to the recommended municipal securities transaction). Thus, although certain enforcement actions and guidance contemplate a consideration of available alternatives under certain situations, it is not a general expectation. Nevertheless, such statements serve as an example and evidence that the concept is not unfamiliar to broker-dealers. 638 See FINRA Regulatory Notice 12–03 (‘‘For example, registered representatives should compare a structured product with embedded options to the same strategy through multiple financial instruments on the open market, even with any possible advantages of purchasing a single product.’’). See also supra footnote 635. 639 See, e.g., Morgan Stanley Letter (‘‘Large firms with an open architecture like Morgan Stanley offer an enormous range of products to their clients. To take but one example, Morgan Stanley offers approximately 300 large capitalization equity mutual funds to its retail customers.’’); see also Morningstar Letter; Primerica Letter; ICI Letter; Chapman Letter (stating that ‘‘identical’’ is too stringent because they believe all securities have distinctions). 640 Commenters suggesting different approaches acknowledged this concern. See, e.g., IAC 2018 Recommendation (‘‘[T]he Commission should recognize there will often not be a single best option and that more than one of the available options may satisfy this standard.’’). 641 See LPL August 2018 Letter. 642 Conversely, where a broker-dealer only has a few products, an associated person of the brokerdealer may be expected to understand and consider all of these options when recommending a security or investment strategy. We recognize that this factsand-circumstances approach does not provide a clear bright-line rule; however, we are providing further guidance below on a broker-dealer’s process for evaluating reasonably available alternatives and the scope herein. Furthermore, nothing in this discussion excuses a broker-dealer from satisfying the Care Obligation. An associated person of the broker-dealer cannot use a large platform as an VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 PO 00000 Frm 00065 Fmt 4701 Sfmt 4700 33381 requirement might not allow an associated person of a broker-dealer to develop a proper understanding of every security or investment strategy’s potential risks, rewards, or costs, and thus it might not be possible to fulfill the obligation set forth in paragraph (a)(2)(ii)(A). Furthermore, such a requirement could encourage brokerdealers to limit their product menus or otherwise restrict access to products and services currently available to retail customers, which is contrary to the purpose and goals of Regulation Best Interest.643 As discussed above, the determination of whether a recommendation is in the ‘‘best interest’’ of the retail customer and does not place the interests of the brokerdealer ahead of the retail customer’s interest must be based on information reasonably known to the associated person (based on her reasonable diligence, care, and skill) at the time the recommendation is made. Accordingly, in fulfilling the Care Obligation, the associated person should exercise reasonable diligence, care, and skill to consider reasonably available alternatives offered by the broker-dealer. This exercise would require the associated person to conduct a review of such reasonably available alternatives that is reasonable under the circumstances. Consistent with the Compliance Obligation discussed below, a broker-dealer should have a reasonable process for establishing and understanding the scope of such ‘‘reasonably available alternatives’’ that would be considered by particular associated persons or groups of associated persons (e.g., groups that specialize in particular product lines) in fulfilling the reasonable diligence, care, and skill requirements under the Care Obligation. What will be a reasonable determination of the scope of alternatives considered will depend on the facts and circumstances, at the time of the recommendation, including both the nature of the retail customer and the retail customer’s investment profile, and the particular associated persons or groups of associated persons that are providing the recommendations. With respect to broker-dealers that materially limit the range of products or services that they recommend to retail customers (e.g., limits its product offerings to only proprietary or other limited menus of products), the Conflict of Interest excuse for not developing a proper understanding of a recommended security or investment strategy’s potential risks, rewards, or costs. 643 See LPL August 2018 Letter. E:\FR\FM\12JYR2.SGM 12JYR2 33382 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 Obligation provision requires brokerdealers to have reasonably designed policies and procedures to identify and disclose the material limitations and any conflicts of interest associated with such limitations, and to prevent such limitations and associated conflicts of interest from causing the broker-dealer or associated person to make recommendations that place the interest of the broker-dealer or associated person ahead of the interest of the retail customer.644 Similarly, where a brokerdealer offers numerous products on its platform, a broker-dealer or an associated person could reasonably limit the universe of ‘‘reasonably available alternatives’’ if there is a reasonable process or methodology for limiting the scope of alternatives or the universe considered for a particular retail customer, particular category of retail customers, or the retail customer base more generally.645 In addition to the particular retail customer’s investment profile, we believe the scope of reasonably available alternatives considered could depend upon a variety of factors, including but not limited to, the associated person’s customer base (including the general investment objectives and needs of the customer base), the investments and services available to the associated person to recommend (including limitations due to licensing of the associated person), and other factors such as specific limitations on the available investments and services with respect to certain retail customers (e.g., product or service income thresholds; product geographic limitations; or product limitations based on account type, such as those only eligible for IRA accounts). A reasonable process would not need to consider every alternative that may exist (either outside the brokerdealer or on the broker-dealer’s platform) or to consider a greater number of alternatives than is necessary in order for the associated person to exercise reasonable diligence, care, and skill in providing a recommendation that complies with the Care Obligation. 644 See Section II.C.3. Broker-dealers would be required to disclose the conflict of interest, as well as the material facts associated with such a conflict pursuant to the Disclosure Obligation provision as described in Section II.C.1. 645 We note that where a broker-dealer (or an associated person) limits the securities or investment strategies that are considered as ‘‘reasonably available alternatives’’ from the universe of securities or investment strategies involving securities offered by the broker-dealer, this limitation may constitute a material limitation placed on the securities or investment strategies involving securities that may be recommended, which the broker-dealer (or an associated person) would need to disclose and address as provided in the Disclosure and Conflict of Interest Obligations. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 Importantly, where all reasonably available alternatives considered would be inconsistent with a retail customer’s investment profile, a broker-dealer would not be able to form a reasonable belief that the best of these options is in the best interest of that retail customer. All recommendations to retail customers of securities or investment strategies are required to satisfy the Care Obligation, and broker-dealers cannot use a limited product menu or a process to determine the scope of reasonably available alternatives considered to justify a recommendation that is not in the best interest of the retail customer. We recognize that the process by which a broker-dealer and its associated persons develop and make recommendations to retail customers, including the scope of reasonably available alternatives considered, will depend upon a variety factors, including the nature of the broker-dealer’s business.646 The disclosure of this process pursuant to the Disclosure Obligation will provide critical information to retail customers and underscores our acknowledgment that we do not expect every broker-dealer or associated person to follow the same process. Instead, consistent with the Compliance Obligation, broker-dealers and their associated persons must have a reasonable process for developing and making recommendations to retail customers in compliance with the Care Obligation, including the consideration of reasonably available alternatives, which will depend on the facts and circumstances. We emphasize that what is in the ‘‘best interest’’ of a retail customer depends on the facts and circumstances of a recommendation at the time it is made, including matching the recommended security or investment strategy to the retail customer’s investment profile at the time of the recommendation, and the process for coming to that conclusion. Whether a broker-dealer has complied with the Care Obligation will be evaluated based on the facts and circumstances at the time of the recommendation (and not in hindsight) and will focus on whether 646 Accordingly, we believe that disclosure of this process is of fundamental importance to a retail customer’s understanding of what services are being provided, and in deciding whether those services are appropriate to the retail customer’s needs and goals, and have thus clarified that the basis for a broker-dealer’s or an associated person’s recommendations as a general matter (i.e., what might commonly be described as the firm’s or associated person’s investment approach, philosophy or strategy) is a material fact relating to the scope and terms of the relationship that must be disclosed pursuant to the Disclosure Obligation. See Section II.C.1. PO 00000 Frm 00066 Fmt 4701 Sfmt 4700 the broker-dealer had a reasonable basis to believe that the recommendation is in best interest of the retail customer. Finally, broker-dealers or their associated persons are not required to prepare and maintain documentation regarding the basis for each specific recommendation, including an evaluation of a recommended securities transaction or investment strategy against similar available alternatives. In circumstances where the ‘‘match’’ between the retail customer profile and the recommendation appears less reasonable on its face (for example, where a retail customer’s account objective is preservation of income and the recommendation involves higher risk, or where there are more significant conflicts of interest present), the more important the process will likely be for a broker-dealer to establish that it had a reasonable belief that the recommendation was in the best interest of the retail customer and did not place the broker-dealer’s interest ahead of the retail customer. This could include reasonably designed policies and procedures to establish compliance with the Care Obligation, as required by the new Compliance Obligation, and could include maintaining supporting documentation for certain recommendations.647 Application of Care Obligation to Account Type Recommendations As discussed above, Regulation Best Interest will apply to recommendations by a broker-dealer of a securities account type. Thus, the Care Obligation will require a broker-dealer to have a reasonable basis to believe that a recommendation of a securities account type (e.g., brokerage or advisory, or among the types of accounts offered by the firm) is in the retail customer’s best interest at the time of the recommendation and does not place the financial or other interest of the brokerdealer ahead of the interest of the retail customer.648 We believe broker-dealers would need to consider various factors in determining whether a particular account is in a particular retail customer’s best interest. For example, broker-dealers generally should consider: (1) The services and products provided in the account (ancillary 647 See supra footnote 610 and accompanying text. 648 As discussed in Section II.B.2, whether and how Regulation Best Interest applies will depend on whether the financial professional making the recommendation is dually registered. In the section that follows we discuss how the Care Obligation will apply to recommendations to open an IRA or to roll over assets into an IRA. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 services provided in conjunction with an account type, account monitoring services, etc.); (2) the projected cost to the retail customer of the account; (3) alternative account types available; (4) the services requested by the retail customer; and (5) the retail customer’s investment profile. Moreover, retail customer-specific factors, such as those identified in the definition of ‘‘Retail Customer Investment Profile,’’ may not be applicable or available in every context, and would depend on the facts and circumstances at the time of account type recommendation. For example, one or more factors may have more or less relevance, or information about those factors may not be obtained or analyzed at all where the brokerdealer has a reasonable basis for believing that a particular factor is or is not relevant.649 In addition, as discussed above, we recognize that factors other than cost may properly be considered when determining whether an account is in a retail customer’s best interest.650 Where the financial professional making the recommendation is dually registered (i.e., an associated person of a broker-dealer and a supervised person of an investment adviser (regardless of whether the professional works for a dual-registrant, affiliated firms, or unaffiliated firms)) the financial professional would need to make this evaluation taking into consideration the spectrum of accounts offered by the financial professional (i.e., both brokerage and advisory taking into account any eligibility requirements such as account minimums), and not just brokerage accounts. For example, all other things being equal, it may be in the retail customer’s best interest to recommend a brokerage account to the retail customer who intends to buy and hold a long-term investment (e.g., maintain an account primarily composed of bonds or mutual funds and has a stated buy-and-hold strategy), as opposed to an advisory account (i.e., it may not be in the retail customer’s best interest in this context to pay an ongoing fee for a security that he or she plans to hold to maturity).651 On the other hand, it may not be in the retail customer’s best interest to recommend a brokerage account where the retail 649 As discussed above, where a broker-dealer determines not to obtain or analyze one or more of the factors specifically identified in the definition of ‘‘Retail Customer Investment Profile,’’ the brokerdealer generally should document its determination that the factor(s) are not relevant components of a retail customer’s investment profile in light of the facts and circumstances of the particular recommendation. 650 See id. 651 See id. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 customer plans to engage in at least a moderate level of trading and prefers to pay for advice in connection with such trading on the basis of a consistent recurring monthly or annual charge.652 Furthermore, where a retail customer holds a variety of investments, or prefers differing levels of services (e.g., both episodic recommendations from a broker-dealer and continuous advisory services including discretionary asset management from an investment adviser), it may be in the retail customer’s best interest to recommend both a brokerage and an advisory account. Similarly, where the financial professional is only registered as an associated person of a broker-dealer (regardless of whether that broker-dealer entity is a dual-registrant or affiliated with an investment adviser), he or she would need to take into consideration only the brokerage accounts available.653 However, even if a brokerdealer only offered brokerage accounts, the associated person would nevertheless need to have a reasonable basis to believe that the recommended account was in the best interest of the retail customer. For example, if the retail customer were seeking a relationship where the financial professional would have unlimited investment discretion (i.e., having responsibility for a customer’s trading decisions),654 the associated person would not have a reasonable basis to believe that a brokerage account was in the best interest of the retail customer. Thus, as with limited product menus, a limited selection of account types would not excuse a broker-dealer from making a recommendation not in the best interest of the retail customer. Application of Care Obligation to IRA Rollovers and Related Recommendations Regulation Best Interest also applies to recommendations to open an IRA or to roll over assets into an IRA. Thus, the Care Obligation will require a brokerdealer to have a reasonable basis to believe that the IRA or IRA rollover is 652 See id. We reiterate that this is a facts and circumstances determination, and that these examples are not meant to provide a bright line rule, but rather to illustrate certain considerations that a broker-dealer could consider when determining whether a recommended account type is in the best interest of the retail customer. 653 For example, if the natural person that is an associated person of the broker-dealer is not registered as an investment adviser representative, but is associated with a broker-dealer that is a dualregistrant, that associated person would only need to consider the brokerage accounts offered by the firm, and not the firm’s advisory accounts in making the recommendation. 654 See Solely Incidental Interpretation. PO 00000 Frm 00067 Fmt 4701 Sfmt 4700 33383 in the best interest of the retail customer at the time of the recommendation and does not place the financial or other interest of the broker-dealer ahead of the interest of the retail customer, taking into consideration the retail customer’s investment profile and other relevant factors, as well as the potential risks, rewards, and costs of the IRA or IRA rollover compared to the investor’s existing 401(k) account or other circumstances.655 When making a recommendation to open an IRA, or to roll over workplace retirement plan assets into an IRA rather than keeping assets in a previous employer’s workplace retirement plan (or rolling over assets to a new employer’s workplace retirement plan), broker-dealers should consider a variety of factors, the importance of which will depend on the particular retail customer’s needs and circumstances. In addition to the Factors to Consider Regarding a Recommendation to a Particular Retail Customer discussed above, as well as the Retail Customer’s Investment Profile, broker-dealers should consider a variety of additional factors specifically salient to IRAs and workplace retirement plans, in order to compare the retail customer’s existing account to the IRA offered by the broker-dealer. These factors should generally include, among other relevant factors: Fees and expenses; level of service available; available investment options; ability to take penalty-free withdrawals; application of required minimum distributions; protection from creditors and legal judgments; holdings of employer stock; and any special features of the existing account.656 With respect to available investment options, we caution broker-dealers not to rely on, for example, an IRA having ‘‘more investment options’’ as the basis for recommending a rollover. Rather, as with other factors, broker-dealers should consider available investment options in an IRA, among other relevant factors, in light of the retail customer’s current situation and needs in order to develop a reasonable basis to believe that the rollover is in the retail customer’s best interest. While these examples may be relevant to an analysis of available options, this list is not meant to be exhaustive. Furthermore, each factor generally should be analyzed with respect to a particular retail customer in order for a broker-dealer to form a reasonable belief that the recommendation is in the best 655 See infra Section II.C.2; see also FINRA Regulatory Notice 13–45 (outlining several considerations regarding IRA rollovers). 656 See id. E:\FR\FM\12JYR2.SGM 12JYR2 33384 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations interest of that retail customer and does not place the financial or other interest of the broker-dealer ahead of the interest of the retail customer. Finally, as described above, certain factors may have more or less relevance, or not be relevant at all, depending on the particular facts and circumstances of each recommendation. d. Have a Reasonable Basis To Believe That a Series of Recommended Transactions, Even if in the Retail Customer’s Best Interest When Viewed in Isolation, Is Not Excessive and Is the Retail Customer’s Best Interest When Taken Together in Light of the Retail Customer’s Investment Profile and Does Not Place the Interest of the BrokerDealer Ahead of the Interest of the Retail Customer As proposed, the third component of the Care Obligation would require a broker-dealer to exercise reasonable diligence, care, skill, and prudence to have a reasonable basis to believe that a series of recommended transactions, even if in the retail customer’s best interest when viewed in isolation, is not excessive and is in the retail customer’s best interest when taken together in light of the retail customer’s investment profile.657 The Proposing Release noted that this requirement is intended to incorporate and enhance a brokerdealer’s existing ‘‘quantitative suitability’’ obligation by applying the requirement irrespective of whether a broker-dealer exercises actual or de facto control over a customer’s account, thereby making the obligation consistent with the current requirements for ‘‘reasonable basis suitability’’ and ‘‘customer specific suitability.’’ 658 We received a few comments suggesting modifications to this component of the obligation. For example, one commenter recommended the Commission clarify the meaning of ‘‘series of transactions,’’ while a second commenter requested a carve-out for ‘‘active traders’’ who are ‘‘interested in trading individual stocks . . . with a great degree of regularity.’’ 659 Another commenter maintained that the quantitative suitability obligations should only apply to those accounts 657 Proposing Release at 21613. Release at 21613–21614. 659 See Letter from Keith Lampi, President, Alternative and Direct Investment Securities Association (‘‘ADISA’’) (Aug. 7, 2018) (‘‘ADISA Letter’’) (recommending the Commission clarify the meaning of ‘‘series of transactions’’); Letter from Joseph C. Cascarelli, Corporate Counsel, Network 1 Financial Securities (Aug. 7, 2018) (‘‘Network 1 Letter’’) (suggesting a ‘‘carve-out exemption formula’’ from Regulation Best Interest to accommodate investors and their stockbrokers who specialize in ‘‘active trading’’). jbell on DSK3GLQ082PROD with RULES2 658 Proposing VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 over which the member firm has ‘‘control,’’ and that if the Commission does not include the control element of FINRA Rule 2111 as part of the Care Obligation, that the Commission ‘‘should at a minimum confirm that this requirement applies only to recommendations by a single associated person, not across multiple associated persons at the firm who act independently.’’ 660 After considering these comments, the Commission is adopting the proposed ‘‘quantitative care’’ component of the Care Obligation as proposed. As noted in the Proposing Release, we believe that imposing the quantitative care obligation without a ‘‘control’’ element would provide consistency in the investor protections provided to retail customers by requiring a broker-dealer to always form a reasonable basis as to the recommended frequency of trading in a retail customer’s account— irrespective of whether the brokerdealer ‘‘controls’’ or exercises ‘‘de facto control’’ over the retail customer’s account.661 This would also be consistent with the other components of the Care Obligation, which apply regardless of whether a broker-dealer ‘‘controls’’ or exercises ‘‘de facto control’’ over the retail customers’ account. While the Commission appreciates the concern raised about ‘‘active traders’’ and the concern relating to a retail customer that could maintain several accounts at the same firm, we nevertheless believe that retail customers could, and should, benefit from the protections of this requirement, namely the protection from a brokerdealer recommending a level of trading that is so excessive that the resulting cost-to-equity ratio or turnover rate makes a positive return virtually impossible.662 As we indicated in the Proposing Release, the fact that a customer may have some knowledge of financial markets or some ‘‘control’’ should not absolve the broker-dealer of the ultimate responsibility to have a reasonable basis to believe that any recommendations it makes are in the best interest of the retail customer.663 Where a retail customer expresses a desire for ‘‘active trading,’’ 664 a brokerdealer may take this factor into consideration when evaluating a recommendation; however, the brokerdealer will nevertheless need to reasonably believe that a series of PO 00000 660 SIFMA August 2018 Letter. Proposing Release at 21613–21614. 662 See id. 663 See id. 664 See Network 1 Letter. recommended transactions is in the best interest of the retail customer. We further note that Regulation Best Interest does not require a broker-dealer to refuse to accept a customer’s order that is contrary to the broker-dealer’s recommendation. Nor does Regulation Best Interest apply to self-directed or otherwise unsolicited transactions by a retail customer, whether or not he or she also receives separate recommendations from the broker-dealer. With respect to the concern about applying the requirement ‘‘only to recommendations by a single associated person, not across multiple associated persons at the firm who act independently,’’ 665 we note that both the firm and their associated persons have to comply with the Care Obligation. If we took this commenter’s suggestion, we are concerned we would potentially create a loophole and a perverse outcome that would allow for avoidance of the Care Obligation, and permit potentially excessive trading, by encouraging recommendations across a number of associated persons. We reiterate our position that, consistent with the other components of the Care Obligation under the Care Obligation, when a series of transactions is recommended to a retail customer, a broker-dealer must evaluate whether the series of recommended transactions places the broker-dealer’s interest ahead of the retail customer’s—this is true for both the associated person making the recommendation, as well as for the firm.666 This will necessarily depend on the facts and circumstances of each particular recommendation, and of each particular series of transactions; however, we note that, as part of developing a retail customer’s investment profile, a broker-dealer is required to exercise reasonable diligence to ascertain the retail customer’s investment profile, which would include seeking to obtain and analyze a retail customer’s other investments.667 Finally, with respect to the meaning of series of recommended transactions, what would constitute a ‘‘series’’ of recommended transactions would depend on the facts and circumstances, and would need to be evaluated with respect to a particular retail customer. In other words, a broker-dealer would need to reasonably believe that the level of trading (series of recommended transactions) is appropriate for a particular retail customer, and thus a bright line definition across all retail 661 See Frm 00068 Fmt 4701 Sfmt 4700 665 See SIFMA 2018 Letter. Proposing Release at 21613–21614. 667 See supra Section II.C.2.c. 666 See E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations customers would be unworkable. Moreover, providing a bright line definition could encourage firms to focus on a particular number of transactions rather than focusing on ensuring that a series of recommendations, taken together, are in the best interest of the retail customer. Finally, a ‘‘series’’ of recommended transactions is an established term under the federal securities laws and SRO rules that is evaluated in concert with existing guideposts, such as turnover rate,668 cost-to-equity ratio,669 and use of in-and-out trading,670 which have been developed over time and which serve as indicators of excessive trading. jbell on DSK3GLQ082PROD with RULES2 3. Conflict of Interest Obligation We proposed the Conflict of Interest Obligation to require a broker-dealer entity 671 to: (1) Establish, maintain, and enforce written policies and procedures reasonably designed to identify, and disclose, or eliminate all material conflicts of interest associated with recommendations covered by Regulation Best Interest; and (2) establish, maintain and enforce written policies and procedures reasonably designed to identify and disclose and mitigate, or eliminate, material conflicts of interest arising from financial incentives associated with such recommendations. This proposed 668 See, e.g., Carras v. Burns, 516 F.2d 251, 258 (4th Cir. 1975); Shearson Lehman Hutton Inc., 49 S.E.C. 1119, 1122 at footnote 10 (1989); Laurie Jones Canady, 54 S.E.C. 65, 74 (1999), Exchange Act Release No. 41250 (Apr. 5, 1999) (using the turnover rate for relevant period), petition denied, 230 F.3d 362 (D.C. Cir. 2000). 669 See, e.g., Shearson Lehman, 49 S.E.C. at 1121 (stating that ‘‘[o]ne test for excessive trading is the relationship between the account opening balance and the amounts of markups, commissions, and margin charges’’); Michael E. Tennenbaum, 47 S.E.C. 703 (Jan.19, 1982). 670 See, e.g., Hecht v. Harris, Upham & Co., 283 F. Supp. 417, 435–36 (N.D. Cal. 1968), modified in part and aff’d, 430 F.2d 1202 (9th Cir. 1970); R.H. Johnson & Co., 36 S.E.C. 467 (1955); Behel, Johnson & Co., 26 S.E.C. 163 (1947). Cody v. S.E.C., 693 F.3d 251, 260 (1st Cir. 2012). 671 Unlike the Disclosure and Care Obligations, which apply to a broker or dealer and to natural persons who are associated persons of a broker or dealer, the Conflict of Interest Obligation (and the Compliance Obligation discussed in Section II.C.4 below) applies solely to the broker or dealer entity, and not to the natural persons who are associated persons of a broker or dealer. For purposes of discussing the Conflict of Interest Obligation and the Compliance Obligation, the term ‘‘brokerdealer’’ refers only to the broker-dealer entity, and not to such individuals. While the Conflict of Interest Obligation applies only to the broker-dealer entity, the conflicts of interest that the broker-dealer entity must analyze are conflicts (as defined in paragraph (c)(3) of the rule) between: (i) The brokerdealer entity and the retail customer, (ii) the natural persons who are associated persons and the retail customer, and (iii) the broker-dealer entity and the natural persons who are associated persons. VerDate Sep<11>2014 20:12 Jul 11, 2019 Jkt 247001 approach reflected our view that establishing reasonably designed policies and procedures is critical to identifying and addressing conflicts of interest. In addition, the proposed approach would serve the Commission’s goal of addressing conflicts of interest that may harm investors while providing flexibility to establish systems tailored to broker-dealers’ business models. The Commission solicited comment on the Conflict of Interest Obligation, including the specific requirements to create policies and procedures with respect to disclosure, mitigation, and elimination of conflicts of interest. Commenters requested changes to several aspects of the Conflict of Interest Obligation, including providing more clarity and guidance surrounding when specific conflicts need to be disclosed, mitigated or eliminated.672 In consideration of these comments, we are adopting the Conflict of Interest Obligation with revisions to: (1) Create an overarching obligation to establish written policies and procedures to identify and at a minimum disclose, pursuant to the Disclosure Obligation, or eliminate all conflicts of interest associated with the recommendation; and (2) require broker-dealers to establish policies and procedures to be reasonably designed to mitigate or eliminate certain identified conflicts of interest. In addition to the overarching obligation, we specifically require broker-dealers to establish, maintain, and enforce written policies and procedures reasonably designed to: (i) Identify and mitigate any conflicts of interest associated with recommendations that create an incentive for a natural person who is an associated person of a broker or dealer to place the interest of the broker or dealer, or such natural person making the recommendation, ahead of the interest of the retail customer; (ii)(A) identify and disclose any material limitations placed on the securities or investment strategies involving securities that may be recommended (i.e., only make recommendations of proprietary or other limited range of products) to a retail customer and any conflicts of interest associated with such limitations, in accordance with the Disclosure Obligation, and (B) prevent such limitations and associated conflicts of interest from causing the broker, dealer, or a natural person who is an associated person of the broker or dealer 672 See, e.g., SIFMA August 2018 Letter; Primerica Letter; BISA Letter; CCMC Letters; Wells Fargo Letter. PO 00000 Frm 00069 Fmt 4701 Sfmt 4700 33385 to make recommendations that place the interest of the broker, dealer, or such natural person ahead of the interest of the retail customer; and (iii) identify and eliminate any conflicts of interest associated with sales contests, bonuses, and non-cash compensation that are based on the sales of specific securities or specific types of securities within a limited period of time.673 Each of these changes and the requirements pursuant to the Conflict of Interest Obligation is discussed in more detail below. a. Reasonably Designed Policies and Procedures We proposed to require broker-dealers to establish reasonably designed policies and procedures as we believe they are critical to identifying and addressing conflicts of interest 674 and helping ensure compliance with the requirements to disclose conflicts of interest pursuant to the Disclosure Obligation.675 In addition, policies and procedures may minimize compliance costs that may be passed on to retail customers.676 As discussed in the Proposing Release, it would be reasonable for broker-dealers to use a risk-based compliance and supervisory system rather than requiring a detailed review of each recommendation and to have flexibility to tailor policies and procedures to their specific business models. The Commission also provided guidance on components a broker-dealer should consider including in its program with regard to the Conflict of Interest Obligation.677 In response to the proposed policies and procedures requirement, some 673 Rule 15l–1 under the Exchange Act. FSI August 2018 Letter (‘‘Experience shows that investors already ignore much of the enormous volume of regulatory disclosures they are being provided. Instead, a more realistic approach is to require broker-dealers to adopt written supervisory procedures to detect and manage conflicts of interest, to avoid those they can and take steps to mitigate the impact of those conflicts that can’t be avoided.’’). 675 See Proposing Release at Section II.D.3.b. See also CCMC Letters (policies and procedures requirement should assist broker-dealers in managing the potential impact of conflicts of interest); FPC Letter (acknowledging the importance of firms’ policies and procedures when providing financial planning to act in the client’s best interest). 676 See Proposing Release at Section II.D.3.b. See also Cambridge Letter (‘‘Cambridge believes the SEC’s goals of facilitating disclosure and mitigating material conflicts of interest, while minimizing additional compliance costs that may be passed on to the retail customers can best be accomplished by requiring broker-dealers to adopt written supervisory procedures to detect and manage conflicts of interest, to avoid those they can and take steps to mitigate the impact of those conflicts that can’t be avoided.’’). 677 Proposing Release at Section II.D.3.b. 674 See E:\FR\FM\12JYR2.SGM 12JYR2 33386 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 commenters asserted that it was an effective means of addressing conflicts 678 while others were concerned that the Commission was providing too much flexibility in addressing conflicts of interest.679 A few commenters expressed agreement with allowing a flexible risk-based approach tailored to a broker-dealer’s business model as opposed to a detailed review of each recommendation.680 A few commenters expressed concern with the Commission’s assertion that policies and procedures may minimize compliance costs that may be passed on to retail customers, noting the uncertainty surrounding how conflicts of interest should be addressed by policies and procedures.681 One commenter suggested that the Commission should adopt a safe harbor for the Conflicts of Interest Obligation by demonstrating compliance with certain existing FINRA rules.682 As discussed below under the new Compliance Obligation, some commenters suggested that the policies and procedures requirement should apply to aspects of the entire rule.683 In consideration of the comments received, we are adopting the approach with respect to reasonably designed policies and procedures to identify and address conflicts of interest set forth in the proposal substantially as proposed. As stated in the Proposing Release, we believe that broker-dealers should have flexibility to tailor their policies and procedures to their particular business model, focusing on specific areas of their business that pose the greatest risk of noncompliance and greatest risk of potential harm to retail customers as opposed to a detailed review of each recommendation.684 While we recognize a commenter’s statement 685 that policies and 678 See Fidelity Letter; SIFMA August 2018 Letter; Morgan Stanley Letter. 679 See, e.g., NASAA August 2018 Letter; CFA Institute Letter; Galvin Letter; Better Markets August 2018 Letter (policies and procedures should be ‘‘actually designed’’ to achieve those ends, not just ‘‘reasonably designed’’ to do so). But see IRI Letter (‘‘The Conflict of Interest Obligation should be simplified and streamlined to give BDs the flexibility to determine appropriate steps to manage material conflicts.’’). 680 See Cambridge Letter; CCMC Letters. But see NASAA August 2018 Letter (suggesting the Commission reconsider the risk-based approach to comply with its duties). 681 See, e.g., Better Markets August 2018 Letter; CFA Institute Letter. 682 See AXA Letter. 683 See, e.g., NASAA August 2018 Letter (suggesting that, at a minimum, a firm’s policies and procedures should require an analysis of the costs and risks of a product as well as the client’s financial goals). 684 See Proposing Release at II.D.3.b. 685 See Better Markets August 2018 Letter. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 procedures should be ‘‘actually designed’’ to address conflicts of interest, we do not believe that the design of policies and procedures should be measured against a standard of strict liability, but should instead be measured against a standard of reasonableness. In addition, we believe that policies and procedures are an effective tool to identify and address conflicts of interest, and would allow the Commission to identify and address potential compliance deficiencies or failures (such as inadequate or inaccurate policies and procedures, or failure to follow the policies and procedures) early on, reducing the chance of retail customer harm.686 We also believe that there is no one-size-fits all framework, and, as such, brokerdealers should have flexibility to reasonably design their policies and procedures to tailor them to account for their business model, given the structure and characteristics of their relationships with retail customers, including the varying levels and frequency of recommendations provided and the types of conflicts that may be presented. This requirement of ‘‘reasonably designed’’ policies and procedures is also consistent with Commission rules and regulations in other contexts, including under the Advisers Act.687 Further, the Commission continues to believe that while not required components, as an effective practice, broker-dealers should consider including in their supervisory and compliance programs the components listed in the Proposing Release, which may be relevant in considering whether policies and procedures are reasonably designed.688 The Commission is not providing a safe harbor to Regulation Best Interest for broker-dealers who demonstrate compliance with FINRA rules 689 because, while FINRA rules may address specific conflicts of interest, Regulation Best Interest establishes a infra footnote 809. Rule 206(4)–7 under the Advisers Act. See also Section 15(g) of the Exchange Act; 15E(g) of the Exchange Act. 688 These components could include, among other things: policies and procedures outlining how the firm identifies conflicts, identifying such conflicts and specifying how the broker-dealer intends to address each conflict; robust compliance and monitoring systems; processes to escalate identified instances of noncompliance for remediation; procedures that designate responsibility to business line personnel for supervision of functions and persons, including determination of compensation; processes for escalating conflicts of interest; processes for periodic review and testing of the adequacy and effectiveness of policies and procedures; and training on policies and procedures. Proposing Release at Section II.D.3.b. 689 See supra footnote 682. PO 00000 686 See 687 See Frm 00070 Fmt 4701 Sfmt 4700 broader obligation to address conflicts both at the firm level and at the associated person level.690 As to commenters’ concerns that the policies and procedures requirement provides too much flexibility and as discussed in more detail below, the Commission has changed the specific requirements to be addressed by the policies and procedures pursuant to the Conflict of Interest Obligation to provide more certainty to firms on which conflicts of interest should be addressed through disclosure, mitigation or elimination. While the Commission also understands concerns related to compliance costs, we believe that the revisions to the Conflict of Interest Obligation, including the greater specificity in the rule text, as well as the guidance provided below, will ease the adjustment of brokerdealers’ existing supervisory and compliance systems and streamline compliance with Regulation Best Interest. b. Conflicts of Interest The Proposing Release distinguished between material conflicts of interest in general and material conflicts of interest arising from financial incentives. Under the Proposing Release, broker-dealers would be required to establish, maintain, and enforce policies and procedures to identify and, in the case of material conflicts of interest, disclose or eliminate, and in the case of financial incentives, disclose and mitigate, or eliminate material conflicts of interest arising from financial incentives.691 The Commission proposed to interpret a material conflict of interest as a conflict of interest that a reasonable person would expect might incline a broker—consciously or unconsciously— to make a recommendation that is not disinterested.692 For material conflicts of interest arising from financial incentives associated with a recommendation, the Proposing Release discussed compensation practices established by the broker-dealer, including fees and other charges for the services provided and products sold; employee compensation or employment incentives (e.g., quotas, bonuses, sales contests, special awards, differential or variable compensation, incentives tied to appraisals or performance reviews); compensation practices involving thirdparties, including both sales 690 ‘‘While FINRA has repeatedly emphasized the importance of identifying and managing conflicts and has a number of rules that address discrete conflicts of interest, there is currently no similarly broad conflicts provision in FINRA rules, including the suitability rule.’’ See FINRA 2018 Letter. 691 See Proposing Release at Section II.D.3. 692 Proposing Release at 21602. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations compensation and compensation that does not result from sales activity, such as compensation for services provided to third-parties (e.g., sub-accounting or administrative services provided to a mutual fund); receipt of commissions or sales charges, or other fees or financial incentives, or differential or variable compensation, whether paid by the retail customer or a third-party; sales of proprietary products or services, or products of affiliates; and transactions that would be effected by the brokerdealer (or an affiliate thereof) in a principal capacity.693 In addition, the Commission proposed to limit conflicts of interest to those associated with recommendations as broker-dealers may provide a range of services not involving a recommendation, and such services are subject to general antifraud liability and specific requirements to address associated conflicts of interest.694 Recognizing the phrase ‘‘financial incentives’’ could be interpreted broadly, the Commission solicited comment on the proposed requirement and the distinction between the different requirements under the Conflict of Interest Obligation. In response, many commenters suggested that the scope of the description of financial incentives be narrowed as it was too broad and requested guidance or examples of material conflicts of interest that would not fall within the description of financial incentives.695 Specifically, a number of commenters suggested that the mitigation obligation should focus on financial incentives at the registered representative level as opposed to the firm level.696 A number of commenters suggested that the distinction between material conflicts and financial incentives should be removed altogether.697 Commenters also stated that the mitigation requirement is a higher standard of conduct than the investment adviser fiduciary duty which allows for conflicts to be addressed through disclosure sufficient for informed consent.698 693 Id. jbell on DSK3GLQ082PROD with RULES2 694 See Proposing Release at 21617. In including this limitation, the Commission explained that it was not intending to change the disclosure obligations associated with these services under the general antifraud provisions of the federal securities laws. 695 See, e.g., SIFMA August 2018 Letter; Primerica Letter; BISA Letter; Committee of Annuity Insurers Letter; IPA Letter; CFA Institute Letter. 696 See, e.g., Primerica Letter; TIAA Letter; ICI Letter; Invesco Letter; Money Management Institute Letter; Committee of Annuity Insurers Letter. 697 See, e.g., CFA August 2018 Letter; CFA Institute Letter; Morgan Stanley Letter; SIFMA August 2018 Letter; CCMC Letters. 698 See Franklin Templeton Letter (stating that by including this heightened requirement for financial VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 In consideration of comments and as discussed in more detail below, the Commission has restructured the Conflict of Interest Obligation to: (1) Create an overarching obligation to establish, maintain and enforce written policies and procedures that are reasonably designed to identify and at a minimum disclose (pursuant to the Disclosure Obligation), or eliminate, all conflicts of interest associated with the recommendation; and (2) adopt specific requirements with respect to such policies and procedures for the mitigation and elimination of identified conflicts of interest. In particular, we have revised the proposed policies and procedures requirement for mitigation to focus on conflicts of interest that create an incentive for an associated person to place his or her interests ahead of the interest of the retail customer as described below, by eliminating the distinction between material conflicts of interest and material conflicts of interest arising from financial incentives, and removing the affirmative mitigation requirement at the firm level. However, in light of this change, we are adding a new provision requiring broker-dealers to establish, maintain, and enforce written policies and procedures to specifically require broker-dealers to identify and disclose material limitations, and any associated conflicts of interest a broker-dealer places on the securities or investment strategies involving securities that may be recommended to the retail customer, such as recommendations being based on limited product menus (i.e., only make recommendations of proprietary or other limited range of products) and prevent such limitations and associated conflicts of interest from causing the broker-dealer to make recommendations that place its interest ahead of the retail customer. We believe the policies and procedures need to address those certain conflicts of interest inherent in the broker-dealer business model by heightened measures in order to prevent conflicts of interest, Regulation Best Interest would impose a higher standard on broker-dealers than is required of investment advisers with respect to such conflicts); Primerica Letter (stating that by requiring broker-dealers to disclose and mitigate or eliminate conflicts resulting from financial incentives, the standard is actually higher than the standard that applies under the Advisers Act); CCMC Letters (stating that the requirement to mitigate or eliminate material conflicts of interest arising from financial incentives effectively subjects broker-dealers to a higher standard than investment advisers, who are generally able to disclose conflicts of interest). See also UBS Letter; ASA Letter. Some commenters also suggested that the obligation to address conflicts of interest should be harmonized between broker-dealers and investment advisers. See, e.g., Schwab Letter. PO 00000 Frm 00071 Fmt 4701 Sfmt 4700 33387 recommendations that are not in the best interest of the retail customer. Therefore, we are adding a provision requiring broker-dealers to establish, maintain, and enforce written policies and procedures reasonably designed to identify and to eliminate any conflicts of interest associated with sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sale of specific securities or specific types of securities within a limited period of time. For purposes of Regulation Best Interest, and for the reasons described in more detail in the context of the Disclosure Obligation, we have also amended the rule text by eliminating ‘‘material’’ from ‘‘conflict of interest’’ and codified the definition of a conflict of interest 699 to mean an interest that might incline a broker-dealer— consciously or unconsciously—to make a recommendation that is not disinterested.700 While ‘‘material’’ has been eliminated, pursuant to the Disclosure Obligation, broker-dealers are required to disclose all material facts relating to conflicts of interest associated with recommendations, consistent with the Proposing Release’s intent of facilitating disclosure to assist retail customers in making informed investment decisions.701 Regarding the application of the Conflict of Interest Obligation only to those conflicts of interest associated with recommendations, one commenter stated that given the lack of detail in the Proposing Release, broker-dealers may have difficulty determining whether material conflicts are associated with a recommendation and how to adequately address such conflicts, which could create inconsistent application of Regulation Best Interest.702 We continue to believe this approach is appropriate, for the reasons discussed in the Proposing Release 703 and also believe 699 See Section II.D.1. To provide clarity that the interpretation of ‘‘conflict of interest’’ is limited to Regulation Best Interest, the Commission has revised the rule text to include a definition of the term. 700 See id. 701 Id. 702 See State Attorneys General Letter. (‘‘Given the lack of detail in the Proposed Rule, brokerdealers may have difficulty determining whether material conflicts are (1) ‘‘associated with recommendations’’ and therefore subject to disclosure or elimination; or (2) ‘‘arising from financial incentives associated with such recommendations’’ and therefore subject to disclosure and mitigation, or elimination. This ambiguity, while designed to give maximum flexibility to broker-dealers, may in fact result in inconsistent application of the Proposed Rule nationwide and further add to the existing confusion.’’) 703 See Proposing Release at 21618. E:\FR\FM\12JYR2.SGM 12JYR2 33388 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations that our revised Conflict of Interest Obligation provides more specificity about how to address specific conflicts of interest, in conjunction with our Disclosure Obligation, which should address commenters’ concerns. jbell on DSK3GLQ082PROD with RULES2 c. Identifying Conflicts of Interest In the Proposing Release, the Commission stated that having a process to identify and appropriately categorize conflicts of interest is a critical first step to ensure that broker-dealers have reasonably designed policies and procedures to address conflicts of interest in order to comply with the Conflict of Interest Obligation. As stated in the Proposing Release, reasonably designed policies and procedures to identify conflicts of interest generally should do the following: (i) Define such conflicts in a manner that is relevant to a broker-dealer’s business (i.e., conflicts of both the broker-dealer entity and the associated persons of the broker-dealer), and in a way that enables employees to understand and identify conflicts of interest; (ii) establish a structure for identifying the types of conflicts that the broker-dealer (and associated persons of the broker-dealer) may face; (iii) establish a structure to identify conflicts in the broker-dealer’s business as it evolves; (iv) provide for an ongoing (e.g., based on changes in the brokerdealer’s business or organizational structure, changes in compensation incentive structures, and introduction of new products or services) and regular, periodic (e.g., annual) review for the identification of conflicts associated with the broker-dealer’s business; and (v) establish training procedures regarding the broker-dealer’s conflicts of interest, including conflicts of natural persons who are associated persons of the broker-dealer, how to identify such conflicts of interest, as well as defining employees’ roles and responsibilities with respect to identifying such conflicts of interest.704 Most commenters did not express a view on such guidance relating to the process of identifying conflicts of interest. Therefore, for the reasons discussed in the Proposing Release, we are reiterating this guidance here. d. Overarching Obligation Related to Conflicts of Interest As proposed, the first component of the Conflict of Interest Obligation would have required a broker-dealer to establish, maintain, and enforce written policies and procedures reasonably designed to identify, and disclose, or eliminate, all material conflicts of 704 Id. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 interest that are associated with recommendations covered by Regulation Best Interest. In guidance, the Commission stated that reasonably designed policies and procedures should establish a clearly defined and articulated structure for: determining how to effectively address material conflicts of interest identified (i.e., whether to eliminate or disclose (and mitigate, as required) the material conflict); and setting forth a process to help ensure that material conflicts are effectively addressed as required by the policies and procedures. As such, the requirement was intended to provide flexibility to brokerdealers regarding how to address conflicts of interest, whether through disclosure pursuant to the Disclosure Obligation, or elimination. The Commission also indicated that there may be situations in which disclosure alone is not sufficient, and brokerdealers may need to establish policies and procedures designed to eliminate the conflict or both disclose and mitigate it.705 The Commission also provided examples of how a brokerdealer could eliminate a conflict.706 As discussed above, we received many comments generally on the Conflict of Interest Obligation, requesting clarification on which conflicts needed to be disclosed, versus those that should be mitigated or eliminated.707 Some commenters suggested that disclosure and informed consent should be considered to effectively address conflicts, similar to the approach taken under the Advisers Act.708 Some commenters suggested that disclosure alone was sufficient to address conflicts arising from financial incentives.709 For example, a few commenters identified specific types of conflicts they believed could be addressed by appropriate disclosure, such as third-party payments.710 A few commenters requested that the examples of how to eliminate conflicts of interest in the Proposing Release be removed.711 705 See Proposing Release at 21619–21620. 706 Id. supra footnote 672. 708 See IPA Letter; Morgan Stanley Letter; ASA Letter. 709 See, e.g., Committee of Annuity Insurers Letter; Stifel Letter; Mass Mutual Letter; SIFMA August 2018 Letter; HD Vest Letter; Primerica Letter. 710 See, e.g., Invesco Letter; Transamerica August 2018 Letter; Primerica Letter. 711 See, e.g., ICI Letter (‘‘This example suggests a firm that offers proprietary funds should consider relinquishing the advisory fees the firm or its affiliate receives for managing those funds as a means to address conflicts that selling such funds creates. This example is inconsistent with the SEC’s PO 00000 707 See Frm 00072 Fmt 4701 Sfmt 4700 After carefully considering comments, we are adopting, similar to the Proposing Release, an overarching requirement to establish, maintain, and enforce reasonably designed policies and procedures to identify and, at a minimum, disclose, in accordance with the Disclosure Obligation, or eliminate all conflicts of interest associated with the recommendation. However, as discussed in the following sections, we are otherwise revising the Conflict of Interest Obligation in response to these comments. Subparagraphs (a)(2)(iii)(B)– (D) of the rule text will now require policies and procedures that are reasonably designed to address specific conflicts of interest in areas that we believe create greater incentives for, and increased risk that, the broker-dealer or associated person may place its or his or her own interest ahead of the retail customer’s interest, specifically conflicts of interest that: (1) Create certain incentives to associated persons; (2) conflicts of interest associated with material limitations on the securities or investment strategies involving securities, such as, limited product menus; and (3) sales contests, sales quotas, bonuses, and non-cash compensation based on the sales of specific securities or type of security within a limited period of time. In adopting this overarching requirement, we are reaffirming guidance in the Proposing Release on establishing a process to identify and determine how to address a conflict, as discussed above.712 Further, similar to the Proposing Release, while we are not requiring broker-dealers to develop policies and procedures to disclose and mitigate all conflicts of interest, we are requiring that broker-dealers develop policies and procedures reasonably designed to ‘‘at a minimum disclose, or eliminate’’ all conflicts.713 We continue to believe that where a broker-dealer cannot fully and fairly disclose a conflict of interest in accordance with the Disclosure Obligation, the brokerdealer should eliminate the conflict or adequately mitigate (i.e., reduce) the explicit statements elsewhere in the Best Interest Proposal that Regulation Best Interest would not preclude a firm from offering proprietary products. . . .The SEC should clarify in any adopting release that firms selling proprietary funds are not obligated to credit fund advisory fees against other broker-dealer charges. The ability to charge fees to manage proprietary funds is critical to preserve the ability of firms to offer both proprietary and third-party funds.’’); Committee of Annuity Insurers Letter (‘‘This suggested method for elimination of material conflicts of interest relating to affiliated mutual funds presents a number of problematic issues. . . .This example is exacerbated in the context of variable annuities.’’). 712 See Section II.C.3.c. 713 Proposing Release at 21620. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations conflict such that full and fair disclosure in accordance with the Disclosure Obligation is possible. In some cases, conflicts of interest may be of a nature and extent that it would be difficult to provide disclosure that adequately conveys to a retail customer the material facts or the nature, magnitude and potential effect of the conflict for informed decision-making or where disclosure may not be sufficiently specific or comprehensible for the retail customer to understand whether and how the conflict will affect the recommendations he or she receives.714 Also, in certain situations, a brokerdealer, even if not required, may determine that in addition to addressing a conflict through disclosure, to take additional steps beyond disclosure to also mitigate the conflict of interest. The Commission acknowledges commenters’ concerns regarding the examples of how to eliminate conflicts of interest that were provided in the Proposing Release. The Commission’s intent was not to prevent firms from offering certain products to the extent that they are in a retail customer’s best interest. In order to avoid confusion and to respond to commenters, we are not including these examples as final guidance here as we have instead decided to focus the rule text on specific conflicts of interest associated with certain sales practices based on the sale of specific securities that we require to be eliminated and thus such examples are not necessary. In discussing the separate mitigation and elimination requirements below, we provide guidance on the specific conflicts for which we are requiring these heightened measures beyond disclosure. However, while we have removed the examples of potential conflicts of interest that may be more appropriately avoided, we emphasize that pursuant to the overarching obligation, elimination of conflicts of interest is one method of addressing the conflict, in lieu of disclosure, which broker-dealers may find appropriate in certain circumstances even when not required by Regulation Best Interest. jbell on DSK3GLQ082PROD with RULES2 e. Mitigation of Certain Incentives to Associated Persons We proposed to require firms to establish, maintain, and enforce written policies and procedures reasonably 714 See id.; see also Fiduciary Interpretation (stating that where an investment adviser cannot fully and fairly disclose a conflict such that the client can provide informed consent, the adviser should eliminate the conflict or adequately mitigate (i.e., modify practices to reduce) the conflict such that full and fair disclosure and informed consent are possible). VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 designed to identify and disclose and mitigate, or eliminate, material conflicts of interest arising from financial incentives with such recommendations. In proposing this requirement, we recognized the importance of the brokerage model as a potentially costeffective option for investors, acknowledging that the compensation structures and arrangements within the business model create inherent conflicts 715 but that such compensation may be appropriate in light of the time and experience necessary to understand investments. As such, we aimed to promote investor choice and access to products and instead of requiring broker-dealers to establish policies and procedures to eliminate compensation structures and arrangements,716 required policies and procedures to mitigate those conflicts of interest. We proposed a principles-based approach to provide flexibility to firms to develop and tailor policies and procedures that included conflict mitigation measures based on each firm’s circumstances, for example, the size, retail customer base, nature and significance of the conflict, and complexity of the product.717 We stated that, depending on the conflict and the firm’s assessment, more or less demanding measures may be appropriate.718 We provided examples of situations in which heightened mitigation measures may be appropriate and also suggested that broker-dealers assess their policies and procedures as they may be reasonably designed at the outset but may later cease to be reasonably designed based on subsequent events or information.719 Finally, we provided a non-exhaustive list of potential practices that we believe broker-dealers should consider including in their policies and procedures, and as discussed above, suggested that some practices may be more appropriately avoided as they may be difficult to mitigate.720 As discussed above, many commenters expressed concern with the 715 See Proposing Release at II.D.3.e. See also Tully Report. 716 While the Commission’s goal is to promote access and choice to investors, as discussed in more detail in Section II.C.3.g, Elimination of Certain Conflicts of Interest, the Commission believes it is in the public interest and will enhance investor protection to require broker-dealers to reasonably design policies and procedures to eliminate certain conflicts of interest as we believe such conflicts create too strong of an incentive for a broker-dealer to make a recommendation that places the brokerdealer’s interest ahead of the retail customer’s interest. 717 Proposing Release at II.D.3.e. 718 Id. 719 Id. 720 Id. PO 00000 Frm 00073 Fmt 4701 Sfmt 4700 33389 breadth of the mitigation requirement and requested that mitigation be limited to certain types of compensation 721 or solely to financial incentives to the individual registered representative.722 Many commenters were also concerned about what they described as ambiguities in the Proposing Release, including the lack of a definition of the term ‘‘mitigate’’ 723 and requested further guidance surrounding conflicts that needed to be mitigated versus those that can be disclosed.724 Some commenters suggested that supervision should be adequate mitigation and requested clarification on whether their existing supervisory practices, if compliant, were sufficient.725 As discussed above under Section II.C.3.b, a number of commenters expressed concern that the mitigation requirement is a higher standard of conduct than the investment adviser fiduciary duty and requested that it be aligned with the fiduciary duty.726 Many commenters expressed concern over some of the examples, and in particular neutral compensation factors, described as a potential mitigation measure.727 Similarly, some 721 See, e.g., Cetera August 2018 Letter; SIFMA August 2018 Letter. But see CFA August 2018 Letter (stating that the Commission has proposed an appropriately broad definition of material conflicts that arise out of financial incentives and that it should not be narrowed but a cleaner approach would be to eliminate the artificial distinction between those material conflicts of interest that arise from financial incentives and those that do not, and to apply the same obligation to disclose and mitigate all material conflicts, whatever the source). 722 See, e.g., Primerica Letter; Committee of Annuity Insurers Letter; Cetera August 2018 Letter. See also Wells Fargo Letter (stating that receipt of fees and other revenue that does not otherwise result in a direct financial incentive at the registered representative level should be disclosed); ICI Letter (recommending revisions to the proposed conflict of interest obligation to focus the mitigation obligation on the fees, revenue, or other financial incentives that may influence the recommendation of a broker-dealer representative—the individual making the recommendation); Invesco Letter. 723 See, e.g., UVA Letter. 724 See, e.g., CFA August 2018 Letter; Wells Fargo Letter; Committee of Annuity Insurers Letter; NASAA August 2018 Letter; Cetera August 2018 Letter; Morningstar Letter. 725 See, e.g., BISA Letter; AALU Letter; Primerica Letter; Committee of Annuity Insurers Letter. 726 Supra footnote 698. 727 See, e.g., SIFMA August 2018 Letter; ICI Letter; Edward Jones Letter; Morgan Stanley Letter; Transamerica August 2018 Letter; Ameriprise Letter; Capital Group Letter; Cetera August 2018 Letter; CCMC Letters; Letter from Michelle Bryan Oroschakoff, Chief Legal Officer, LPL Financial (Dec. 18, 2018) (‘‘LPL December 2018 Letter’’) (requesting confirmation that the non-exhaustive list of potential practices was intended merely as a list of examples and are not required mitigation practices); Mass Mutual February 2019 Letter. But see NASAA August 2018 Letter (stating that neutral compensation across products could constitute E:\FR\FM\12JYR2.SGM Continued 12JYR2 33390 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 commenters suggested that the Commission should take more of a principles-based approach as they viewed the Proposing Release as too prescriptive because it incorporated examples from the DOL Fiduciary Rule.728 One commenter expressed concern over the suggestion that heightened mitigation may be appropriate if a retail customer has a less sophisticated understanding, stating that it is unclear how mitigation would be measured and could create heightened costs and risks for firms.729 Finally, some commenters requested confirmation that certain practices are permissible such as use of compensation grids,730 receipt of revenue sharing,731 differential compensation,732 recommendations based on a limited range of products and proprietary products,733 and use of employment benefits.734 In response to commenters, we have revised the Proposing Release’s requirement with respect to mitigation to require broker-dealers to establish policies and procedures reasonably designed to identify and mitigate any conflicts of interest associated with such recommendations that create an incentive for a natural person who is an associated person of a broker- dealer to place the interest of the broker-dealer, or such natural person ahead of the interest of the retail customer. We agree with commenters that it is appropriate to focus on the incentives that directly affect the associated person making a recommendation, because we believe those conflicts are most likely to undermine the associated person’s ability to make a recommendation that is in the best interest of the retail customer, and thus present heightened risk of recommendations that are not in a retail customer’s best interest and that place the associated person’s or firm’s interests ahead of the retail customer’s interest. appropriate mitigation), State Attorneys General Letter (suggesting differential compensation be permitted based solely on neutral factors). 728 See, e.g., LPL August 2018 Letter; Cetera August 2018 Letter; Davis Harman Letter. 729 See Primerica Letter. 730 See, e.g., SIFMA August 2018 Letter; Committee of Annuity Insurers Letter; Primerica Letter. 731 See, e.g., SIFMA August 2018 Letter; Cetera August 2018 Letter. 732 See, e.g., Cetera August 2018 Letter; Transamerica August 2018 Letter; Ameriprise Letter. 733 See, e.g., NY Life Letter; Fidelity Letter; ICI Letter; T.Rowe Letter. These commenters suggested that disclosure would be an appropriate way to address conflicts of interest associated with limited product menus and proprietary products. 734 See, e.g., AALU Letter. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 While disclosure can be an effective tool for retail customers to increase awareness of a conflict of interest,735 in certain cases, we do not believe that disclosure alone sufficiently reduces the potential effect that these conflicts of interest may have on recommendations made to retail customers.736 Instead, we believe that broker-dealers are most capable of identifying and addressing the conflicts that may affect the obligations of their associated persons with respect to the recommendations they make, and therefore are in the best position, to affirmatively reduce the potential effect of these conflicts of interest such that they do not taint the recommendation. We are persuaded by commenters 737 that expressed concern that requiring broker-dealers to establish policies and procedures reasonably designed to mitigate all financial incentives, including any compensation, may result in broker-dealers narrowing their product shelf and compensation practices which would be inconsistent with the Commission’s stated goal.738 As stated in the Proposing Release, while the Commission’s goal in adopting Regulation Best Interest is to enhance investor protection by reducing the potential harm to retail customers from conflicts of interest that may affect broker-dealer recommendations, we want to do so while preserving, to the extent possible, access and choice for investors who prefer to pay for investment recommendations on a transaction-by-transaction basis, which is the ‘‘pay as you go’’ model that broker-dealers generally provide, as well as preserving retail customer choice of the level and types of advice provided and the products available.739 As such, 735 See Section II.C.1, Disclosure Obligation; Relationship Summary Adopting Release. 736 See, e.g., Tully Report; CFA August 2018 Letter; AARP August 2018 Letter; Warren Letter (‘‘the [Commission] should not rely on disclosure alone to protect consumers.’’). See also DOL Fiduciary Rule Release at 20950. ‘‘Disclosure alone has proven ineffective to mitigate conflicts in advice.’’ 737 See, e.g., Primerica Letter (‘‘The SEC’s current formulation of the conflicts obligation thus inappropriately, and we believe unintentionally, preferences advisory models over brokerage models.’’); Transamerica August 2018 Letter (expressing concern that the proposed interpretation of financial incentives is overbroad and may result in broker-dealers narrowing their product shelf, which seems inconsistent with the SEC’s stated goal of preserving the broker-dealer model to protect an investor’s right to choose between brokerage and advisory accounts). 738 The Commission recognizes that a brokerdealer’s financial or other interest can and will inevitably exist. 739 We are persuaded by commenters regarding the competitive issues for broker-dealers that could arise if we require mitigation of firm-level financial incentives, which is not required by an investment PO 00000 Frm 00074 Fmt 4701 Sfmt 4700 transaction based-compensation need not be eliminated pursuant to Regulation Best Interest. Accordingly, rather than requiring mitigation of all firm-level financial incentives, we have determined to refine our approach by generally allowing firm-level conflicts to be generally addressed through disclosure.740 At the same time, we are persuaded by commenters 741 that there are some conflicts that should be addressed through mitigation at the firm level due to the potential impact that we believe certain conflicts of interest (either at the associated person or firm level) may have on recommendations to retail customers; therefore we are requiring policies and procedures for mitigation or elimination of those conflicts (as identified in the rule text) and are not leaving it to the brokerdealer to determine whether disclosure alone is sufficient.742 We believe that this approach appropriately balances our goal of reducing the potential harm conflicts of interest may have on brokerdealers’ recommendations to retail customers and preserving retail access (in terms of choice and cost) to brokerage products and services. i. Guidance on Covered Incentives The Commission interprets this requirement to establish, maintain, and enforce reasonably designed policies and procedures to identify and mitigate adviser’s fiduciary duty, and could further encourage migration from the broker-dealer to investment adviser model and result in a loss of choice for retail customers. See Section I; CCMC Letters (‘‘Imposing a standard on broker-dealers with respect to managing conflicts of interest that is greater than that imposed on investment advisers, on top of the additional regulatory obligations to which broker-dealers are subject that are not imposed on investment advisers, threatens to undermine the SEC’s objective of preserving retail customer choice and access to the brokerage advice model and may introduce a new source of confusion when it comes to investors’ understanding of the duties they are owed.’’); AALU Letter (‘‘Overly-rigid mitigation requirements could limit consumer choice of products and access to professional financial advice’’). See also 913 Study; Proposing Release at 21575. 740 As discussed above in the section about the Disclosure Obligation, the Commission believes that compliance with the Disclosure Obligation, including disclosure of the material facts relating to the scope and terms of the relationship with the retail customer and all conflicts of interest, should give sufficient information to enable a retail customer to make an informed decision with regard to the recommendation. See II.D.1. Nevertheless, as noted, there may be situations in which disclosure alone may not be sufficient to provide ‘‘full and fair’’ disclosure in accordance with the Disclosure Obligation discussed above, and the broker-dealer may need to take additional steps to mitigate or eliminate the conflict, consistent with an investment adviser’s fiduciary duty. See Section II.C.3.d. 741 See, e.g., CFA August 2018 Letter. 742 See Section II.C.3.f and g. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 any conflicts of interest that create an incentive for the associated person to place the interest of the broker-dealer or such associated person ahead of the interest of the retail customer, to only apply to incentives provided to the associated person, whether by the firm or third-parties that are within the control of or associated with the brokerdealer’s business.743 It would not cover external interests of the associated person not within the control of or associated with the broker-dealer’s business.744 In the case of a dually registered individual, this requirement would generally only apply to incentives provided to the associated person when making a recommendation in a brokerage capacity and not when making a recommendation in an investment advisory capacity as the investment adviser fiduciary duty would apply to the advice given in that instance.745 The Commission generally considers the following as examples of incentives to an associated person that would need to be addressed under this revised provision: (i) Compensation from the broker-dealer or from third-parties, including fees and other charges for the services provided and products sold; (ii) employee compensation or employment incentives (e.g., incentives tied to asset accumulation and not prohibited under (a)(2)(iii)(D), as discussed below, special awards, differential or variable compensation, incentives tied to appraisals or performance reviews); and (iii) commissions or sales charges, or other fees or financial incentives, or differential or variable compensation, whether paid by the retail customer, the broker-dealer or a third-party. These 743 The ability to control the compensation of associated person, including incentives, is an important mechanism by which broker-dealers exercise supervisory control over sales practices. 744 For example, if an associated person of a broker-dealer participates in a securities transaction outside of the broker-dealer and receives compensation, although the broker-dealer would need to approve the transactions and record it in its books and records under FINRA Rule 3280 (Private Securities Transaction of an Associated Person), as described in more detail above, this requirement to mitigate certain incentives to an associated person would not apply to compensation that is not an incentive provided by or in the control of the broker-dealer. Nevertheless, additional registration, disclosure or other obligations, and antifraud liabilities may apply to any other firm through which an associated person may have such external interests under federal or state law (for example, as a stateregistered adviser). We also note that an associated person of a broker-dealer who receives transactionbased compensation and participates in a private securities transactions that is not in accordance with FINRA Rule 3280 should be mindful of the broker-dealer registration requirements under Section 15 of the Exchange Act. 745 See Fiduciary Interpretation; Section II.B.3. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 examples focus on compensation that varies based on the advice given, such as commissions, markups/markdowns, loads, revenue sharing, and Rule 12b–1 fees. ii. Guidance on Mitigation Methods By requiring that a broker-dealer establish policies and procedures reasonably designed to ‘‘mitigate’’ these conflicts of interest, we mean the policies and procedures must be reasonably designed to reduce the potential effect such conflicts may have on a recommendation given to a retail customer. Thus, whether or not a broker-dealer’s policies and procedures are reasonably designed to mitigate such conflicts will be based on whether they are reasonably designed to reduce the incentive for the associated person to make a recommendation that places the associated person’s or firm’s interests ahead of the retail customer’s interest. As noted in the Proposing Release, in lieu of mandating specific mitigation measures or a ‘‘one-size fits all’’ approach, we are providing brokerdealers with flexibility to develop and tailor reasonably designed policies and procedures that include conflict mitigation measures, based on each firm’s circumstances.746 Reasonably designed policies and procedures should include mitigation measures that depend on the nature and significance of the incentives provided to the associated person and a variety of factors related to a broker-dealer’s business model (such as the size of the broker-dealer, retail customer base (e.g., diversity of investment experience and financial needs), and the complexity of the security or investment strategy involving securities that is being recommended), some of which may be weighed more heavily than others. For example, more stringent mitigation measures may be appropriate in situations where the characteristics of the retail customer base in general displays less understanding of the incentives associated with particular securities or investment strategies; 747 746 See Proposing Release at 21618. See also Letter from Steven W. Stone, Morgan, Lewis & Bockius LLP (May 3, 2019) (‘‘Morgan Lewis Letter’’) (‘‘The Commission should recognize that firms may appropriately employ only some—or various combinations—of these approaches depending on their businesses and business models, compensation structures, and related conflicts of interest, and should not prescribe a one-size-fits-all approach to mitigating compensation-related conflicts.’’). 747 FINRA’s heightened suitability requirements for options trading accounts require that a registered representative have ‘‘a reasonable basis for believing, at the time of making the recommendation, that the customer has such knowledge and experience in financial matters that PO 00000 Frm 00075 Fmt 4701 Sfmt 4700 33391 where the compensation is less transparent (for example, an incentive from a third-party or charge built into the price of the product or a transaction versus a straight commission); or in a situation involving a complex security or investment strategy.748 A brokerdealer could reasonably determine through its policies and procedures that the same mitigation measures could apply to a particular type of retail customer, type of security or investment strategy, or type of incentive across the board; or in some instances a brokerdealer may reasonably determine that some conflicts create incentives that may be more difficult to mitigate, and are more appropriately avoided in their entirety or for certain categories of retail customers.749 As noted in the Proposing Release, policies and procedures may be reasonably designed at the outset, but may later cease to be reasonably designed based on subsequent events or information obtained (for example, such as through supervision (e.g., exception testing) of associated person recommendations), and the actual experience of a broker-dealer should be used to revise the broker-dealer’s measures as appropriate.750 Further, what are considered reasonable mitigation measures may vary based on the size of the firm.751 While many broker-dealers have programs currently in place to manage conflicts of interest, each broker-dealer will need to carefully consider whether its existing framework complies with this provision.752 In response to commenters’ concerns regarding the potential mitigation he may reasonably be expected to be capable of evaluating the risks of the recommended transaction, and is financially able to bear the risks of the recommended position in the complex product.’’ FINRA Rule 2360(b)(19). 748 See Proposing Release at 21620–21621. 749 Id. 750 Id. 751 In the FINRA Conflicts Report, FINRA identified certain mitigation measures firms implemented that we believe highlight differences in conflict management frameworks, based on the size of the firm. For example, large firms may address conflicts of interest through enterprise management or operational risk frameworks, and components of such programs, for example, risk and control self-assessments, may provide an opportunity to identify and evaluate possible impacts. By contrast, small firms selling basic products may have a conflicts management framework that relies largely on the tone set by the firm owner coupled with required supervisory controls, particularly related to suitability, and the firm’s compensation structure. See FINRA Conflicts Report. An effective practice FINRA observed at a number of firms is implementation of a comprehensive framework to identify and manage conflicts of interest across and within firms’ business lines that is scaled to the size and complexity of their business. See FINRA Conflicts Report at 5. 752 See Proposing Release at 21621. E:\FR\FM\12JYR2.SGM 12JYR2 33392 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 methods described in the Proposing Release, and, in particular, the references to neutral factors,753 we would like to emphasize that this nonexhaustive list of factors is purely illustrative and the factors are not required elements.754 In providing these examples, we did not intend to take a prescriptive approach, as suggested by some commenters, but a principlesbased approach designed to provide flexibility to broker-dealers, depending on their business model, level of conflicts, and the retail customers they serve.755 Among other things, firms may adopt a range of reasonable alternatives to meet the mitigation requirement of the Conflict of Interest Obligation. As noted above, we recognize that there are a number of different kinds of incentives and that, depending on the specific characteristics of an incentive, different levels and types of mitigation measures may be necessary. For example, incentives tied to asset accumulation generally would present a different risk and require a different level or kind of mitigation, than variable compensation for similar securities, which in turn may present a different level or kind of risk and may require different mitigation methods than differential or variable compensation or financial incentives tied to firm revenues. In certain instances, we believe that compliance with existing supervisory requirements and disclosure may be sufficient, for example, where a firm may develop a surveillance program to monitor sales activity near compensation thresholds.756 As discussed above, while not required elements, the Commission believes the following non-exhaustive list of practices could be used as potential mitigation methods for firms to comply with (a)(2)(iii)(B) of Regulation Best Interest: • Avoiding compensation thresholds that disproportionately increase compensation through incremental increases in sales; • minimizing compensation incentives for employees to favor one type of account over another; or to favor one type of product over another, proprietary or preferred provider products, or comparable products sold on a principal basis, for example, by 753 See, e.g., Mass Mutual February 2019 Letter; Edward Jones Letter; IRI Letter; Capital Group Letter; SIFMA August 2018 Letter; Committee of Annuity Insurers Letter. 754 See Proposing Release at 21621. 755 See Proposing Release at 21622. 756 FINRA Conflicts Report at 30–31. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 establishing differential compensation based on neutral factors; 757 • eliminating compensation incentives within comparable product lines by, for example, capping the credit that an associated person may receive across mutual funds or other comparable products across providers; • implementing supervisory procedures to monitor recommendations that are: Near compensation thresholds; near thresholds for firm recognition; involve higher compensating products,758 proprietary products or transactions in a principal capacity; or, involve the roll over or transfer of assets from one type of account to another (such as recommendations to roll over or transfer assets in an ERISA account to an IRA) or from one product class to another; 759 • adjusting compensation for associated persons who fail to adequately manage conflicts of interest; and • limiting the types of retail customer to whom a product, transaction or strategy may be recommended.760 While the Commission is providing flexibility so that broker-dealers can determine the nature and extent of mitigation, whether a broker-dealer has developed policies and procedures reasonably designed to mitigate a conflict is not measured against industry practice (although such practice could be a useful point of reference). Each firm must look at the facts and circumstances surrounding the mitigation methods, the particular broker-dealer’s business model, and whether or not the policies and procedures were reasonably designed for the particular firm to reduce the impact of the incentive in a manner to prevent the incentive from causing the associated person to place the broker757 As noted above, we are not requiring firms to establish differential compensation based on neutral factors but do believe firms could choose to do so as potential practice to promote compliance with the requirement to establish, maintain, and enforce written policies and procedures reasonably designed to identify and mitigate any conflicts of interest that create an incentive for an associated person to place its interest ahead of the interest of the retail customer. 758 See Morgan Lewis Letter (suggesting, among other things, that firms can conduct surveillance (whether transactions, periodic, or forensic) to identify activity that appears to be driven by compensation considerations—whether at the representative, team, or business level—rather than a customer’s interest). 759 See FINRA Exam Report 2017. FINRA observed a variety of effective practices in recommending the purchase and sale of UITs, including tailoring supervisory systems to products’ features and sources of risk to customers. 760 See, e.g., supra footnote 747; FINRA Regulatory Notice 12–03, Heightened Supervision of Complex Products (Jan. 2012). PO 00000 Frm 00076 Fmt 4701 Sfmt 4700 dealer’s or the associated person’s interest ahead of the retail customer’s interest. In response to a commenter’s concern that we suggested in the Proposing Release that some compensation conflicts may be more appropriately avoided for certain categories of retail customers,761 we would like to clarify that such a suggestion is an example and not a requirement. Nevertheless, we are adopting a requirement to establish, maintain, and enforce written policies and procedures reasonably designed to eliminate the incentives that we believe create the most problematic conflicts, namely incentives to associated persons that are tied to recommendations of specific securities or specific types of securities within a limited period of time as we believe these incentives cannot be adequately mitigated, and are likely to result in recommendations that place the interest of the broker-dealer or associated person ahead of the interests of the retail customer. Furthermore, in accordance with the Care Obligation, a broker-dealer, when making a recommendation, is required to, among other things, have a reasonable basis to believe that the recommendation is in the best interest of the particular retail customer.762 In particular, and consistent with existing suitability obligations, a broker-dealer is required to exercise ‘‘reasonable diligence’’ to ascertain (and consider) the retail customer’s investment profile which, among other things, includes the retail customer’s investment experience and risk tolerance.763 A broker-dealer that has established reasonably designed policies and procedures to mitigate the conflicts associated with the incentives provided to the associated person would nevertheless violate Regulation Best Interest if the recommendation does not comply with the Care Obligation. Finally, in response to commenters’ questions regarding the permissibility of specific practices, the Commission believes the revised, explicit requirements related to: Mitigation of incentives to associated persons as discussed herein; mitigation of any material limitations placed on the securities or investment strategies that may be recommended to retail customers; and elimination of certain 761 See Primerica Letter (‘‘The SEC’s statements in the Proposals regarding the additional protections broker-dealers should afford ‘less sophisticated’ retail customers could create a sub-class of retail customers that broker-dealers would have to identify based on subjective and poorly defined criteria, and potentially further restrict access to help with saving and investing for customers who need it most.’’). 762 See Section II.C.2. 763 Id. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations practices, as discussed below, sufficiently address these comments. To the extent the Commission has not identified a practice that needs to be eliminated, it would be permitted, subject to compliance with the requirements of Regulation Best Interest. jbell on DSK3GLQ082PROD with RULES2 f. Mitigation of Material Limitations on Recommendations to Retail Customers As part of the proposed requirement to manage conflicts of interest arising from financial incentives through mitigation, firms would have been required to establish policies and procedures reasonably designed to mitigate the conflicts of interest associated with offering a limited range of products and proprietary products. We also solicited comment on information related to the magnitude of conflicts of interest when broker-dealers recommend, among other things, proprietary products and a limited range of products. In response, several commenters requested that the Commission confirm that a product menu limited to appropriate alternative investments offered by the broker-dealer would not violate Regulation Best Interest.764 Some commenters requested we clarify that, for certain customers, a firm can limit its offerings to proprietary products or products for which the firm receives revenue sharing payments if the limitation is properly disclosed and appropriate to meet the retail customer’s needs.765 764 See, e.g., SIFMA August 2018 Letter (requesting clarification on how a broker-dealer could satisfy the Conflict of Interest Obligation if the platform is limited to certain bond offerings); Fidelity Letter (stating that given the vast array of readily available investment options and the breadth of securities typically available to customers through broker-dealers, some limitation of the universe of investment options must be undertaken in order for a broker-dealer to adequately understand, compare and formulate a recommendation); Prudential Letter (‘‘It is unclear what ‘significantly limits’ means for firms that offer predominantly, but not exclusively, proprietary products. It is also unclear what constitutes a ‘small choice of investments.’ Additional examples or more prescriptive instructions regarding when firms must disclose such limitations would be helpful.’’). See also Guardian August 2018 Letter; LPL August 2018 Letter; LPL December 2018 Letter. 765 See, e.g., SIFMA August 2018 letter; CFA Institute Letter; Letter from Emanuel Alves, Senior Vice President and General Counsel, John Hancock Life Insurance Company (Aug. 3, 2018) (‘‘John Hancock Letter’’); Ameriprise Letter. See also NY Life Letter (recommending the Commission require disclosure of the limits on the universe of available products, while allowing further context so that firms describe the full scope and impact of those limits); SPARK Letter (recognizing that the SEC did not want to mandate specific mitigation procedures or a ‘‘one-size-fits’’ all’’ approach but requesting further guidance in the case of, among other things, broker-dealers who only offer proprietary products or only offer limited investment menus). But see CFA August 2018 Letter (suggesting that simply stating that a firm offers a limited selection of VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 In consideration of these comments, and our revisions to remove firm-level conflicts from the proposed mitigation provision discussed above, we are adopting a new requirement to specifically address the conflicts of interest presented when broker-dealers place any material limitations on the securities or investment strategies that may be recommended to a retail customer (i.e., only make recommendations of proprietary or other limited ranges of products). While we generally believe that most firmlevel conflicts of interest can be addressed through appropriate disclosure, this new provision focuses on the specific firm-level conflicts— namely, the conflicts associated with the establishment of a product menu— which we believe are most likely to affect recommendations made to retail customers and have the greatest potential to result in recommendations that place the interest of the brokerdealer or associated person ahead of the interest of the retail customer.766 Given the potential impact on recommendations to retail customer, we believe these conflicts should not be left to the broker-dealer to determine whether disclosure alone is sufficient, and are requiring broker-dealers to establish, maintain, and enforce written policies and procedures reasonably designed to (1) identify and disclose any material limitations broker-dealers place on their securities offerings or investment strategies involving securities and any associated conflicts of interest and (2) prevent such limitations and associated conflicts of interest from causing the broker-dealer to make recommendations that place the broker-dealer’s interest ahead of the interest of the retail customer. While we believe broker-dealers should be permitted to limit their product offerings from which they make recommendations to retail customers, provided that they comply with Regulation Best Interest,767 we are also investments may not be enough for an investor to understand the limitations). 766 See CFA August 2018 Letter (‘‘[M]any brokerdealers currently restrict choice by only recommending from a limited menu of proprietary funds or by only recommending products from companies that make revenue sharing payments. If limits on investor choice are of concern to the Commission, surely such limits deserve equal scrutiny. After all, evidence suggests that the limited menus offered by some firms consist entirely of low quality products that impose excessive costs, deliver inferior returns, and expose investors to excessive risk.’’) 767 See Section II.C.2 for a related discussion of the application of the Care Obligation to such limitations. See also AFL-CIO April 2019 Letter (recommending that the Commission make clear that it will hold firms accountable for developing PO 00000 Frm 00077 Fmt 4701 Sfmt 4700 33393 concerned that without requiring a broker-dealer to have a process in place to disclose and address negative effects of such limitations, retail customers may be unaware that a broker-dealer offers only a limited set of products and therefore would be unable to make an informed investment decision.768 We are also concerned that retail customers may be harmed by such limitations if they are more likely to result in recommendations that are not in the best interest of the retail customer.769 Broker-dealers will be required to establish, maintain and enforce written policies and procedures reasonably designed to: (i) Identify and disclose any material limitations placed on the securities or investment strategies involving securities that may be recommended to a retail customer and any conflicts of interest associated with such limitations, in accordance with the Disclosure Obligation, and (ii) prevent such limitations and associated conflicts of interest from causing the broker, dealer, or a natural person who is an associated person of the broker or dealer to make recommendations that place the interest of the broker, dealer, or such natural person ahead of the interest of the retail customer. As discussed in the context of the Disclosure Obligation and the Relationship Summary, for purposes of this requirement, a ‘‘material limitation’’ 770 placed on the securities or investment strategies involving securities would include, for example, recommending only proprietary products (i.e., any product that is managed, issued, or sponsored by the financial institution or any of its affiliates), a specific asset class, or products with third-party arrangements (i.e., revenue sharing).771 In addition, the fact that the broker-dealer recommends only products from a select a product menu that complies with the first prong of the proposed best interest standard and that under such approach, firms would periodically assess their product offerings against other products available in the marketplace in order to ensure that their offerings are competitive). 768 See Disclosure Obligation at Section II.C.1. 769 We believe that by including this requirement to address material limitations to product menus, which does not rely on disclosure alone, coupled with the requirements under the Care Obligation, we are addressing a commenter’s concern that product limitations can limit investor choice which in turn harms investors. See CFA August 2018 Letter. 770 As discussed in Section II.C.1, Disclosure Obligation, a limitation is ‘‘material’’ if there is ‘‘a substantial likelihood that a reasonable shareholder would consider it important.’’ Basic, Inc. v. Levinson, 485 U.S. 224, 224 (1988). In the context of this Regulation Best Interest, this standard would apply in the context of retail customers, as defined. 771 See II.C.1.; Relationship Summary Adopting Release. E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 33394 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations group of issuers could also be a material limitation. We recognize, however, that, as a practical matter, almost all brokerdealers limit their offerings of securities and investment strategies to some degree. We do not believe that disclosing the fact that a broker-dealer does not offer the entire possible range of securities and investment strategies would convey useful information to a retail customer, and therefore we would not consider this fact, standing alone, to constitute a material limitation.772 Rather, consistent with the examples of a ‘‘material limitation’’ provided above, whether the limitation is material will depend on the facts and circumstances of the extent of the limitation. Adopting this revised requirement is critical to ensuring that retail customers are aware of any material limitations associated with a broker-dealer’s recommendation and associated conflicts of interest and that brokerdealers, through their policies and procedures, establish processes to evaluate whether or not such a limited range of products is consistent with making recommendations that are in the retail customer’s best interest and that do not place the interests of the brokerdealer or associated person ahead of the retail customer’s interest, consistent with Care Obligation.773 Broker-dealers would be able to satisfy paragraph (a)(2)(iii)(C)(1) by identifying any material limitations and complying with the Disclosure Obligation which, as discussed above, requires disclosure of ‘‘the type and scope of services provided to the retail customer, including any material limitations on the securities or investment strategies involving securities that may be recommended to the retail customer.’’ 774 Similar to the requirement to establish, maintain, and enforce written policies and procedures reasonably designed to mitigate certain incentives to associated persons, firms will have flexibility to develop and tailor reasonably designed policies and procedures to prevent such limitations and the associated conflicts from causing the broker-dealer or associated person from placing their interest ahead of the retail customer’s interest. In developing such policies and procedures, the Commission believes that firms should, for example, consider establishing product review processes for products that may be recommended, 772 See Basic, Inc. v. Levinson, 485 U.S. 224, 224 (1988). 773 See Section II.C.2 and infra footnote 779. 774 Section II.C.1. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 including establishing procedures for identifying and mitigating the conflicts of interests associated with the product, or declining to recommend a product where the firm cannot effectively mitigate the conflict, and identifying which retail customers would qualify for recommendations from this product menu.775 As part of this process, firms may consider evaluating the use of ‘‘preferred lists,’’ 776 restricting the retail customers to whom a product may be sold, prescribing minimum knowledge requirements for associated persons who may recommend certain products,777 and conducting periodic product reviews to identify potential conflicts of interest, whether the measures addressing conflicts are working as intended, and to modify the mitigation measures or product selection accordingly.778 The Commission’s intent is not to prevent firms from offering proprietary products or other limited range of products so long as firms comply with the Disclosure, Care,779 and Conflict of 775 For example, in its Conflicts Report, FINRA identified the following as effective practices to identify and manage conflicts of interest for new products: (i) A product review process to identify and mitigate conflicts of interest that may be associated with a product; (ii) evaluation of whether to decline to offer products to customers when the conflicts associated are too significant to be mitigated effectively; (iii) differentiation of product eligibility between institutional and retail clients; (iv) post-launch reviews of products to identify potential problems; (v) evaluation of registered representatives’ ability to understand a product, provide training where necessary, and limit access to products for which they cannot demonstrate sufficient understanding to perform a suitability analysis and effectively explain a product and its risks to customers; and (vi) disclosure of product conflicts and risks. See FINRA Conflicts Report at 3, 18–25. 776 See FINRA Conflicts Report at 24. 777 Cf. FINRA Conflicts Report at 19 (stating that as an effective practice in evaluating new products, a product review committee may engage in these activities to address conflicts of interest). 778 Cf., e.g., NASD Notice to Members 03–71, Non-Conventional Investments—NASD Reminds Members of Obligations When Selling NonConventional Investments (Nov. 2003). Similarly, under the Compliance Obligation, we suggest that compliance policies and procedures’ adequacy and effectiveness should be reviewed as frequently as necessary in connection with changes in business activities, affiliations, or regulatory and legislative developments. See Section II.D.4, Compliance Obligation. 779 In particular, consistent with the Care Obligation and as discussed further in Section II.C.2, Care Obligation, as part of determining whether a broker-dealer has a reasonable basis to believe that a recommendation is in the best interest of the retail customer, broker-dealers generally need to evaluate reasonably available alternatives offered by the broker-dealer. When a broker-dealer materially limits is product offerings or offers only a limited menu of products, it must still comply with the Care Obligation, and could not use its limited menu to justify recommending a product that does not satisfy this obligation. See Section II.C.2. PO 00000 Frm 00078 Fmt 4701 Sfmt 4700 Interest Obligations. In fact, we believe that these limitations can be beneficial, such as by helping ensure that a brokerdealer and its associated persons understand the securities they are recommending, as required by the Care Obligation.780 This requirement is designed to allow firms to determine whether and how to restrict their menu of investment options based, among other things, on their retail customer base and area of expertise, while protecting the interests of retail customers when recommendations are made from such limited menus by requiring firms have a reasonably designed process to identify, disclose, and prevent the conflicts of interest associated with such limitations from resulting in recommendations that place the broker-dealer’s interests ahead of the retail customer’s interest. We also note that the risk that limited product menus result in recommendations that are not in the retail customer’s best interest is also addressed through the Care Obligation 781 and required disclosure pursuant to the Disclosure Obligation.782 g. Elimination of Certain Conflicts of Interest Under Section 15(l)(2) of the Exchange Act, the Commission may examine and, where appropriate, promulgate rules prohibiting or restricting certain sales practices, conflicts of interest, and compensation schemes for brokers, dealers, and investment advisers that the Commission deems contrary to the public interest and protection of investors. As discussed below, the Commission finds that it is in the public interest and consistent with the protection of investors to require that broker-dealers establish, maintain, and enforce written policies and procedures reasonably designed to identify and eliminate any sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sales of specific securities or specific types of securities within a limited period of time. 780 See also supra footnote 775. id. 782 Material limitations are material facts that need to be disclosed pursuant to the Disclosure Obligation. The Commission is concerned about the potential effect that such limitations have on the securities or investment strategies involving securities recommended to a retail customer, and any associated conflicts of interest, could have on the ability of a broker-dealer to make a recommendation in the best interest of the retail customer. See Disclosure Obligation at Section II.C.1. 781 See E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations In the Proposing Release, the Conflict of Interest Obligation would have required the establishment of policies and procedures reasonably designed to at a minimum disclose or eliminate all material conflicts of interest related to the recommendation (or to disclose and mitigate or eliminate those material conflicts of interest arising from financial incentives). We did not mandate the absolute elimination of, or policies and procedures reasonably designed to eliminate any particular conflicts.783 We were concerned that the absolute elimination of specified particular conflicts could mean a broker-dealer may not receive compensation for its services.784 Our intent, rather, was to identify certain practices that may be more appropriately avoided for certain categories of retail customers, including, for example, sales contests, trips, prizes, and other similar bonuses based on sales of certain securities or accumulation of AUM.785 We also provided examples of how a broker-dealer could eliminate conflicts of interest.786 We requested comment on elimination, including suggestions of whether certain conflicts should be required to be eliminated and how broker-dealers could eliminate conflicts of interest. Specifically, we requested comment on whether the Commission should explicitly prohibit receipt of certain non-cash compensation (e.g., sales contests, trips, prizes, and other bonuses based on sales of certain securities, accumulation of AUM or any other factor).787 In response, several commenters requested greater certainty as to whether certain conflicts of interest should be eliminated and if so, which ones.788 783 See Proposing Release at 21619. jbell on DSK3GLQ082PROD with RULES2 784 Id. 785 See id. FINRA rules also establish restrictions on the use of non-cash compensation in connection with the sale and distribution of certain types of products. See FINRA Rules 2310, 2320, 3221, and 5110. 786 Proposing Release at 21621–21622. 787 Id. 788 See TIAA Letter (‘‘If the SEC were to provide more specific direction as to which conflicts are significant enough to warrant complete elimination, broker-dealers would be better able to effectively address material conflicts of interest in a manner consistent with the SEC’s goals and preferred approach.’’); Wells Fargo Letter (‘‘Rather than leaving broker-dealers vulnerable to secondguessing, the SEC should either provide more guidance on how such conflicts may be mitigated or simply identify a set of financial incentives that are prohibited.’’); AXA Letter (‘‘In the absence of clear guidance from the Commission as to which financial incentives must be eliminated, and not just mitigated and disclosed, broker-dealers may be forced to curtail otherwise legitimate practices and the sale of certain products and services out of an abundance of caution—thereby depriving investors VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 Some commenters generally requested that certain sales contests and financial incentives be prohibited.789 Of these commenters, many expressed concern that product-based incentives could lead to recommendations that are not in a customer’s best interest, with some commenters stating that firms could find ways to mitigate these conflicts 790 and others advocating that they should be prohibited in their entirety.791 Other of choice of offerings for which they might otherwise be suited. . . It would also be helpful if the Commission could provide additional examples of the types of conflicts (besides ‘‘sales contests, trips, prizes . . . based on sales of certain securities’’) that likely require elimination.’’); see also Money Management Institute Letter; Northwestern Mutual Letter; AALU Letter. 789 See, e.g., PIABA Letter (favoring a prohibition on compensation structures that would incentivize a broker to: Recommend a proprietary product or recommend one type of product line over another; and/or which would reward the sale of certain products within a product line’’), Americans for Financial Reform (recommending prohibiting brokers from adopting practices, such as sales quotas and contests, that clearly incentivize their representatives to base their recommendations on their own financial interests rather than the customer’s best interests); NASAA August 2018 Letter (‘‘[W]e encourage the Commission to proceed further by declaring these two practices—sales contests and preferential treatment of allocations— per se impermissible under Regulation Best Interest.’’); Galvin Letter (identifying the following practices as per se violations of the standard as they are contrary to the requirement to provide advice that is in the true best interest of customers: Sales contests; sales quotas (especially for in-house products); and incentives to sell high-cost and highrisk products); See also Warren Letter; Better Markets August 2018 Letter; CFA August 2018 Letter. But see Primerica Letter (‘‘The SEC should recognize that sales contests, trips, prizes, awards, and similar bonuses can be used to incentivize positive behavior and clarify there is no per se requirement to eliminate such incentives.’’). 790 See, e.g., SIFMA August 2018 Letter (‘‘With respect to product-based sales contests, we agree that instances where a firm cannot adequately mitigate incentives that are misaligned with the customer’s best interest, the firm should eliminate such sales contests. A firm, however, may be able to mitigate such conflicts through several methods. . .under a principles-based regime, we ask that the SEC allow firms to decide whether to mitigate or eliminate such conflicts.’’); Cetera August 2018 Letter (‘‘A commonly-cited example is sales contests or incentives that are focused on sales of a single product. While we agree that such arrangements may be per se inappropriate and Cetera does not permit them, this judgment is largely subjective. We suggest that reaching consensus on what other practices fall into this category would be well-nigh impossible. So long as a broker-dealer can demonstrate that it has made a good faith determination regarding identification and management of conflicts, it should not be subject to either regulatory action or private litigation based on those determinations.’’); CFA Institute Letter (‘‘Our view is that recommendations aimed at winning sales contests and meeting internal quotas are irreconcilable with the concept of a best interest standard and should not be allowed.’’). 791 See, e.g., PIABA Letter; CFA August 2018 Letter. See also Fidelity Letter (‘‘The SEC has properly pointed out that certain conflicts of interest can be so problematic that it simply may not be possible to mitigate them effectively. For PO 00000 Frm 00079 Fmt 4701 Sfmt 4700 33395 commenters requested clarification that incentives not tied to a particular investment product would be permitted and would not need to be eliminated.792 A number of commenters requested clarification that incentives based on asset growth would be permitted as they do not raise the same types of conflicts present with product-based sales.793 A number of commenters expressed concern that provisions requiring elimination of certain conflicts could be in conflict with current treatment under the Internal Revenue Code governing certain employee benefits.794 After considering comments, we are modifying the rule text of the Conflict of Interest Obligation to include new paragraph (a)(2)(iii)(D), which requires the broker or dealer to establish, maintain, and enforce written policies and procedures reasonably designed to identify and eliminate any sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sales of specific securities or specific types of securities within a limited period of time. In adopting this new requirement, the Commission believes it will provide certainty to broker-dealers regarding the types of practices where conflicts of interest are so pervasive such that they cannot be reasonably mitigated and must be example, we agree that sales contests improperly favoring certain investment products over others involve uniquely troubling conflicts and should generally be impermissible.’’); NY Life Letter (In this context, the proposal notes that single product sales contests create conflicts that may best be eliminated. We agree that it is inappropriate to use a contest or other non-cash compensation to incentivize the sale of a specific investment or variable insurance product over other available alternatives, irrespective of a consumer’s situation and needs.’’) But see AALU Letter (finding that the Commission should not prohibit currentlycompliant compensation arrangements and business models, including non-cash compensation). 792 See, e.g., SIFMA August 2018 Letter; Edward Jones Letter; NY Life Letter; Prudential Letter; LPL August 2018 Letter; Transamerica August 2018 Letter; Northwestern Mutual Letter; Letter from Eric R. Dinallo, Executive Vice President, General Counsel, Guardian Life (Feb. 6, 2019) (‘‘Guardian February 2019 Letter’’); Primerica Letter; Cambridge Letter. Some of these commenters stated that FINRA’s rules and supervisory practices appropriately cover these incentives. See Transamerica August 2018 Letter; NY Life Letter; Northwestern Mutual Letter; Guardian August 2018 Letter; Primerica Letter. 793 Generally these commenters believed that programs tied to assets under management, total production or revenue growth do not give associated persons an incentive to recommend specific securities that may be inconsistent with a customer’s best interest. See, e.g., SIFMA August 2018 Letter; Bank of America Letter; Edward Jones Letter; Transamerica August 2018 Letter; ASA Letter; UBS Letter; Fidelity Letter; NY Life Letter; Money Management Institute Letter; IPA Letter. 794 See AALU Letter; NY Life Letter; Guardian February 2019 Letter; Northwestern Mutual Letter. E:\FR\FM\12JYR2.SGM 12JYR2 33396 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 eliminated in their entirety, as we believe they create too strong of an incentive for the associated persons to make a recommendation that places their financial or other interest ahead of the interest of retail customers’ interests and therefore would be inconsistent with Regulation Best Interest.795 The requirement is designed to eliminate sales contests, sales quotas, bonuses and non-cash compensation that are based on the sales of specific securities and specific types of securities within a limited period of time. We believe that these practices, particularly when coupled with a time limitation, create high-pressure situations for associated persons to engage in sales conduct contrary to the best interest of retail customers. For purposes of this requirement, we interpret non-cash compensation to mean any form of compensation received in connection with the sale and distribution of specific securities or specific types of securities that is not cash compensation, including but not limited to merchandise, gifts and prizes, travel expenses, meals and lodging except we do not intend it to cover certain employee benefits, including healthcare and retirement benefits.796 We recognize that some associated persons may focus their business on certain general categories of securities (e.g., mutual funds, variable annuities, bonds, or equities) and that brokerdealers may provide compensation or other incentives related to such sales. As discussed further herein, this requirement is not designed to prohibit broker-dealers from providing such incentives, provided that they do not create high-pressure situations to sell a specifically identified type of security (e.g., stocks of a particular sector or bonds with a specific credit rating) within a limited period of time, such that the associated person cannot make a recommendation in the retail customer’s best interest. We believe the conflicts created by these practices are in direct opposition to our goal of reducing the effect of conflicts of interest on broker-dealer recommendations to retail customers.797 We agree with many commenters that broker-dealers cannot reasonably be 795 See Section I. See also AFL–CIO April 2019 Letter (‘‘The Commission must provide greater clarity regarding how the obligation to eliminate or mitigate conflicts would apply to different types of conflicts. In particular, it must make clear that conflicts cannot be addressed through disclosure alone and that firms would be prohibited from artificially creating harmful incentives that undermine compliance with the best interest standard.’’). 796 Infra footnote 803 and accompanying text. 797 See Section I. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 expected to make recommendations in a particular retail customer’s best interest consistent with the requirements of the Care Obligation, if they are motivated to ‘‘push’’ certain securities or types of securities in order to win a contest or reach a target in order to receive a bonus or other non-cash compensation. We are also persuaded that it would be difficult, if not impossible, for a firm to establish reasonably designed policies and procedures to sufficiently mitigate the incentive created to put the brokerdealer’s interest ahead of the retail customer’s interest, as discussed above, as the point of these practices is simply to increase the sale a particular security or type of security, for example, in the context where a broker-dealer is attempting to reduce its inventory of or exposure to that security. Accordingly, we believe that these practices should be eliminated in order to enhance investor protection 798 and achieve the goals of Regulation Best Interest. By explicitly requiring broker-dealers to establish, maintain, and enforce written policies and procedures reasonably designed to eliminate certain practices, we believe we are responding to commenters who requested certainty as to which specific incentives are prohibited.799 Also in response to commenters requesting clarification as to what practices would be permitted, the requirement to have reasonably designed written policies and procedures to eliminate sales contests, sales quotas, bonuses, and non-cash compensation applies only to those that are based on the sales of specific securities or types of securities, and does not apply to compensation practices based on, for example, total products sold, or asset growth or accumulation,800 and customer satisfaction. In addition, this elimination requirement would not prevent firms from offering only proprietary products, placing material limitations on the menu of products, or incentivizing the sale of such products through its compensation practices, so 798 See Chairman Jay Clayton, Statement on Investor Roundtables Regarding Standards of Conduct for Investment Professionals Rulemaking (Aug. 22, 2018), available at https://www.sec.gov/ news/public-statement/statement-clayton-082218. See also CFA Institute; CFA. 799 See supra footnote 788 and accompanying text. 800 See CCMC Letters (asserting that increasing assets under management is a natural outgrowth of serving clients well and is fundamentally different from sales contests based on a particular product); UBS Letter (stating that compensation and other rewards based on the growth of overall revenues or assets under management should continue to be permitted as they do not incent sales of one product over another but instead simply reward overall business growth). PO 00000 Frm 00080 Fmt 4701 Sfmt 4700 long as the incentive is not based on the sale of specific securities or types of securities within a limited period of time.801 While conflicts of interest are also associated with sales contests, sales quotas, bonuses and non-cash compensation that apply to, among other things, total products sold, or asset accumulation and growth, we agree with commenters 802 these conflicts present less risk that the incentive would compromise compliance with the Care Obligation and Conflict of Interest Obligation such that a recommendation could be made that is in a retail customer’s best interest and that does not place the place the interest of the broker-dealer or associated person ahead of the interest of the retail customer. We also recognize that certain production requirements may exist for other reasons, specifically to maintain a contract of employment.803 As discussed above, we do not intend to prohibit the receipt of certain employee benefits by statutory employees, and do not believe this provision would apply, as we do not consider these benefits to be non-cash compensation for purposes of Regulation Best Interest. In addition, we do not intend to prohibit training or education meetings, including attendance at company-sponsored meetings such as annual conferences,804 provided that these meetings are not based on the sale of specific securities 801 Although we are not defining what would constitute a ‘‘limited period of time,’’ as noted above, we are concerned about time limitations that create high-pressure situations for associated persons to increase the sales of specific securities or specific types of securities which compromise the best interests of their customers. 802 See, e.g., Ameriprise Letter (‘‘We believe such concerns around incentives do not exist with respect to programs that reward asset growth or asset flows, or recruitment bonuses tied to assets under management or revenue growth because these programs do not give associated persons an incentive to recommend specific securities that may not be consistent with a customer’s best interest.’’); Empower Letter (‘‘We also believe asset-gathering or account-retention incentives should not be subject to the same level of scrutiny as incentives aimed at increasing sales of particular securities. The potential for a conflict of interest to result in a bad outcome for a retail investor is much higher when a recommendation is related to individual securities rather than the type of account in which such securities should be held.’’) 803 See Prudential Letter; NY Life Letter; Guardian February 2019 Letter; AALU Letter. Under the Internal Revenue Code, statutory employees are eligible for certain employee benefits such as 401(k) and health insurance. In order to qualify under this definition, full time life insurance sales agents must devote their principal business to the solicitation of life insurance or annuities primarily for one company. See Department of Treasury, Internal Revenue Service, Employer’s Supplemental Tax Guide, Publication 15–A (2018), available at https://www.irs.gov/pub/irs-pdf/p15a.pdf. 804 See Guardian August 2018 Letter; NY Life Letter. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations or type of securities within a limited time period. We emphasize that prohibiting certain incentives does not mean that all other incentives are presumptively compliant with Regulation Best Interest. As discussed above, such other incentives and practices that are not explicitly prohibited are permitted provided that the broker-dealer establishes reasonably designed policies and procedures to disclose and mitigate the incentive created, and the broker-dealer and its associated persons comply with the Care Obligation. Nevertheless, if the firm determines that the conflicts associated with these practice are too difficult to disclose and mitigate, the firm should consider carefully assessing whether it is able to satisfy its best interest obligation in light of the identified conflict and in certain circumstances, may wish to avoid such practice entirely. jbell on DSK3GLQ082PROD with RULES2 4. Compliance Obligation As proposed, under the Conflict of Interest Obligation, a broker-dealer entity 805 would be required to: (1) Establish, maintain, and enforce written policies and procedures reasonably designed to identify, and disclose, or eliminate all material conflicts of interest associated with recommendations covered by Regulation Best Interest; and (2) establish, maintain and enforce written policies and procedures reasonably designed to identify and disclose and mitigate, or eliminate, material conflicts of interest arising from financial incentives associated with such recommendations. As discussed above, in response to commenters, we have made modifications to the Conflict of Interest Obligation to more appropriately focus on the conflicts of interest that create an incentive for broker-dealers and their associated persons to place the interest of the broker-dealer or the associated person ahead of the interest of the retail customer. We solicited comment on the proposed requirement to establish, maintain, and enforce certain policies and procedures as part of the Conflict of Interest Obligation, including whether we should require policies and procedures specifically to assist compliance with Regulation Best Interest. While commenters generally viewed the requirement to adopt policies and procedures as an effective means of addressing conflicts of 805 See supra footnote 671. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 interest,806 some commenters suggested broadening this requirement to a general policies and procedures obligation that would be reasonably designed to ensure that recommendations are made in the customer’s best interest or reasonably designed to ensure compliance with Regulation Best Interest as a whole.807 After considering the comments received, we are adopting the Compliance Obligation, which requires, in addition to the policies and procedures required by the Conflict of Interest Obligation, that broker-dealer entities 808 establish, maintain and enforce written policies procedures reasonably designed to achieve compliance with Regulation Best Interest. The Compliance Obligation creates an affirmative obligation under the Exchange Act with respect to the rule as a whole,809 while providing sufficient flexibility to allow brokerdealers to establish compliance policies and procedures that accommodate a broad range of business models.810 The 806 See CFA August 2018 Letter; Fidelity Letter; Vanguard Letter; FPC Letter. 807 See CFA August 2018 Letter; UBS Letter. 808 Similar to the Conflict of Interest Obligation, the Compliance Obligation applies solely to the broker or dealer entity, and not to the natural persons who are associated persons of a broker or dealer. For purposes of discussing the Compliance Obligation, the term ‘‘broker-dealer’’ refers only to the broker-dealer entity, and not to such individuals. See footnote 671 and accompanying text. 809 As noted in the Proposing Release, brokerdealers are currently subject to supervisory obligations under Section 15(b)(4)(E) of the Exchange Act and SRO rules, including the establishment of policies and procedures reasonably designed to prevent and detect violations of, and to achieve compliance with, the federal securities laws and regulations, as well as applicable SRO rules. See Proposing Release at 21622. Specifically, the Exchange Act authorizes the Commission to sanction a broker-dealer or any associated person that fails to reasonably supervise another person subject to the firm’s or the person’s supervision that commits a violation of the federal securities laws. Exchange Act Sections 15(b)(4)(E) and (b)(6)(A). The Exchange Act provides an affirmative defense against a charge of failure to supervise where reasonable procedures and systems for applying the procedures have been established and effectively implemented without reason to believe those procedures and systems are not being complied with. Id. While the Compliance Obligation creates an explicit requirement, we believe that broker-dealers would likely establish policies and procedures to comply with Regulation Best Interest pursuant to Section 15(b)(4)(E). In order to comply, broker-dealers could adjust their current systems of supervision and compliance, as opposed to creating new systems. 810 This approach is similar to the one taken under rule 206(4)–7 under the Advisers Act which requires policies and procedures reasonably designed to prevent violations of the Advisers Act, which should be tailored to address compliance considerations relevant to the operations of each adviser. See Compliance Programs of Investment Companies and Investment Advisers, Advisers Act Release No. 2204 (Dec. 17, 2003) (‘‘Advisers Act Release 2204’’). See also Questions Advisers Should PO 00000 Frm 00081 Fmt 4701 Sfmt 4700 33397 Commission believes that the Compliance Obligation is important to help ensure that broker-dealers have strong systems of controls in place to prevent violations of Regulation Best Interest, including the component Disclosure and Care Obligations, in addition to the policies and procedures required pursuant to the Conflict of Interest Obligation, and to protect the interests of retail customers.811 As with the policies and procedures requirement included in the Conflict of Interest Obligation, whether policies and procedures are reasonably designed to comply with Regulation Best Interest will depend on the facts and circumstances of a given situation.812 As such, the Compliance Obligation does not enumerate specific requirements that broker-dealers must include in their policies and procedures as brokerdealers are too varied in their operations for rules to impose a single set of universally applicable specific required elements. Each broker-dealer when adopting policies and procedures should consider the nature of that firm’s operations and how to design such policies and procedures to prevent violations from occurring, detect violations that have occurred, and to correct promptly any violations that have occurred.813 A firm’s compliance policies and procedures should be reasonably designed to address and be proportionate to the scope, size, and risks associated with the operations of the firm and the types of business in which the firm engages.814 As such, the Commission is not mandating specific requirements pursuant to the Compliance Obligation. In addition to the required policies and procedures, depending on the size and complexity of the firm, we believe a reasonably designed compliance program generally Ask While Establishing or Reviewing Their Compliance Programs (May 2006), available at https://www.sec.gov/info/cco/adviser_compliance_ questions.htm (‘‘No one standard set of policies and procedures will address the requirements established by the Compliance Rule for all advisers because each adviser is different, has different business relationships and affiliations, and therefore, has different conflicts of interest.’’). 811 Similar to the discussion included under Section II.C.3.a, we believe that policies and procedures to comply with Regulation Best Interest would allow the Commission to identify and address potential compliance deficiencies or failures (such as inadequate or inaccurate policies and procedures, or failure to follow the policies and procedures) early on, reducing the chance of retail customer harm. 812 See Section II.C.3. 813 See Advisers Act Release 2204. 814 See Section II.C.3.a. E:\FR\FM\12JYR2.SGM 12JYR2 33398 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations would also include: 815 Controls; remediation of non-compliance; 816 training; 817 and periodic review and testing.818 jbell on DSK3GLQ082PROD with RULES2 D. Record-Making and Recordkeeping In connection with proposed Regulation Best Interest, we proposed new record-making and recordkeeping requirements for broker-dealers with respect to certain information collected from or provided to retail customers. Specifically, we proposed amendments to Exchange Act Rules 17a–3 and 17a– 4, which specify minimum requirements with respect to the records that broker-dealers must make, and how long those records and other documents must be kept, respectively. We received several comments on the proposed new requirements and are adopting them substantially as proposed with additional clarifications and guidance to address commenters’ concerns. We proposed amending Rule 17a– 3 819 to add a new paragraph (a)(25), which would require, for each retail customer to whom a recommendation of any securities transaction or investment strategy involving securities is or will be provided, a record of all information collected from and provided to the retail customer pursuant to Regulation Best Interest, as well as the identity of each natural person who is an associated person of a broker or dealer, if any, responsible for the account. The new paragraph would specify that the neglect, refusal, or inability of a retail customer to provide or update any such information would excuse the brokerdealer from obtaining that information. We are adopting the provision substantially as proposed but redesignating it as new paragraph (a)(35) of Rule 17a–3.820 We are also amending the text of paragraph (ii) of the amendment as adopted to refer to ‘‘any information described in paragraph (a)(35)(i) of this section’’ rather than the 815 Cf. FINRA Conflicts Report at 6 (identifying supporting structures, policies, processes, controls and training as critical to protect customers and the firm). 816 Id. at 10 (‘‘Most firms’ policies describe an escalation process for handling those conflicts of interest that cannot be handled through other firm policies. . . .’’). 817 ‘‘For firms, training is an important vehicle to communicate firm culture, specific requirements of a firm’s code of conduct and its conflicts management framework.’’ Id. at 15. 818 Cf. Questions Advisers Should Ask While Establishing or Reviewing Their Compliance Programs (May 2006), available at https:// www.sec.gov/info/cco/adviser_compliance_ questions.htm; FINRA Conflicts Report. 819 See Exchange Act Rule 17a–3. 820 The Commission is also reserving paragraphs (a)(24) through (a)(34) of Rule 17a–3 for use in connection with future rulemakings. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 proposed ‘‘any information required under paragraph (a)(25)(i) of this section.’’ This is a non-substantive change reflecting the fact that paragraph (i) of the new provision requires a record of the information collected from a retail customer by the broker-dealer pursuant to Regulation Best Interest; it does not require the information itself directly as implied by the original wording of paragraph (i) of the proposed amendment. It is therefore more accurate to refer in paragraph (ii) to the information ‘‘described in,’’ rather than ‘‘required under,’’ paragraph (i), as well as to update the reference in paragraph (ii) to ‘‘paragraph (a)(35)(i) of this section.’’ Several commenters expressed concern that the proposed rule amendment would significantly expand recordkeeping requirements.821 One commenter expressed concern that the record retention requirements of the proposed new paragraph to Rule 17a–3 would apply to each recommendation made by the broker-dealer rather than to each account (as required by existing paragraph (a)(17) of Rule 17a–3, which operates on a per-account basis). Another commenter requested clarification that ‘‘the current books and records requirement is sufficient to meet record-keeping requirements to satisfy Reg BI,’’ adding that the Commission should ‘‘affirm that Reg BI does not create new record-keeping requirements to prove that an advisor acted in a client’s best interest.’’ 822 The Commission notes that the proposed new requirements of Rule 17a–3 are not designed to create additional, standalone burdens for broker-dealers but instead to provide a means by which they can demonstrate, and Commission examiners can confirm, their compliance with the new substantive requirements of Regulation Best Interest. In response to commenter concerns that the proposed requirements would significantly expand their recordkeeping obligations, we reiterate that, as stated in the Proposing Release, broker-dealers should already be attempting to collect much of the information that would be required under Regulation Best Interest pursuant to the FINRA suitability rule and existing Exchange Act books and records rules. For example, we note that under existing Rule 17a–3(a)(17), broker-dealers that make recommendations for accounts with a natural person as customer or owner are already required to create and 821 See SIFMA August 2018 Letter; Edward Jones Letter; Primerica Letter. 822 See Raymond James Letter. PO 00000 Frm 00082 Fmt 4701 Sfmt 4700 periodically update customer account information, although as part of developing a ‘‘retail customer’s investment profile,’’ Regulation Best Interest may require broker-dealers to seek to obtain certain retail customer information that is currently not required by Rule 17a–3(a)(17).823 In addition, Regulation Best Interest would require broker-dealers to disclose in writing the material facts relating to the scope and terms of their relationship with the retail customer and the material facts relating to conflicts of interest that are associated with the investment recommendations provided to the retail customer. As such, it would not be accurate to state, as suggested by the commenter, that the Commission’s current books and records requirements for broker-dealers are sufficient to meet recordkeeping requirements to satisfy Regulation Best Interest. The additional books and records requirements the Commission is adopting today are designed to allow firms to demonstrate compliance with the substantive requirements of Regulation Best Interest. We further note that the new recordmaking requirements would not require the duplication of existing records. Rather, if a broker-dealer relied upon previously existing records to demonstrate its compliance with Regulation Best Interest for a given recommendation, it would not be required to create and preserve duplicate copies but instead could create a new record noting which preexisting documents were provided to the customer, or what customer information already being preserved by the broker-dealer was relied upon, to meet the obligations of Regulation Best Interest. However, reliance upon previously existing records would only be permissible so long as such records are preserved—a record noting that a document was relied upon would no longer meet the recordkeeping obligations of Regulation Best Interest if such document was no longer preserved by the broker-dealer. Commenters also requested that the Commission limit new recordkeeping requirements to customer profile information itself, not the ‘‘related and 823 See Exchange Act Rule 17a–3(a)(17). As explained in the Proposing Release, Rule 17a– 3(a)(17) applies to each account with a natural person as a customer or owner, while proposed Regulation Best Interest would apply to each recommendation of any securities transaction or investment strategy involving securities to a retail customer. Because of this difference, the Commission believes it would be appropriate to locate the record-making requirements related to Regulation Best Interest in a new paragraph of Rule 17a-3 rather than in an amendment to paragraph (a)(17). E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 underlying communications.’’ 824 In response to these concerns, the Commission clarifies that new paragraph (a)(35) of Rule 17a–3 as adopted requires a record of all information collected from and provided to the retail customer pursuant to Regulation Best Interest. Regulation Best Interest does not reference, and the Commission does not intend that it require, ‘‘related and underlying communications’’—rather, it applies only to the information that is actually provided to or obtained from the customer pursuant to Regulation Best Interest. Once again, the purpose of the new record-making provision is to allow broker-dealers to demonstrate their compliance with the substantive requirements of Regulation Best Interest. Complying with those substantive requirements will require broker-dealers to obtain from and provide to customers certain information, and new paragraph (a)(35) of Rule 17a–3 requires a record of such information. In response to comments received requesting clarification as to whether information provided to or obtained from a customer orally would be covered by the new record-making requirements,825 the Commission clarifies that the requirements of new paragraph (a)(35) of Rule 17a–3 apply to all information collected from or provided to a retail customer pursuant to Regulation Best Interest, whether provided orally or in writing (electronically or otherwise).826 Several commenters requested clarification that, except with respect to the specific recordkeeping requirements in the rule text, Regulation Best Interest does not require additional records (e.g., records to evidence best interest determinations on a recommendationby-recommendation basis).827 One commenter also stated that, as drafted, there are significant obstacles and costs, including increased privacy and cybersecurity risks, that would result from implementing the proposed new rule, in particular with respect to the ‘‘all information collected from . . . . the retail customer’’ requirement.828 In response, the Commission clarifies that while the substantive requirements of Regulation Best Interest apply on a 824 See SIFMA August 2018 Letter; Morgan Stanley Letter. 825 See SIFMA August 2018 Letter; Primerica Letter. 826 In the case of information provided orally under the circumstances outlined in Section II.C.1, Disclosure Obligation, Oral Disclosure or Disclosure After a Recommendation, the broker-dealer must maintain a record of the fact that oral disclosure was provided to the retail customer. 827 See SIFMA August 2018 Letter; Edward Jones Letter; Morgan Stanley Letter; CCMC Letters. 828 See Primerica Letter. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 recommendation-by-recommendation basis, consistent with our approach elsewhere, we are not requiring that broker-dealers create and maintain records to evidence best interest determinations on a recommendationby-recommendation basis. Nor have we determined to require broker-dealers to provide information to retail customers relating to the basis for each particular recommendation (i.e., disclose such information), and thus did not envision this information to come within the scope of Rule 17(a)(35). Rather, in order to demonstrate compliance with Regulation Best Interest, a broker-dealer must be able to demonstrate that it had a reasonable basis to believe that each particular recommendation made to a retail customer was in the best interest of the customer at the time of the recommendation based on the customer’s investment profile and the potential risks, rewards, and costs associated with the recommendation. As noted above, the Commission does not intend this to require, in practice, the creation of extensive new and potentially duplicative records for each and every recommendation to a retail customer. Instead, broker-dealers should be able to explain in broad terms the process by which the firm determines what recommendations are in its customers’ best interests, and similarly to explain how that process was applied to any particular recommendation to a retail customer. However, we are not mandating that broker-dealers create and maintain a record of each such determination. Nonetheless, as noted above we are providing guidance suggesting that firms may wish to adequately document an evaluation of a recommendation and the basis for that recommendation in particular contexts, such as the recommendation of a complex product, or where a recommendation may seem inconsistent with a retail customer’s investment objectives on its face.829 In addition, in response to requests from commenters for confirmation that the proposed record-making requirements do not contemplate broker-dealers needing to create and maintain records of why certain products were recommended over others on a recommendation-byrecommendation basis,830 we confirm that broker-dealers are not expected to maintain records comparing potential investments to one another so long as they are able to demonstrate that each 829 See supra footnote 610 and accompanying text. PO 00000 830 See SIFMA August 2018 Letter; CCMC Letters. Frm 00083 Fmt 4701 Sfmt 4700 33399 individual recommendation actually made to a customer meets the requirements of Regulation Best Interest on its own. Regulation Best Interest applies to recommendations made to a retail customer, rather than to potential recommendations considered by the broker-dealer but not actually made to the customer. In response to the commenter’s privacy and cybersecurity concerns with respect to the proposed requirement to make a record of all information collected from the customer pursuant to Regulation Best Interest, as noted in the Proposing Release 831 and Section II.C above, although a broker-dealer’s customer obligations under Regulation Best Interest (e.g., the Care Obligation) go beyond those set forth in the FINRA’s suitability rule, the concept of the ‘‘customer’s investment profile’’ that a broker-dealer would be required to compile—that is, the customer information it would be required to obtain—pursuant to Regulation Best Interest is consistent with that under FINRA’s suitability rule. As such, we believe that since broker-dealers are already required to seek to obtain identical types of retail customer information pursuant to the FINRA suitability rule, broker-dealers should already have in place policies and procedures, including training programs, to address such privacy and cybersecurity concerns. We also proposed an amendment to paragraph (e)(5) of Rule 17a–4, which currently requires broker-dealers to maintain and preserve in an easily accessible place all account information required by paragraph (a)(17) of Rule 17a–3 for at least six years after the earlier of the date the account was closed or the date on which the information was replaced or updated.832 The proposed amendment would require broker-dealers to retain any information that the retail customer provides to the broker-dealer or the broker-dealer provides to the retail customer pursuant to the proposed amendment to Rule 17a–3 being adopted today as Rule 17a–3(a)(35), in addition to the existing requirement to retain information obtained pursuant to Rule 17a–3(a)(17). As a result, brokerdealers would be required to retain all records of the information collected from or provided to each retail customer pursuant to Regulation Best Interest for at least six years after the earlier of the date the account was closed or the date 831 Proposing Release at 21611 (noting that Retail Customer Investment Profile is consistent with FINRA Rule 2111(a) (Suitability)). 832 See Exchange Act Rule 17a–4(e)(5). E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 33400 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations on which the information was replaced or updated. The Commission is adopting this amendment to Rule 17a– 4(e)(5) substantially as proposed, with the proposed reference to paragraph (a)(25) of Rule 17a–3 replaced with a reference to paragraph (a)(35) to reflect the redesignation of the latter new rule provision as discussed above. The Commission received several comments regarding the proposed amendment to Rule 17a–4 requesting clarification as to what communications would be required to be retained pursuant to the proposed rule amendment beyond those already required to be retained by existing paragraph (b)(4) of Rule 17a–4.833 Rule 17a–4(b)(4) requires broker-dealers to retain originals of all communications received and copies of all communications sent by the brokerdealer relating to its business as such for a period of not less than three years, the first two in an easily accessible place. In response, the Commission notes that while the records that a brokerdealer would be required to make in connection with Regulation Best Interest under new paragraph (a)(35) of Rule 17a–3 may be ‘‘business as such’’ records, the Commission believes it is important, including for examination purposes, that broker-dealers separately retain records that specifically demonstrate compliance with Regulation Best Interest and new paragraph (a)(35) of Rule 17a–3 rather than simply including them in the much broader ‘‘business as such’’ category required to be retained under Rule 17a– 4(b)(4). Rule 17a–3(e)(5) currently serves the purpose of allowing broker-dealers to demonstrate compliance with the customer information records required to be made pursuant to Rule 17a– 3(a)(17), and the amendment to Rule 17a–3(e)(5) being adopted today will serve the same purpose with respect to records required to be retained by broker-dealers to demonstrate compliance with Regulation Best Interest and new paragraph (a)(35) of Rule 17a–3. Finally, as noted in the Proposing Release, the written policies and procedures that broker-dealers will be required to create pursuant to Regulation Best Interest are already currently required to be retained pursuant to Exchange Act Rule 17a– 4(e)(7),834 which requires broker-dealers to retain compliance, supervisory, and procedures manuals (and any updates, 833 See Exchange Act Rule 17a–4(b)(4); SIFMA August 2018 Letter; Edward Jones Letter; Prudential Letter. 834 See Exchange Act Rule 17a–4(e)(7). VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 modifications, and revisions thereto) describing the policies and practices of the broker-dealer with respect to compliance with applicable laws and rules, and supervision of the activities of each natural person associated with the broker-dealer, for a specified period of time. As such, we did not propose, and are not adopting, any additional recordkeeping requirements with respect to the written policies and procedures that broker-dealers will be required to create pursuant to Regulation Best Interest. E. Compliance Date We are providing a compliance date of June 30, 2020, consistent with the transition provisions described in the Relationship Summary Adopting Release.835 In light of the importance of the protections provided by Regulation Best Interest, we believe that this compliance date will provide adequate notice and opportunity for brokerdealers to comply with Regulation Best Interest, including by creating or updating the necessary disclosures and to developing, updating or establishing their policies and procedures and systems, as appropriate, to achieve compliance with Regulation Best Interest. On and after the Compliance Date, broker-dealers that provide recommendations of securities transactions or investment strategies that register with the Commission would be required to comply with Regulation Best Interest as of the date of registration. While most commenters requested an implementation period of 18–24 months,836 one commenter requested an implementation period of 12–18 months.837 We believe the operational capability needed to develop processes to comply with Regulation Best Interest is sufficiently established by firms of all sizes and resources. While we understand commenters’ requests for periods longer than 12 months after effectiveness, the Commission has determined, in light of the importance of the protections afforded by Regulation Best Interest to retail Relationship Summary Adopting Release. Cetera August 2018 Letter; SIFMA August 2018 Letter; HD Vest Letter (recommending that the Commission adopt a 24-month implementation period); Northwestern Mutual Letter; IRI Letter (recommending that the Commission adopt an 18to-24-month implementation period); CCMC Letters; AXA Letter (recommending that the Commission adopt at least an 18-month implementation period); ACLI Letter; TIAA Letter (recommending that the Commission adopt an 18month implementation period). 837 See Raymond James Letter (recommending that the Commission adopt a 12–18-month implementation period). PO 00000 835 See 836 See Frm 00084 Fmt 4701 Sfmt 4700 customers, that a Compliance Date of one year after effectiveness is an appropriate timeframe for firms to conduct the requisite operational changes to their systems to establish internal processes to comply with Regulation Best Interest.838 The Commission also believes that it is important to coordinate the transition dates of the Relationship Summary requirements with those of Regulation Best Interest to ensure that all retail investors receive the full suite of protections and benefits afforded by the amended and new rules. Finally, the Commission staff intends to offer firms significant assistance and support during the transition period and thereafter with the aim of helping to ensure that the investor protections and other benefits of the final rule are implemented in an efficient and effective manner. III. Economic Analysis A. Introduction and Primary Goals of the Regulation, Comments on Market Failure and Quantification, and Broad Economic Considerations 1. Introduction and Primary Goals of the Regulation Regulation Best Interest enhances the broker-dealer standard of conduct beyond existing suitability obligations and aligns the standard of conduct with retail customers’ reasonable expectations. Under Regulation Best Interest, broker-dealers and their associated persons will be required to act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker-dealer or an associated person making the recommendation ahead of the interests of the retail customer. They also will be required to address conflicts of interest by establishing, maintaining, and enforcing policies and procedures reasonably designed to identify and fully and fairly disclose material facts about conflicts of interest, and in instances where the Commission has determined that disclosure is insufficient to reasonably address the conflict, to mitigate or, in certain instances, eliminate the conflict. As a result, Regulation Best Interest should enhance the efficiency 839 of recommendations that broker-dealers provide to retail customers, allow retail customers to better evaluate the recommendations received, improve retail customer protection when 838 See 839 See E:\FR\FM\12JYR2.SGM footnote 809 and accompanying text. infra footnote 846 and accompanying text. 12JYR2 jbell on DSK3GLQ082PROD with RULES2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations receiving recommendations from broker-dealers, and, ultimately, reduce agency costs 840 and other costs. Importantly, Regulation Best Interest is designed to preserve, to the extent possible, (1) access and choice for investors who may prefer the transaction-based model that brokerdealers generally provide, or the feebased model that investment advisers generally provide, or a combination of both types of arrangements, and (2) retail customer choice of the level and types of services provided and the securities available. For example, retail customers who intend to buy and hold a long-term investment on a nondiscretionary basis may find that paying a one-time commission to a brokerdealer who recommends such an investment is more cost effective than paying an ongoing advisory fee to an investment adviser merely to hold the same investment.841 Retail customers who would prefer advisory accounts but have not yet accumulated sufficient assets to qualify for investment advisory accounts, which may require customers to have a minimum amount of assets, may similarly benefit from recommendations from broker-dealers. Other retail customers who hold a variety of investments, or prefer different levels of services from financial professionals, may benefit from having access to both brokerage and advisory accounts. The Commission is mindful of the costs imposed by, and the benefits obtained from our rules. Whenever the Commission engages in rulemaking under the Exchange Act and is required to consider or determine whether an action is necessary or appropriate in the public interest. Section 3(f) of the Exchange Act also requires the Commission to consider, in addition to the protection of investors, whether the action would promote efficiency, competition, and capital formation.842 Also, when making rules pursuant to the Exchange Act, S the Commission is required under Section 23(a)(2) to consider, among other matters, the impact any rule would have on competition and is prohibited from adopting any rule that would impose a burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act.843 The following analysis considers, in detail, the economic effects that the Commission believes are likely to or 840 See 841 See infra footnote 855 and accompanying text. infra footnote 1353 and accompanying text. 842 See 843 See may result from Regulation Best Interest. The analysis includes consideration of the benefits and costs to retail investors and broker-dealers, and also takes into account the broader implications of Regulation Best Interest for efficiency, competition, and capital formation. Where possible, the Commission has sought to quantify the likely economic effects of Regulation Best Interest. The Commission is providing both a qualitative assessment and quantified estimates of the potential effects of Regulation Best Interest, where feasible. The Commission has incorporated data and other information provided by commenters to assist it in the analysis of the economic effects of Regulation Best Interest.844 However, as explained below in more detail, because the Commission does not have, has not received, and, in certain cases, does not believe it can reasonably obtain data that may inform on certain economic effects, the Commission is unable to quantify certain economic effects. The Commission further notes that even in cases where it has some data or it has received some data regarding certain economic effects, the quantification of these effects is particularly challenging due to the number of assumptions that it would need to make to forecast how broker-dealers will respond to Regulation Best Interest, and how those responses will, in turn, affect the broader market for investment advice and the retail customers’ participation in financial markets. 2. Broad Economic Considerations Investors generally derive utility from consuming goods and services over their lifetime and from bequeathing wealth to others.845 The amount of goods and services that an investor can consume or the amount of wealth the investor can bequeath is limited by the value of the resources available to the investor over his or her lifetime. These resources generally vary across market and economic conditions and over time. An investor generally seeks to allocate his or her resources across market and economic conditions and over time to achieve the highest expected utility possible over his or her lifetime. For example, an investor may decide to save, and therefore allocate, a proportion of his or her wages to maximize his or her expected utility 844 See infra Section III.A.3. e.g., Irving Fisher, Theory of Interest, as Determined by Impatience to Spend Income and Opportunity to Invest it (1930). 845 See, 15 U.S.C. 77b(b) and 15 U.S.C. 78c(f). 15 U.S.C. 78w(a)(2). VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 PO 00000 Frm 00085 Fmt 4701 Sfmt 4700 33401 from bequeathing wealth toward his or her children’s future education. Capital markets facilitate this allocation and reallocation of resources. An investor can allocate available resources across financial assets available to them in the capital markets, such that these resources become available to the investor at the times, and in the market and economic conditions, when he or she needs them. There may be many combinations of financial assets or investment strategies that achieve an investor’s allocation goals, but each of these strategies may not necessarily provide the investor with the same benefits or cause the investor to bear the same costs. The expected benefit of allocating resources to an investment strategy depends on the expected utility to the investor from the expected payoff of the strategy and from whether this strategy pays off in the market and economic conditions and at the times that the investor cares about. Importantly, the various costs of allocating resources to any strategy reduce the resources available for consumption and saving. A rational investor seeks out investment strategies that are efficient in the sense that they provide the investor with the highest possible expected net benefit, in light of the investor’s investment objective that maximizes expected utility.846 From the discussion above, an efficient investment strategy may depend on the investor’s utility from consumption, including: (1) His or her risk tolerance; (2) time available for the funds to be invested, and not consumed; (3) the resources that the investor has currently available (e.g., current wealth) or anticipates to become available at some point in the future (e.g., future income); and (4) the cost to the investor of implementing the strategy. An investor’s efficient investment strategy may change over time because the investor’s preferences, as well as market conditions and investment performance, may change over time. In general, a typical investor may not have the knowledge or the time to identify efficient strategies on his or her own. In addition, investors may be limited in their access to information and their human computational capacity when evaluating choices.847 As 846 See, e.g., Andreu Mas-Colell, Michael D. Whinston, & Jerry R. Green, Microeconomic Theory (1995), specifically Chapter 10: Competitive Markets for a discussion of efficient allocations of resources. 847 See, e.g., Herbert A. Simon, A Behavioral Model of Rational Choice, 69 Q. J. Econ. 99 (1955) for one of the first works on bounded rationality. E:\FR\FM\12JYR2.SGM Continued 12JYR2 33402 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 an alternative to attempting to identify efficient strategies on his or her own, an investor may solicit advice from financial professionals. While there are many types of financial professionals 848 that can provide advice related to a retail customer’s finances, we focus here (and in Regulation Best Interest) on a type of professional that retail customers commonly access, namely brokerdealers and their associated persons. A broker is any person engaged in the business of effecting transactions in securities for the account of others.849 A dealer is any person engaged in the business of buying and selling securities for its own account, through a broker or otherwise.850 Within the scope of these definitions, a ‘‘broker-dealer’’ (or, a firm that fits both definitions) may offer a wide variety of services to retail customers. These services include buying and selling securities for the retail customer as well as providing limited personalized investment advice in the form of recommendations of whether or not to engage in securities transactions or investment strategies involving securities.851 Federal securities laws and SRO rules govern broker-dealers’ conduct of business. Among other things, they require that a broker-dealer or associated person ‘‘have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the [firm] or associated person to ascertain the customer’s investment profile.’’ 852 While a suitable recommendation must take into account the elements of a retail customer’s investment profile that make securities transactions or an investment strategy efficient for that particular retail customer, this requirement for See also Richard H. Thaler, Behavioral Economics: Past, Present, and Future, 106 Am. Econ. Rev. 1577 (2016) for a discussion of the evolution of bounded rationality in economics. 848 The list of financial professionals that can provide advice related to a retail customer’s finances includes broker-dealers and their associated persons, investment advisers, banks, and insurance agents. 849 See Section 3(a)(4)(A) of the Securities Exchange Act. 850 See Section 3(a)(5)(A) of the Securities Exchange Act. 851 We focus our discussion on recommendations that are the focus of Regulation Best Interest but note that broker-dealers and their representatives provide a wide variety of ‘‘agency services’’ as described in footnote 1 of the Proposing Release. See, e.g., 913 Study. See also infra Section III.B.1.a. 852 See FINRA Rule 2111 (Suitability); see also infra Section III.B.2.b. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 suitability may not lead to an efficient result for the retail customer. The efficiency of a recommendation to a retail customer may depend on: (1) The menu of securities transactions and investment strategies the broker-dealer or its associated persons considers and makes available to the retail customer; (2) the return distribution and the costs of these securities transactions and strategies; (3) the associated person’s understanding of these investment options and the retail customer’s objectives, such as the retail customer’s risk tolerance and time preference; and (4) the retail customer’s resource constraints. A recommendation provided by an associated person of the broker-dealer may be influenced by the conflicts of interest that the associated person may have or the conflicts of interest that the broker-dealer may have at the time of the recommendation. These conflicts can arise as a result of how brokerdealers generate revenue from various securities or investment strategies that they make available to retail customers and how broker-dealers compensate their associated persons for providing recommendations to retail customers. In the United States, broker-dealers may earn transaction-based compensation that is commonly paid either directly by the retail customer (e.g., commissions and markups or markdowns) or indirectly through the investment sponsor (e.g., 12b–1 fees or revenue sharing). Broker-dealers may compensate their associated persons that provide recommendations to retail customers with a portion of the commissions and markups or markdowns these persons generate through their recommendations. Such financial incentives can vary depending on the investment product line, account type, or other factors (e.g., amount of customer assets brought into the brokerdealer or revenue generated from customer accounts). A retail customer generally chooses to accept or reject a recommendation supplied by the associated person of the broker-dealer.853 Some retail customers may base their decisions on an assessment of whether the recommendations they receive would result in securities transactions or investment strategies that are efficient for them. These customers’ assessment 853 Note, however, that a retail customer may receive automated advice without involvement of an associated person of the broker-dealer. For example, a broker-dealer may generate recommendations through an asset allocation model. FINRA Regulatory Notice 12–25; See also FINRA Report on Digital Investment Advice (Mar. 2016). PO 00000 Frm 00086 Fmt 4701 Sfmt 4700 may depend on factors such as their perception of the associated person’s ability to properly understand and account for the customer’s objectives, any information they have about the associated person’s or firm’s conflicts of interest with respect to that recommendation, and the extent to which these conflicts are expected to result in less than efficient recommendations for the retail customer. However, other retail customers may rely in full or in part on factors less directly related to the recommendation at hand. Instead, they might rely on factors such as their level of trust with the associated person or firm, and in certain circumstances might be inclined to simply accept all of the associated person’s recommendations without evaluating for themselves whether the recommendations are efficient.854 As noted above, broker-dealers or their associated persons may have conflicts of interest that could influence their recommendations to retail customers at the time when they are provided. A retail customer’s choice to accept a particular recommendation often directly affects the compensation that an associated person or broker-dealer itself receives. For example, an associated person may receive greater compensation from selling certain securities or strategies relative to other securities or strategies. Differences in compensation across the securities or strategies offered by a broker-dealer may add complexity to an associated person’s incentives and may create conflict between the interests of the associated person, who desires to maximize his or her compensation, and the interests of the retail customer, who expects the recommended transaction to be efficient for him or her. In general, this conflict of interest may result in a broker-dealer recommending securities or investment strategies that are less efficient for the retail customer. For instance, the recommended securities or strategies may be enhancing the associated person’s compensation at the expense of the retail customer. Put another way, because of the financial incentives, broker-dealers and their associated 854 See, e.g., the discussion on investor trust in the markets for financial advice in Section III.B.4.a, infra. See also Gross Letter. See also Roman Inderst & Marco Ottaviani, How (not) to pay for advice: A framework for consumer financial protection, 105 the J. Fin. Econ 393 (2012) for a discussion of the economic surplus extracted by broker-dealers that provide recommendations to retail customers, and how this surplus relates to the factors that determine a retail customer’s decision to accept or reject a recommendation. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 persons may be motivated to recommend certain types or quantities of securities or strategies, and those recommendations may place the interests of the broker-dealer or its associated persons ahead of the interests of the retail customer, which may not result in the retail customer maximizing his or her expected net benefit. An inefficient recommendation may lead to various results for the retail customer, including inferior investment outcomes, such as risk-adjusted expected returns that are lower relative to other similar investments or investment strategies. A retail customer may accept a recommendation that is less efficient if he or she is unable to assess correctly the efficiency of the recommendation. The difference between the net benefit to the retail customer from accepting a less than efficient recommendation about a securities transaction or investment strategy, where the associated person or broker-dealer puts its interests ahead of the interests of the retail customer, and the net benefit the retail customer might expect from a similar securities transaction or investment strategy that is efficient for him or her, as defined above, is an agency cost.855 As discussed in the Proposing Release and above, this agency cost arises because of the conflicts of interest of the broker-dealer and its associated persons, and the differences between the information sets available to the broker-dealer and the retail customer at the time of the recommendation. In certain principal-agent relationships, the principal may be able to reduce the agency costs that he or she is facing in various ways, including by structuring the agent’s compensation in a way that better aligns the interest of the agent with that of the principal.856 A feature of the agency relationship between a retail customer (the principal) and a broker-dealer (the agent) that is common in many principal-agent relationships (including the investment adviser-client relationship) is that the retail customer generally does not have full transparency about the agent’s compensation for providing advice and the sources of the agent’s compensation. Thus, the retail customer, through the decision to accept or reject a recommendation received, has generally limited understanding of and control 855 See, e.g., Michael C. Jensen, and William. H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 J. Fin. Econ. 305 (1976) for a more general discussion of agency costs. 856 See, e.g., Stephen A. Ross, The Economic Theory of Agency: The Principal’s Problem, 63 Am. Econ. Rev. ( Papers & Proc.) 134 (1973). VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 over the compensation that the brokerdealer and its associated person obtains from providing the recommendation. These limitations restrict the retail customer’s ability to reduce the agency costs that he or she is facing. We also recognize that even if the retail customer were to have full transparency about the broker-dealer’s and its associated person’s compensation from providing advice, the retail customer’s ability to reduce the agency costs may be constrained in other ways. For example, if the menu of securities from which the associated person of the broker-dealer offers recommendations is limited, the retail customer’s and the associated person’s ability to identify and select a more efficient investment may be constrained. Different retail customers may face different agency costs depending on whether they base their decision to act on a recommendation on an assessment of the efficiency of the recommendation. Specifically, as noted above, a retail customer that evaluates and uses a recommendation received based on an assessment about the efficiency of that recommendation may be more successful in identifying and controlling, albeit in a limited fashion, the compensation that the broker-dealer and its associated person receive from the recommendation—such as by being more likely to reject a less than efficient recommendation—compared to a retail customer that makes this decision without forming an assessment of the efficiency of the recommendation. Thus, the agency costs may be higher for those retail customers that make their decision of whether to act on a recommendation received without an assessment of the efficiency of the recommendation. While the discussion above focuses on the actions that the principal (i.e., the retail customer) can take to reduce the agency costs that he or she is facing, the agent can also take actions to reduce the agency costs to the principal. For example, in the agency paradigm, when the principal may forgo sharing a potentially large surplus with the agent because of the high agency costs, the agent may have an incentive to structure the terms of the relationship in a way that reduces the agency costs to the principal.857 In the agency relationship 857 See, e.g., Sanford J. Grossman & Oliver D. Hart, The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration, 94 J. Pol. Econ. 691 (1986) for a discussion of the actions that agents can take to reduce the agency costs to the principal in the context of the relationship between an owner (the principal) and a manager (the agent) when the agent that has a valuable investment opportunity that can only be financed by the principal. PO 00000 Frm 00087 Fmt 4701 Sfmt 4700 33403 between a retail customer and a brokerdealer, given the features of the compensation that the broker-dealer and its associated persons receive for providing recommendations (e.g., this compensation does not depend on the value of the assets in a principal’s account), the broker-dealer and its associated persons may not have sufficient incentive to take actions voluntarily that would reduce agency costs to the retail customer, such as voluntarily increasing transparency with respect to compensation.858 Although the dynamics of the agency relationship between a retail customer and a broker-dealer may not cause the broker-dealer to take steps to increase transparency, competitive factors in the broker-dealer industry such as steps toward transparency taken by other broker-dealers may cause increased transparency in that relationship. Competitive dynamics are more effective in areas where comparisons can be more easily made. For example, in the market for mutual funds —particularly index funds— comparability and competition, among other factors, have driven down fees significantly.859 858 Limited transparency with respect to how broker-dealers and their associated persons are compensated from recommending a security and what constrains their menus of securities may make it difficult for retail customers to grasp the size of the agency costs that they are facing at the time when they receive the recommendation. As a result, this limited transparency may allow broker-dealers and their associated persons to extract informational rents (i.e., in the context of a transaction, compensation in excess of what is competitively feasible that stems solely from the informational advantage of one party over another) from the retail customers when providing recommendations. The adviser business model also has its own set of conflicted incentives to gather assets (based on AUM fees) or maximize the time that it takes to complete a job (if paid an hourly fee). Dual-registrants also have an incentive to recommend the type of account that is most profitable to the firm. See AFL–CIO April 2019 Letter. See also Morgan Lewis Letter (describing investment adviser compensation and conflicts disclosure in Form ADV); Bruce Ian Carlin & Gustavo Manso, Obfuscation, Learning, and the Evolution of Investor Sophistication, 24 Rev. Fin. Stud. 754 (2011) for a discussion about the relationship between informational rents and the opacity of recommended investments (e.g., securities with complex payoff structures). 859 Comparability among index funds that follow the same market index is facilitated in part by their passive style of investing. Actively managed funds that follow the same investment strategy can show different performance due to, among other things, the ‘‘skill’’ of the manager of outperforming the market (or any other benchmark). This skill is unobservable and generally hard to measure, which makes comparisons across actively managed funds difficult. In contrast, comparisons across index funds that follow the same market index and that have passive investment styles are based more on observable variables, such as fees, rather than unobservable variables, such as managerial skill. In E:\FR\FM\12JYR2.SGM Continued 12JYR2 33404 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 While we do not have evidence to establish the degree to which brokerdealers can extract large informational rents from retail customers under the current legal and regulatory regime that governs the broker-dealers’ standard of conduct, the existing agency costs of the relationship between the retail customer and the broker-dealer would likely be larger, absent the current legal and regulatory regime.860 In general, standards and regulation are effective means of reducing agency costs when principals (e.g., retail customers) and agents (e.g., broker-dealers) cannot reduce the agency costs on their own by negotiating to address the market frictions in their relationship through mechanisms available to them, such as bilateral contracting 861 or ‘‘side payments.’’ 862 Regulation Best Interest enhances the current standard of conduct for brokerdealers and codifies it in an Exchange Act rule. Regulation Best Interest is designed to: (1) Enhance the current standard of conduct applicable to broker-dealers and associated persons when they make a recommendation to a retail customer of any securities transaction or investment strategy involving securities; (2) reduce conflicts of interest that currently exist between retail customers and broker-dealers and their associated persons; and (3) reduce this context, disclosure that is more salient with respect to these observable variables may facilitate comparisons across index funds. 860 See, e.g., Matthew L. Kozora, Security Recommendations and the Liabilities of BrokerDealers (U.S. Sec. & Exch. Comm’n, Working Paper, May 1, 2016), available at https://www.sec.gov/ files/Kozora_BD-Liability_05-2016.pdf, which provides evidence from investor awards in FINRA arbitrations that the author interprets as indicative of informational rents being nonzero. See also our more comprehensive discussion in Section III.B.3.c, infra, about potential investor harm associated with investment advice, including from potential informational rents. 861 See Proposing Release at 21643. 862 Another way principals and agents negotiate around market frictions is through ‘‘side payments.’’ In a transaction between two parties, a side payment is a monetary exchange from one party to another that is not part of the transaction. This mechanism is discussed in the literature on bilateral externalities, which focuses on how the actions of one party can affect the well-being of the other party. This mechanism also applies to the relationship between a broker-dealer and a retail customer because the action taken by a brokerdealer, namely providing a recommendation, may affect the well-being of the retail customer receiving that recommendation. In the literature on bilateral externalities, if the party taking these externality actions is unconstrained, the allocation of resources across the two parties may be inefficient. However, in certain circumstances, the parties can avoid this inefficient outcome through side payments that neutralize the effect of the externality on the allocations. See, e.g., Mas-Colell et al. (1995), supra footnote 846, specifically Part 3: Market Equilibrium and Market Failure for a discussion of bilateral externalities. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 information asymmetries that currently limit the ability of retail customers to evaluate the efficiency of recommendations they receive from broker-dealers and their associated persons. In each of these three ways, Regulation Best Interest is designed to reduce the agency costs in the relationship between broker-dealers and their retail customers, including in situations where the existing legal and regulatory regime that governs brokerdealers’ standard of conduct has had limited effectiveness. 3. Comments on Market Failure of the Principal-Agent Relationship and Quantification; Comments That the Broker-Dealer, Commission-Based Model Should Be Severely Restricted or Eliminated The economic analysis in the Proposing Release characterized the relationship between a retail customer and a broker-dealer as one between a principal (the retail customer) and an agent (the broker-dealer).863 The analysis noted that the potential conflict between interests and the differences between the information sets available to the agent and the principal may result in agency costs. It further noted that the inability of the broker-dealers and retail customers to overcome the market frictions underlying these agency costs may result in inefficient allocations of resources. An inability of the principal and the agent to efficiently negotiate around the frictions that produce agency costs and take actions that would increase the efficiency of their allocations is what economists refer to as a ‘‘market failure’’ of the principalagent relationship,864 generally, and of the agency relationship between the retail customer and the broker-dealer, specifically.865 The analysis in the Proposing Release recognized that while the Commission cannot provide a quantified estimate of the magnitude of this agency cost, the existence of these costs and their persistence justifies regulatory intervention.866 A number of commenters questioned this approach. Certain of these commenters stated that the Commission needs to more fully identify the market failure that needs to be addressed, and certain commenters stated that the Commission did not provide a Proposing Release at 21629–21631. e.g., Mas-Colell et al. (1995), supra footnote 846. 865 In general, because frictions such as asymmetric information are ever present, all markets and agency relationships have some degree of market failure. 866 See Proposing Release at 21631. PO 00000 863 See 864 See, Frm 00088 Fmt 4701 Sfmt 4700 quantitative assessment of the severity of the market failure that would prompt the need for regulatory intervention.867 We address these concerns below. With respect to the issue of appropriately identifying the market failure, one commenter questioned whether the relationship between the retail customer and the broker-dealer is a principal-agent relationship.868 This commenter stated that in many instances, a broker-dealer’s provision of recommendations to a retail customer resembles an arm’s length transaction (e.g., purchasing a car) that benefits the more informed broker-dealer at the expense of the less informed retail customer. This commenter disagreed with the Commission’s broader view that the market failure stems from the agency costs of the relationship between 867 See, e.g., CFA August 2018 Letter at 105, noting that ‘‘[c]orrectly diagnosing the problem requires identifying and analyzing the market failure that has occurred in investment advice securities markets, as well as assessing the significance of that problem’’; See also, e.g., Letter from Charles Cox, Former SEC Chief Economist, et al. (Feb. 6, 2019) (‘‘Former SEC Senior Economists Letter’’) at 2, noting that ‘‘the Commission confronts important questions about advisers balancing their own compensation against the effect of that compensation on the customer’s expected returns. We wonder if the extreme asymmetry of information and financial sophistication between advisers and many of their clients constitutes a market failure that the April proposals are intended to ameliorate.’’ In addition, the Former SEC Senior Economists Letter raised three main concerns with the economic analysis in the Proposing Release: (1) The discussion of the potential problems in the customer-adviser relationship was incomplete and identified other features of the market for ongoing retail investment advice that might be problematic; (2) there was inadequate discussion and analysis of the existing economic literature on financial advice; and (3) there were questions of whether the disclosure requirements in the Proposing Release would provide meaningful information for customers. The economic analysis addresses these concerns. For instance, with respect to (1), Section III.A.2 provides a more in depth discussion of the potential problems that may arise when a brokerdealer provides recommendations to a retail customer. With respect to (2), Section III.B.3 engages more fully with the economic literature on financial advice. Finally, with respect to (3), Sections III.B.4, III.C.2, and III.C.4 provide discussions on the effectiveness of the disclosure requirements of Regulation Best Interest. 868 See CFA August 2018 Letter at 107, noting that ‘‘[t]he Commission’s economic analysis gets off to a faulty start by mischaracterizing, or at least oversimplifying, the broker-customer ‘advice’ relationship, as a principal-agent relationship. While there are certainly instances where a broker and its customer can exhibit features of a bona fide principal-agent relationship—for example when executing a customer’s order—it’s not clear that, in the context of receiving investment recommendations, those same characteristics are present. Certainly, the brokerage industry expressly refutes this characterization, having argued successfully in the Fifth Circuit that brokers engage in nothing more than an arm’s length commercial sales transaction, no different from a car dealer soliciting interest in inventory.’’ E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 a broker-dealer and a retail customer,869 and instead stated that the market failure is due to conflicts of interest caused by the way broker-dealers and their associated persons are generally compensated for providing recommendations to retail customers.870 Similarly, another commenter stated that the Commission failed to discuss how the current compensation practices associated with providing recommendations to retail customers creates incentives for the broker-dealer and its associated persons to favor one securities transaction or investment strategy over another when making recommendations to retail customers.871 This commenter further questioned whether the information asymmetry and the discrepancy in the level of financial sophistication between broker-dealers and their retail customers constitute a market failure.872 One commenter noted that the poor performance of actively managed funds that are being recommended by broker-dealers to small retail customers reflects a principal-agent problem that causes an ‘‘enormous’’ wealth transfer from retail customers to the financial industry, including broker-dealers.873 This commenter stated that this problem arises because of the broker-dealer’s commission-based compensation for providing recommendations and because of the information asymmetries between the broker-dealer and the retail customer at the time of the recommendation.874 This commenter 869 See CFA August 2018 Letter at 108, noting that ‘‘[t]ypically, principal-agent relationships don’t involve third party payments to the agent, which can adversely affect the level of loyalty the agent provides to the principal.’’ 870 See CFA August 2018 Letter at 107, noting that the Commission ‘‘fails to acknowledge that conflicts of interest are a real problem that result in real harm to investors [. . .]’’ and ‘‘[. . .] the Release fails to make clear whether the Commission is truly seeking to address the underlying problem of conflicts’ harmful impact on investors.’’ 871 See Former SEC Senior Economists Letter at 3, noting that ‘‘[n]owhere does the EA emphasize that an adviser’s compensation provides numerous opportunities for her to favor one investment over another on the basis of the compensation it pays to her or to her firm.’’ 872 See Former SEC Senior Economists Letter at 2. See also supra footnote 867 that describes in more detail the concerns raised by this commenter. 873 See Letter from Monique Morrissey, Economist and Heidi Shierholz, Senior Economist and Director of Policy, EPI (Aug. 7, 2018) (‘‘EPI Letter’’) at 6, noting that ‘‘[i]n an equilibrium with knowledgeable investors, we would expect returns from active and passive strategies to be equal. The fact that actively-managed funds marketed to small investors tend to perform poorly reflects a market distortion—naivete´—or a ‘principal-agent problem’ in economics parlance, which results in enormous transfers from investors to the financial industry.’’ 874 See EPI Letter at 2, noting that ‘‘[c]onflicts of interest between buyers and sellers are commonplace. Many salesmen, including brokers VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 also stated that recommendations subject to conflicts of interest may have no value for retail customers.875 As an initial matter, in response to comments regarding the need to discuss fully the existing market failure, it is important to recognize that the Commission has been studying and carefully considering the issues related to the broker-dealer-client relationship and the related standard of conduct for broker-dealers for many years, which led to the development of the Proposing Release and the economic analysis therein.876 In light of the comments on the Proposing Release, the extensive outreach by the Commission and staff, as well as investor testing, the Commission has more specifically and fully described the relationship between the broker-dealer and the client, the related market failure, and the resulting potential economic effects of Regulation Best Interest in addressing the market failure.877 The Commission continues to believe that agency costs are at the root of existing allocative inefficiencies in the market for broker-dealer advice. Moreover, this economic analysis recognizes that a proper understanding of the economic fundamentals of an investor’s decision to allocate resources across market and economic conditions and over time is central to identifying the frictions that cause inefficiencies in the agency relationship between a broker-dealer and a retail customer. In response to the commenter that stated that in a principal-agent relationship agents do not receive compensation from third parties (e.g., investment sponsors), the Commission notes that the compensation that the investment sponsor provides to the agent is ultimately funded by the principal (i.e., the retail customer).878 In addition, in response to the commenter’s concern that a brokerdealer’s provision of recommendations and car dealers, are paid on commission. However, it has long been recognized that markets for professional advice are different from markets for automobiles because information asymmetries are inherent in these transactions.’’ 875 See EPI Letter at 8, noting that ‘‘the SEC never considers that ‘advice’ offered may not just be of lower quality than expected, but worse than no advice at all’’ and that ‘‘much of the ‘advice’ provided by broker-dealers not only lacks value, but is actually harmful, steering savers to higher-cost products and costly services that will reduce their future standard of living compared to how they would fare in the absence of this ‘advice.’ This may be true whether or not, in the absence of conflicted ‘advice,’ investors would have availed themselves of more paid or free advice from more impartial sources.’’ 876 See Proposing Release at 21579–21583. 877 See supra Section III.A.2. 878 See supra footnote 869. PO 00000 Frm 00089 Fmt 4701 Sfmt 4700 33405 to retail customers resembles an arm’s length transaction that is ‘‘no different from a car dealer soliciting interest in inventory,’’ 879 the Commission notes that under the current regulatory regime broker-dealers and their associated persons are subject to a suitability standard of conduct that has been interpreted to ‘‘be consistent with [the] customer’s best interests.’’ 880 In contrast, in an arm’s length transaction, the parties involved are generally not subject to a standard of conduct that would constrain the more informed party from acting solely in its own interest.881 Finally, in response to the commenter’s concern with respect to the identification of the market failure,882 the Commission notes that while conflicts of interest arise in many types of transactions, in certain instances the parties involved can negotiate an arrangement between themselves that would reduce the effect of conflicts of interest on the allocation of resources across the parties and improve the efficiency of this allocation. The Commission further notes that agency costs may deter the parties from engaging in privately negotiated arrangements that would improve the efficiency of the allocation of resources between the parties. From this perspective, the Commission believes that it is the agency costs rather than the conflicts of interest themselves that should be viewed as the source of the market failure. In response to the commenter that noted that the Commission did not discuss how the compensation received by the broker-dealer and its associated persons creates incentives to favor one security or investment strategy over another when making recommendations to retail customers,883 the Commission has incorporated into this economic analysis a detailed discussion of the incentives created by the current compensation practices associated with providing recommendations to retail customers.884 In addition, in response to the commenter’s concerns about whether the information asymmetry and the discrepancy in the level of financial sophistication between retail customers and a broker-dealer and its associated persons are the source of market failure, the Commission notes that this economic analysis establishes a more 879 See supra footnote 868. infra footnote 979 and accompanying text. 881 However, in certain markets, there may be market mechanisms in place that would prevent the more informed party to a transaction from acting solely in its own interest. 882 See supra footnote 870. 883 See supra footnote 871. 884 See infra Section III.C.4. 880 See E:\FR\FM\12JYR2.SGM 12JYR2 33406 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 clear link between bounded rationality, including access to information and financial literacy of retail customers, and agency costs, and reflects our conclusion that the agency costs are at the root of the market failure. The Commission further notes that the so-called ‘‘informational rent’’ that a broker-dealer may be incentivized to extract from a retail customer to take advantage of the information asymmetry or the discrepancy in the level of financial sophistication is one component of the agency costs associated with the relationship between a retail customer and a brokerdealer. In addition, the Commission notes that the evidence on the size of the agency costs associated with such informational rents is limited.885 This evidence is not generally supportive of a commenter’s assessment that the wealth transfer from retail customers to broker-dealers is ‘‘enormous.’’ 886 The Commission agrees with this commenter, who stated that the way broker-dealers are compensated for providing recommendations and the information asymmetry between retail customers and broker-dealers are important determinants of the agency costs. However, based on the evidence discussed below, the Commission disagrees with this commenter’s assessment that the advice provided by the associated persons of the brokerdealer has no value.887 With respect to the issue of measuring the severity of the market failure, some commenters stated that the Commission failed to take into account existing academic literature that provides evidence of investor harm caused by accepting advice from the associated persons of the broker-dealer. A subset of these commenters believed that the evidence provided in some of these academic studies is compelling and that the Commission should use it to quantify the severity of the market failure.888 One commenter also urged the Commission to supplement the academic evidence on investor harm with evidence from data available to the Commission from regulatory oversight.889 885 See supra Section III.A.2 and infra Section III.B.3. 886 See supra footnote 873. 887 See infra Section III.B.3.b. 888 See, e.g., CFA August 2018 Letter; EPI Letter; AARP August 2018 Letter; Better Markets August 2018 Letter; Former SEC Senior Economists Letter. 889 See CFA August 2018 Letter at 112. This commenter suggested that we present additional information about the existence and frequency of the potential harm to investors ‘‘that results from conflicted brokerage ‘advice’,’’ which may collectively be seen as misconduct by financial professionals. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 In response to these comments, the Commission maintains that the existence of misconduct that commenters requested the Commission to document does not render the approach taken in Regulation Best Interest irrational, inappropriate, or unreasonable, nor does it suggest that an alternative approach would be more effective in fulfilling the Commission’s mission. The Commission is aware and understands the concerns raised by the commenters with regards to the evidence on investor harm and the extent to which such evidence can inform on our understanding of the severity of the market failure in the market for broker-dealer advice. As discussed in the Proposing Release and reiterated in this economic analysis, the Commission believes that retail investors can be harmed when they accept recommendations from a brokerdealer that places the financial or other interest of the broker-dealer or its associated persons ahead of the interests of the retail customers. In addition, this economic analysis engages more fully with the economic literature on financial advice and considers these studies in analyzing the costs and benefits associated with Regulation Best Interest.890 B. Economic Baseline This section discusses, as it relates to this rulemaking, the current state of the broker-dealer and investment adviser markets; the current regulatory environment and market practices surrounding the provision of recommendations by broker-dealers; evidence on the potential value and harm of investment advice; and how issues related to trust, financial literacy, and disclosure effectiveness affect conflicts between investors and financial professionals. The economic baseline has been revised and expanded relative to the Proposing Release to address comments, discussed more fully below. 1. Providers of Financial Services 891 a. Broker-Dealers Regulation Best Interest will affect the market for broker-dealer services, infra Section III.B.3.c. addition to broker-dealers and Commissionregistered investment advisers discussed below in the baseline, there are a number of other entities, such as state-registered investment advisers, commercial banks and bank holding companies, and insurance companies, which also provide financial advice services to retail customers; however, because of unavailability of data, the Commission is unable to estimate the number of some of those other entities that are likely to provide financial advice to retail customers as well as their size and the scope of services they provide. PO 00000 890 See 891 In Frm 00090 Fmt 4701 Sfmt 4700 including firms that are dually registered as broker-dealers and investment advisers 892 and brokerdealers affiliated with an investment adviser.893 The market for broker-dealer services encompasses a small set of large and medium sized broker-dealers and thousands of smaller broker-dealers competing for niche or regional segments of the market.894 The market for broker-dealer services includes many different markets for a variety of services, including (1) managing orders for customers and routing them to various trading venues; (2) providing advice to customers that is in connection with and reasonably related to their primary business of effecting securities transactions; 895 (3) holding retail customers’ funds and securities; (4) handling clearance and settlement of trades; (5) intermediating between retail customers and carrying/clearing brokers; (6) dealing in corporate debt and equities, government bonds, and municipal bonds, among other securities; (7) privately placing securities; and (8) effecting transactions in mutual funds that involve transferring funds directly to the issuer. Some broker-dealers may specialize in just one narrowly defined service, while A number of broker-dealers (see infra footnote 899) have non-securities businesses, such as insurance or tax services. As of December 2018, there were approximately 17,300 state-registered investment advisers. The Department of Labor in its Regulatory Impact Analysis identifies approximately 398 life insurance companies that could provide advice to retirement investors. See infra footnote 1002. 892 Not all firms that are dually registered as an investment adviser and a broker-dealer offer both brokerage and advisory accounts to retail investors. For example, some dually registered firms offer advisory accounts to retail investors but offer only brokerage services, such as underwriting services, to institutional clients. For purposes of the discussion of the baseline in this economic analysis, a dually registered firm is any firm that is dually registered with the Commission as an investment adviser and a broker-dealer. 893 Some broker-dealers may be affiliated with investment advisers and not dually registered. From Question 10 on Form BD, 2,098 (55.7%) brokerdealers report that, directly or indirectly, they control, are controlled by, or are under common control with an entity that is engaged in the securities or investment advisory business. Comparatively, 2,421 (18.2%) SEC-registered investment advisers report an affiliate that is a broker-dealer in Section 7A of Schedule D of Form ADV, including 1,878 SEC-registered investment advisers that report an affiliate that is a registered broker-dealer. Approximately 77% of total regulatory AUM are managed by the 2,421 SECregistered investment advisers. 894 See Risk Management Controls for Brokers or Dealers with Market Access, Securities Exchange Act Release No. 63241 (Nov. 3, 2010) [75 FR 69791, 69822 (Nov. 15, 2010)]. For simplification, we present our analysis as if the market for brokerdealer services encompasses one broad market with multiple segments, even though, in terms of competition, it could also be discussed in terms of numerous interrelated markets. 895 See Solely Incidental Interpretation. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations others may provide a wide variety of services. As of December 2018, there were approximately 3,764 registered brokerdealers with over 140 million customer accounts. In total, these broker-dealers have over $4.3 trillion in total assets, which are total broker-dealer assets as reported on Form X–17a–5.896 More than two-thirds of all brokerage assets and close to one-third of all customer accounts are held by the 17 largest broker-dealers, as shown in Table 1, Panel A.897 Of the broker-dealers registered with the Commission as of December 2018, 563 broker-dealers were dually registered as investment advisers.898 These firms hold over 90 million (63%) customer accounts. Approximately 539 broker-dealers (14%) report at least one type of nonsecurities business, including insurance, retirement planning, mergers and acquisitions, and real estate, among others.899 Approximately 73.5% of registered broker-dealers report retail customer activity.900 Panel B of Table 1 is limited to the broker-dealers that report some retail investor activity. As of December 2018, there were approximately 2,766 brokerdealers that served retail investors, with over $3.8 trillion in total assets (89% of total broker-dealer assets) and almost 139 million (97%) customer accounts.901 Of those broker-dealers serving retail investors, 452 were dually registered as investment advisers.902 The number of broker-dealers that serve retail customers (i.e., 2,766) likely 33407 overstates the number of broker-dealers that will be subject to Regulation Best Interest, because not all broker-dealers that serve retail investors provide recommendations to retail investors. We do not have reliable data to determine the precise number of broker-dealers that provide recommendations (and the extent to which broker-dealers that provide recommendations do so, as opposed to executing unsolicited trades), and as a result, we have assumed, for purposes of this Section III and Sections IV (Paperwork Reduction Act Analysis) and V (Final Regulatory Flexibility Act Analysis) that 2,766 broker-dealers will be subject to Regulation Best Interest. TABLE 1—PANEL A: REGISTERED BROKER-DEALERS AS OF DECEMBER 2018 903 [Cumulative broker-dealer total assets and customer accounts] 904 jbell on DSK3GLQ082PROD with RULES2 Size of broker-dealer (total assets) Total number of BDs Number of dually registered BDs Cumulative total assets (billion) Cumulative number of customer accounts 905 >$50 billion ............................................................................................... $1 billion to $50 billion ............................................................................. $500 million to $1 billion .......................................................................... $100 million to $500 million ..................................................................... $10 million to $100 million ....................................................................... $1 million to $10 million ........................................................................... <$1 million ................................................................................................ 17 114 35 105 490 1,021 1,982 10 23 7 20 115 182 206 $2,879 1,363 23 23 17 3.6 0.5 40,550,200 96,037,591 397,814 1,603,818 4,277,432 460,748 5,675 Total .................................................................................................. 3,764 563 4,309 143,333,278 896 Assets are estimated by Total Assets (allowable and non-allowable) from Part II of the FOCUS filings (Form X–17A–5 Part II, available at https://www.sec.gov/files/formx-17a-5_2.pdf) and correspond to balance sheet total assets for the broker-dealer. The Commission does not have an estimate of the total amount of customer assets for broker-dealers. We estimate broker-dealer size from the total balance sheet assets as described above. 897 Approximately $4.24 trillion of total assets of broker-dealers (98%) are at broker-dealers with total assets in excess of $1 billion. Of the 33 dualregistrants in the group of broker-dealers with total assets in excess of $1 billion, total assets for these dual-registrants are $2.32 trillion (54%) of aggregate broker-dealer assets. Of the remaining 99 brokerdealers with total assets in excess of $1 billion that are not dual-registrants, 91 have affiliated investment advisers. 898 This number includes the number of brokerdealers who are also registered as state investment advisers. For purposes of the discussion of the baseline in this economic analysis, a dual-registrant is any firm that is dually registered with either the Commission or a state as an investment adviser and a broker-dealer. Excluding state registered advisers, there are 359 entities that are dually registered with the Commission as an investment adviser and a broker-dealer. 899 We examined Form BD filings to identify broker-dealers reporting non-securities business. For the 393 broker-dealers reporting such business, staff analyzed the narrative descriptions of these businesses on Form BD, and identified the most common types of businesses: Insurance (202), VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 management/financial/other consulting (99), advisory/retirement planning (71), mergers and acquisitions (70), foreign exchange/swaps/other derivatives (28), real estate/property management (30), tax services (15), and other (146). Note that a broker-dealer may have more than one line of nonsecurities business. 900 The value of customer accounts is not available from FOCUS data for broker-dealers. Therefore, to obtain estimates of firm size for broker-dealers, we rely on the value of brokerdealers’ total assets as obtained from FOCUS reports. Retail sales activity is identified from Form BR, which categorizes retail activity broadly (by marking the ‘‘sales’’ box) or narrowly (by marking the ‘‘retail’’ or ‘‘institutional’’ boxes as types of sales activity). We use the broad definition of sales as we preliminarily believe that many firms will just mark ‘‘sales’’ if they have both retail and institutional activity. However, we note that this may capture some broker-dealers that do not have retail activity, although we are unable to estimate that frequency. 901 Total assets and customer accounts for brokerdealers that serve retail customers also include institutional accounts. Data available from Form BD and FOCUS data is not sufficiently granular to identify the percentage of retail and institutional accounts at firms. 902 Excluding state registered advisers, there are 359 entities that are dually registered with the Commission as an investment adviser and a brokerdealer. Of the 31 dual-registrants in the group of retail broker-dealers with total assets in excess of $500 million, total assets for these dual-registrants are nearly $2.01 trillion (53%) of aggregate retail PO 00000 Frm 00091 Fmt 4701 Sfmt 4700 broker-dealer assets (Table 1, Panel B). Of the remaining 81 retail broker-dealers with total assets in excess of $500 million that are not dualregistrants, 76 have affiliated investment advisers. 903 The data is obtained from FOCUS filings as of December 2018. Note that there may be a doublecounting of customer accounts among, in particular, the larger broker-dealers as they may report introducing broker-dealer accounts as well in their role as clearing broker-dealers. 904 In addition to the approximately 143 million individual accounts at broker-dealers, there are approximately 302,000 omnibus accounts (0.2% of total accounts at broker-dealers), with total assets of $32.1 billion, across all 3,764 broker-dealers, of which approximately 99% are held at brokerdealers with greater than $1 billion in total assets. See also supra footnote 897. Omnibus accounts reported in FOCUS data are the accounts of noncarrying broker-dealers with carrying brokerdealers. These accounts may have securities of multiple customers (of the non-carrying firm), or securities that are proprietary assets of the noncarrying broker-dealer. We are unable to determine from the data available how many customer accounts non-carrying broker-dealers may have. The data does not allow the Commission to parse the total assets in those accounts to determine to whom such assets belong. Therefore, our estimate may be under inclusive of all customer accounts held at broker-dealers. 905 Customer Accounts includes both brokerdealer and investment adviser accounts for dualregistrants. E:\FR\FM\12JYR2.SGM 12JYR2 33408 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations TABLE 1—PANEL B: REGISTERED RETAIL BROKER-DEALERS AS OF DECEMBER 2018 [Cumulative broker-dealer total assets and customer accounts] Size of broker-dealer (total assets) Total number of BDs Number of dually registered BDs Cumulative total assets (billion) Cumulative number of customer accounts >$50 billion ............................................................................................... $1 billion to $50 billion ............................................................................. $500 million to $1 billion .......................................................................... $100 million to $500 million ..................................................................... $10 million to $100 million ....................................................................... $1 million to $10 million ........................................................................... <$1 million ................................................................................................ 16 75 21 84 378 783 1,409 8 18 5 17 96 153 155 $2,806 990 13 18 14 2.8 0.4 40,545,792 91,991,118 365,632 1,603,818 3,762,620 450,132 5,672 Total BDs 906 ..................................................................................... 2,766 452 3,844 138,724,784 Table 2 reports information on brokerage commissions,907 fees, and selling concessions from the fourth quarter of 2018 for all broker-dealers, including dual-registrants.908 We observe significant variation in the sources of revenues for broker-dealers, with large broker-dealers, on average, generating substantially higher levels of aggregate commission and fee revenues (on a nominal basis) than smaller broker-dealers. On average, brokerdealers, including those that are dually registered as investment advisers, earn about $5.1 million per quarter in revenue from commissions and nearly four times that amount in fees,909 although the Commission notes that fees encompass various types of fees, not just fees for advisory services.910 The level of revenues earned by broker-dealers (including dually registered firms) for commissions and fees increases with broker-dealer size, but also tends to be more heavily weighted toward commissions for broker-dealers with less than $10 million in assets and is weighted more heavily toward fees for broker-dealers with assets in excess of $10 million. For example, for the 114 broker-dealers with assets between $1 billion and $50 billion, average revenues from commissions are approximately $45 million, while average revenues from fees are approximately $225 million.911 In addition to revenue generated from commissions and fees, broker-dealers may also receive revenues from other sources, including margin interest, underwriting, research services, and third-party selling concessions, such as from sales of investment company (‘‘IC’’) shares. As shown in Table 2, Panel A, these selling concessions are generally a smaller fraction of brokerdealer revenues than either commissions or fees, except for brokerdealers with total assets between $10 million and $100 million. For these broker-dealers, revenue from third-party selling concessions is the largest category of revenues and constitutes approximately 42% of total revenues earned by these firms. Table 2, Panel B below provides aggregate revenues by revenue type (commissions, fees, or selling concessions from sales of IC shares) for broker-dealers delineated by whether the broker-dealer is also a dualregistrant. Broker-dealers dually registered as investment advisers have a significantly larger fraction of their revenues from fees compared to commissions or selling concessions, whereas broker-dealers that are not dually registered generate approximately 42% of their advicerelated revenues as commissions and only 33% of their advice-related revenues from fees, although we lack granularity to determine whether advisory services, in addition to supervision and administrative services, contribute to fees at standalone brokerdealers. TABLE 2—PANEL A: AVERAGE BROKER-DEALER REVENUES FROM REVENUE GENERATING ACTIVITIES 912 Size of broker-dealer in total assets N jbell on DSK3GLQ082PROD with RULES2 >$50 billion ............................................................................................... $1 billion–$50 billion ................................................................................ 500 million–1 billion ................................................................................. 100 million–500 million ............................................................................ 10 million–100 million .............................................................................. 906 Total BDs includes all retail-facing brokerdealers, including those dual-registrants that have retail-facing broker-dealers. 907 Mark-ups or mark-downs are not included as part of the brokerage commission revenue in FOCUS data; instead, they are included in Net Gains or Losses on Principal Trades, but are not uniquely identified as a separate revenue category. 908 Source: FOCUS data. 909 Fees, as detailed in the FOCUS data, include fees for account supervision, investment advisory services, and administrative services. Beyond the broad classifications of fee types included in fee revenue, we are unable to determine whether fees such as Rule 12b–1 fees, sub-accounting, or other such service fees (e.g., payments by an investment company for personal service and/or maintenance VerDate Sep<11>2014 20:12 Jul 11, 2019 Jkt 247001 Commissions 17 114 35 105 490 $170,336,258 45,203,225 8,768,547 12,801,889 3,428,843 of shareholder accounts) are included. The data covers both broker-dealers and dually registered firms. FINRA’s Supplemental Statement of Income, Line 13975 (Account Supervision and Investment Advisory Services) denotes that fees earned for account supervision are those fees charged by the firm for providing investment advisory services where there is no fee charged for trade execution. Investment Advisory Services generally encompass investment advisory work and execution of client transactions, such as wrap arrangements. These fees also include fees charged by broker-dealers that are also registered with the Commodity Futures Trading Commission (‘‘CFTC’’), but do not include fees earned from affiliated entities (Item A of question 9 under Revenue in the Supplemental Statement of Income). PO 00000 Frm 00092 Fmt 4701 Sfmt 4700 Fees 913 $414,300,268 225,063,257 30,141,270 33,726,336 8,950,892 Sales of IC shares $23,386,192 53,671,602 5,481,248 16,610,013 9,092,971 910 With respect to the FOCUS data, additional granularity of what services comprise ‘‘advisory services’’ is not available. See also Solely Incidental Interpretation. 911 An estimate of total fees in this size category would be 114 broker-dealers with assets between $1 billion and $50 billion multiplied by the average fee revenue of $225 million, or $25.65 billion in total fees. 912 The data is obtained from December 2018 FOCUS reports and averaged across size groups. 913 Fees, as detailed in the FOCUS data, include fees for account supervision, investment advisory services, and administrative services. The data covers both broker-dealers and dually registered firms. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations 33409 TABLE 2—PANEL A: AVERAGE BROKER-DEALER REVENUES FROM REVENUE GENERATING ACTIVITIES 912—Continued Size of broker-dealer in total assets N Commissions Sales of IC shares Fees 913 1 million–10 million .................................................................................. <1 million .................................................................................................. 1,021 1,982 996,130 197,907 1,037,825 269,459 652,905 85,219 Average of All Broker-Dealers .......................................................... 3,764 5,092,808 21,948,551 4,368,823 TABLE 2—PANEL B: AGGREGATE TOTAL REVENUES FROM REVENUE GENERATING ACTIVITIES FOR BROKER-DEALERS BASED ON DUAL-REGISTRANT STATUS Broker-dealer type Commissions (billion) N Sales of IC shares (billion) Fees 914 (billion) Dually Registered as IAs ......................................................................... Standalone Registered BDs .................................................................... 563 3,201 $4.62 4.07 $17.56 3.22 $2.65 2.55 All ...................................................................................................... 3,764 8.69 20.78 5.20 As shown in Table 3, based on responses to Form BD, broker-dealers’ most commonly provided business lines include private placements of securities (62.7% of broker-dealers); retail sales of mutual funds (55.4%); acting as a broker or dealer retailing corporate equity securities over the counter (52.0%); acting as a broker or dealer retailing corporate debt securities (47.2%); acting as a broker or dealer selling variable contracts, such as life insurance or annuities (41.0%); acting as a broker of municipal debt/bonds or U.S. government securities (39.8% and 37.4%, respectively); acting as an underwriter or selling group participant of corporate securities (31.2%); and investment advisory services (26.4%), among others.915 TABLE 3—LINES OF BUSINESS AT RETAIL BROKER-DEALERS AS OF DECEMBER 2018 Total jbell on DSK3GLQ082PROD with RULES2 Line of business Number of broker-dealers Private Placements of Securities ......................................................................................................................... Mutual Fund Retailer ........................................................................................................................................... Broker or Dealer Retailing: Corporate Equity Securities OTC ................................................................................................................. Corporate Debt Securities ............................................................................................................................ Variable Contracts ........................................................................................................................................ Municipal Debt/Bonds Broker .............................................................................................................................. U.S. Government Securities Broker .................................................................................................................... Put and Call Broker or Dealer or Options Writer ................................................................................................ Underwriter or Selling Group Participant—Corporate Securities ........................................................................ Non-Exchange Member Arranging For Transactions in Listed Securities by Exchange Member ..................... Investment Advisory Services ............................................................................................................................. Broker or Dealer Selling Tax Shelters or Limited Partnerships—Primary Market .............................................. Trading Securities for Own Account .................................................................................................................... Municipal Debt/Bonds Dealer .............................................................................................................................. U.S. Government Securities Dealer .................................................................................................................... Solicitor of Time Deposits in a Financial Institution ............................................................................................ Underwriter—Mutual Funds ................................................................................................................................. Broker or Dealer Selling Interests in Mortgages or Other Receivables .............................................................. Broker or Dealer Selling Oil and Gas Interests ................................................................................................... Broker or Dealer Making Inter-Dealer Markets in Corporate Securities OTC .................................................... Broker or Dealer Involved in Networking, Kiosk, or Similar Arrangements (Banks, Savings Banks, Credit Unions) ............................................................................................................................................................. Internet and Online Trading Accounts ................................................................................................................. Exchange Member Engaged in Exchange Commission Business Other than Floor Activities .......................... Broker or Dealer Selling Tax Shelters or Limited Partnerships—Secondary Market ......................................... Commodities ........................................................................................................................................................ Executing Broker ................................................................................................................................................. Day Trading Accounts ......................................................................................................................................... Broker or Dealer Involved in Networking, Kiosk, or Similar Arrangements (Insurance Company or Agency) .. Real Estate Syndicator ........................................................................................................................................ Broker or Dealer Selling Securities of Non-Profit Organizations ........................................................................ 914 See id. BD requires applicants to identify the types of business engaged in (or to be engaged in) 915 Form VerDate Sep<11>2014 20:12 Jul 11, 2019 Jkt 247001 that accounts for 1% or more of the applicant’s annual revenue from the securities or investment advisory business. Table 3 provides an overview of PO 00000 Frm 00093 Fmt 4701 Sfmt 4700 Percent of broker-dealers 1,735 1,533 62.70 55.40 1,438 1,306 1,132 1,101 1,035 993 862 785 730 619 614 475 339 308 237 216 207 207 51.97 47.20 40.91 39.79 37.41 35.89 31.15 28.37 26.38 22.37 22.19 17.17 12.25 11.13 8.57 7.81 7.48 7.48 197 192 171 164 162 107 89 88 94 71 7.12 6.94 6.18 5.93 5.85 3.87 3.22 3.18 3.40 2.57 the types of businesses listed on Form BD, as well as the frequency of participation in those businesses by registered broker-dealers as of December 2018. E:\FR\FM\12JYR2.SGM 12JYR2 33410 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations TABLE 3—LINES OF BUSINESS AT RETAIL BROKER-DEALERS AS OF DECEMBER 2018—Continued Total Line of business Number of broker-dealers Exchange Member Engaged in Floor Activities .................................................................................................. Broker or Dealer Selling Securities of Only One Issuer or Associate Issuers ................................................... Prime Broker ........................................................................................................................................................ Crowdfunding FINRA Rule 4518(a) ..................................................................................................................... Clearing Broker in a Prime Broker ...................................................................................................................... Funding Portal ..................................................................................................................................................... Crowdfunding FINRA Rule 4518(b) ..................................................................................................................... Number of Retail-Facing Broker-Dealers ............................................................................................................ b. Investment Advisers Other parties that could be affected by Regulation Best Interest are SEC- or state-registered investment advisers, because Regulation Best Interest could affect the competitive landscape in the market for the provision of financial advice.916 This section first discusses SEC-registered investment advisers, followed by a discussion of stateregistered investment advisers. As of December 2018, there were approximately 13,300 investment advisers registered with the Commission. The majority of SECregistered investment advisers report that they provide portfolio management services for individuals and small businesses.917 Of all SEC-registered investment advisers, 359 identify themselves as dually registered broker-dealers.918 Further, 2,421 investment advisers (18%) report an affiliate that is a brokerdealer, including 1,878 investment advisers (14%) that report an SECregistered broker-dealer affiliate.919 As shown in Panel A of Table 4 below, in aggregate, investment advisers have over $84 trillion in AUM. A substantial percentage of AUM at investment advisers is held by institutional clients, such as investment companies, pooled investment vehicles, and pension or profit sharing plans; therefore, the total number of accounts for investment advisers is only 29% of the number of customer accounts for broker-dealers. 61 43 21 21 14 8 5 2,766 Percent of broker-dealers 2.20 1.55 0.76 0.76 0.51 0.29 0.18 .......................... Based on staff analysis of Form ADV data, approximately 62% of registered investment advisers (8,235) have some portion of their business dedicated to retail investors, including both high net worth and non-high net worth individual clients,920 as shown in Panel B of Table 4.921 In total, these firms have approximately $41.4 trillion of AUM.922 Approximately 8,200 registered investment advisers (61%) serve almost 32 million non-high net worth individual clients and have approximately $4.8 trillion in AUM, while approximately 8,000 registered investment advisers (60%) serve approximately 4.8 million high net worth individual clients with $6.15 trillion in AUM.923 TABLE 4—PANEL A: REGISTERED INVESTMENT ADVISERS (RIAS) AS OF DECEMBER 2018 [Cumulative RIA AUM and accounts] Number of RIAs jbell on DSK3GLQ082PROD with RULES2 Size of investment adviser (AUM) Number of dually registered RIAs Cumulative AUM (billion) Cumulative number of accounts >$50 billion ............................................................................................... $1 billion to $50 billion ............................................................................. $500 million to $1 billion .......................................................................... $100 million to $500 million ..................................................................... $10 million to $100 million ....................................................................... $1 million to $10 million ........................................................................... <$1 million ................................................................................................ 270 3,453 1,635 5,927 1,070 162 782 15 121 47 119 24 3 30 $59,264 22,749 1,151 1,397 59 0.8 0.02 20,655,756 13,304,154 1,413,099 5,135,070 310,031 69,664 13,976 Total .................................................................................................. 13,299 359 84,621 41,081,750 916 In addition to SEC-registered investment advisers, which are the focus of this section, Regulation Best Interest could also affect banks, trust companies, insurance companies, and other providers of financial advice. 917 Of the approximately 13,300 SEC-registered investment advisers, 8,410 (63.24%) report in Item 5.G.(2) of Form ADV that they provide portfolio management services for individuals and/or small businesses. In addition, there are approximately 17,300 state-registered investment advisers, of which 125 are also registered with the Commission. Approximately 13,900 state-registered investment VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 advisers are retail facing (see Item 5.D of Form ADV). 918 See supra footnote 892. 919 Item 7.A.1 of Form ADV. 920 We note that the data on individual clients obtained from Form ADV may not be exactly the same as who would be a ‘‘retail customer’’ as defined in Regulation Best Interest because the data obtained from Form ADV regarding clients who are individuals does not involve any test of use for personal, family, or household purposes. 921 We use the responses to Items 5.D.(a)(1), 5.D.(a)(3), 5.D.(b)(1), and 5.D.(b)(3) of Part 1A of Form ADV. If at least one of these responses was PO 00000 Frm 00094 Fmt 4701 Sfmt 4700 filled out as greater than 0, the firm is considered as providing business to retail investors. Part 1A of Form ADV. 922 The aggregate AUM reported for these investment advisers that have retail investors includes both retail AUM as well as any institutional AUM also held at these advisers. 923 Estimates are based on IARD system data as of December 31, 2018. The AUM reported here is specifically that of those non-high net worth clients. Of the 8,235 investment advisers serving retail investors, 318 are also dually registered as brokerdealers. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations 33411 TABLE 4—PANEL B: RETAIL REGISTERED INVESTMENT ADVISERS (RIAS) AS OF DECEMBER 2018 [Cumulative RIA AUM and accounts] jbell on DSK3GLQ082PROD with RULES2 Size of investment adviser (AUM) Number of RIAs Number of dually registered RIAs Cumulative AUM (billion) Cumulative number of accounts >$50 billion ............................................................................................... $1 billion to $50 billion ............................................................................. $500 million to $1 billion .......................................................................... $100 million to $500 million ..................................................................... $10 million to $100 million ....................................................................... $1 million to $10 million ........................................................................... <$1 million ................................................................................................ 119 1,614 1,007 4,548 706 102 169 14 111 44 113 23 3 10 $30,291 9,570 700 1,026 40 0.5 0.02 20,592,326 13,224,188 1,392,842 5,287,584 308,285 69,534 13,946 Total IAs 924 ...................................................................................... 8,235 318 41,434 40,887,325 In addition to SEC-registered investment advisers, other investment advisers are registered with state regulators.925 As of December 2018, there are 17,268 state-registered investment advisers,926 of which 125 are also registered with the Commission. Of the state-registered investment advisers, 204 are dually registered as brokerdealers, while approximately 4.6% (786) report a broker-dealer affiliate. In aggregate, state-registered investment advisers have approximately $334 billion in AUM. Eighty-two percent of state-registered investment advisers report that they provide portfolio management services for individuals and small businesses, compared to 63% for Commission-registered investment advisers. Approximately 81% of stateregistered investment advisers (13,927) have some portion of their business dedicated to retail investors,927 and in aggregate, these firms have approximately $324 billion in AUM.928 Approximately 13,910 (81%) stateregistered advisers serve 14 million nonhigh net worth retail clients and have approximately $137 billion in AUM, while over 11,497 (67%) state-registered advisers serve approximately 170,000 high net worth retail clients with $169 billion in AUM.929 924 Total IAs includes all retail-facing investment advisers, including those dual-registrants that have retail-facing SEC-registered broker-dealers and SECregistered investment advisers. 925 Item 2.A. of Part 1A of Form ADV and Advisers Act rules 203A–1 and 203A–2 require an investment adviser to register with the SEC if it (1) is a large adviser that has $100 million or more of regulatory AUM (or $90 million or more if an adviser is filing its most recent annual updating amendment and is already registered with the SEC); (2) is a mid-sized adviser that does not meet the criteria for state registration or is not subject to examination; (3) meets the requirements for one or more of the revised exemptive rules under section 203A; (4) is an adviser (or subadviser) to a registered investment company; (5) is an adviser to a business development company and has at least $25 million of regulatory AUM; or (6) receives an order permitting the adviser to register with the Commission. Although the statutory threshold is $100 million, the SEC raised the threshold to $110 million to provide a buffer for mid-sized advisers with AUM close to $100 million to determine whether and when to switch between state and Commission registration. Advisers Act rule 203A– 1(a). 926 There are 70 investment advisers with latest reported regulatory AUM in excess of $110 million but that are not listed as registered with the SEC. None of these 70 investment advisers has exempted status with the Commission. For the purposes of this rulemaking, these are considered potentially erroneous submissions. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 c. Trends in the Relative Numbers of Providers of Financial Services Over time, the relative number of broker-dealers and investment advisers has changed. Figure 1 presented below PO 00000 Frm 00095 Fmt 4701 Sfmt 4700 shows the time series trend of growth in broker-dealers and SEC-registered investment advisers between 2005 and 2018. Over the last 14 years, the number of broker-dealers has declined from over 6,000 in 2005 to less than 4,000 in 2018, while the number of investment advisers has increased from approximately 9,000 in 2005 to over 13,000 in 2018. This change in the relative numbers of broker-dealers and investment advisers over time likely is a reflection of the market for investment advice, and potentially of the choices available to retail investors regarding how to receive or pay for such advice, the nature of the advice, and the attendant conflicts of interest. 927 We use the responses to Items 5.D.(a)(1), 5.D.(a)(3), 5.D.(b)(1), and 5.D.(b)(3) of Part 1A. If at least one of these responses was filled out as greater than 0, the firm is considered as providing business to retail investors. Form ADV Part 1A. 928 The aggregate AUM reported for these investment advisers that have retail investors includes both retail AUM as well as any institutional AUM also held at these advisers. 929 Estimates are based on IARD system data as of February 10, 2018. The AUM reported here is specifically that of those non-high net worth investors. Of the 13,927 state-registered investment advisers serving retail investors, 134 may also be dually registered as broker-dealers. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 Increases in the number of investment advisers and decreases in the number of broker-dealers could have occurred for a number of reasons, including changes in regulation and the enforcement of regulation, anticipation of possible regulatory changes, technological innovation (e.g., the increase in automated advisers, which are often colloquially referred to as ‘‘roboadvisors’’ and online trading platforms), product proliferation (e.g., index mutual funds and exchange-traded products), and industry consolidation driven by economic and market conditions, particularly among broker-dealers.930 Commission staff has observed the transition by broker-dealers from traditional brokerage services to also providing investment advisory services (often under an investment adviser 930 See Hester Peirce, Dwindling Numbers in the Financial Industry, Brookings Center on Markets and Regulation Report (May 15, 2017), available at https://www.brookings.edu/research/dwindlingnumbers-in-the-financial-industry/ (‘‘Brookings Report’’), which notes that ‘‘SEC restrictions have increased by almost thirty percent [since 2000],’’ and that regulations post-2010 were driven in large part by the Dodd-Frank Act. Further, the Brookings Report observation of increased regulatory restrictions on broker-dealers only reflects CFTC or SEC regulatory actions, but does not include regulation by FINRA, other SROs, National Futures Association (‘‘NFA’’), or the Municipal Securities Rulemaking Board (‘‘MSRB’’). VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 registration, whether federal or state), and many firms have been more focused on offering fee-based accounts because they provide a more steady source of revenue than accounts that charge commissions and are dependent on transactions.931 Broker-dealers have indicated that the following factors have contributed to this migration: Provision of revenue stability or increase in 931 Beyond Commission observations, the Brookings Report, supra footnote 930, also discusses the shift from broker-dealer to investment advisory business models for retail investors, in part due to the DOL Fiduciary Rule. Declining transaction-based revenue due to declining commission rates and competition from discount brokerage firms has made fee-based securities and services more attractive to providers of such securities and services. Although discount brokerage firms generally provide execution-only services and do not compete directly in the advice market with full service broker-dealers and investment advisers, entry by discount brokers has contributed to lower commission rates throughout the broker-dealer industry. Further, fee-based activity generates a steady stream of revenue regardless of the customer trading activity, unlike commission-based accounts. See also Angela A. Hung, et al., Investor and Industry Perspectives on Investment Advisers and Broker-Dealers, RAND Institute for Civil Justice Technical Report (2008), available at https://www.rand.org/content/dam/ rand/pubs/technical_reports/2008/RAND_ TR556.pdf (‘‘2008 RAND Study’’), which discusses a shift from transaction-based to fee-based brokerage accounts prior to recent regulatory changes. PO 00000 Frm 00096 Fmt 4701 Sfmt 4700 profitability,932 perceived lower regulatory burden, and provisions of more services to retail customers.933 Some firms have reported record profits as a result of moving clients into feebased accounts, and cite that it provides ‘‘stability and high returns.’’ 934 932 Commission staff examined a sample of recent Form 10–K or Form 10–Q filings of large brokerdealers, many of which are dually registered as investment advisers, that have a large fraction of retail customer accounts to identify relevant brokerdealers. See, e.g., Edward Jones 3/14/2019 Form 10– K available at https://www.sec.gov/Archives/edgar/ data/815917/000156459019007788/ck000081591710k_20181231.htm; Raymond James 11/21/2018 Form 10–K available at https://www.sec.gov/ Archives/edgar/data/720005/000072000518000083/ rjf-20180930x10k.htm; Stifel 2/20/2019 Form 10–K available at https://www.sec.gov/Archives/edgar/ data/720672/000156459019003474/sf-10k_ 20181231.htm; Wells Fargo 2/27/2019 10–K available at https://www.sec.gov/Archives/edgar/ data/72971/000007297119000227/wfc12312018x10k.htm; and Ameriprise 2/23/2018 Form 10–K available at https://www.sec.gov/ Archives/edgar/data/820027/000082002718000008/ amp12312017.htm. We note that discussions in Form 10–K and 10–Q filings of this sample of broker-dealers here may not be representative of other large broker-dealers or of small to mid-size broker-dealers. 933 See infra Section III.B.2.e.ii, which discusses industry trends, particularly in response to the DOL Fiduciary Rule. 934 See Hugh Son, Morgan Stanley WealthManagement Fees Climb to All-Time High, Bloomberg, Jan. 18, 2018, https:// www.bloomberg.com/news/articles/2018-01-18/ morgan-stanley-wealth-management-fees-hit- E:\FR\FM\12JYR2.SGM 12JYR2 ER12JY19.000</GPH> 33412 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations Further, there has been a substantial increase in the number of retail clients at investment advisers, both high net worth clients and non-high net worth clients as shown in Figure 2. Although the number of non-high net worth retail customers of investment advisers dipped between 2010 and 2012, it increased by more than 12 million new non-high net worth retail clients between 2012 and 2017, and has declined since 2017. With respect to AUM, we observe a similar, albeit more pronounced pattern for non-high net worth retail clients as shown in Figure 3. For high net worth retail clients, there 33413 has been a pronounced increase in AUM since 2012, although AUM has leveled off since 2015 and there also has been leveling and subsequent reduction in AUM for non-high net worth retail clients over a similar time period. Figure 2: Time Series of the Number of Retail Clients of Investment Advisers (2010- 2018) 1o.ooo.ooo s.ooo.ooo ' - ...,..,.,... ~ _____ .., ______ 1010~9 1011~9 lOll~ l013J09 jbell on DSK3GLQ082PROD with RULES2 -:&.stimatecl Noa-HNW ctitllls record-on-stock-rally. Morgan Stanley increased the percentage of client assets in fee-based accounts from 37% in 2013 to 44% in 2017, while decreasing the dependence on transaction-based revenues from 30% to 19% over the same time period. See Morgan VerDate Sep<11>2014 20:41 Jul 11, 2019 Jkt 247001 ---- 2014~9 lOIS~ 1016~ 1017~9 1018~ - - EstimateclHNW CHeats Stanley Strategic Update (Jan. 18, 2018), available at https://www.morganstanley.com/about-us-ir/ shareholder/4q2017-strategic-update.pdf. See also Lisa Beilfuss & Brian Hershberg, WSJ Wealth Adviser Briefing: The Reinvention of Morgan and PO 00000 Frm 00097 Fmt 4701 - Sfmt 4725 Merrill, Adviser Profile, Wall St. J., Jan. 25, 2018, https://blogs.wsj.com/moneybeat/2018/01/25/wsjwealth-adviser-briefing-the-reinvention-of-morganand-merrill-adviser-profile/. E:\FR\FM\12JYR2.SGM 12JYR2 ER12JY19.001</GPH> u.ooo.ooo """"'-- ~ Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations We estimate the number of associated natural persons of broker-dealers through data obtained from Form U4, which generally is filed for individuals who are engaged in the securities or investment banking business of a broker-dealer that is a member of an SRO (‘‘registered representatives’’).935 Similarly, we approximate the number of supervised persons of registered investment advisers through the number of registered investment adviser representatives (or ‘‘registered IARs’’), who are supervised persons of investment advisers who meet the definition of investment adviser representatives in Advisers Act rule 203A–3 and are registered with one or more state securities authorities to solicit or communicate with clients.936 We estimate the number of registered representatives and registered IARs, including dually-registered representatives, (together ‘‘registered financial professionals’’) at brokerdealers, investment advisers, and dualregistrants by considering only the employees of those firms that have Series 6 or Series 7 licenses or are registered with a state as a registered representative or investment adviser representative.937 We only consider employees at firms who have retailfacing business, as defined previously.938 We observe in Table 5 that approximately 60% of registered financial professionals are employed by dually registered entities. The percentage varies by the size of the firm. For example, for firms with total assets between $1 billion and $50 billion, 67% of all registered financial professionals in that size category are employed by dually registered firms. Focusing on dually registered firms only, approximately 60.5% of total registered financial professionals at these firms are dually registered representatives; approximately 39.1% are only registered representatives; and less than one percent are only registered investment adviser representatives. 935 The number of associated natural persons of broker-dealers may be different from the number of registered representatives of broker-dealers because clerical/ministerial employees of broker-dealers are associated persons but are not required to register with FINRA. Therefore, the registered representative number does not include such persons. However, we do not have data on the number of associated natural persons and therefore are not able to provide an estimate of the number of associated natural persons. We believe that the number of registered representatives is an appropriate approximation because they are the individuals at broker-dealers that provide advice and services to customers. 936 See Advisers Act, [17 CFR 275.203A–3 (2019)]. However, we note that the data on numbers of registered IARs may undercount the number of supervised persons of investment advisers who provide investment advice to retail investors because not all supervised persons who provide investment advice to retail investors are required to register as IARs. For example, Commission rules exempt from IAR registration supervised persons who provide advice only to non-individual clients or to individuals that meet the definition of ‘‘qualified client.’’ In addition, state securities authorities may impose different criteria for requiring registration as an investment adviser representative. 937 We calculate these numbers based on Form U4 filings. Representatives of broker-dealers, investment advisers, and issuers of securities must file this form when applying to become registered in appropriate jurisdictions and with SROs. Firms and representatives have an obligation to amend and update information as changes occur. Using the examination information contained in the form, we consider an employee a registered financial professional if he or she has an approved, pending, or temporary registration status for either Series 6 or 7 (registered representative) or is registered as an investment adviser representative in any state or U.S. territory (IAR). We limit the firms to only those that do business with retail investors, and only to licenses specifically required as a registered representative or IAR. 938 See supra footnotes 900 and 927. jbell on DSK3GLQ082PROD with RULES2 d. Registered Representatives of BrokerDealers, Investment Advisers, and Dually Registered Firms VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 PO 00000 Frm 00098 Fmt 4701 Sfmt 4700 E:\FR\FM\12JYR2.SGM 12JYR2 ER12JY19.002</GPH> 33414 33415 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations TABLE 5—TOTAL REGISTERED REPRESENTATIVES AT BROKER-DEALERS, INVESTMENT ADVISERS, AND DUALLY REGISTERED FIRMS WITH RETAIL INVESTORS 939 Size of firm (total assets for standalone BDs and dually registered firms; AUM for standalone IAs) Total number of reps. % of reps. in dually registered firms % of reps. in standalone BD w/an IA affiliate % of reps. in standalone BD w/o an IA affiliate % of reps. in standalone IA w/a BD affiliate % reps. in standalone IA w/o a BD affiliate >$50 billion ............................................... $1 billion to $50 billion ............................. $500 million to $1 billion .......................... $100 million to $500 million ..................... $10 million to $100 million ....................... $1 million to $10 million ........................... <$1 million ................................................ 84,461 170,256 29,874 66,924 106,178 33,790 12,522 73 67 71 51 55 35 8 7 11 5 27 42 54 52 0 0 1 0 2 11 36 19 15 7 4 1 0 3 1 7 16 18 1 0 1 Total Licensed Representatives ....... 504,005 60 23 2 9 6 In Table 6 below, we estimate the number of employees who are registered representatives, registered investment adviser representatives, or dually registered representatives.940 Similar to Table 5, we calculate these numbers using Form U4 filings. Here, we also limit the sample to employees at firms that have retail-facing businesses as discussed previously.941 In Table 6, approximately 25% of registered employees at registered broker-dealers or investment advisers are dually registered representatives. However, this proportion varies significantly across size categories. For example, for firms with total assets between $1 billion and $50 billion,942 approximately 35% of all registered employees are dually registered representatives. In contrast, for firms with total assets below $1 million, 13% of all employees are dually registered representatives. TABLE 6—NUMBER OF EMPLOYEES AT RETAIL-FACING FIRMS WHO ARE REGISTERED REPRESENTATIVES, INVESTMENT ADVISER REPRESENTATIVES, OR BOTH 943 jbell on DSK3GLQ082PROD with RULES2 Size of firm (total assets for standalone BDs and dually registered firms; AUM for standalone IAs) Total number of employees Percentage of dually registered representatives Percentage of registered representatives only Percentages of IARs only >$50 billion ............................................................................................... $1 billion to $50 billion ............................................................................. $500 million to $1 billion .......................................................................... $100 million to $500 million ..................................................................... $10 million to $100 million ....................................................................... $1 million to $10 million ........................................................................... <$1 million ................................................................................................ 218,539 328,842 43,211 119,214 176,559 56,230 18,334 19 35 18 23 20 17 13 16 12 40 24 39 39 46 1 4 10 9 1 1 3 Total Employees at Retail-Facing Firms .......................................... 960,929 25 23 4 Approximately 87% of investment adviser representatives are dually registered representatives. This percentage is relatively unchanged from 2010. According to information provided in a FINRA comment letter in connection with the 913 Study, 87.6% of registered investment adviser representatives were dually registered as registered representatives as of midOctober 2010.944 In contrast, approximately 52% of registered representatives were dually registered as investment adviser representatives at the end of 2018.945 e. Investor Account Statistics 939 The classification of firms as dually registered, standalone broker-dealers, and standalone investment advisers comes from Forms BD, FOCUS, and ADV as described earlier. The number of representatives at each firm is obtained from Form U4 filings. Note that all percentages in the table have been rounded to the nearest whole percentage point. 940 We calculate these numbers based on Form U4 filings. 941 See supra footnotes 900 and 927. 942 Firm size is defined as total assets from the balance sheet for broker-dealers and dual-registrants (source: FOCUS reports) and as AUM for investment advisers (source: Form ADV). We are unable to obtain customer assets for broker-dealers, and for investment advisers, we can only obtain information from Form ADV as to whether the firm assets exceed $1 billion. We recognize that our approach of using firm assets for broker-dealers and customer assets for investment advisers does not allow for direct comparison; however, our objective is to provide measures of firm size and not to make comparisons between broker-dealers and investment advisers based on firm size. Across both broker-dealers and investment advisers, larger firms, regardless of whether we stratify on firm total assets or AUM, have more customer accounts, are more likely to be dually registered, and have more representatives or employees per firm than smaller broker-dealers or investment advisers. 943 See supra footnotes 899, 920, 940, and 942. Note that all percentages in the table have been rounded to the nearest whole percentage point. 944 See Letter from Angela C. Goelzer, FINRA, to Jennifer B. McHugh, Senior Advisor to the Chairman, U.S. Securities and Exchange Commission, re: File Number 4–606; Obligations of Brokers, Dealers and Investment Advisers (Nov. 3, 2010), at 1, available at https://www.sec.gov/ comments/4-606/4606-2836.pdf. 945 In order to obtain the percentage of IARs that are dually registered as registered representatives of broker-dealers, we sum the representatives at dually registered entities and those at investment advisers across size categories to obtain the aggregate number of representatives in each of the two categories. We then divide the aggregate dually registered representatives by the sum of the dually registered representatives and the IARs at investment adviser-only firms. We perform a similar calculation to obtain the percentage of registered representatives of broker-dealers that are dually registered as IARs. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 PO 00000 Frm 00099 Fmt 4701 Sfmt 4700 Investors seek financial advice and services to achieve a number of different goals, such as saving for retirement or children’s college education. Approximately 73% of adults live in a E:\FR\FM\12JYR2.SGM 12JYR2 33416 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations household that invests.946 The OIAD/ RAND survey indicates that noninvestors are more likely to be female, to have lower family income and educational attainment, and to be younger than investors.947 Approximately 35% of households that do invest do so through accounts such as broker-dealer or advisory accounts.948 As shown above in Figures 2 and 3, the number of retail investors and their AUM associated with investment advisers has increased significantly, particularly since 2012. As of December 2016, nearly $24.2 trillion is invested in retirement accounts, of which $7.5 trillion is in IRAs.949 A total of 43.3 million U.S. households have either an IRA or a brokerage account; an estimated 20.2 million U.S. households have a brokerage account, and 37.7 million households have an IRA (including 72% of households that also hold a brokerage account).950 With respect to IRA accounts, one commenter documents that 43 million U.S. households own either traditional or Roth IRAs and that approximately 70% are held with financial professionals, with the remainder being direct market.951 Further, this commenter finds that approximately 64% of households have aggregate IRA (traditional and Roth) balances of less than $100,000, and approximately 36% of investors have balances below $25,000. As noted in one study, the growth of assets in traditional IRAs comes from rollovers from workplace retirement plans; for example, 58% of traditional IRAs consist of rollover assets, and contributions due to rollovers exceeded $460 billion in 2015 (the most recently available data).952 While the number of retail investors obtaining services from investment advisers and the aggregate value of associated AUM has increased, the OIAD/RAND study also suggests that the general willingness of investors to use planning or to take financial advice regarding strategies, securities, or accounts is relatively fixed over time.953 With respect to the account assets associated with retail investors, the OIAD/RAND survey also estimates that approximately 10% of investors who have brokerage or advisory accounts hold more than $500,000 in assets, while approximately 47% hold $50,000 in assets or less. Altogether, investors who have brokerage or advisory accounts typically trade infrequently, with approximately 31% reporting no annual transactions and an additional approximately 30% reporting three or fewer transactions per year.954 With respect to particular securities, commenters have provided us with additional information about ownership of mutual funds and IRA account statistics. For example, one commenter stated that 56 million U.S. households and nearly 100 million individual investors own mutual funds, of which 80% are held through 401(k) and other work-based retirement plans, while 63% of investors hold mutual funds outside of those plans.955 Of those investors who own mutual funds outside of workplace retirement plans, approximately 50% use financial professionals, while nearly one-third purchase direct-sold funds either directly from the fund company or through a discount broker.956 Table 7 below provides an overview of account ownership segmented by account type (e.g., IRA, brokerage, or both) and investor income category based on the SCF Survey.957 TABLE 7—OWNERSHIP BY ACCOUNT TYPE IN THE U.S. BY INCOME GROUP [As reported by the 2016 SCF Survey] % Brokerage only Income category jbell on DSK3GLQ082PROD with RULES2 Bottom 25% ................................................................................................................................. 25%–50% ..................................................................................................................................... 50%–75% ..................................................................................................................................... 75%–90% ..................................................................................................................................... Top 10% ...................................................................................................................................... Average ........................................................................................................................................ 1.2 3.2 4.1 7.5 12.0 4.4 % IRA only 7.6 14.5 21.4 33.4 24.7 18.3 % Both brokerage and IRA 2.4 5.4 11.4 16.5 43.9 11.6 With respect to the nature of the accounts held by investors and whether they are managed by financial professionals, the OIAD/RAND survey finds that 36% of its sample of participants report that they currently use a financial professional and approximately 33% receive some kind of recommendation service.958 Of the 946 See OIAD/RAND, defining ‘‘investors’’ as persons ‘‘owning at least one type of investment account, (e.g., an employer-sponsored retirement account, a non-employer sponsored retirement account such as an IRA, a college savings investment account, or some other type of investment account such as a brokerage or advisory account), or owning at least one type of investment asset (e.g., mutual funds, exchange-traded funds or other funds; individual stocks; individual bonds; derivatives; and annuities).’’ 947 Id. at 36. 948 Id. at 39. 949 See Sarah Holden & Daniel Schrass, The Role of IRAs in U.S. Households’ Saving for Retirement, 2016, ICI Res. Persp., Jan. 2017, available at https:// www.ici.org/pdf/per17-08.pdf. See also ICI Letter. 950 The data is obtained from the Federal Reserve System’s 2016 Survey of Consumer Finances (‘‘SCF Survey’’), a triennial survey of approximately 6,200 U.S. households, and imputes weights to extrapolate the results to the entire U.S. population. As noted, some survey respondent households have both a brokerage and an IRA. See Board of Governors of the Federal Reserve System, Survey of Consumer Finances (2016), available at https:// www.federalreserve.gov/econres/scfindex.htm. The SCF Survey data does not directly examine the incidence of households that could use advisory accounts instead of brokerage accounts; however, some fraction of IRA accounts reported in the survey could be those held at investment advisers. 951 See Sarah Holden & Daniel Schrass, The Role of IRAs in US Households’ Saving for Retirement, 2018, ICI Res. Persp., Dec. 2018, available at https:// www.ici.org/pdf/per24-10.pdf. See also ICI Letter. 952 See Holden & Schrass (2018), supra footnote 951. 953 See OIAD/RAND at 50 (noting that this conclusion was limited by the methodology of comparing participants in a 2007 survey with those surveyed in 2018). 954 See OIAD/RAND. 955 See ICI Letter; see also Sarah Holden, Daniel Schrass, & Michael Bogdan, Ownership of Mutual Funds, Shareholder Sentiment, and Use of the internet, 2018, ICI Res. Persp., Nov. 2018, available at https://www.ici.org/pdf/per22-06.pdf. 956 See Holden et al. (2018), supra footnote 955. See also ICI Letter. 957 See SCF Survey, supra footnote 950. To the extent that investors have IRA accounts at banks that are not also registered as broker-dealers, our data may overestimate the numbers of IRA accounts held by retail investors that could be subject to Regulation Best Interest. 958 See OIAD/RAND at 48. In a focus group preceding the survey, focus group participants provided a number of reasons for not using a financial professional in making investments, including being unable or unwilling to pay the fees, doing their own financial research, being unsure of how to work with a professional, and being concerned about professionals selling securities without attending to investors’ plans and goals. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 PO 00000 Frm 00100 Fmt 4701 Sfmt 4700 E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations subset of those investors who report holding a brokerage, advisory, or similar account, approximately 33% self-direct their own account, 25% have their account managed by a financial professional, and 10% have their account advised by a financial professional.959 For those investors who take financial advice, the OIAD/RAND study suggests that they may differ in characteristics from other investors. The survey further finds that investors who take financial advice are generally older, retired, and have a higher income than other investors, but also may have lower educational attainment (e.g., high school or less) than other investors.960 Similarly, one question in the SCF Survey asks what sources of information households’ financial decision-makers use when making decisions about savings and investments. Respondents can list up to fifteen possible sources from a preset list that includes ‘‘Broker’’ or ‘‘Financial Planner’’ as well as ‘‘Banker,’’ ‘‘Lawyer,’’ ‘‘Accountant,’’ and a list of non-professional sources.961 Panel A of Table 8 below presents the breakdown of where households who have brokerage accounts seek advice about savings and investments. The table shows that of those respondents with brokerage accounts, 23% (4.7 million households) use advice services of broker-dealers for savings and investment decisions, while 49% (7.8 million households) take advice from a ‘‘financial planner.’’ Approximately 33417 36% (7.2 million households) seek advice from other sources such as bankers, accountants, and lawyers. Almost 25% (5.0 million households) do not use advice from the above sources. Panel B of Table 8 below presents the breakdown of advice received by households who have an IRA. Approximately 15% (5.7 million households) rely on advice services of their broker-dealers and 48% (18.3 million households) obtain advice from financial planners. Approximately 41% (15.5 million households) seek advice from bankers, accountants, or lawyers, while the 25% (9.5 million households) use no advice or seek advice from other sources. TABLE 8—PANEL A: SOURCES OF ADVICE FOR HOUSEHOLDS WHO HAVE A BROKERAGE ACCOUNT IN THE U.S. BY INCOME GROUP 962 % Taking advice from brokers Income category Bottom 25% ............................................................................................. 25%–50% ................................................................................................. 50%–75% ................................................................................................. 75%–90% ................................................................................................. Top 10% .................................................................................................. Average .................................................................................................... % Taking advice from financial planners 20.55 22.98 20.75 22.56 25.29 23.02 53.89 38.03 52.00 48.94 50.53 49.02 % Taking advice from lawyers, bankers, or accountants 35.64 43.92 31.42 32.25 38.47 35.99 % Taking no advice or from other sources 24.30 32.36 23.61 28.10 21.06 24.94 TABLE 8—PANEL B: SOURCES OF ADVICE FOR HOUSEHOLDS WHO HAVE AN IRA IN THE U.S. BY INCOME GROUP 963 % Taking advice from brokers Income category Bottom 25% ............................................................................................. 25%–50% ................................................................................................. 50%–75% ................................................................................................. 75%–90% ................................................................................................. Top 10% .................................................................................................. Average .................................................................................................... The OIAD/RAND survey notes that for survey participants who reported working with a specific individual for investment advice, 70% work with a dual-registrant, 5.4% with a brokerdealer, and 5.1% with an investment adviser.964 959 See OIAD/RAND at 46. OIAD/RAND at 48. 961 See SCF Survey, supra footnote 950, which specifically asks participants ‘‘Do you get advice from a friend, relative, lawyer, accountant, banker, broker, or financial planner? Or do you do something else?’’ See Federal Reserve Codebook for 2016 Survey of Consumer Finances (2016), available at https://www.federalreserve.gov/ econres/files/codebk2016.txt. Other response choices presented by the survey include ‘‘Calling Around,’’ ‘‘Magazines,’’ ‘‘Self,’’ ‘‘Past Experience,’’ ‘‘Telemarketer,’’ and ‘‘Insurance Agent,’’ as well as jbell on DSK3GLQ082PROD with RULES2 960 See VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 % Taking advice from financial planners 12.14 9.79 14.93 14.68 21.40 15.25 f. Financial Incentives of Firms and Financial Professionals Commission experience indicates that there is a broad range of financial incentives provided by standalone broker-dealers and dually registered other choices. Respondents could also choose ‘‘Do Not Save/Invest.’’ The SCF Survey allows for multiple responses, so these categories are not mutually exclusive. However, we would note that the list of terms in the question does not specifically include ‘‘investment adviser.’’ 962 See SCFR Survey, supra footnote 950. 963 Id. 964 See OIAD/RAND at 53. As documented by OIAD/RAND, retail investors surveyed had difficulty in accurately identifying the type of relationship that they have with their financial professional. PO 00000 Frm 00101 Fmt 4701 Sfmt 4700 38.30 43.82 45.20 52.14 55.40 48.45 % Taking advice from lawyers, bankers, or accountants 43.69 40.67 41.23 41.65 40.03 41.17 % Taking no advice or from other sources 31.85 32.74 25.23 24.26 18.56 25.28 firms to their financial professionals.965 While some firms provide base pay for their financial professionals ranging from approximately $45,000 to $85,000 per year, many firms provide compensation only through a percentage of commissions, plus performance965 Information on compensation and financial incentives generally relates to 2016 compensation arrangements for a sample of approximately 20 firms, comprising both standalone broker-dealers and dually registered firms. We acknowledge that the information provided in this baseline may not be representative of the compensation structures more generally because of the diversity and complexity of services and securities offered by standalone broker-dealers and dually registered firms. E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 33418 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations based awards, such as individual or team bonuses based on production.966 Commission-based compensation to financial professionals range from 30% to 95% of total commissions paid to the firm on a particular transaction, although this compensation is generally reduced by various costs and expenses attributable to the financial professional (e.g., clearing costs associated with some securities, charges related to an SRO or the Securities Investor Protection Corporation (‘‘SIPC’’), and insurance, among others). Several firms have varying commission-based compensation rates depending on the investment type being sold. For example, compensation ranges from 76.5% for stocks, bonds, options, and commodities to 90% for openended mutual funds, private placements, and unit investment trusts. Several firms charge varying commissions on securities depending on the amount of security sold (e.g., rates on certain proprietary mutual funds range from 0.75% to 5.75% depending on the share class), but do not provide those rates to financial professionals based on investment type. Some firms also provide incentives for their financial professionals to recommend proprietary securities and services over third-party or nonproprietary securities. Commission rates for some firms, however, decline as the dollar amount sold increases, and such rates vary across asset classes as well (e.g., within a given share class, rates range from 1.50% to 5.75% depending on the dollar amount of the fund sold). With respect to compensation to individual financial professionals, if compensation rates for mutual funds are approximately 90% (as discussed above, for example), financial professionals can earn between 0.68% and 5.18%, depending on the type and amount of security sold. For financial professionals who do not earn commission-based compensation, some firms charge retail customers flat fees ranging from $500 to $2,500, depending on the level of service required, such as financial planning, while others charge hourly rates ranging from $150 to $350 per hour. For dually registered firms that charge clients based on a percentage of AUM, the average percentage charge varies based on the size of the account: The larger the AUM, the lower the percentage fee charged. Percentagebased fees for the sample firms range 966 Commission experience indicates that some firms award production bonuses based on commissions generated, while other firms provide awards based on AUM. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 from approximately 1.5% for accounts below $250,000 to 0.5% for accounts in excess of $1 million.967 If compensation rates range between 30% and 95%, a firm charging a customer $500 can provide compensation to the financial professional between $150 and $475 for each financial plan provided. For feebased accounts, assuming that a retail customer has an account worth $250,000, the firm will charge accountlevel fees of $3,750 ($250,000 × 1.5%), and the financial professional can earn between $1,170 and $3,560 annually for each account. However, accounts may also be subject to additional fees beyond those described here and the financial professionals also may receive additional compensation. In addition to ‘‘base’’ compensation, most firms also provide bonuses (based on either individual or team performance) or variable compensation, ranging from approximately 10% to 83% of base compensation. These bonuses could be awarded based on either commissions generated or AUM. While the majority of firms base at least some portion of their bonuses on production, usually in the form of total gross revenue, other forms of bonus compensation are derived from customer retention, customer experience, and manager assessment of performance. Moreover, some firms use a tiered system within their compensation grids depending on firm experience and production levels. Financial professionals’ variable compensation can also increase when they enroll retail customers in advisory accounts versus other types of accounts, such as brokerage accounts. Some firms also provide transition bonuses for financial professionals with prior work experience based on historical trailing production levels and AUM. Although many firms do not have any incentivebased contests or programs, some firms 967 We note that some firms could have higher or lower commission-based compensation rates or asset-based fee percentages than those provided here. For example, based on a review of Form ADV Part 2A (the brochure) of several large dualregistrants (not included in the sample above), asset-based fees for low AUM accounts could range as high as 2.0% to 3.0%, with the average fee for high AUM accounts ranging between 0.5% to 1.5%. See also AdvisoryHQ, Average Financial Advisor Fees in 2018–2019: Fees Charged by Advisory & Wealth Management Firms, https:// www.advisoryhq.com/articles/financial-advisorfees-wealth-managers-planners-and-fee-onlyadvisors/. The AdvisoryHQ report shows that average asset-based fees range from 1.18% for accounts less than $50,000 to less than 0.60% for accounts in excess of $30 million, while fixed-fees range from $7,500 for accounts less than $500,000 to $55,000 for accounts in excess of $7.5 million. Again, we note that these are charges to clients and are not indicative of the total compensation earned by the financial professional per account. PO 00000 Frm 00102 Fmt 4701 Sfmt 4700 award non-cash incentives for meeting certain performance, best practices, or customer service goals, including trophies, dinners with senior officers, and travel to annual meetings with other award winners.968 2. Regulatory Baseline and Current Market Practices Broker-dealers’ current standards of conduct are governed by federal and state law and regulation as well as the rules and guidance of SROs,969 particularly, for the purposes of this rulemaking, those related to the suitability of recommendations and disclosure of conflicts of interest. In response to comment letters that stated the Proposing Release did not fully consider the current market practices, we have provided an overview of these practices reported by commenters and from industry studies.970 Together, these laws and regulations comprise the regulatory baseline. a. Federal and State Securities Laws Under the antifraud provisions of the federal securities laws and SRO rules, broker-dealers are required to deal fairly with their customers.971 In addition, broker-dealers must comply with a wide 968 See FINRA Regulatory Notice 16–29, Gifts, Gratuities and Non-Cash Compensation Rules— FINRA Requests Comment on Proposed Amendments to Its Gifts, Gratuities and Non-Cash Compensation Rules (Aug. 2016). At the time this notice was published, FINRA’s impression was that investment-specific internal sales contests for noncash compensation were not widely used. 969 Generally, all registered broker-dealers that deal with the public must become members of FINRA, a registered national securities association, and may choose to become exchange members. See Exchange Act section 15(b)(8) and Exchange Act rule 15b9–1. FINRA is the sole national securities association registered with the SEC under section 15A of the Exchange Act. Accordingly, for purposes of discussing a broker-dealer’s regulatory requirements when providing advice, we focus on FINRA’s regulation, examination, and enforcement with respect to member broker-dealers. 970 See, e.g., AALU Letter; Letter from John L. Thornton, Co-Chair, Committee in Capital Markets Regulation (Jul. 18, 2018) (‘‘CCMR Letter’’); CFA August 2018 Letter; Davis & Harman Letter; EPI Letter; Lincoln Financial Letter; NASAA August 2018 Letter; UVA Letter (which stated that the Proposing Release did not adequately address current market practices and/or provide industry studies and surveys of those practices). 971 See, e.g., FINRA Rule 2010 (Standards of Commercial Honor and Principles of Trade); NASD Interpretive Material 2310–2, Fair Dealing with Customers (‘‘Implicit in all member and registered representative relationships with customers and others is the fundamental responsibility for fair dealing. Sales efforts must therefore be undertaken only on a basis that can be judged as being within the ethical standards of [FINRA’s] Rules, with particular emphasis on the requirement to deal fairly with the public.’’); Charles Hughes & Co. v. SEC, 139 F.2d 434 (2d Cir. 1943), cert. denied, 321 U.S. 786 (1944); Hanly v. SEC, 415 F.2d 589, 596 (2d Cir. 1969); see also e.g., 913 Study at 51 and footnote 221. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations range of specific obligations specified in the Exchange Act and the rules thereunder. Moreover, there is a body of case law holding that broker-dealers that exercise discretion or control over customer assets, or have a relationship of trust and confidence with their customers, may owe customers a fiduciary duty, depending on the circumstances.972 Additionally, some states provide through statute or regulation, among other requirements such as minimum requirements for sales practices, that broker-dealers have some form of state-specific fiduciary duty to their customers in at least some circumstances. Substantial variation exists among states’ fiduciary standards, ranging from states with express fiduciary standards that apply to brokerdealers to those with limited or no such standards.973 jbell on DSK3GLQ082PROD with RULES2 b. FINRA Rule 2111: Suitability FINRA Rule 2111 (the ‘‘Suitability Rule’’) requires that a broker-dealer or associated person have a reasonable 972 See, e.g., U.S. v. Skelly, 442 F.3d 94, 98 (2d Cir. 2006) (fiduciary duty found ‘‘most commonly’’ where ‘‘a broker has discretionary authority over the customer’s account’’); United States v. Szur, 289 F.3d 200, 211 (2d Cir. 2002) (‘‘Although it is true that there ‘is no general fiduciary duty inherent in an ordinary broker/customer relationship,’ a relationship of trust and confidence does exist between a broker and a customer with respect to those matters that have been entrusted to the broker.’’) (citations omitted); Leib v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 461 F. Supp. 951, 953– 954 (E.D. Mich. 1978), aff’d, 647 F.2d 165 (6th Cir. 1981) (recognizing that a broker who has de facto control over non-discretionary account generally owes customer duties of a fiduciary nature; looking to customer’s sophistication, and the degree of trust and confidence in the relationship, among other things, to determine duties owed); Arleen W. Hughes, Exchange Act Release No. 4048 (Feb. 18, 1948) (Commission Opinion), aff’d sub nom. Hughes v. SEC, 174 F.2d 969 (D.C. Cir. 1949) (‘‘Release 4048’’) (noting that fiduciary requirements generally are not imposed upon broker-dealers who render investment advice as an incident to their brokerage unless they have placed themselves in a position of trust and confidence, and finding that Hughes was in a relationship of trust and confidence with her clients). See also Gross Letter (which discussed the obligations of broker-dealers with discretionary or de facto control over customer accounts); Solely Incidental Interpretation. 973 See AARP August 2018 Letter; PIABA Letter; U. of Miami Letter. See also Michael S. Finke & Thomas Patrick Langdon, The Impact of the BrokerDealer Fiduciary Standard on Financial Advice (Working Paper, Mar. 9, 2012) for a discussion of state fiduciary standards. One comment letter also provided an extensive overview of the fiduciary obligations of state-registered investment advisers, ‘‘typified by an expectation of undivided loyalty where the adviser acts primarily for the benefit of its clients.’’ See NASAA February 2019 Letter at 22 and footnote 40. This comment letter also stated that ‘‘[s]ome states also extend these fiduciary obligations beyond investment advisers to brokers, especially in dual-hatted scenarios,’’ and that these fiduciary obligations were extended even when broker-dealers handled non-discretionary accounts. Id. at 23–24 and footnote 41. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 basis to believe that a recommended securities transaction or investment strategy involving securities is suitable for the retail customer.974 A brokerdealer cannot disclaim away its suitability obligation under the Suitability Rule.975 We reviewed the Suitability Rule and drew upon it and enhanced the suitability requirement in developing Regulation Best Interest.976 FINRA also requires additional specific suitability obligations with respect to certain types of securities or transactions, such as variable insurance products and derivatives securities, including options and securities-based futures.977 As discussed by several commenters,978 the regulatory baseline also includes FINRA guidance on best practices, such as guidance regarding suitability, which provides guidance on how broker-dealers and associated persons should comply with suitability obligations when making recommendations to customers. FINRA guidance regarding suitability includes Regulatory Notice 12–25, which states that under the Suitability Rule, ‘‘a broker’s recommendations must be consistent with his customers’ best interests,’’ 979 as well as other regulatory notices that provide guidance on the suitability of specific securities or investment strategies involving securities, including, but not limited to, mutual funds, variable contracts including annuities, structured and complex securities, leveraged and 974 See FINRA Rule 2111, supra footnote 161. As a ‘‘General Principle,’’ the rule states that associated persons have a ‘‘fundamental responsibility for fair dealing’’ and that the rule is intended to promote ethical sales practices and high standards of commercial conduct. See FINRA Rule 2111.01. See also, In re Application of Raghavan Sathianathan, Exchange Act Release No. 54722 at 10 (Nov. 8, 2006) (‘‘Sathianathan’s recommendations . . . were unsuitable because they were designed to maximize his own commissions rather than to establish a suitable portfolio.’’). See also 913 Study at 59 and footnote 187. 975 FINRA Rule 2111.02 (Disclaimers). 976 See supra footnote 161. The primary requirements for the Suitability Rule are described in the Proposing Release at Section IV.B.2.a. 977 See, e.g., FINRA Rule 2330 (Members’ Responsibilities Regarding Deferred Variable Annuities); FINRA Rule 2360 (Options); FINRA Rule 2370 (Securities Futures); FINRA Rule 2821 (Sales Practices for Deferred Variable Annuities including a Suitability Obligation). See also 913 Study at 65–66. 978 See CFA August 2018 Letter; Bank of America Letter; Transamerica August 2018 Letter. 979 See FINRA Regulatory Notice 12–25; see also FINRA Regulatory Notice 13–31, Suitability— FINRA Highlights Examination Approaches, Common Findings and Effective Practices for Complying With its Suitability Rules (Sep. 2013) (which provides ‘‘. . . effective practices . . . to help firms enhance compliance and supervision under the suitability rule’’). PO 00000 Frm 00103 Fmt 4701 Sfmt 4700 33419 inverse exchange-traded products, and IRA rollovers.980 c. FINRA Report on Conflicts of Interest In 2013, FINRA published as guidance a Report on Conflicts of Interest (‘‘FINRA Conflicts Report’’) to provide an overview of effective practices that broker-dealers could employ to manage and mitigate conflicts of interest.981 In the report, FINRA provides suggestions for broker-dealers for addressing conflicts of interest related to three broad areas: A firm-level approach to identify and manage conflicts of interest; the production and distribution of new securities; and compensation and other financial incentives of associated persons.982 With respect to new securities, the FINRA Conflicts Report recommends, among other things, new security review committees and disclosure of conflicts related to recommendations of new securities to customers.983 The FINRA Conflicts Report also provides guidance to broker-dealers on managing conflicts of interest that arise from compensation and financial incentives of brokerdealers. For example, the FINRA Conflicts Report recommends increased surveillance of recommendations near compensation thresholds and capping compensation credits across similar 980 See, e.g., NASD Notice to Members 94–16, NASD Reminds Members Of Mutual Fund Sales Practice Obligations (Mar. 1994) and NASD Notice to Members 95–80, NASD Further Explains Members Obligations and Responsibilities Regarding Mutual Funds Sales Practices (Sep. 1995) (mutual fund suitability and sales practices); NASD Notice to Members 96–86, NASD Regulation Reminds Members and Associated Persons that Sales of Variable Contracts are Subject to NASD Suitability Requirements (Dec. 1996) and NASD 99– 35, NASD Reminds Members of Their Responsibilities Regarding Sales of Variable Annuities (May 1999) (suitability and sales practices of variable contracts and variable annuities); NASD Notice to Members 05–59, NASD Provides Guidance Concerning the Sale of Structure Products; and FINRA Regulatory Notice 12–03, Complex Products—Heightened Supervision of Complex Products (Jan. 2012); (suitability and sales practices of structured and complex products); FINRA Regulatory Notice 09–31, FINRA Reminds Firms of Sales Practice Obligations Relating to Leveraged and Inverse Exchange-Traded Funds (June 2009) (sales practices of leveraged and inverse ETFs); and FINRA Regulatory Notice 13–45, Rollovers to Individual Retirement Accounts— FINRA Reminds Firms of Their Responsibilities Concerning IRA Rollovers (Dec. 2013) (obligations when recommending a rollover or transfer of assets from a sponsored retirement plan to an IRA). 981 See FINRA Conflicts Report, supra footnote 459. See also IRI Letter, which notes that the FINRA Conflicts Report ‘‘. . . provides valuable guidance as to the elements of an effective practice framework for managing BDs’ conflicts of interest. . .’’ See also SIFMA August 2018 Letter; CFA August 2018 Letter; Raymond James Letter; Ameriprise Letter; ACLI Letter; Fein Letter. 982 See FINRA Conflicts Report, supra footnote 459. 983 Id. E:\FR\FM\12JYR2.SGM 12JYR2 33420 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations as applicable SRO rules.989 Specifically, the Exchange Act authorizes the Commission to sanction a broker-dealer or any associated person that fails to reasonably supervise another person d. Other Broker-Dealer Obligations: subject to the firm’s or the person’s Disclosure, Supervision, and supervision that commits a violation of Compensation the federal securities laws.990 The Broker-dealers are subject to other Exchange Act provides an affirmative disclosure obligations under the federal defense against a charge of failure to securities laws and SRO rules. For supervise where reasonable procedures instance, under existing antifraud and systems for applying the procedures provisions of the Exchange Act, a have been established and effectively broker-dealer has a duty to disclose implemented without reason to believe material adverse information to its those procedures and systems are not 985 Broker-dealers found to be being complied with. Further, under the customers. acting as fiduciaries also have a duty to federal securities laws and FINRA rules, disclose material conflicts of interest.986 prices for securities and broker-dealer Broker-dealers are also prohibited from compensation are required to be fair and making misleading statements.987 reasonable, taking into consideration all Courts have found that broker-dealers, relevant circumstances.991 in making recommendations, should Broker-dealers also register with and have disclosed that they were: Acting as report information, including about a market maker for the recommended their business and affiliates, to the security; trading as a principal with Commission, the SROs, and other respect to the recommended security; jurisdictions through Form BD.992 Form engaging in revenue sharing with a BD requires information about the recommended mutual fund; or background of the applicant, its ‘‘scalping’’ a recommended security.988 principals, controlling persons, and Broker-dealers are also currently employees, as well as information about subject to supervisory obligations under the type of business in which the Section 15(b)(4)(E) of the Exchange Act broker-dealer proposes to engage and all and SRO rules, including the control affiliates engaged in the establishment of policies and securities or investment advisory procedures reasonably designed to business.993 Once a broker-dealer is prevent and detect violations of, and to registered, it must keep its Form BD achieve compliance with, the federal current by amending it promptly when securities laws and regulations, as well the information is or becomes inaccurate for any reason.994 In 984 Id. addition, firms report similar 985 A broker-dealer may be liable if it does not information and additional disclose ‘‘material adverse facts of which it is aware.’’ See, e.g., Chasins v. Smith, Barney & Co., information—such as written customer 438 F.2d 1167, 1172 (2nd Cir. 1970); SEC v. Hasho, complaints and other disciplinary 784 F. Supp. 1059, 1110 (S.D.N.Y. 1992); In the matters— to FINRA pursuant to FINRA Matter of RichMark Capital Corp., Exchange Act Rule 4530 (Reporting Requirements). Release No. 48758 (Nov. 7, 2003) (Commission jbell on DSK3GLQ082PROD with RULES2 investment types to prevent representatives from preferentially recommending securities that yield the largest compensation.984 Opinion) (‘‘When a securities dealer recommends stock to a customer, it is not only obligated to avoid affirmative misstatements, but also must disclose material adverse facts of which it is aware. That includes disclosure of ‘adverse interests’ such as ‘economic self-interest’ that could have influenced its recommendation.’’) (citations omitted). See also Relationship Summary Proposal. 986 See, e.g., United States v. Szur, 289 F.3d 200, 212 (2d Cir. 2002) (broker’s fiduciary relationship with customer gave rise to a duty to disclose commissions to customer, which would have been relevant to customer’s decision to purchase stock); Arleen W. Hughes, Exchange Act Release No. 4048 (Feb. 18, 1948) (Commission Opinion), aff’d sub nom. Hughes v. SEC, 174 F.2d 969, 976 (D.C. Cir. 1949) (broker-dealer acted in the capacity of a fiduciary and, as such, broker-dealer was under a duty to make full disclosure of the nature and extent of her adverse interest when engaging in principal transactions, ‘‘including her cost of the securities and the best price at which the security might be purchased in the open market’’). 987 See Proposing Release at footnotes 175–177 and 205, and accompanying text. See Exchange Act Sections 10(b) and 15(c). 988 See 913 Study at footnotes 251–54. See also id. at footnotes 225–232 (which discuss existing SRO rules on disclosures). VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 e. DOL Fiduciary Rule as It Relates to Current Market Practice This section discusses the recently vacated DOL Fiduciary Rule,995 the 989 See supra footnote 809. See also Proposing Release at 21622. 990 Exchange Act Sections 15(b)(4)(E) and (b)(6)(A). 991 See, e.g., Exchange Act Sections 10(b) and 15(c); FINRA Rules 2121 (Fair Prices and Commissions), 2122 (Charges for Services Performed), and 2341 (Investment Company Securities). See also FINRA Rule 3221 (Non-Cash Compensation). Several commenters stated that, as part of their overall business practices, they use non-cash compensation (e.g., firm-sponsored business conferences), which they believe is in compliance with existing FINRA Rule 3221 on noncash compensation practices. See Guardian August 2018 Letter; NY Life Letter. 992 See Relationship Summary Proposal at 21472; see also generally Form BD. 993 See generally Form BD. 994 See Exchange Act rule 15b3–1(a). 995 See supra footnote 32. PO 00000 Frm 00104 Fmt 4701 Sfmt 4700 implications for broker-dealers, and the industry response to the DOL Fiduciary Rule. Although the DOL Fiduciary Rule was vacated by the Fifth Circuit Court of Appeals in June, we discuss the DOL Fiduciary Rule as part of the baseline because certain broker-dealers and other industry participants may have adjusted their practices in order to plan for the implementation of the requirements of this rule. It is possible that some of these broker-dealers may continue to operate their business using these adjusted practices, while other may have reverted to the pre-DOL Fiduciary Rule practices. Below, we discuss actual and potential costs, as well as changes in services and securities offerings, in response to the DOL Fiduciary Rule as reported by industry participants through surveys. We also describe how, following the Fifth Circuit Court of Appeals decision vacating the DOL Fiduciary Rule, certain of those costs have been reduced and the trend toward reduction in retail investor access to services and securities offerings that may have been caused in part by the DOL Fiduciary Rule appears to have ended and may be reversing. i. Department of Labor’s Fiduciary Rule and Temporary Enforcement Policy As noted above, prior to the Fifth Circuit decision, many firms took steps to come into compliance with the DOL Fiduciary Rule, and in particular, the BIC Exemption and other PTEs, including changes to business practices.996 Following the decision by the Fifth Circuit, the DOL acknowledged that uncertainty about fiduciary obligations and the scope of exemptive relief under the prohibited transaction provisions of ERISA and the Internal Revenue Code following the court’s decision could temporarily disrupt existing investment advice arrangements during the transition period, and also that financial institutions had devoted significant resources to comply with PTEs issued in connection with the DOL Fiduciary Rule, including the BIC Exemption.997 Based on these concerns, the DOL issued a temporary enforcement policy stating that it would not pursue claims against fiduciaries working in good faith to comply with the BIC Exemption’s Impartial Conduct Standards for transactions that would have been exempted by the BIC Exemption or treat such fiduciaries as violating applicable 996 See supra footnotes 32–34 and accompanying text. 997 See U.S. Department of Labor Field Assistance Bulletin 2018–02, available at https://www.dol.gov/ agencies/ebsa/employers-and-advisers/guidance/ field-assistance-bulletins/2018-02. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations prohibited transactions rules.998 Prior to the Fifth Circuit decision, some brokerdealers that offered services to IRAs and other retirement accounts may have implemented changes to services and securities to comply with and meet the conditions of the BIC Exemption and other PTEs, including the Impartial Conduct Standards.999 Although the Commission does not currently have data on the number of firms that may have devoted resources to comply with the PTEs,1000 the Commission can broadly estimate the maximum number of broker-dealers that could have undertaken changes in order to comply with requirements of the PTEs from the number of broker-dealers that have retail customer accounts. Approximately 73.5% (2,766) of registered broker-dealers report sales to retail customers.1001 Similarly, approximately 8,235 (62% of) investment advisers serve high net worth and non-high net worth individual clients. The Commission understands that these numbers are an upper bound and likely overestimate the broker-dealers and investment advisers that provide retirement account services and began compliance with the requirements of the PTEs.1002 jbell on DSK3GLQ082PROD with RULES2 998 Id. 999 See, e.g., Michael Wursthorn, A Complete List of Brokers and Their Approach to ‘The Fiduciary Rule’, Wall St. J., Feb. 6, 2017, https:// www.wsj.com/articles/a-complete-list-of-brokersand-their-approach-to-the-fiduciary-rule1486413491?mod=article_inline for a discussion of how broker-dealers adjusted certain practices in response to the DOL Fiduciary Rule. 1000 In order to perform this analysis, the Commission would need to know which financial firms offer services to IRAs and other retirement accounts. Under the current reporting regimes for both broker-dealers and investment advisers, they are not required to disclose whether (or what fraction of) their accounts are held by retail investors in retirement accounts. 1001 As of December 2018, 3,764 broker-dealers have filed Form BD. Retail sales by broker-dealers were obtained from Form BR. See supra footnote 900. 1002 The Department of Labor Regulatory Impact Analysis (‘‘DOL RIA’’) identifies approximately 4,000 broker-dealers (FINRA, 2016), of which approximately 2,500 are estimated to have either ERISA accounts or IRA accounts serviced by brokerdealers, similar to the estimates that we provide above. In addition to broker-dealers, the DOL RIA estimates that other providers of ERISA or IRA accounts include: Approximately 10,600 federally registered investment advisers and 17,000 stateregistered investment advisers (NASAA 2012/2013 Report), of which approximately 17,000 of federal and state investment advisers that are not dually registered, approximately 6,000 ERISA plan sponsors (2013 Form 5500 Schedule C), and approximately 400 life insurance companies (2014 SNL Financial Data). See U.S. Department of Labor, Regulating Advice Markets: Definition of the Term ’Fiduciary’, Conflicts of Interest, Retirement Investment Advice: Regulatory Impact Analysis for Final Rule and Exemptions (Apr. 2016), available at https://www.dol.gov/sites/default/files/ebsa/ VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 ii. Industry Response to DOL Fiduciary Rule Although the DOL Fiduciary Rule became effective in June 2017, the DOL provided transitional relief through July 2019,1003 which is now indefinitely extended under the temporary enforcement policy put in place in June 2018 following the Fifth Circuit decision. As described above, a significant subset of broker-dealers have retail customers with retirement accounts and would have been affected by the DOL Fiduciary Rule, and at least some broker-dealers began taking steps to effectuate compliance with the DOL Fiduciary Rule. A number of commenters stated that we did not sufficiently consider the existing regulatory environment and the current market practices of firms and financial professionals in light of the DOL’s Fiduciary Rule and other existing rules and regulations.1004 Below, we discuss the industry response to the DOL Fiduciary Rule and the effect of the Fifth Circuit decision on broker-dealers. In the Proposing Release, we predominantly based our discussion of the industry and customer effects of the DOL Fiduciary Rule on information from a single industry study.1005 Commenters provided additional citations to industry studies,1006 which describe changes in market practices across a broader-sample of brokerdealers in response to the DOL Fiduciary Rule.1007 In these studies, laws-and-regulations/rules-and-regulations/ completed-rulemaking/1210-AB32-2/ria.pdf. 1003 See supra footnote 1002. 1004 See, e.g., AALU Letter; CCMC Letters; CCMR Letter; CFA August 2018 Letter; Davis & Harman Letter; EPI Letter; Lincoln Financial Letter; Morningstar Letter; NASAA August 2018 Letter; Wells Fargo Letter. 1005 See SIFMA Study, supra footnote 33. The SIFMA Study surveyed 21 SIFMA members and captured 43% of U.S. ‘‘financial advisors’’ (132,000 out of 310,000), 35 million retail retirement accounts, and 27% of qualified retirement savings assets ($4.6 trillion out of $16.9 trillion). The types of retirement accounts serviced by the participants in the SIFMA Study were not defined. 1006 See, e.g., CCMC Letters; Davis & Harman Letter; EPI Letter; Lincoln Financial Letter. 1007 See, e.g., Financial Services Roundtable & Harper Polling, Department of Labor Fiduciary Rule: National Survey of Financial Professionals (July 2017), available at https://www.sec.gov/ comments/ia-bd-conduct-standards/cll4-2641320161289.pdf (see Appendix A) (‘‘FSR Study’’). The FSR Study surveyed 600 financial advisers in July 2017, including certified financial planners, chartered financial analysts, broker-dealers, and dually registered representatives. See also Center for Capital Markets Competitiveness, Fiduciary Rule: Initial Impact Analysis, FTI Consulting Report Presented to the U.S. Chamber of Commerce (Sept. 7, 2017), available at https:// www.centerforcapitalmarkets.com/wp-content/ uploads/2017/07/Fiduciary-Rule-Initial-ImpactAnalysis.pdf (‘‘Chamber Study’’). The Chamber Study surveyed 14 financial advisory companies PO 00000 Frm 00105 Fmt 4701 Sfmt 4700 33421 certain of the survey participants reported that they responded to the DOL Fiduciary Rule and the BIC Exemption by reducing certain services and access to advice to small retirement accounts. Certain participants further reported that they encouraged customers toward self-directed accounts and/or advisory accounts, including robo-advisors. Certain other participants reported that they reduced or eliminated certain securities within certain types of retirement accounts that they offered. Finally, certain participants reported that they increased certain fees for some of their customers. However, as it is generally the case with survey analysis, the surveys in the aforementioned studies are subject to potential selection biases (i.e., the sample of respondents is not necessarily random) and methodological limitations (e.g., the design of the questionnaire may influence the choices made by the respondents). Given these limitations, it is generally not clear whether the results of these studies capture significant or marginal changes in broker-dealer practices, and whether these changes are indicative of broader trends in the market for advice in response to the DOL Fiduciary Rule. Changes to Services and Securities A number of studies indicated that, as a result of the DOL Fiduciary Rule, certain industry participants had already or were planning to alter their menu of services and securities that they made available to retail customers. For example, of the 21 SIFMA members that participated in the SIFMA Study, 53% eliminated or reduced access to certain brokerage advice services and 67% migrated away from open choice to fee-based or limited brokerage services.1008 Another study also discussed a shift from commissionbased accounts to fee-based accounts but offered no details about the sample or the methodology employed to arrive (insurance companies, securities manufacturers, and broker-dealers) responsible for $10 trillion in AUM and nearly 26 million investment accounts. The types of accounts serviced by the participants in the Chamber Study were not defined. See also A.T. Kearney, The $20 Billion Impact of the New Fiduciary Rule on the U.S. Wealth Management Industry, Perspective for Discussion (Oct. 2016), available at https://www.atkearney.com/ documents/10192/7041991/DOL+Perspective++August+2016.pdf/b2a2176b-c821-41d9-b12ed3d2b0807d69 (‘‘Kearney Study’’). We note that the development of business models and practices discussed herein reflect changes made voluntarily by firms in response to the DOL Fiduciary Rule, but were not necessarily required by the DOL Fiduciary Rule. 1008 See SIFMA Study, supra footnote 33. E:\FR\FM\12JYR2.SGM 12JYR2 33422 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 at the estimates.1009 Finally, another study documented that at least 29% of their survey participants expected to move clients, particularly those with low account balances, to roboadvisors.1010 In addition, a number of media articles describe several cases of broker-dealers that have adjusted their practices with respect to the range of accounts offered as a result of the DOL Fiduciary Rule.1011 Further, industry studies noted that certain of their respondents changed their securities offerings as a result of the DOL Fiduciary Rule.1012 For example, 95% of the SIFMA Study participants altered their securities offerings by reducing or eliminating certain asset or share classes; 86% of the respondents reduced the number or type of mutual funds (e.g., 29% eliminated no-load funds, while 67% reduced the number of mutual funds), and 48% reduced annuity securities offerings.1013 Similarly, another study found that nearly 30% of survey participants eliminated or reduced securities or services available to retirement investors in response to the DOL 1009 See Kearney Study (provided by the Davis & Harman and Lincoln Financial Letters). 1010 See FSR Study, which states that ‘‘[a]dvisors who say the average net worth of their clients is under $25,000 are more likely to say they will definitely, probably, or have already directed more clients to robo advisor services, both online and at call centers (43% vs. 29% overall).’’ 1011 For example, in response to the DOL Fiduciary Rule, J.P. Morgan and Merrill Lynch phased out commission-based retirement plans and instead charged fees based on AUM. See Crystal Kim, BofA, JPMorgan, and the Fiduciary Rule: Will They or Won’t They, Barron’s, Mar. 15, 2017, https://www.barrons.com/articles/bofa-jpmorganand-the-fiduciary-rule-will-they-or-wont-they1489588442. However, upon the Fifth Circuit’s ruling on the DOL Fiduciary Rule, J.P. Morgan and Merrill Lynch reversed their earlier decision and began to offer commission-based retirement plans again. See Jed Horowitz, JPMorgan to Remove Some Fiduciary Rule Handcuffs, Others May Follow, AdvisorHub, May 4, 2018, https://advisorhub.com/ jpmorgan-to-remove-some-fiduciary-rule-handcuffsothers-may-follow/; Imani Moise, Merrill Lynch Does about Face on Fiduciary-Era Policy, Reuters, Aug. 30, 2018, https://www.reuters.com/article/usbank-of-america-fiducuary/merrill-lynch-doesabout-face-on-fiduciary-era-policyidUSKCN1LF1R9. See also Daisy Maxey, Winners and Losers in a Post-Fiduciary World, Wall St. J., May 24, 2017, available at https://www.wsj.com/ articles/winners-and-losers-in-a-post-fiduciaryworld-1495638708; Nir Kaissir, Merrill Lynch Can’t Restore the Bad Old Days of Conflicts, Bloomberg, Sept. 4, 2018, available at https:// www.bloomberg.com/opinion/articles/2018-09-04/ merrill-lynch-can-t-restore-the-bad-old-days-ofconflicts. 1012 While the industry studies discussed in this section examined shifts in services and securities provided to retail investors, one limitation of these studies is that they did not discuss whether the quality of advice provided to retail investors also changed as a result. 1013 See SIFMA Study, supra footnote 33. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 Fiduciary Rule,1014 while the Chamber Study noted that 13.4 million accounts of the companies surveyed had limited access to certain securities, including mutual funds, variable annuities, and exchange-traded funds.1015 Finally, the SIFMA Study states that although the DOL Fiduciary Rule applied only in connection with services for retirement accounts, certain of the survey participants had implemented the changes to both retirement and nonretirement accounts.1016 These studies do not discuss the attributes of the securities that the participants chose to no longer offer. In addition, as noted above, survey analysis is subject to certain limitations that, generally, complicate the interpretation of their results. For instance, it is not generally clear whether the results of these studies capture significant or marginal changes in broker-dealer practices, and whether these changes are indicative of broader trends in the market for advice in response to the DOL Fiduciary Rule. Besides the studies mentioned above, a number of media articles provide anecdotal evidence of broker-dealers that chose to no longer offer certain securities.1017 Some commenters also American Bankers Association, ABA Survey: Department of Labor Fiduciary Rule (July 20, 2017), available at https://www.aba.com/ Advocacy/Issues/Documents/dol-fiduciary-rulesurvey-summary-report.pdf (‘‘ABA Study’’). The ABA Study conducted a survey of 57 banks about their understanding of the DOL Fiduciary Rule on securities and services available to retirement investors. See also Kearney Study, which anticipated a shift from mutual funds to exchangetraded funds, and that ‘‘certain high-cost investment products (such as variable annuities) will be phased out as the business model is no longer viable under [the DOL Fiduciary Rule].’’ See also FSR Study, which reported that 63% of its survey participants anticipated fewer investment options and 56% had already reduced or anticipated reducing the number of mutual funds offered to retirement customers. 1015 See Chamber Study. See also Editorial Board, Tom Perez’s Fiduciary Flop, Wall St. J., Mar. 18, 2018, https://www.wsj.com/articles/tom-perezsfiduciary-flop-1521412228, which noted that some firms restricted sales of commission-based securities such as load mutual funds and variable annuities in retirement accounts. 1016 See, e.g., SIFMA Study, supra footnote 33. 1017 See Alex Steger, Exclusive: UBS to Cut over 800 Funds from Platform, City Wire, Mar. 13, 2018, https://citywireusa.com/professional-buyer/news/ exclusive-ubs-to-cut-over-800-funds-from-platform/ a1100101; Michael Thrasher, Ameriprise Drops Hundreds of Funds Offered to Brokerage Clients, WealthManagement.com, June 8, 2017, https:// www.wealthmanagement.com/industry/ameriprisedrops-hundreds-funds-offered-brokerage-clients; Hugh Son, Morgan Stanley to Reduce Wealth Fees Even with Rule Uncertainty, Bloomberg, Jan. 26, 2017, https://www.bloomberg.com/news/articles/ 2017-01-26/morgan-stanley-to-proceed-with-wealthchanges-ahead-of-new-rules; Margarida Correia, LPL Puts Final Touches on Product Lineups in Preparation for Fiduciary Rule, Financial Planning, Mar. 9, 2017, https://www.financial-planning.com/ news/lpl-puts-final-touches-on-product-lineups-in- PO 00000 1014 See Frm 00106 Fmt 4701 Sfmt 4700 provided data about historical trends in certain product markets.1018 For example, one commenter provided data for the market of mutual funds and showed that between 2007 and 2018, the percentage of assets in load mutual funds declined from 27% to 12%, while no-load share classes increased from 51% to 71% over the same time period.1019 Further, this commenter stated that this shift has occurred because of the growth in assets in 401(k) plans and other retirement accounts, as well as the increase in the number of advisory accounts, both of which tend to invest in no-load share classes. However, the DOL Fiduciary Rule may have caused certain product markets to adjust.1020 For example, innovations, including the introduction of T and clean share classes of mutual funds, can be regarded as a paradigm shift in terms of how product sponsors compensate broker-dealers for distribution services. One commenter noted that these products may reduce the expected fund underperformance net of costs for retail investors relative to A shares by nearly 50 basis points annually.1021 The Effect of Costs and Fees Some firms may have responded to the DOL Fiduciary Rule by either presenting customers with the option to enter into different and potentially more costly advice relationships compared to a brokerage advice relationship or by passing some of the compliance costs to customers.1022 However, one study observed that 63% of the responding firms that limited or eliminated access to advised brokerage services stated that they had at least some customers who chose to move to self-directed accounts rather than fee-based accounts and cited the reasons that customers provided as (1) ‘‘did not want to move to a fee-based account,’’ (2) ‘‘was not in the retirement investor’s best interest to move to a feepreparation-for-fiduciary-rule?tag=00000154-3e16d45e-a175-7f9f48a20001; Bruce Kelly, Wells Fargo Advisors Restricting Investments for Retirement Accounts, Investment News, May 24, 2017, https:// www.investmentnews.com/article/20170524/FREE/ 170529959/wells-fargo-advisors-restrictinginvestments-for-retirement-accounts. 1018 See, e.g., ICI Letter. 1019 See id. 1020 See, e.g., James Chen, Clean Shares, Investopedia, available at https:// www.investopedia.com/terms/c/clean-shares.asp, stating that ‘‘[t]he mutual fund industry introduced clean shares, along with T shares, in response to the Department of Labor’s fiduciary rule.’’ 1021 See Letter from Aron Szapiro, Director of Policy Research, Morningstar (Sept. 2017). 1022 See supra footnote 1011 (which describes how certain firms responded to the DOL Fiduciary Rule and later reversed changes in response to the Fifth Circuit decision). E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations based account,’’ (3) ‘‘did not meet the account minimums,’’ or (4) ‘‘wished to maintain positions in certain asset classes which were not eligible for a feebased account.’’ 1023 Another study further observed that nearly 40% of the responding firms believed that the relationship with their customers had been altered as a result of the DOL Fiduciary Rule and that customers with smaller account balances were nearly ten times more likely to have been negatively affected by the DOL Fiduciary Rule than customers with larger account balances.1024 Further, another study observed that 68% of the responding firms were less likely to provide services to smaller accounts, and 46% anticipated that they may service fewer clients overall.1025 One study observed that, generally, based on the numbers provided by the respondents, a fee-based account can be more costly than a brokerage account; however, such comparison is generally hard to make without knowing the securities in the two types of accounts, and it is not clear that the survey made this clear to respondents.1026 One study 1027 observed that approximately 52% of its survey participants indicated that they may pass on the costs associated with complying with the DOL Fiduciary Rule to clients in the form of higher fees, while another study stated that more than 6 million client accounts of the survey participants may be subject to higher costs and fees as a result of the DOL Fiduciary Rule, although it is not clear whether this estimate assumes full adoption of the DOL Fiduciary Rule.1028 Estimated Costs of Compliance and Effects on Compensation Structures One study observed that survey respondents were expecting to incur compliance costs as a result of the DOL Fiduciary Rule that would vary by the size of the respondent.1029 For instance, 1023 See SIFMA Study, supra footnote 33. ABA Study. 1025 See FSR Study. See also Chamber Study, which found that some survey participants have added minimum account balances and have migrated away from commission-based models toward fee-based models. 1026 See SIFMA Study. We note that only a subset of the SIFMA Study participants provided information on the costs associated with brokerage and advisory accounts. See CFA August 2018 Letter. The SIFMA Study did not provide any information on the set of firms comprised in this subset that provided information on brokerage and advisory costs. See also ICI Letter (which provided similar estimates for fees and costs attributable to brokerage and advisory accounts). 1027 See FSR Study. 1028 See Chamber Study. 1029 See SIFMA Study. As a general matter, we note that the estimates reported by industry studies, jbell on DSK3GLQ082PROD with RULES2 1024 See VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 large firms with net capital in excess of $1 billion were expected to have startup and ongoing compliance costs of $55 million and $6 million, respectively, while firms between $50 million and $1 billion in net capital were expected to have start-up and ongoing compliance costs of $16 million and $3 million, respectively. The study further estimated that the total start-up compliance costs for large and mediumsize firms combined would have been approximately $4.7 billion, while ongoing costs would have been approximately $700 million per year. Another study observed that the costs of complying with DOL Fiduciary Rule would encompass technology, legal, process changes, educational, and training costs for firms.1030 This study forecasted that the DOL Fiduciary Rule may cause a $2 trillion redistribution in assets from broker-dealers to investment advisers, robo-advisors, and selfdirected accounts, and a nearly $20 billion decrease in revenues to the entire financial services industry, including broker-dealers. The study further forecasted that as a result of the DOL Fiduciary Rule product sponsors ‘‘will be incentivized to streamline product offerings, lower fees, and improve performance,’’ and investor would pay $7.5 billion less in mutual fund and ETF expenses by the end of 2010. However, as noted above, this study does not provide details about how it obtained its estimates. Several media articles provide some anecdotal evidence suggesting that as a response to the DOL Fiduciary Rule some broker-dealers began to alter the compensation structures of their registered representatives.1031 For example, some broker-dealers have indicated that they adjusted their compensation structures by equalizing commissions and deferred sales charges across similar securities.1032 Other broker-dealers banned sales quotas, contests, special awards, and bonuses,1033 including deferred bonuses including this study, are based on a rulemaking with more extensive requirements for changes to business models than those required by Regulation Best Interest. 1030 See Kearney Study. 1031 See Son (2017), supra footnote 1017; Tara Siegel Bernard, Do Financial Advisers Have to Act in Your Interest? Maybe, N.Y. Times, Mar. 22, 2018, https://www.nytimes.com/2018/03/22/your-money/ financial-advisers-customer-interest.html. 1032 See, e.g., Andrew Welsch, Facing Higher Costs, Raymond James Cuts Adviser Pay in Rare Move, Financial Planning, July 11, 2017, https:// onwallstreet.financial-planning.com/news/facinghigher-costs-raymond-james-cuts-adviser-pay-inrare-move?tag=00000151-16d0-def7-a1db97f024310000. 1033 See Bernard (2018). PO 00000 Frm 00107 Fmt 4701 Sfmt 4700 33423 as part of recruitment efforts.1034 However, following the decision by the Fifth Circuit to vacate the DOL Fiduciary Rule, some firms reinstated back-end recruiting bonuses.1035 iii. Additional Evidence of Current Market Practices In this section, we include information on Commission observations on the broker-dealer industry. Commission experience indicates that there have been a number of changes to the broker-dealer industry and its business practices over time.1036 Consistent with the trend baseline provided in Section III.B.1.c and industry studies and anecdotal evidence described above, we have observed firms choosing to do business with retail investors as investment advisers, not as broker-dealers, by either migrating existing brokerage accounts to advisory accounts or directing new retail customers to advisory accounts. Beyond broker-dealer trends in business practices, Commission experience also indicates that some broker-dealers have responded to the DOL Fiduciary Rule and the Fifth Circuit decision vacating the DOL Fiduciary Rule by modifying their existing business practices. For example, some firms, consistent with anecdotal evidence discussed above, eliminated brokerage IRA accounts in response to the DOL Fiduciary Rule; however, upon the Fifth Circuit decision, the firms reinstituted 1034 See Mason Braswell, Morgan Stanley Resumes Recruiting Offers—Slimmer and DOLCompliant, AdvisorHub, Nov. 3, 2016, https:// advisorhub.com/morgan-stanley-resumesrecruiting-offers-slimmer-and-dol-compliant/; Deon Roberts, Wells Fargo Overhauling Bonuses to Comply with New Rules on Financial Advisers, Charlotte Observer, Dec. 14, 2016, https:// www.charlotteobserver.com/news/business/ banking/bank-watch-blog/article120961138.html. 1035 See Mason Braswell, Farewell Fiduciary Rule? Morgan Stanley Sweetens Recruiting Bonuses, AdvisorHub, May 1, 2018, https://advisorhub.com/ farewell-fiduciary-rule-morgan-stanley-sweetensrecruiting-bonuses/. ‘‘Back-end’’ bonuses are expressly contingent on the achievement of sales or asset targets. See U.S. Department of Labor, Conflict of Interest FAQs (Part I—Exemptions) (Oct. 27, 2016), available at https://www.dol.gov/sites/ default/files/ebsa/about-ebsa/our-activities/ resource-center/faqs/coi-rules-and-exemptions-part1.pdf. 1036 Information on the broker-dealer industry and business practices comes from a variety of Commission resources and generally relates to market trends and changes to business practices that have emerged in recent years and is comprised of both standalone broker-dealers and dually registered firms. With respect to industry trends, Commission resources generally verify data cited above in Section III.B.2.e.ii. We acknowledge that the information provided in this baseline may not be representative of business practices more generally because of the diversity and complexity of services and securities offered by standalone broker-dealers and dually registered firms. E:\FR\FM\12JYR2.SGM 12JYR2 33424 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations brokerage IRAs. Other examples of changes following the Fifth Circuit decision include changes to incentivebased compensation in certain types of accounts and principal trading restrictions. 3. Investment Advice and Evidence of Potential Investor Harm A number of commenters expressed the view that the Proposing Release did not fully document the problems attributed to potential conflicts of interest stemming from the brokerdealer model and the resulting harm to retail customers.1037 In order to address these commenters’ concerns, we analyze academic and industry studies to present an overview of the market for advice for retail customers.1038 Below, we discuss which types of investors seek investment advice; the benefits attained through investment advice for retail investors; limitations to the value of that advice that stem from agency costs, particularly those related to conflicts of interest arising from financial professional compensation; and evidence of potential investor harm. Where appropriate, we note limitations to the application of various academic studies that form the basis of other economic analyses, which investigate potential investor harm attributed to recommendations received from financial professionals. jbell on DSK3GLQ082PROD with RULES2 1037 See, e.g., AARP August 2018 Letter; Better Markets August 2018 Letter; CFA August 2018 Letter; EPI Letter; U. of Miami Letter; Morningstar Letter; PIABA Letter; Letter from Ron A. Rhoades, Director, Personal Financial Planning Program and Assistant Professor of Finance, Gordon Ford College of Business, Western Kentucky University (Aug. 6, 2018) (‘‘Rhoades August 2018 Letter’’); Former SEC Senior Economists Letter. 1038 Although the discussion here generally focuses on studies provided by comment letters, at times we have included additional references either to more fully articulate specific arguments or to provide counterarguments to studies provided by comment letters in an effort to present a complete overview of pertinent literature. Because the studies we cite in this section generically discuss investment advice or advice rather than recommendations, and use a variety of terms to describe financial professionals or firms (e.g., brokers, advisers, or financial advisers) and investors (e.g., investors, customers, or clients), in the discussion that follows, we use generic terms of advice or investment advice, financial professional, firm, and retail investor or investor. Although we believe that the studies generally discuss advice as it relates to broker-dealers or investment advisers, because of generic terms used, such as ‘‘financial adviser,’’ it is possible that other types of advice providers (e.g., commercial banks, tax consultants, etc.) could be included in some of the studies cited below. However, because not all authors clearly define which financial professionals are included in a given study, we are unable to provide an exhaustive list of all types of financial professionals that make up the market for advice. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 a. Who Seeks Investment Advice 1039 Approximately 37% of U.S. households currently engage with financial professionals according to OIAD/RAND; however, households who hire these professionals are not uniformly distributed among the U.S. population.1040 In addition to OIAD/ RAND, a number of academic studies, provided with comment letters, examine characteristics of investors and their propensity for seeking (and following) investment advice. Older, wealthier, more educated, and financially more literate retail investors are more likely to seek and act on advice obtained from financial professionals, suggesting that investors who may benefit most from advice (younger, less educated, and less financially sophisticated) are least likely to obtain it.1041 Several studies examine 1039 One limitation of the majority of the studies examined is that we are unable to distinguish whether the retail investor is seeking and/or receiving investment advice from a broker-dealer or an investment adviser (or some other type of financial professional). The studies generally do not have sufficiently granular data to distinguish broker-dealer customers from investment adviser clients. Further, for studies where retail investors can be distinguished by their investment choices (e.g., purchasing direct-sold versus broker-sold funds), we are unable to determine whether differences exist between broker-sold funds sold by broker-dealers and broker-sold funds sold by investment advisers. As discussed below, some commenters expressed the view that buy-and-hold retail investors were more likely to prefer the services of brokerage accounts over advisory accounts. See infra footnote 1055. 1040 According to OIAD/RAND, the use of financial professionals varies by both income and education levels. For example, 38% of retail investors with income greater than $100,000 engage with financial professionals, while only 13.7% of retail investors with incomes below $25,000 did so. Another study, the Survey of Consumer Finance, indicates that the use of financial professionals by American households is closer to 60%, but also includes financial planners, accountants, lawyers, and bankers, in addition to broker-dealers and investment advisers. See SCF Survey, supra footnote 950. 1041 See, e.g., Utpal Bhattacharya et al., Is Unbiased Financial Advice to Retail Investors Sufficient? Answers from a Large Field Study, 25 Rev. Fin. Stud. 975 (2012); Daniel Hoechle et al., The Impact of Financial Advice on Trade Performance and Behavioral Biases, 21 Rev. Fin. 871 (2017); Jeremy Burke & Angela A. Hung, Do Financial Advisors Influence Savings Behavior?, RAND Labor and Population Report Prepared for the Department of Labor (2015), available at https:// www.rand.org/content/dam/rand/pubs/research_ reports/RR1200/RR1289/RAND_RR1289.pdf; Claude Montmarquette & Nathalie Viennot-Briot, Econometric Models on the Value of Advice of a Financial Advisor, CIRANO Project Report No. 2012RP–17 (July 2012), available at https:// www.cirano.qc.ca/pdf/publication/2012RP-17.pdf; Andreas Hackethal, Michael Haliassos, & Tullio Jappelli, Financial Advisors: A Case of Babysitters?, 36 J. Banking & Fin. 509 (2012). See also AARP August 2018 Letter; CFA August 2018 Letter; FPC Letter; Primerica Letter; Wells Fargo Letter (which provided several studies cited here; other studies (e.g., Hoechle et al. (2017)) are included because they capture characteristics of the investors most PO 00000 Frm 00108 Fmt 4701 Sfmt 4700 the choice by retail investors to select into broker-sold or direct-sold mutual funds. These studies find less financially sophisticated investors are more likely to purchase ‘‘broker-sold’’ funds and therefore more likely to receive advice from a financial professional.1042 As we detail below, retail investors bear costs associated with obtaining advice from financial professionals, which may deter some investors, especially those with limited wealth or income, from seeking investment advice. However, an investor’s lack of sophistication may also prevent the investor from obtaining or using investment advice even when advice is provided at no cost. One paper examines the outcomes from a large sample of active retail investors of a large broker-dealer.1043 These retail investors received unsolicited and unbiased advice from the broker-dealer at no cost. Although the advice was designed to improve the efficiency of the investors’ portfolios, only 5% of investors accepted the offer to receive the free advice. Moreover, those that did accept the advice rarely followed the advice. Investors who participated in the study had only minimal improvements to their portfolio efficiency. The authors cite lack of financial sophistication and lack of familiarity or trust as reasons why the unsolicited advice was not followed.1044 likely to seek and act on financial advice that are not captured by the studies suggested by the commenters). Studies also note that the characteristics of investors most likely to seek advice are also likely to be those most attractive to financial professionals as they have more assets to manage. See Michael S. Finke, Financial Advice: Does it Make a Difference? (Working Paper, May 5, 2012) (which describes the relationship between investors and financial professionals). 1042 See, e.g., Christopher J. Malloy & Ning Zhu, Mutual Fund Choices and Investor Demographics (Working Paper, Mar. 14, 2004), available at https:// pdfs.semanticscholar.org/16a1/8daed89c3c48 a765ad3a265018b4d27bd0f4.pdf; John Sabelhaus, Daniel Schrass, & Steven Bass, Characteristics of Mutual Fund Investors, 2008, ICI Res. Fundamentals, Feb. 2009, available at https:// www.ici.org/pdf/fm-v18n2.pdf; John Chalmers & Jonathan Reuter, Is Conflicted Advice Better than No Advice? (Working Paper, Sept. 14, 2015), available at https://www.semanticscholar.org/ paper/Is-Conflicted-Investment-Advice-Better-thanNo-Chalmers-Reuter/3337ce8c3a72bf55dac43f407 fd104b93aec863b. See also AARP August 2018 Letter; CFA August 2018 Letter; EPI Letter (which provided the Chalmers & Reuter (2015) citation; Malloy & Zhu (2004) and Sabelhaus et al. (2009) are included because they capture aspects of the mutual fund selection decision by retail investors that are not captured by the studies suggested by the commenters). We provide a more detailed discussion of these studies below in Section III.B.3.c. 1043 See Bhattacharya et al. (2012), supra footnote 1041. 1044 See id. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations b. Benefits and Limitations of Investment Advice A number of commenters provided academic studies of benefits that investors may obtain from hiring financial professionals.1045 One benefit of hiring a firm or financial professional is that professional advice can help the average retail investor overcome common ‘‘investment mistakes’’ that he or she may make when investing.1046 Common ‘‘investment mistakes’’ made by retail investors include limited allocation of assets to equities, underdiversification, excessive trading, and home bias.1047 These studies also attempt to identify reasons why retail investors persistently make inefficient investment choices. Beyond correcting potential ‘‘investment mistakes,’’ academic studies document a multitude of other benefits that accrue to retail investors as a result of seeking investment advice, including, but not limited to: Higher household savings rates, setting longterm goals and calculating retirement needs, more efficient portfolio diversification and asset allocation, increased confidence and peace of mind, improvement in financial situations, and improved tax efficiency.1048 For example, one study jbell on DSK3GLQ082PROD with RULES2 1045 See infra footnote 1048. 1046 See Bhattacharya et al. (2012), supra footnote 1041. ‘‘Investment mistakes’’ are investors’ actions that would go against what a rational investor would do when undertaking efficient investment decisions (here and below, infra footnote 1047, we provide studies that analyze common ‘‘investment mistakes’’ made by retail investors). For example, evidence suggests that retail investors tend to trade too frequently. See Brad M. Barber & Terrance Odean, Trading is Hazardous to Your Wealth: The Common Stock Performance of Individual Investors, 55 J. FIN. 773 (2000). 1047 As described in Bhattacharya et al. (2012), supra footnote 1041, possible explanations for common ‘‘investment mistakes’’ may arise from behavioral biases (e.g., cognitive errors), the cost of information acquisition, or the selection of the financial professional. See, e.g., Luigi Guiso, Paolo Sapienza, & Luigi Zingales, People’s Opium? Religion and Economic Attitudes, 50 J. Monetary Econ. 225 (2003); Laurent E. Calvet, John Y. Campbell, & Paolo Sodini, Down or Out: Assessing the Welfare Costs of Household Investment Mistakes, 115 J. Pol. Econ. 707 (2007); Barber & Odean (2000), supra footnote 1046; Karen K. Lewis, Trying to Explain Home Bias in Equities and Consumption, 37 J. Econ. Literature 571 (1999). 1048 See, e.g., Mitchell Marsden, Catherine D. Zick, & Robert N. Mayer, The Value of Seeking Financial Advice, 32 J. Fam. & Econ. Issues 625 (2011); Jinhee Kim, Jasook Kwon, & Elaine A. Anderson, Factors Related to Retirement Confidence: Retirement Preparation and Workplace Financial Education, 16 J. Fin. Counseling & Plan. 77 (2005); Michael S. Finke, Sandra J. Huston, & Danielle D. Winchester, Financial Advice: Who Pays, 22 J. Fin. Counseling & Plan. 18 (2011); Daniel Bergstresser, John M.R. Chalmers, & Peter Tufano, Assessing the Costs and Benefits of Brokers in the Mutual Fund Industry, 22 Rev. Fin. Stud. 4129 (2009); Ralph Bluethgen, Steffen Meyer, & Andreas VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 notes that investors who engaged financial professionals for at least 15 years had approximately 173% more assets on average than investors who did not hire financial professionals, driven by higher household savings rates and increased asset allocation to non-cash instruments.1049 Further, financial professionals may be able to help retail investors overcome information asymmetries that exist between firms that supply securities and their customers that retail investors would not be able to disentangle on their own.1050 Commenters also provided academic studies which discussed the limitations of the advice received from financial professionals, including how both direct and indirect costs of advice can reduce returns earned by investors.1051 How financial professionals are compensated can erode the value of advice in two primary ways: (1) The direct costs associated with purchasing advice Hackethal, High-Quality Financial Advice Wanted! (Working Paper, Feb. 2008), available at https:// citeseerx.ist.psu.edu/viewdoc/ summary?doi=10.1.1.596.2310; Neal M. Stoughton, Youchang Wu, & Josef Zechner, Intermediated Investment Management, 66 J. Fin. 947 (2011). Marsden et al. (2011) documents benefits attributable to hiring a financial professional, such as better retirement account diversification and savings goals, but does not find that hiring a financial professional measurably increases the amount of overall wealth accumulation for those investors. See also, Burke & Hung (2015), supra footnote 1041, for additional studies on the causal relation between the use of a financial professional and wealth accumulation. Francis M. Kinniry et al., Putting a Value on Your Value: Quantifying Vanguard Advisor’s Alpha, Vanguard Research (Sept. 2016), available at https:// www.vanguard.com/pdf/ISGQVAA.pdf, estimates the value to investors associated with obtaining financial advice of approximately 3% in net returns to investors, associated with suitable asset allocation, managing expense ratios, behavioral coaching, alleviating home bias, among others. See also AARP August 2018 Letter; CCMC Letters; CFA August 2018 Letter; Edward Jones Letter; Letter from Brian M. Nelson (Jul. 10, 2018) (‘‘Nelson Letter’’) (which provided several of these studies; other studies were included because they capture aspects of the benefits of advice for retail investors that are not captured by the studies suggested by the commenters (e.g., Marsden et al. (2011), Finke et al. (2011)). 1049 See Montmarquette & Vionnet-Briot (2012), supra footnote 1041. While this study describes the benefits of hiring financial professionals on asset accumulation, it also notes that termination of relationships with financial professionals resulted in a significant loss of overall investment asset value. See Primerica Letter; Wells Fargo Letter (which provided references to this academic study). 1050 See Roman Inderst & Marco Ottaviani, Financial Advice, 50 J. Econ. Literature 494 (2012). See also AARP August 2018 Letter. 1051 See, e.g., AARP August 2018 Letter; CFA August 2018 Letter; EPI Letter; Letter from Ron A. Rhoades, Director, Personal Financial Planning Program and Assistant Professor of Finance, Gordon Ford College of Business, Western Kentucky University (Dec. 6, 2018) (‘‘Rhoades December 2018 Letter’’). PO 00000 Frm 00109 Fmt 4701 Sfmt 4700 33425 detract from returns over time; 1052 and (2) the indirect costs to retail investors that arise from conflicts of interest between financial professionals and investors. Financial professionals are generally compensated directly by retail investors in three principal ways: Commission-based (e.g., broker-dealers), fee-based on AUM (e.g., investment advisers), and flat or hourly fees (e.g., financial planners), although some financial professionals may receive compensation in multiple ways for providing advice to the same investor.1053 One study estimates that the average annual costs associated with commission-based accounts are approximately 75 bps, while the average fee-based account costs 130 bps.1054 We acknowledge that in addition to the fees charged for particular types of services, other expenses may be incurred that reduce returns earned by investors, some of which may be earned by the financial professional or the firm and paid by the firm’s product or service providers (e.g., fund loads, 12b–1 fees, and shareholder servicing fees). Some commenters expressed the view that certain investors (e.g., buy-and-hold investors) may prefer to pay a single commission relative to an ongoing fee1052 As noted in one study, the direct costs (fees and expenses) may not be transparent to retail investors. Coupled with conflicts of interest that can bias any advice provided, information asymmetry between financial professionals and retail investors may be large. See Finke (2012), supra footnote 1041. 1053 For example, investment advisers and supervised persons may receive account-level advisory fees, and may also receive compensation for the sale of securities or other investment products, including asset-based sales charges or service fees for the sale of mutual funds to their advisory clients. See Items 5.C, 5.E, and 14.A of Form ADV Part 2A; Items 4.A.2, 4.B, and 5 of Form ADV Part 2B. When we refer to advisers and supervised persons receiving fees for the sale of securities or other investment products, we generally mean advisers that are also registered broker-dealers or advisers whose affiliated brokerdealers receive these fees. Form ADV instructs advisers that if they receive compensation in connection with the purchase or sale of securities, they should carefully consider the applicability of broker-dealer registration requirements of the Exchange Act and any applicable state securities statutes. See Form ADV, Part 2A, Note to Item 5.E. 1054 See John H. Robinson, Who’s the Fairest of Them All? A Comparative Analysis of Financial Advisor Compensation Models, 20 J. Fin. Plan. 56 (2007). See also AARP August 2018 Letter. One study, however, argues that when the direct costs associated with commissions are combined with the estimated agency costs, there is little difference in the costs between commission-based and fee-based advice. See Quinn Curtis, The Fiduciary Rule Controversy and the Future of Investment Advice (Univ. of Va. Sch. of Law, Law & Econ. Research Paper Series No. 2018–04, Mar. 2018). See also UVA Letter. We note that services provided may also vary between brokerage and advisory accounts, which could also affect differences in costs paid by retail investors. E:\FR\FM\12JYR2.SGM 12JYR2 33426 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 based obligation that is tied to AUM in their account.1055 We note that this choice may be dependent on the investor’s holding period and other ongoing expenses that affect an investor’s net return over time. For example, a buy-and-hold investor that chooses an account where fees are based on AUM may pay more over time than a similar buy-and-hold investor that pays a single commission. Further, some commission-based securities, such as mutual funds, may have ongoing expenses, including 12b–1 fees, which could lead to an erosion of net returns over time.1056 Such ongoing expenses, however, may not be adequately accounted for by investors when making investment decisions about the type of account to open and what type of security to purchase.1057 Several commenters provided analyses to show the expected effect of one-time costs and ongoing expenses (e.g., operating costs or advisory fees) to investors from both commission-based and fee-based perspectives, conditional on the investor’s holding period.1058 Separately, investors may face indirect costs that are a result of agency problems that emerge when financial professionals seek to maximize their own compensation and take actions that place their own interests ahead of the investors that they are supposed to serve.1059 A number of commenters and academic studies have stated that commission-based compensation is more likely to contribute to conflicts of interest between financial professionals and retail investors than fee-based compensation.1060 Other commenters, 1055 See, e.g., Cetera August 2018 Letter; AALU Letter; Pacific Life August 2018 Letter; NAIFA Letter; Empower Retirement Letter; CCMR Letter; Primerica Letter. 1056 See CFA August 2018 Letter; EPI Letter. See also ICI Letter (which described a shift from load to no load funds, decreasing expense ratios, and a decline in the percentage of funds that charge 12b–1 fees). 1057 See infra footnote 1084 and corresponding discussion. 1058 See, e.g., Cetera August 2018 Letter and November 2018 Letter; Pacific Life August 2018 Letter. 1059 See Jeremy Burke et al., Impacts of Conflicts of Interest in the Financial Services Industry (RAND Labor & Population, Working Paper No. WR–1076, Feb. 2015), available at https://www.rand.org/pubs/ working_papers/WR1076.html; Hamid Mehran & Rene M. Stulz, The Economics of Conflicts of Interest in Financial Institutions, 85 J. Fin. Econ. 267 (2007). See also Letter from D. Bruce Johnsen, Professor of Law, Scalia Law School, George Mason University (Aug. 7, 2018) (‘‘Johnsen Letter’’); Robinson (2007), supra footnote 1054. Brokerdealers may act in a brokerage (i.e., agency) capacity or a dealer (i.e., principal) capacity. See Proposing Release at Section I. While the discussion is framed in terms of agency problems, it is applicable to both capacities. 1060 See IPA Letter; CFA August 2018 Letter. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 however, indicated that commissionbased compensation provides benefits to investors.1061 One study finds that conflicts of interest are likely to be present in all forms of compensation earned by financial professionals. For example, fee-based compensation could result in so-called ‘‘reverse churning’’ and a disincentive to reduce AUM, even if that would be in the investor’s best interest, while flat-fee models can lead to shirking and overbilling.1062 However, due to limitations on the data available regarding fee-based advice, most of the academic studies to date regarding conflicts of interest focus on commission-based compensation models. As such, the potential conflicts associated with the fee-based compensation models, including feebased compensation earned by brokerdealers, have not been subject to as much analysis. Studies show that commission-based compensation potentially leads to biased advice, including excessive trading in accounts and recommendations to purchase highcommission securities, both of which benefit the financial professional and may lead to lower net returns.1063 Financial professionals also may benefit from other forms of transactionbased payment from customers, such as mark-ups and mark-downs; for instance, one study documents that the size of the mark-up or mark-down is significantly positively related to whether the brokerdealer solicits the transaction and whether the broker-dealer acts in a principal capacity.1064 Because markups and mark-downs are payments from the customer to the broker-dealer, they give rise to conflicts of interest between a broker-dealer and his or her customer at the time of a recommendation, particularly if they are opaque to the customer, at the time of the recommendation. Mechanisms, including regulation,1065 disclosure, and 1061 See AALU Letter; Invesco Letter; ACLI Letter; NAIFA Letter. See Burke et al. (2015), supra footnote 1059 for a survey on the academic literature on conflicts of interest. 1062 See Robinson (2007), supra footnote 1054. 1063 See, e.g., Stoughton et al. (2011), supra footnote 1048; Roman Inderst & Marco Ottaviani, Misselling Through Agents, 99 Am. Econ. Rev. 883 (2009); Max Beyer, David de Meza, & Diane Reyniers, Do Financial Advisor Commissions Distort Client Choice?, 119 Econ. Letters 117 (2013). See also AARP August 2018 Letter. Financially unsophisticated investors, as discussed by Stoughton et al. (2011), are those most likely to purchase inefficient assets. 1064 See Allen Ferrell, The Law and Finance of Broker-Dealer Mark-Ups (Harvard John M. Olin Ctr. for Law, Econ., and Bus., Discussion Paper, Apr. 6, 2011), available at https://www.finra.org/sites/ default/files/NoticeAttachment/p123492.pdf. See AARP August 2018 Letter. 1065 See, e.g., antifraud provisions of the federal securities laws, FINRA Rule 2121 (Fair Prices and PO 00000 Frm 00110 Fmt 4701 Sfmt 4700 reputation,1066 may be able to mitigate the risk of financial professionals acting on conflicts of interest to the detriment of their customers.1067 In addition to direct payments of commissions from retail investors, financial professionals may receive payments from third parties, such as securities issuers, which can increase costs to investors through higher management fees and reduced net returns, and provide incentives to recommend these securities over those that do not provide such incentives.1068 While a number of studies suggest that conflicts of interest may lead to investor harm, one study, which provides a survey of the literature on conflicts of interest, states that ‘‘although conflicts of interest are omnipresent when contracting is costly and parties are imperfectly informed, there are important factors that mitigate their impact and, strikingly, it is possible for customers of financial institutions to benefit from the existence of such conflicts . . . The existence of a conflict of interest . . . does not mean that . . . the customers of that Commissions); MSRB Rules G–15 and G–30, amended pursuant to Exchange Act Release No. 79347 (Nov. 17, 2016) [81 FR 84637] (Nov. 23, 2016); and FINRA Rules 2121 and 2232, amended pursuant to Exchange Act Release No. 79346 (Nov. 17, 2016) [81 FR 84659] (Nov. 23, 2016). 1066 See William P. Rogerson, Reputation and Product Quality, 14 Bell J. Econ. 508 (1983); Benjamin Klein & Keith B. Leffler, The Role of Market Forces in Assuring Contractual Performance, 89 J. Pol. Econ. 615 (1981); W. Bentley MacLeod, Reputations, Relationships, and Contract Enforcement, 45 J. Econ. Literature 595 (2007) for theoretical models of the effect of reputation on investment quality. See AARP August 2018 Letter. For example, FINRA and MSRB introduced rules in May 2018 regarding mark-up disclosure rules for same-day trades, allowing investors to be able to see what they have paid for riskless principal transactions (FINRA Rule 2232 and MSRB Rule G–15). The Commission has also brought enforcement cases for undisclosed excessive markups under Exchange Act Rule 10b–5. 1067 See, e.g., Inderst & Ottaviani (2012), supra footnote 1050. See also Bolton et al. (2007), infra footnote 1073, which posits that competition or consolidation affect reputation costs and provide a disciplining mechanism for providers of financial advice. Although various mechanisms exist to address agency problems in general, such as monitoring, bonding, and contracting (see, e.g., Finke (2012), supra footnote 1041), the agency problem between financial professionals and retail investors is not necessarily one that can be solved cost-effectively through these approaches. See infra Section III.A.2 for a discussion of limitations to these approaches. See also Curtis (2018), supra footnote 1054. See also AARP August 2018 Letter; CFA August 2018 Letter; UVA Letter. 1068 See Stoughton et al. (2011), supra footnote 1048. The authors also state that ‘‘[i]n addition to the advisory fees charged to the clients, wrap account managers may receive rebates from fund management companies as well,’’ and that wrap accounts have increased in popularity. See also Mark Egan, Brokers vs. Retail Investors: Conflicting Interests and Dominated Products, J. Fin. (forthcoming 2019). See also AARP August 2018 Letter; CFA August 2018 Letter. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 institution will be harmed . . . [A] variety of mechanisms help control conflicts of interest and their impact [e.g., a financial institution’s reputation].’’ 1069 Another study of commission-based compensation in the United Kingdom indicates that commission-based compensation leads to significant bias in certain types of securities (e.g., with profit bonds or distribution bonds) and financial professionals and when bias exists, retail investors are harmed and the costs associated with such harm are significant; however, the study also states that the advice market in the United Kingdom is not overrun with bias (‘‘adviser recommendations are not dominated by self-interest’’) and the market for advice generally works well.1070 Although financial professionals may aid retail investors in correcting common investing mistakes and overcoming informational hurdles associated with securities transactions or investment strategies, the average retail investor may not be able to assess the quality of advice received from financial professionals.1071 The difficulty in assessment can arise from several sources, including a large degree of heterogeneity in the quality of advice, insufficient financial literacy on the part of investors, and information asymmetry 1069 See Mehran & Stulz (2007), supra footnote 1059. See also Johnsen August 2018 Letter. 1070 See Robert Laslett, Tim Wilsdon, & Kyla Malcolm, Polarisation: Research into the Effect of Commission Based Remuneration on Advice, Charles River Associates Report Submitted to the U.K. Financial Services Authority (Jan. 2002), available at https://www.crai.com/sites/default/files/ publications/polarisation-research-into-the-effectof-commission-based-remuneration-on-advice.pdf. Laslett et al. (2002) estimate harm resulting from biased advice of approximately £140 million per year. Following the ban on commission-based compensation in the U.K. in 2013, another study finds that while the quality of financial advice increases, increased costs of providing advice lead some financial professionals to turn away small retail investors. See Tracey McDermott & Charles Roxbury, Financial Advice Market Review, Financial Conduct Authority and HM Treasury Final Report (Mar. 2016), available at https:// www.fca.org.uk/publication/corporate/famr-finalreport.pdf (which provides an overview of the effects of the Retail Distribution Review by the Financial Conduct Authority in the United Kingdom). Further, McDermott & Roxbury (2016) report that financial advice costs approximately £150 per hour and that giving retirement advice requires an average of nine hours on the part of the financial professional. 1071 A number of studies consider advice to be a credence good, which is a type of good with qualities that cannot be observed by the consumer after purchase, making it difficult to assess its utility. See, e.g., Roman Inderst, Consumer Protection and the Role of Advice in the Market for Retail Financial Services, 167 J. Institutional & Theoretical Econ. 4 (2011) (which provides a review of investors’ ability to assess the quality of investment advice). VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 between the financial professional and investors.1072 Information asymmetry arises when information necessary to assess the quality of the advice received may not be available to the retail investor, even when it is available to the financial professional. For example, a financial professional may disclose conflicts of interest that could affect the advice provided, but the information may not be sufficiently precise to help a retail investor gauge how those conflicts affect the advice provided. Conflicts of interest, therefore, can erode the benefits of advice provided to retail investors, particularly if investors are unaware that the conflicts exist or if they do not understand the implications of conflicts.1073 Financial professionals may use this information asymmetry, particularly with unsophisticated investors, to capture economic rents for themselves, and this could exacerbate biases that investors sometimes exhibit, such as return chasing or underdiversification.1074 One experimental study sent ‘‘mystery shoppers’’ to broker-dealers and investment advisers in several large cities in the United States and found that financial professionals provided recommendations that benefited themselves and exacerbated behavioral biases on the part of investors, including return chasing or recommendations of high-cost actively managed funds.1075 1072 See, e.g., Bluethgen et al. (2008), supra footnote 1048. Although this study documents reasons why investors may be unable to assess the quality of advice, the focus is on using adviser characteristics as screening mechanisms to alleviate the first complication noted, the high degree of heterogeneity in the quality of advice. The paper finds that good predictors of high quality advice include the financial professional’s cognitive ability (e.g., analytical skills, rationality, and financial knowledge), how financial professionals are compensated (financial professionals that have a high fraction of commission-based revenue are less likely to recommend high quality investments, e.g., index funds), and the firm’s business model. See also Finke (2012), supra footnote 1041; AARP August 2018 Letter. See also Relationship Summary Adopting Release. 1073 See, e.g., Inderst & Ottaviani (2012), supra footnote 1050; Patrick Bolton, Xavier Freixas, & Joel Shapiro, Conflicts of Interest, Information Provision, and Competition in the Financial Services Industry, 85 J. Fin. Econ. 297 (2007). See also AARP August 2018 Letter. 1074 See, e.g., Marco Ottaviani, The Economics of Advice (Working Paper, May 2000), available at https://faculty.london.edu/mottaviani/EOA.pdf (included because they capture aspects of the information asymmetries between retail investors and financial professionals that are not captured by the studies suggested by the commenters); Miriam Krausz & Jacob Paroush, Financial Advising in the Presence of Conflict of Interests, 54 J. Econ. & Bus. 55 (2002); Inderst & Ottaviani (2012), supra footnote 1050; Stoughton et al. (2011), supra footnote 1048. See also AARP August 2018 Letter. 1075 See Sendhil Mullainathan, Markus Noeth, & Antoinette Schoar, The Market for Financial Advice: An Audit Study (Nat’l Bureau of Econ. PO 00000 Frm 00111 Fmt 4701 Sfmt 4700 33427 Although financial professionals may be hired to help overcome ‘‘investment mistakes’’ made by investors,1076 a number of studies show that financial professionals themselves may be subject to the same behavioral biases as unadvised retail investors, such as return chasing and overconfidence.1077 One study, using data on Canadian investors and their financial professionals, observes that financial professionals appear to have the same ‘‘misguided beliefs’’ as their investors, and therefore do not correct, and may even exacerbate common investment mistakes.1078 In that study, financial professionals invested in the same manner that they recommended to their Research, Working Paper No. 17929, Mar. 2012), available at https://www.nber.org/papers/ w17929.pdf. See also AARP August 2018 Letter; CFA August 2018 Letter; EPI Letter. Although the Mullainathan et al. (2012) study included both broker-dealers and investment advisers, the study notes that most professionals in their sample focused on the lower end of the retail spectrum and tended to be compensated through commissions rather than fees based on AUM. See also Santosh Anagol, Shawn Cole, & Shayak Sarkar, Understanding the Advice of Commissions Motivated Agents: Evidence from the Indian Life Insurance Market (Harvard Bus. Sch., Working Paper No. 12–055, Oct. 2015), available at https:// www.hbs.edu/faculty/Publication%20Files/12-055_ 13c23c02-e57f-4aea-9630-316aa4b772ce.pdf, which used a similar audit approach to evaluate the quality of advice provided by life insurance agents in India, and found that agents recommended unsuitable products and strategies that paid high commissions. 1076 See supra footnote 1046. 1077 See, e.g., Mullinathan et al. (2012), supra footnote 1075; Terrance Odean, Are Investors Reluctant to Realize Their Losses?, 53 J. Fin. 1775 (1998); Zur Shapira & Itzhak Venezia, Patterns of Behavior of Professionally Managed and Independent Investors, 25 J. Banking & Fin. 1573 (2001). See also AARP August 2018 Letter. See also Anagol et al. (2015), supra footnote 1075, which documents that life insurance agents in India purchase the same inefficient products that they recommend to their clients. One study of Canadian financial professionals and their clients observed a commonality among portfolios of a given financial professional, and that the financial professional’s own portfolio allocations strongly predicted the asset allocations of his or her customers, indicating limited customization, regardless of the customer’s risk tolerance, age, or financial sophistication. Although the results of this paper indicate that conflicts of interest are unlikely to motivate advice because financial professionals and their investors hold similar portfolios, it does raise questions of the high cost of financial advice when customization is limited. See Stephen Foerster et al., Retail Financial Advice: Does One Size Fit All?, 72 J. Fin. 1441 (2017) (included because they capture insights into how financial professionals may be subject to similar biases as retail investors that are not captured by the studies suggested by the commenters). See Robinson (2007), supra footnote 1054. 1078 See Juhani T. Linnainmaa, Brian T. Melzer, & Alessandro Previtero, The Misguided Beliefs of Financial Advisors (Kelley Sch. of Bus., Research Paper No. 18–9, May 2018), available at https:// www.aleprevitero.com/wp-content/uploads/2018/ 06/SSRN-id3101426.pdf. See also CFA August 2018 Letter. E:\FR\FM\12JYR2.SGM 12JYR2 33428 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations clients; they traded excessively, chased returns, bought expensive actively managed funds, under-diversified their portfolios, and earned similar net returns. Further, these financial professionals continued to follow similar investment strategies as those they recommended to their clients, even after they had left the industry, suggesting that they believed their own investment advice.1079 jbell on DSK3GLQ082PROD with RULES2 c. Evidence of Potential Investor Harm A number of commenters provided citations to academic studies that analyze the evidence of potential investor harm driven by conflicts of interest of financial professionals.1080 A number of these studies, including Bergstresser et al. (2009), Del Guercio and Reuter (2014), and Christoffersen, Evans, and Musto (2013), underpinned the economic analyses of the Council of Economic Advisors 2015 Study (‘‘CEA Study’’) and the DOL RIA assessment of the aggregate harm borne by retail investors in retirement plans due to conflicts of interest.1081 Below we 1079 Linnainmaa et al. (2018), supra footnote 1078, also suggest that conflicts of interest may not be driven by financial professionals, but instead are between the firm and its clients, and that firms deliberately hire financial professionals who believe their misguided (and ultimately expensive) advice. In light of their findings, the authors suggest that regulation designed to stem conflicts of interest could be ineffective if aligning investors and financial professionals does not alter the advice that they provide, could raise barriers to entry that could reduce the amount of advice available, and may limit investor choice. 1080 See, e.g., AARP August 2018 Letter; Better Markets August 2018 Letter; CFA August 2018 Letter; EPI Letter; State Attorneys General Letter. 1081 See Letter from Linda Agerbak (Jun. 21, 2018) (‘‘Agerbak Letter’’); Better Markets August 2018 Letter; CFA August 2018 Letter; EPI Letter; Letter from Public Citizen (Aug. 7, 2018) (‘‘Public Citizen Letter’’); State Attorneys General Letter; Former SEC Senior Economists Letter. See also Bergstresser et al. (2009), supra footnote 1048; Diane Del Guercio & Jonathan Reuter, Mutual Fund Performance and the Incentive to Generate Alpha, 69 J. Fin. 1673 (2014); Susan E.K. Christoffersen, Richard Evans, & David K. Musto, What Do Consumers’ Fund Flows Maximize? Evidence from Their Brokers’ Incentives, 68 J. Fin. 201 (2013). See Office of the President of the United States, Council of Economic Advisers, The Effects of Conflicted Investment Advice on Retirement Savings (Feb. 2015), available at https:// obamawhitehouse.archives.gov/sites/default/files/ docs/cea_coi_report_final.pdf. See also DOL RIA, supra footnote 1002. Both the CEA Study and the DOL RIA assumed that the DOL Fiduciary Rule would eliminate all conflicts of interest and, therefore, all of the harms to retirement investors resulting from conflicts. See also Curtis (2018) and infra footnote 1103. By contrast, Regulation Best Interest would not require elimination or mitigation of firm-level conflicts, and will require written policies and procedures reasonably designed to eliminate or mitigate of some representative-level conflicts, which means that some conflicts and their attendant harms may remain, especially at the firm level. The disclosure requirements of Regulation Best Interest, however, may empower some customers to push back on broker-dealer conflicts VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 discuss evidence of potential investor harm attributable to recommendations of certain investments by financial professionals, including mutual funds, 401(k) plans, corporate bonds, and nontraded REITs. We then discuss the aggregate measures of investor harm estimated by the CEA Study and the DOL RIA and the limitations of those estimates. Directly addressing the question of whether and how brokerage customers or advisory clients are affected by conflicts of interest (e.g., through quantification) requires measurement of the effect of advice, subject to different levels of conflict, received from brokerdealers or investment advisers. Most data currently available to researchers does not make distinctions between types of firms or financial professionals, and generally aggregates all firms or financial professionals into a single category of financial professionals (e.g., ‘‘adviser’’ or ‘‘financial adviser’’). Further, an investor’s propensity to choose a particular type of relationship may be correlated with the investor’s skill or choice of investment and, therefore, may introduce bias into studies that are able to differentiate between types of advice relationships. Despite these limitations, by examining the existing academic literature, discussed below, we are able to gain qualitative insight into, and address commenter concerns, about conflicts of interest in the market for financial advice and the potential harm to investors. The majority of studies to date that investigate the potential harm to investors arising from potential conflicts of interest have generally centered on findings based on analysis of investments in mutual funds. Due to the readily available data for mutual funds, the literature is rich with studies exploring various aspects of those securities, including the performance of funds, relationships between flows and performance or expenses, and differences in performance of funds depending on the distribution channel. These studies have further been used by commenters and other providers of economic analyses to estimate the magnitude of investor harm potentially stemming from conflicts of interest as it relates to mutual fund investments.1082 of interest and more generally may have a deterrent effect. 1082 See CEA Study, supra footnote 1081, and DOL RIA, supra footnote 1002. See also EPI Letter; Better Markets August 2018 Letter; St. John’s U. Letter; Letter from Royce A. Charney, President, Trust Administrators (Aug. 7, 2018) (‘‘Charney Letter’’); Agerbak Letter; CFA August 2018 Letter. PO 00000 Frm 00112 Fmt 4701 Sfmt 4700 Evidence suggests that there is a strong relationship between past performance and subsequent fund flows, even when funds do not persistently outperform, suggesting that investors and/or their financial professionals may engage in returnchasing behavior.1083 Several studies also examine the effect of mutual fund costs, and find that (1) fund flows are negatively related to front-end loads, but are relatively insensitive to fund-level operating expenses (e.g., 12b–1 fees), indicating that investors may be aware of upfront costs when selecting funds, but may be less attuned to the effect on net returns of ongoing operating expenses; 1084 and (2) unsophisticated investors are more likely to pay higher fees than sophisticated investors and are less likely to expend search costs to look for lower-fee funds.1085 Retail investors, however, can benefit when funds commence operation of an institutional ‘‘twin’’ fund as overall expenses decrease and managerial effort increases, suggesting that retail investors may not be able to monitor fund managers as effectively as institutional investors.1086 Analyses in the CEA Study and the DOL RIA focus on the underperformance of certain broker-sold funds, potentially driven by conflicts of interest and a misalignment of incentives between financial professionals and investors.1087 A number of studies document that actively managed load mutual funds purchased by investors through a financial professional underperform 1083 See Judith Chevalier & Glenn Ellison, Risk Taking by Mutual Funds as a Response to Incentives, 105 J. Pol. Econ. 1167 (1997); Jonathan B. Berk & Richard C. Green, Mutual Fund Flows and Performance in Rational Markets, 112 J. Pol. Econ. 1269 (2004); Brad M. Barber, Terrance Odean, & Lu Zheng, Out of Sight, Out of Mind: The Effects of Expenses on Mutual Fund Flow, 78 J. Bus. 2095 (2005); Erik R. Sirri & Peter Tufano, Costly Search and Mutual Fund Flows, 53 J. Fin. 1589 (1998). In the theoretical model provided by Berk and Green (2004), active funds do not outperform passive funds because investors compete to invest in strong past performers (i.e., they chase returns), driving these funds’ returns to the competitive level. See also AARP August 2018 Letter; CFA August 2018 Letter. 1084 See Barber et al. (2005), supra footnote 1083. 1085 See Todd Houge & Jay Wellman, The Use and Abuse of Mutual Fund Expenses, 70 J. Bus. Ethics 23 (2007). See AARP August 2018 Letter. 1086 See Richard B. Evans & Rudiger Fahlenbrach, Institutional Investors and Mutual Fund Governance: Evidence from Retail-Institutional Fund Twins, 25 Rev. Fin. Stud. 3530 (2012). See AARP August 2018 Letter. The authors identify funds as ‘‘twins’’ if they share the same manager, investment objectives, fund families, and have a gross return correlation of 0.95 or greater. 1087 See CEA Study, supra footnote 1081, and DOL RIA, supra footnote 1002. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 other types of mutual funds.1088 For example, several studies find that actively managed load funds underperform a buy-and-hold strategy by between 1.56% and 2.28% annually, while other studies show that actively managed load funds underperform noload funds by between 1% and 1.5% per year.1089 This underperformance could be driven by poor market timing of investors (e.g., return chasing),1090 or because increased expenditures by the funds on marketing and advertising successfully attract retail flows, and such expenses decrease net returns to investors over time.1091 Fees and expenses, as documented by several studies, are two of the most reliable predictors of future returns, and fees should reflect performance (e.g., funds with high fees hypothetically should have better ex post performance in order to justify the fees), as at least some portion of the fees are dedicated to portfolio management; however, these studies consistently find a negative relationship between fees and performance—lower cost funds on average are more likely to generate higher performance net of fees than high cost funds.1092 1088 See Bergstresser et al. (2009), supra footnote 1048; Del Guercio & Reuter (2014), supra footnote 1081. 1089 See, e.g., Mercer Bullard, Geoffrey Friesen, & Travis Sapp, Investor Timing and Fund Distribution Channels (Working Paper, 2008); Geoffrey C. Friesen & Travis R.A. Sapp, Mutual Fund Flows and Investor Returns: An Empirical Examination of Fund Investor Timing Ability, 31 J. Banking & Fin. 2796 (2007); Matthew R. Morey, Should You Carry the Load? A Comprehensive Analysis of Load and No-Load Mutual Fund Out-of-Sample Performance, 27 J. Banking & Fin. 1245 (2003). See also Eugene F. Fama & Kenneth R. French, Luck Versus Skill in the Cross-Section of Mutual Fund Returns, 65 J. Fin. 1915 (2010), which notes that although some active managers may outperform passive benchmarks while others underperform, on average, the alpha attributable to active management will net to zero; therefore, net of fees, on average, and the alpha earned by actively managed funds will be reduced by the aggregate amount of fees and expenses of active management. See also William F. Sharpe, The Arithmetic of Active Management, 47 Fin. Analysts J. 7 (1991). See AARP August 2018 Letter; CFA August 2018 Letter. 1090 See, e.g., Bullard et al. (2008), supra footnote 1089; Friesen & Sapp (2007), supra footnote 1089. 1091 One study documents that heavily advertised funds outperform their benchmarks prior to the marketing efforts, but do not outperform their benchmarks in the post-advertising period. These funds, however, attract significantly more inflows, relative to a control group. See Prem C. Jain & Joanna Shuang Wu, Truth in Mutual Fund Advertising: Evidence on Future Performance and Fund Flows, 55 J. Fin. 937 (2000). See also Nikolai Roussanov, Hongxun Ruan, & Yanhao Wei, Marketing Mutual Funds (Nat’l Bureau of Econ. Research, Working Paper No. 25056, Sept. 2018), available at https://www.nber.org/papers/ w25056.pdf. See AARP August 2018 Letter; CFA August 2018 Letter; EPI Letter. 1092 See Javier Gil-Bazo & Pablo Ruiz-Verdu, The Relation Between Price and Performance in the VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 A number of studies, also cited by the DOL RIA and the CEA Study, explore the distinction between broker-sold funds and direct-sold funds, and the effect of the distribution channel on fund flows and performance. When examining a sample of only broker-sold funds, one study shows that funds that pay higher fees to financial professionals or charge higher excess loads generate greater fund inflows.1093 Moreover, broker-sold funds, on average, underperform direct-sold funds by between 23 bps and 255 bps per annum, with most studies observing average underperformance of approximately 100 bps (1%) per year.1094 Further, conflicts of interest appear to depend upon the choice of investment (e.g., broker-sold versus direct-sold funds) as well as the magnitude of the costs (e.g., mutual fund loads). One study suggests that the market for funds is segmented: More financially sophisticated investors select direct-sold funds, which unbundle portfolio management from advice of financial professionals, while less financially sophisticated investors purchase brokersold funds, which combine portfolio management and advice.1095 Another Mutual Fund Industry, 64 J. Fin. 2153 (2009); Russel Kinnel, Predictive Power of Fees: Why Mutual Fund Fees Are So Important, Morningstar Manager Research (May 2016); William F. Sharpe, The Arithmetic of Investment Expenses, 69 Fin. Analysts J. 34 (2013). Gil-Bazo & Ruiz-Verdu (2009) find that actively managed funds with the worst performance charge, on average, the highest fees. See AARP August 2018 Letter; CFA August 2018 Letter. 1093 See Christoffersen et al. (2013), supra footnote 1081; Chalmers & Reuter (2015), supra footnote 1042; Jasmin Sethi, Jake Spiegel, & Aron Szapiro, Conflicts of Interest in Mutual Fund Sales: What Do the Data Tell Us?, 6 J. Retirement 46 (2019). Christoffersen et al. (2013) and Sethi et al. (2019) measure excess loads by first estimating the baseline (average) load paid with regressions of loads on a number of explanatory variables, then using the residuals from these regressions (excess loads) to explain fund flows and performance. See also Morningstar Letter; Letter from Aron Szapiro, Director of Policy Research, Morningstar, Inc., et al. (Aug. 24, 2018) (‘‘Morningstar Letter Supplement’’). Sethi et al. (2019) find, however, that the relation between excess loads and fund flows tapered off after the DOL Fiduciary Rule was adopted, suggesting that the DOL Fiduciary Rule may have discouraged financial professionals from directing flows to funds with high excess loads. 1094 See, e.g., Bergstresser et al. (2009), supra footnote 1048; Chalmers & Reuter (2015), supra footnote 1042; Xuanjuan Chen, Tong Yao, & Tong Yu, Prudent Man or Agency Problem? On the Performance of Insurance Mutual Funds, 16 J. Fin. Intermediation 175 (2007). See AARP August 2018 Letter. 1095 See Del Guercio & Reuter (2014), supra footnote 1081. Moreover, this study finds that broker-sold actively managed funds underperform broker-sold index funds by between 1.1% and 1.3% per year, which the authors suggest may reflect an agency conflict. See also Diane Del Guercio, Jonathan Reuter, & Paula A. Tkac, Broker Incentives PO 00000 Frm 00113 Fmt 4701 Sfmt 4700 33429 study focuses exclusively on broker-sold funds, but segments those funds into groups that depend on the size of excess loads and whether the funds are sold by affiliated or unaffiliated brokers.1096 That study observes that funds with a one-standard deviation increase in excess loads are related to a reduction in future performance of between 34 bps and 49 bps in the following year. As detailed in Bergstresser et al. (2009), the broker-sold channel is likely to include funds sold through both broker-dealers and investment advisers; however, the data provided to the authors is not granular enough to be able to distinguish the performance characteristics of the two distinct channels.1097 A number of commenters stated that the Proposing Release did not appropriately account for existing economic analyses produced by the CEA Study and the DOL RIA to measure the potential harm to investors from conflicts of interest.1098 The CEA Study and the DOL RIA use the literature on underperformance of broker-sold mutual funds as the foundation for their analyses on the potential harm of retail investors, focusing on harm specifically directed at retirement savings. Applying an estimate of approximately 1% underperformance to broker-sold funds, which is consistent with estimates of underperformance provided by several studies,1099 the CEA Study and the DOL and Mutual Fund Market Segmentation (Nat’l Bureau of Econ. Research, Working Paper No. 16312, Aug. 2010), available at https:// www.nber.org/papers/w16312.pdf. See AARP August 2018 Letter; CFA August 2018 Letter. Although some of the growth in direct-sold funds comes from passive investing (e.g., index funds), greater than 75% of the number of direct-sold funds are actively managed (as of 2012). See Jonathan Reuter, Revisiting the Performance of Broker-Sold Mutual Funds (Working Paper, Nov. 2, 2015), available at https://www2.bc.edu/jonathan-reuter/ research/brokers_revisited_201511.pdf. 1096 See Christoffersen et al. (2013), supra footnote 1081. 1097 See Bergstresser et al. (2009), supra footnote 1048. The Bergstresser et al. study also notes that many funds in the direct-sold channel may be recommended by fee-based advisers, whose services ‘‘are typically paid for with an advisory fee that is outside of the fund expenses or distribution costs. As a practical matter, the ‘direct’ channel may not be as direct as one might imagine.’’ 1098 See also ARA August 2018 Letter; EPI Letter; Better Markets August 2018 Letter; St. John’s U. Letter; Charney Letter; Agerbak Letter; CFA August 2018 Letter. 1099 See Bergstresser et al. (2009), supra footnote 1048; Del Guercio & Reuter (2014), supra footnote 1081; Christoffersen et al. (2013), supra footnote 1081. A number of commenters, regarding the DOL RIA, indicated that both the CEA Study, supra footnote 1081, and the DOL RIA, supra footnote 1002, misinterpreted estimated effects described in the Christoffersen et al. (2013) paper, and overstated the potential harm associated with funds with high excess loads by more than double the actual E:\FR\FM\12JYR2.SGM Continued 12JYR2 33430 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 RIA apply different methods and approaches to calculate the aggregate dollar harm for retail investors in their retirement accounts.1100 Based on $1.7 trillion invested in potentially conflicted funds, the CEA Study estimates annual harm to retirement investors of approximately $17 billion.1101 Similarly, the DOL RIA, which estimates potential loss due to conflicts of interest of between 50 bps and 100 bps per year, produces ten-year aggregate estimates of investor harm of between $95 billion and $189 billion stemming from the underperformance of broker-sold mutual funds. The level of underperformance due to fund selection is highly sensitive to the data sample, including the sample period, as well as the methodology employed to calculate performance. Many of the studies used to support the analyses underlying the CEA Study and the DOL RIA rely on data obtained prior to 2011. However, since 2011 there have been a number of advances in the market for mutual funds (e.g., shifts from load to no-load funds and increase in no-load funds without 12b–1 fees), likely leading some of the inferences drawn from those studies to be dated and not reflective of the current market environment.1102 A number of commenters indicated potential flaws associated with the approach and interpretation of the analyses used by the CEA Study and the DOL RIA.1103 One study updates the Del Guercio and estimate had the interpretation been correct. See Craig M. Lewis, The Flawed Cost-Benefit Analysis Underlying the Department of Labor’s Fiduciary Rule (White Paper, Aug. 2017), available at https:// www.sec.gov/comments/ia-bd-conduct-standards/ cll4-2268185-160965.pdf; Public Interest Comment from Mark Warshawsky & Hester Peirce, George Mason University Mercatus Center (Apr. 17, 2017), available at https://www.mercatus.org/system/files/ warshawsky-dol-fiduciary-rule-pic-v1.pdf. See also Curtis (2018), supra footnote 1054. 1100 See CEA Study, supra footnote 1081, and DOL RIA, supra footnote 1002. 1101 See CEA Study, supra footnote 1081. 1102 See ICI Letter and Section III.B.2.e.ii, supra. 1103 See Lewis (2017), supra footnote 1099; Warshawsky & Peirce (2017), supra footnote 1099. See also Curtis (2018), supra footnote 1054. To date, only one academic study of which we are aware (Curtis (2018)) has analyzed the DOL Fiduciary Rule and the DOL RIA, and discusses issues with the approach taken by the DOL RIA in estimating the benefits and costs of the DOL Fiduciary Rule, noting that the DOL RIA likely underestimates the potential costs of the rule. This study also indicates that the net benefits of the DOL Fiduciary Rule are expected to be close to zero because the DOL Fiduciary Rule may not completely eliminate conflicts of interest and the actual cost of investment advice at the intermediary-level was excluded from the DOL RIA computation of benefit. Once the calculation accounted for costs of advice, Curtis (2018) estimates that the total costs attributed to conflicts of interest, including underperformance of some securities, is only slightly higher than the costs associated with advice that is free of conflicts. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 Reuter (2014) sample using data from between 2003 and 2012 and tests the robustness of the methodology by examining the underperformance of broker-sold funds relative to direct-sold funds.1104 While underperformance of broker-sold funds still existed, depending on the methodology and empirical approach used, the underperformance of these funds was reduced to between 20 bps and 70 bps, with the majority of the estimation approaches falling to between 20 bps and 50 bps, indicating a reduction in the underperformance of broker-sold funds relative to earlier studies.1105 Another study replicates the Christoffersen et al. (2013) analysis of excess loads on underperformance using data from between 2010 and 2017, and finds that after 2010, funds with high excess loads did not underperform funds with low excess loads, which the authors interpret as evidence that financial professionals have improved their recommendations over time.1106 Taken together, these recent studies on fund selection suggest that the magnitude of potential investor harm likely is not as large as that estimated by the CEA Study and the DOL RIA when more recent data is used to compute the underperformance of broker-sold mutual funds. Another recent study replicates and extends the Friesen and Sapp (2007) and Bullard et al. (2008) analyses of market timing ability by investors in mutual fund sales and purchases to newer data (2007 through 2016).1107 The Reuter (2015), supra footnote 1095. (2015), supra footnote 1095, states that ‘‘[t]hese changes suggest that the average brokersold fund has become more competitive with the average direct-sold fund’’; however additional research would be required to determine if these changes are driven by existing fund families, new fund families, or some combination of factors. When performance is value-weighted, Reuter (2015) discusses that brokers appear to direct clients toward funds that pay ‘‘higher-than-average distribution costs.’’ 1106 See Sethi et al. (2019), supra footnote 1093. The authors note that the underperformance of high excess load funds becomes statistically insignificant in the analysis only with the inclusion of prior-year performance of the fund (which Christoffersen et al. (2013), supra footnote 1081, include in one of their models). The authors suggest that the reduction in flows to funds with excess loads could be due in part to the DOL Fiduciary Rule; however, they also note that their analysis does not reveal a clear association between the DOL Fiduciary Rule and returns. The authors further cite to Holden et al. (2018), supra footnote 955, which discusses the shift away from load mutual funds to no-load funds over time. See also ICI Letter; Morningstar Letter; Morningstar Letter Supplement. 1107 See Karthik Padmanabhan, Constantijn Panis, & Timothy Tardiff, The Ability of Investors to Time Purchases and Sales of Mutual Funds (Working Paper, Nov. 1, 2017) (see also Department of Labor April 2019 memo). See, e.g., Bullard et al. (2008), PO 00000 1104 See 1105 Reuter Frm 00114 Fmt 4701 Sfmt 4700 study shows that the difference between dollar returns and buy-and-hold returns (‘‘performance gap’’) declined from 1.56% between 1991 and 2004 to 1.01% between 2007 and 2016 for a combined sample of load and no-load funds, suggesting a moderation in market timing errors in the most recent period. However, the excess performance gap (the difference between the performance gap on load funds and no load funds) has slightly increased between 2007 and 2016, from approximately 1% to 1.12%, indicating that, to the extent that load funds are sold by financial professionals and that all inflows and outflows are due solely to market timing motivations, investors who hold load funds are more prone to market timing errors than investors in no-load funds, and these errors are not being corrected by financial professionals. The studies discussed above acknowledge that interpretation of the empirical result that broker-sold funds underperform direct-sold funds is subject to another caveat because there is likely to be a selection bias in the type of investor that utilizes the direct-sold fund channel relative to those investors who rely on financial professionals for advice and recommendations about which funds to purchase. A similar selection bias is likely to exist for investors who purchase no-load funds versus those that purchase load funds from financial professionals. For example, although numerous studies discussed above suggest that financial advice is more likely to be obtained by older, more financially sophisticated, and wealthier investors,1108 Chalmers and Reuter (2015) observe that younger, less financially experienced, and less wealthy investors are more likely to buy broker-sold funds.1109 Beyond mutual funds, a nascent literature is emerging on other securities that may be prone to conflicts of interest by financial professionals.1110 Recent supra footnote 1089; Friesen & Sapp (2007), supra footnote 1089. 1108 See supra Section III.B.3.a. 1109 See supra footnote 1042. 1110 Some commenters (see, e.g., CFA August 2018 Letter; AARP August 2018 Letter; EPI Letter) also provided studies about conflicts of interest in 401(k) plans which have shown that (i) plan sponsors tilt securities toward high-cost securities (see Ian Ayres & Quinn Curtis, Beyond Diversification: The Pervasive Problem of Excessive Fees and ‘‘Dominated Funds’’ in 401(k) Plans, 124 Yale L.J. 1476 (2015)); (ii) plans have inadequate or excessive investment choices (see Edwin J. Elton, Martin J. Gruber, & Christopher R. Blake, The Adequacy of Investment Choices Offered by 401(K) Plans, 90 J. Pub. Econ. 1299 (2006); Sheena SethiIyengar, Gur Huberman, & Wei Jiang, How Much Choice is Too Much? Contributions to 401(k) Retirement Plans, in Pension Design and Structure: New Lessons from Behavioral Finance (Olivia S. E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations studies have examined potential conflicts of interest in markets for more complex investments, including reverse convertible corporate bonds and nontraded REITs. One study uses a sample of reverse convertible corporate bonds that differ only in the financial incentives provided to financial professionals and the coupon rate, and finds that investors are more likely to purchase—based on the advice given— the inferior bond (lower coupon, all else equal) with the higher ‘‘kick-back’’ to the broker-dealer, which appears to be driven by conflicts of interest between the financial professional and the investors.1111 In an examination of nontraded REITs, one study documents that retail investors in non-traded REITs underperformed by over $45 billion relative to a portfolio of traded REITs, and that nearly one-third of that underperformance was driven by upfront fees used to compensate brokerdealers.1112 Finally, although a significant amount of empirical evidence suggests that there may be investor harm due to conflicts of interest between financial professionals and investors, because of changes to the mutual fund industry (e.g., shifts from load to no-load funds and the introduction of new share classes),1113 increased competition,1114 and the anticipation of regulation designed to ameliorate potential conflicts of interest, several new studies indicate that potential harm to investors arising from conflicts of interest may be declining.1115 One survey paper concludes that although the empirical evidence is consistent with financial professionals having conflicts of interest that may harm consumers, ‘‘none of the articles concludes that clients would have been better off by foregoing advice. Even if people receive lower returns . . . consulting with an advisor may provide intangible benefits that consumers value,’’ and ‘‘it is important to bear in mind that these studies may have data limitations and in general cannot account for selection issues and the intangible benefits that investors receive from financial advisors.’’ 1116 Mitchell & Stephen P. Utkuss eds., 2004)); (iii) plans may include proprietary funds even when other funds perform better (see Veronika K. Pool, Clemens Sialm, & Irina Stefanescu, It Pays to Set the Menu: Mutual Fund Investment Options in 401(K) Plans, 71 J. Fin. 1779 (2016)); and (iv) funds included in 401(k) plans underperform passive benchmarks by approximately 31 bps annually (see Edwin J. Elton, Martin J. Gruber, & Christopher T. Blake, How do Employer’s 401(K) Mutual Fund Selections Affect Performance?, Ctr. for Retirement Research at Bos. Coll., Issue in Brief No. 13–1 (Jan. 2013), available at https://crr.bc.edu/wp-content/ uploads/2013/01/IB_13-1-508.pdf). 1111 See Egan (2019), supra footnote 1068. 1112 See Craig McCann, Fiduciary Duty and NonTraded REITs, Investments & Wealth Monitor, July/ Aug. 2015, at 39, available at https://www.slcg.com/ pdf/workingpapers/Fiduciary%20duty %20and%20Non-traded%20REITs.pdf. See CFA August 2018 Letter. 1113 See ICI Letter and Holden et al. (2018), supra footnote 951. See also Capital Group Letter; Money Management Institute Letter; FPC Letter at footnote 73. As noted above, innovations, including the introduction of T and clean share classes of funds may reduce the expected fund underperformance net of costs for retail investors relative to A shares by nearly 50 basis points annually. See supra footnote 1021 and accompanying text. See also supra footnote 1020 and accompanying text. 1114 See LPL December 2018 Letter; Morgan Stanley Letter (which discuss the migration to open architecture platforms). a. Trust in Investment Advice VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 4. Trust, Financial Literacy, and the Effectiveness of Disclosure A number of commenters stated that the Proposing Release did not sufficiently address how issues related to trust in financial professionals, investors’ level of financial literacy or sophistication, and limitations on the effectiveness of disclosure likely exacerbate the problems of information asymmetry and potential conflicts of interest between retail investors and financial professionals.1117 In order to address commenters’ concerns, we examined and discuss below both academic and industry research on how trust and financial literacy could affect the recommendations provided by financial professionals to retail investors, as well as the effectiveness and limitations of disclosure in ameliorating potential conflicts of interest. In seeking financial advice, a retail investor places not only money but also trust in a financial professional. Commenters stated that retail investors will follow the advice of their ‘‘trusted advisors,’’ because they believe ‘‘financial professional[s] will place the investor’s financial interest before his or 1115 See Reuter (2015), supra footnote 1042; Sethi et al. (2019), supra footnote 1093. See also CFA August 2018 Letter; EPI Letter; Morningstar Letter; Morningstar Letter Supplement. We include recent studies provided by commenters to present the current baseline of empirical findings on potential investor harm stemming from conflicts of interest. 1116 See Burke et al. (2015), supra footnote 1059. The DOL RIA, supra footnote 1002, and some commenters, however, have stated that no advice is a better alternative to advice subject to conflicts of interest. See also EPI Letter; Betterment Letter; PIABA Letter; CFA August 2018 Letter. The DOL RIA suggests that investors who obtain advice subject to conflicts of interest are worse off due to the costs associated with obtaining such advice (e.g., underperformance) than had they not sought or received advice at all. 1117 See AARP August 2018 Letter; CFA August 2018 Letter; FPC Letter; Rhoades December 2018 Letter; EPI Letter. PO 00000 Frm 00115 Fmt 4701 Sfmt 4700 33431 her own.’’ 1118 Moreover, one industry study of over 800 investors notes that ‘‘96% of U.S. investors report that they trust their financial professional and 97% believe their financial professional has their best interest in mind.’’ 1119 Academic studies have explored the issue of trust and how it affects financial decisions of investors. Studies in this strand of academic literature find that higher levels of trust increase investors’ propensity to seek investment advice and hire financial professionals,1120 increase levels of stock market participation,1121 and increase willingness to take on higher-risk investments.1122 Regarding the importance of trust in established advice relationships, some studies find that trust in financial professionals is greater when investors have lower financial literacy or when purchasing complex products, such as insurance products.1123 Further, as trust in 1118 See Letter from Christine Lazaro, President, PIABA (Dec. 7, 2018) (‘‘PIABA December 2018 Letter’’). See also, e.g., Rhoades December 2018 Letter; Gross Letter; Letter from William W. McGinnis, W. McGinnis Advisors (Aug. 7, 2018) (‘‘McGinnis Letter’’); EPI Letter; Betterment Letter; State Attorneys General Letter; Better Markets August 2018 Letter; OIAD/RAND (providing a survey on academic literature on trust). One survey notes, however, that approximately 15% of survey participants do not consult with financial professionals because they ‘‘don’t trust them.’’ See Cetera November 2018 Letter. 1119 See CCMC Letters. See also Center for Capital Markets Competitiveness, Working with Financial Professionals: Opinions of American Investors (2018), available at https://www.centerfor capitalmarkets.com/wp-content/uploads/2018/04/ CCMC_InvestorPolling_v5-1.pdf. 1120 See Jeremy Burke & Angela A. Hung, Trust and Financial Advice (RAND Labor & Population, Working Paper No. WR–1075, Jan. 2015), available at https://www.dol.gov/sites/default/files/ebsa/ laws-and-regulations/rules-and-regulations/ proposed-regulations/1210-AB32-2/trust-andfinancial-advice.pdf. This study indicates that increased financial trust is associated with higher levels of both seeking and following investment advice. See also AARP August 2018 Letter; FPC Letter; CFA August 2018 Letter. 1121 See Luigi Guiso, Paola Sapienza, & Luigi Zingales, Trusting in the Stock Market, 63 J. Fin. 2557 (2008). Guiso et al. (2008) find that higher levels of trust in financial professionals by investors is associated with a 50% increase in the probability of buying stocks and a 3.4% increase in the proportion of equity investments in the aggregate portfolio. See Rhoades December 2018 Letter. 1122 See Nicola Gennaioli, Andrei Shleifer, & Robert Vishny, Money Doctors, 70 J. Fin. 91 (2015). This study suggests that increased trust in financial professionals by investors alleviates anxiety in undertaking higher-risk investments (e.g., equities) (included because they capture aspects of the benefits of higher levels of trust in financial professionals by retail investors that are not captured by the studies suggested by the commenters). 1123 See Thomas Pauls, Oscar Stolper, & Adreas Walter, Broad-Scope Trust and Financial Advice (Working Paper, Nov. 17, 2016), available at https:// www.researchgate.net/publication/314235638_ Broad-scope_trust_and_financial_advice; David de E:\FR\FM\12JYR2.SGM Continued 12JYR2 33432 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 financial professionals grows, investors may be more likely to delegate all investment decisions to the financial professional, irrespective of their level of financial education.1124 Several commenters stated that some financial professionals respond to the trust that retail investors place in them by acting on their conflicts of interest, which could benefit the financial professional at the expense of the investor.1125 In addition, some studies have shown that higher levels of trust by retail investors can provide incentives for financial professionals to provide conflicted investment advice or undertake actions that benefit themselves at the expense of their customers. For example, one study found that because investors trust their financial professionals to provide higher ex ante expected returns on their risky investments, firms employing those professionals increased fees above levels that, in the author’s view, were consistent with a competitive equilibrium, resulting in lower ex post net returns to investors.1126 Further, this study documents that, although a relationship with a trusted professional can encourage investors to invest in financial markets when it is efficient for them to do so, in some cases financial professionals may instead provide more conflicted investment advice or inefficient advice in order to satisfy the desires of investors who trust them (e.g., undertaking lottery-like behavior by investing in the riskiest securities).1127 Although trust in financial professionals can help alleviate certain behavioral biases and encourage participation in the securities markets, one commenter stated that ‘‘[r]etail customers who place their trust in salespeople that market services as acting in their best interest can end up paying excessively high costs for higher risk or underperforming investments that only satisfy a Meza, Bernd Irlenbusch, & Diane Reyniers, Disclosure, Trust and Persuasion in Insurance Markets (IZA Discussion Paper Series, No. 5060, July 2010), available at https://repec.iza.org/ dp5060.pdf. See also OIAD/RAND, which shows that investors most likely in need of investor protection (e.g., financially unsophisticated) are most likely to place their trust in financial professionals. See also Letter from AFL–CIO et al. (Dec. 7, 2018) (‘‘AFL–CIO December 2018 Letter’’). 1124 See Riccardo Calcagno, Maela Giofre, & Maria Cesira Urzi-Brancati, To Trust is Good, but to Control is Better: How Investors Discipline Financial Advisors’ Activity, 140 J. Econ. Behav. & Org. 287 (2017). See OIAD/RAND. 1125 See, e.g., Rhoades December 2018 Letter; EPI Letter; Better Markets August 2018 Letter. 1126 See Calcagno et al. (2017), supra footnote 1124. 1127 See id. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 suitability standard, not a fiduciary standard.’’ 1128 b. Financial Literacy and Investment Advice As discussed above, financial literacy affects those who seek investment advice from financial professionals. One commenter noted that ‘‘[a]s consumers move closer to retirement, they may be more vulnerable to the negative impact of advice that is not in their best interest for three reasons: (1) The assets they have to invest are larger; (2) they may lack strong financial literacy skills; and (3) reduced cognition may affect financial decision making.’’ 1129 A number of studies have shown that financial literacy is significantly related to retirement planning and wealth accumulation by retail investors.1130 Generally, studies find that investors who are more financially literate or sophisticated are more likely to seek investment advice and are more likely to follow that advice than less financially sophisticated investors.1131 Further, one study shows that investors with lower financial literacy who do not seek investment advice underperform investors with higher financial literacy who seek investment advice by more than 50 bps on average, and these losses are predominantly driven by underdiversification of their portfolios.1132 1128 See AARP August 2018 Letter. See also PIABA Letter; St. John’s U. Letter. See also Joseph C. Peiffer & Christine Lazaro, Major Investor Losses Due to Conflicted Advice: Brokerage Industry Advertising Creates the Illusion of a Fiduciary Duty, PIABA Report (Mar. 25, 2015), available at https:// piaba.org/sites/default/files/newsroom/2015-03/ PIABA%20Conflicted%20Advice%20Report.pdf. 1129 See AARP August 2018 Letter. 1130 See, e.g., Jere R. Behrman et al., Financial Literacy, Schooling, and Wealth Accumulation (Nat’l Bureau of Econ. Research, Working Paper No. 16452, Oct. 2010), available at https:// www.nber.org/papers/w16452.pdf; Hans-Martin von Gaudecker, How Does Household Portfolio Diversification Vary with Financial Literacy and Financial Advice?, 70 J. Fin. 489 (2015) (included in response to comment letters that expressed views about limited financial literacy by some retail investors). 1131 See supra Section III.B.3. See also Riccardo Calcagno & Chiara Monticone, Financial Literacy and the Demand for Financial Advice, 50 J. Banking & Fin. 363 (2015), who observe that investors with lower levels of financial literacy are less likely to consult advisers and avoid risky assets; however, when they do seek advice, they generally delegate investment decisions to their financial professionals. Lusardi & Mitchell (2011) indicate that investors who are more financially sophisticated are more likely to plan for wealth accumulation and be successful in their planning. See Annamaria Lusardi & Olivia S. Mitchell, Financial Literacy and Planning: Implications for Retirement Wellbeing (Nat’l Bureau of Econ. Research, Working Paper No. 17078, May 2011), available at https://www.nber.org/papers/ w17078.pdf. See AARP August 2018 Letter. 1132 See von Gaudecker (2015), supra footnote 1130. This study finds that losses borne by PO 00000 Frm 00116 Fmt 4701 Sfmt 4700 A number of studies link retail investor demographic characteristics to financial literacy and document that financial illiteracy, although widespread, is most significant among investors with lower levels of educational attainment, women, and minorities.1133 Moreover, many studies have examined the relationship between age, cognition, and financial literacy, and have shown that older investors, on average, are the least likely to be financially literate, and that financial literacy degrades as investors age.1134 A number of these studies show, however, that investors with low levels of financial literacy are likely to be overconfident in their financial abilities. For example, several studies that explore the relationship between age and financial literacy show that confidence in financial decision making does not decline with age, and potentially leads to poor decisions (e.g., paying higher mortgage rates).1135 Although overconfident investors with low levels of financial literacy could potentially benefit most from seeking and following investment advice, one study shows that over-confident investors are less likely to seek advice and perceive it as less valuable.1136 One potential problem, however, for investors with lower financial literacy is that they may not be able to distinguish the quality of their financial professional or the advice that they receive.1137 One study documents that small traders, relative to large institutional investors, are unable to recognize biases in recommendations investors with lower financial literacy are predominantly driven by under-diversification of their portfolios. 1133 See Lusardi & Mitchell (NBER 2011), supra footnote 1131. See also Annamaria Lusardi & Olivia S. Mitchell, Financial Literacy and Retirement Planning in the United States, 10 J. Pension Econ. & Fin. 509 (2011). See AARP August 2018 Letter. 1134 See Michael S. Finke, John Howe & Sandra J. Huston, Old Age and Decline in Financial Literacy (Working Paper, Aug. 24, 2011), who document that financial literacy scores decline by approximately 1% each year over the age of 60. See also Annamaria Lusardi, Olivia S. Mitchell, & Vilsa Curto, Financial Literacy and Financial Sophistication Among Older Americans (Nat’l Bureau of Econ. Research, Working Paper No. 15469, Nov. 2009), available at https:// www.nber.org/papers/w15469.pdf; Keith Gamble et al., Aging and Financial Decision Making, 61 Mgmt. Sci. 2603 (2015). See AARP August 2018 Letter. 1135 See Finke et al. (2011) and Gamble et al. (2015), supra footnote 1134. 1136 See Marc M. Kramer, Financial Literacy, Overconfidence and Financial Advice Seeking (Working Paper, Dec. 19, 2014), available at https:// efmaefm.org/0EFMAMEETINGS/ EFMA%20ANNUAL%20MEETINGS/2015Amsterdam/papers/EFMA2015_0067_fullpaper.pdf. 1137 See Lauren E. Willis, Against FinancialLiteracy Education, 94 Iowa L. Rev. 197 (2008). See AARP August 2018 Letter. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations provided by securities analysts, and therefore follow analyst recommendations to buy and sell securities without considering other information produced by the analyst.1138 Additionally, financial literacy may influence the quality of advice that financial professionals are willing to provide their clients. Some financial professionals appear to be more likely to provide superior information to more financially literate investors, who may be able to discern the quality of the advice, and more likely to provide inferior and potentially more conflicted information to investors who are less financially literate.1139 jbell on DSK3GLQ082PROD with RULES2 c. Evidence on the Effectiveness and Limitations of Disclosure Regulation Best Interest relies in part on disclosure of certain material facts to retail customers.1140 A number of commenters, however, stated that we failed to sufficiently account for limitations of disclosure in the Proposing Release of Regulation Best Interest.1141 One commenter stated that ‘‘studies show that regulation by disclosure alone can actually undermine investor protection by emboldening advisers to ignore the client’s best interest once they have ‘checked the disclosure box,’ and by rendering investors even more vulnerable to conflicted advice once they receive disclosures.’’ 1142 Another commenter asserted that the ineffectiveness of disclosure arises because of investors’ failure to understand the disclosure, inadequate time to read and process the information, cognitive dissonance, and trust in financial professionals’ oral representations over written disclosures, among others.1143 Below, we discuss 1138 See Ulrike Malmendier & Devin Shanthikumar, Are Small Investors Naive About Incentives?, 85 J. Fin. Econ. 457 (2007). See AARP August 2018 Letter. 1139 See Willis (2008), supra footnote 1137, and Calcagno & Monticone (2015), supra footnote 1131. See also John A. Turner, Bruce W. Klein, & Norman P. Stein, Financial Illiteracy Meets Conflicted Advice: The Case of Thrift Savings Plan Rollovers (Working Paper, Apr. 2015), available at https:// gflec.org/wp-content/uploads/2015/04/Turner0408Assessing-the-Standard-for-FinancialAdvice.pdf, which documents that financial professionals often suggest rolling over from thrift savings plans to more expensive plans (e.g., IRAs), and that such behavior is pervasive among both broker-dealers and investment advisers. See AARP August 2018 Letter. 1140 See supra Section II.C.1. 1141 See AARP August 2018 Letter; Better Markets August 2018 Letter; State Attorneys General Letter; EPI Letter; Morningstar Letter; Warren Letter; UVA Letter. 1142 See Better Markets August 2018 Letter. See infra footnote 1148 for studies submitted by this commenter. 1143 See State Attorneys General Letter. See also EPI Letter. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 studies that have identified characteristics that make disclosure effective as well as limitations to the effectiveness of disclosure to investors, in particular focusing on issues related to disclosure of conflicts of interest and how disclosure could inflate potential conflicts between financial professionals and investors. Characteristics of effective disclosures include saliency of information, clear and concise information delivered in a transparent manner, and increased use of visual and interactive design, among others.1144 One study, examining the effect of disclosure of fees and costs for mutual funds, observes that disclosures that prominently feature fees are more effective than others, but do not appear to reduce the importance that investors place on other fund characteristics, such as performance or risk.1145 Other studies, however, have found that disclosures may be ineffective, particularly if the intended audience does not read the disclosure documents or does not understand the material presented to them. One study, for example, notes that as the length and complexity of the disclosure document increases, so does the time that it takes for investors to read and understand the material contained within; therefore, investors are more likely to prefer shorter, simpler, and more straightforward language in disclosures.1146 Many studies have explored the effect of revealing conflicts of interest to 1144 See Relationship Summary Adopting Release at Section IV, which also discusses the benefits and limitation of disclosure. See also Margaret Hagan, Designing 21st Century Disclosure Methods for Financial Decision Making, Stanford Law School Policy Lab (2016), available at https:// law.stanford.edu/publications/designing-21stcentury-disclosures-for-financial-decision-making/. One study finds that when fund expenses are bundled with brokerage commissions, reducing the transparency of various fees and costs, investors experience larger degrees of underperformance than when the fees are more transparent. See Roger M. Edelen, Richard B. Evans, & Gregory B. Kadlec, Disclosure and Agency Conflict: Evidence from Mutual Fund Commission Bundling, 103 J. Fin. Econ. 308 (2012). See AARP August 2018 Letter. 1145 See Lucy Hayes, William Lee, & Anish Thakrar, Now You See It: Drawing Attention to Charges in the Asset Management Industry (Fin. Conduct Auth., Occasional Paper No. 32, Apr. 2018), available at https://www.fca.org.uk/ publication/occasional-papers/occasional-paper32.pdf. See Morningstar Letter. See also Anagol et al. (2015), supra footnote 1075. 1146 See Tamar Frankel, The Failure of Investor Protection by Disclosure, 81 U. Cin. L. Rev. 421 (2013). See FPC. See also Omri Ben-Shahar & Carl E. Schneider, The Failure of Mandated Disclosure, 159 U. Pa. L. Rev. 647 (2011), which also questions the effectiveness of disclosures and finds mandated disclosures ineffective substitutes for more direct regulation. See AARP August 2018 Letter; Better Markets August 2018 Letter; State Attorneys General Letter. PO 00000 Frm 00117 Fmt 4701 Sfmt 4700 33433 consumers and note that disclosure of conflicts may produce undesirable behavior by the disclosing party, or that receivers of the information provided by disclosures may fail to appropriately account for the implications.1147 A series of studies documents that consumers do not account for conflicts of interest revealed through disclosures, and that such disclosures of conflicts can have the perverse effect of increasing bias and moral licensing in the provision of advice.1148 Moral licensing arises when the discloser of information ‘‘take[s] an ethical action that validates [her] self-image as a good person’’ so she feels as though she ‘‘may well give [herself] permission to play fast and loose with the rules for a while.’’ 1149 Disclosure may also lead to a decrease in trust of biased advice because consumers feel pressured to satisfy the discloser’s self-interest (‘‘panhandler effect’’); 1150 however, the panhandler effect can be mitigated if the disclosure is provided from an external source, the disclosure is not common knowledge between the discloser and the receiver of the information, the receiver can change his or her mind at a later date, and the receiver can change his or her mind in private.1151 One 1147 See also Relationship Summary Adopting Release. 1148 See Daylian M. Cain, George Loewenstein, & Don A. Moore, When Sunlight Fails to Disinfect: Understanding the Perverse Effects of Disclosing Conflicts of Interest, 37 J. Consumer Res. 836 (2011); Daylian M. Cain, George Loewenstein, & Don A. Moore, The Dirt on Coming Clean: Perverse Effects of Disclosing Conflicts of Interest, 34 J. Legal Stud. 1 (2005); George Loewenstein, Daylian M. Cain & Sunita Sah, The Limits of Transparency: Pitfalls and Potential of Disclosing Conflicts of Interest, 101 Am. Econ. Rev. (Papers & Proc.) 423 (2011). These studies also note that, although disclosure is intended to help financially unsophisticated consumers, disclosure is most likely to be beneficial to sophisticated users of the information. One study, however, notes that disclosure can reduce biased advice if the disclosure acts as a deterrent against entering into conflicts, and may improve trust in advisers. See Sunita Sah & George Loewenstein, Nothing to Declare: Mandatory and Voluntary Disclosure Leads Advisors to Avoid Conflicts of Interest, 25 PSYCH. SCI. 575 (2014). See also Morningstar Letter; EPI Letter; Better Markets August 2018 Letter; Warren Letter; UVA Letter; AARP August 2018 Letter; Johnsen Letter. 1149 See Robert A. Prentice, Moral Equilibrium: Stock Brokers and the Limits of Disclosure, 2011 Wis. L. Rev. 1059 (2011). See AARP August 2018 Letter; Better Markets August 2018 Letter; State Attorneys General Letter. 1150 See Cain et al. (2011), supra footnote 1148; Sunita Sah, Prashant Malaviya, & Debora Thompson, Conflict of Interest Disclosure as an Expertise Cue: Differential Effects of Automatic and Deliberative Processing, 147 Organizational Behav. & Hum. Decision Processes 127 (2018), whereby disclosures of conflicts of interest act ‘‘as a heuristic cue to infer greater trust in advisors’ expertise.’’ 1151 See Sunita Sah, George Loewenstein, & Daylian M. Cain, The Burden of Disclosure: Increased Compliance With Distrusted Advice, 104 E:\FR\FM\12JYR2.SGM Continued 12JYR2 33434 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations study notes that, beyond conflicts disclosures, disclosures of actual bias lead to an improvement in performance of portfolios relative to investors who only receive conflict disclosures.1152 From the perspective of the investor, conflicts disclosures may lead to underor over-reaction by investors. According to one study, investors may not know how to appropriately respond to information about conflicts (e.g., estimating the effects on the quality of advice or knowing how to search for an unbiased second opinion) and therefore may fail to adequately adjust their behaviors when conflicts are disclosed.1153 Alternatively, some investors may overreact to disclosures of conflicts of interest, and may instead forgo valuable investment advice.1154 C. Benefits and Costs jbell on DSK3GLQ082PROD with RULES2 1. General In formulating Regulation Best Interest, the Commission has considered the potential benefits of establishing a best interest standard of conduct for broker-dealers, as well as the potential costs. Regulation Best Interest enhances the broker-dealer standard of conduct beyond existing suitability obligations, and aligns the standard of conduct with retail customers’ reasonable expectations. Under Regulation Best Interest, broker-dealers and their associated persons will be required, among other things, to: (1) Act in the J. Personality & Soc. Psychol. 289 (2013). See Morningstar Letter; Better Markets August 2018 Letter; EPI Letter. 1152 See Christopher Tarver Robertson, Biased Advice, 60 Emory L.J. 653 (2011). This study also suggests that obtaining an opinion from an unbiased adviser ‘‘is a much better remedy for biased advice than disclosure.’’ See AARP August 2018 Letter. 1153 See Angela A. Hung, Min Gong, & Jeremy Burke, Effective Disclosures in Financial Decisionmaking, RAND Labor and Population Report Prepared for the Department of Labor (2015), available at https://www.rand.org/content/dam/ rand/pubs/research_reports/RR1200/RR1270/ RAND_RR1270.pdf. See also AARP August 2018 Letter; Better Markets August 2018 Letter; Warren Letter. See also James M. Lacko & Janis K. Pappalardo, The Effect of Mortgage Broker Compensation Disclosures on Consumers and Competition: A Controlled Experiment, Federal Trade Commission, Bureau of Economics Staff Report (Feb. 2004), available at https://www.ftc.gov/ sites/default/files/documents/reports/effectmortgage-broker-compensation-disclosuresconsumers-and-competition-controlled-experiment/ 030123mortgagefullrpt.pdf, which documents that when mortgage customers receive information about mortgage broker compensation through disclosures, such disclosures lead to an increase in more expensive loans and create a bias against broker-sold loans, even when the broker-sold loans are the more cost effective option. See EPI Letter. 1154 See George Loewenstein, Cass R. Sunstein, & Russell Golman, Disclosure: Psychology Changes Everything, 6 Ann. Rev. Econ. 391 (2014). See IRI Letter. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker-dealer ahead of the interests of the retail customer; and (2) address conflicts of interest by establishing, maintaining, and enforcing policies and procedures reasonably designed to identify and fully and fairly disclose material facts about conflicts of interest, and in instances where we have determined that disclosure is insufficient to reasonably address the conflict, to mitigate or, in certain instances, eliminate the conflict. As a result, Regulation Best Interest should enhance the efficiency of recommendations that broker-dealers provide to retail customers, help retail customers evaluate the recommendations received, and improve retail customer protection when receiving recommendations from broker-dealers. The four component obligations of Regulation Best Interest’s work together to enhance the current standard of conduct for broker-dealers and improve disclosure of material facts relating to the scope and terms of the relationship and conflicts of interest. Both on its own and together with the other new rules and forms we are adopting,1155 we anticipate that Regulation Best Interest will reduce the agency costs of the relationship between the associated persons of the brokerdealer and their retail customers, while preserving access to financial advice and choice in the scope of services and how to pay for them. In this section, we discuss broader themes associated with the costs and benefits of Regulation Best Interest, including general comments we received on our analysis of the costs and benefits in the Proposing Release. Following this more general discussion, we discuss the specific costs and benefits associated with Regulation Best Interest’s four component obligations. While the Commission has considered the potential benefits and costs of Regulation Best Interest, the Commission notes that generally it is difficult to quantify such benefits and costs with meaningful precision.1156 Where possible, the Commission has provided an estimate of specific costs; however, several factors make the quantification of many of the effects of Regulation Best Interest difficult. With 1155 See, e.g., Relationship Summary Adopting Release. 1156 See supra Section III.B.3.c for discussion of the wide range of estimates of the potential benefits of Regulation Best Interest stemming from a reduction in investor harm, and discussion surrounding infra footnotes 1165–1182 for other issues associated with these estimates. PO 00000 Frm 00118 Fmt 4701 Sfmt 4700 respect to costs to broker-dealers, there is a lack of data on the extent to which broker-dealers with different business practices engage in disclosure and conflict mitigation activities to comply with existing requirements, and therefore how costly it would be to comply with the proposed requirements. Also, the final rule will provide broker-dealers flexibility in complying with Regulation Best Interest, and, as a result, there could be multiple ways in which broker-dealers will satisfy this obligation, although broker-dealers must comply with each of the elements of the obligation. In addition, Regulation Best Interest may affect broker-dealers differently depending on their business model (e.g., full service broker-dealer, broker-dealer that uses independent contractors, insurance-affiliated broker-dealer) and size. More generally, estimates of the magnitude of such benefits and costs depend on assumptions about (1) the extent to which broker-dealers currently engage in disclosure and conflict mitigation activities, (2) how brokerdealers currently develop recommendations for their customers, (3) how broker-dealers choose to comply with Regulation Best Interest, (4) whether and how broker-dealers change investments and share classes offered as a result of Regulation Best Interest, (5) whether and how product manufacturers change their investment offerings as a result of Regulation Best Interest, (6) whether broker-dealers restrict access to brokerage accounts by raising minimum account sizes or adding additional qualification requirements, (7) whether brokerdealers try to shift customers to advisory accounts as a result of Regulation Best Interest, (8) how retail customers perceive the risk and return of their portfolios, (9) how likely retail investors are to act on a recommendation that complies with Regulation Best Interest, (10) how the risk and return of retail customer portfolios change as a result of how they act on the recommendation, and (11) how investment advisers, including dually registered advisers, react to the adoption of Regulation Best Interest and the other regulatory developments, including the rules we are adopting and interpretations we are issuing simultaneously with Regulation Best Interest. Because many of these factors are firm-specific and thus inherently difficult to quantify, even if it were possible to calculate a range of potential quantitative estimates, that range would be so wide as to not be informative about the magnitude of the E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 benefits or costs associated with Regulation Best Interest. Broader economic forces, beyond broker-dealer and retail customer behavioral responses to Regulation Best Interest, also make meaningful estimates of economic impacts difficult to develop. The market for investment advice and services is complex and vast, and as history demonstrates, is dynamic and affected by market-specific facts (including product developments and regulatory changes) as well as macroeconomic factors (including general economic conditions). For example, the introduction of indexation to the retail investment market and the subsequent increase in index products (and providers) and reduction in the costs of indexing for retail investors have had substantial effects on the market for retail investment advice and services. The more recent introduction of ETFs has had similar unanticipated and underestimated effects, including, in general, reducing investor costs and increasing tax efficiency, as well as increasing the array of product offerings. Developments such as the employerdriven shift from defined benefit plans to defined contribution plans also have had significant effects on the market for investment advice. We expect these and other factors, including factors not currently identified, will continue to affect the market and, accordingly, may change the economic effects of the rule. These sources of uncertainty and complexity make meaningfully quantifying many of the costs and benefits of the rule difficult and, particularly over long time periods, inherently speculative. a. Broad Commenter Concerns With Respect to Costs and Benefits We received many comments regarding our analysis in the Proposing Release of the benefits and costs. In this section, we discuss comments that address broader aspects of our analysis. Comments that address costs and benefits of more specific components of Regulation Best Interest are discussed in the corresponding sections for each rule component that follows. Some commenters stated that our analysis in the Proposing Release did not properly incorporate current market practices into the baseline.1157 As discussed above, we have revised the discussion to include those practices, which may reflect guidance by SROs such as FINRA, requirements and obligations under state laws, practices implemented by broker-dealers in 1157 See, e.g., CFA August 2018 Letter; CCMC Letters. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 response to the (now vacated) DOL Fiduciary Rule that have not been reversed, and any practices implemented by broker-dealers to fulfill their obligations under existing federal securities laws.1158 While we acknowledged in the Proposing Release that variation in the extent to which broker-dealers with different business practices already engage in disclosure and conflict mitigation activities makes quantifying Regulation Best Interest’s costs and benefits with meaningful precision difficult, we more explicitly emphasize how this variation in current market practices affects the costs and benefits of Regulation Best Interest in the discussion that follows.1159 In general, to the extent that broker-dealer practices are already aligned with the requirements of Regulation Best Interest, the anticipated magnitude of both the costs and the benefits associated with a given component of Regulation Best Interest will be correspondingly reduced, and vice versa. As discussed above,1160 commenters noted the existence of fiduciary standards in various states. One commenter provided an overview of the fiduciary obligations of state-registered investment advisers, ‘‘typified by an expectation of undivided loyalty where the adviser acts primarily for the benefit of its clients.’’ 1161 This commenter also stated that ‘‘[s]ome states also extend these fiduciary obligations beyond investment advisers to brokers, especially in dual-hatted scenarios,’’ and that these fiduciary obligations were extended even when brokerdealers handled non-discretionary accounts.1162 We recognize that there is substantial variation in the sources, scope, and application of state fiduciary law. And we acknowledge that such state-level obligations for broker-dealers mean that they may already engage in practices under the baseline that overlap with certain requirements under Regulation Best Interest. To the extent that state-level law incorporates fiduciary principles similar to those reflected in Regulation Best Interest, the magnitude of the costs and benefits discussed below that stem from the application of those principles to broker-dealers will be correspondingly reduced. However, costs and benefits that arise from obligations under Regulation Best Interest that differ from obligations under state law, such as the supra Section III.B.2. Proposing Release at 21643. 1160 See supra Section III.B.2. 1161 See NASAA February 2019 Letter at 22 and footnote 40. 1162 Id. at 23–24. PO 00000 1158 See 1159 See Frm 00119 Fmt 4701 Sfmt 4700 33435 Conflict of Interest Obligation, will be maintained.1163 Some commenters suggested that certain types of costs should remain outside the scope of our analysis. Some stated that our analysis should not consider, for example, costs to brokerdealers resulting from lost revenues on securities they cease offering or costs associated with any potential increase in arbitration claims as a result of Regulation Best Interest, except to the extent that they are passed on to investors in the form of higher fees.1164 These commenters suggested that because these types of costs are a direct result of policies that make investors better off, they should not factor into an assessment of Regulation Best Interest. The Commission has an obligation to consider the economic effect of Regulation Best Interest on affected parties, including broker-dealers, even when those costs are associated with benefits to investors. However, in the specific discussion of each rule component that follows, we highlight instances where a given cost is directly associated with a benefit to investors. Commenters raised several issues related to the quantification of costs and benefits, or lack thereof, in the Proposing Release. They asserted that our analysis focused too much on Regulation Best Interest’s costs and did not quantify any of the benefits, such as the reduction in investor harm.1165 As discussed above, some studies present anecdotal evidence of behavior by certain broker-dealers, such as recommending investments that are inferior to available alternatives, that is harmful to investors.1166 A potential 1163 Whether Regulation Best Interest would have a preemptive effect on any state law would be determined in future judicial proceedings, and would depend on the language and operation of the particular state law at issue. We considered whether we could determine the economic impact of possible, future state-law preemption on retail customers, but concluded that we cannot analyze the economic effects of the possible preemption of state law at this point because the factors that will shape those judicial determinations are too speculative. Among the unknown factors are: (1) The final language in any proposed state legislation or regulation adopting a fiduciary or other standard for broker-dealers; (2) whether that language would constitute the type of law, rule, or regulation that is expressly preempted by the securities law or impliedly preempted under principles applied by courts; and (3) whether, if there was preemption, that preclusion of state law would have any positive or negative effects on investors when compared with the economic effects of Regulation Best Interest. 1164 See AARP August 2018 Letter; EPI Letter; Better Markets August 2018 Letter; Cetera August 2018 Letter. 1165 See AARP August 2018 Letter; Better Markets August 2018 Letter; CFA August 2018 Letter. 1166 See supra footnotes 1068 and 1075. E:\FR\FM\12JYR2.SGM 12JYR2 33436 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations benefit of Regulation Best Interest is therefore a reduction in that harm, as asserted by commenters. However, the anecdotal evidence of investor harm in these studies does not lend itself to aggregation. Commenters also stated that we should have incorporated the approach used by the DOL RIA and the CEA to quantify aggregate investor harm.1167 While both of these analyses surveyed a broad literature on the relative performance of broker-sold versus direct-sold mutual funds, they both relied on a particular study to estimate aggregate investor harm, extrapolating the effect of ‘‘excess loads’’ on the performance of broker-sold funds to total industry-wide AUM.1168 We disagree with this approach because, as noted by commenters, we believe these analyses misapplied the particular study’s results.1169 When the results of the study are correctly applied, the aggregate estimate of investor harm obtained using this approach is negligible.1170 Another commenter advocated a similar approach, claiming that riskadjusted returns net of fees, which calculate the excess return of an investment above a benchmark that matches the risk of the investment, are the only appropriate measure of whether a recommendation is in a retail customer’s best interest.1171 While there are studies showing that broker-sold mutual funds underperform direct-sold funds to varying degrees,1172 we do not believe, for the reasons explained below, that applying estimates of this under-performance to industry-wide AUM produces a meaningful estimate of the aggregate investor harm attributable to recommendations made by brokerdealers that is sufficiently precise to inform our policy choices. First, as discussed above, these studies do not necessarily cleanly distinguish underperformance attributable to brokerdealers from under-performance attributable to investment advisers.1173 Second, interpreting the relative underperformance of broker-sold funds as a measure of investor harm due to conflicts of interest implicitly evaluates investor harm against a benchmark that does not include financial advice. 1167 See Better Markets August 2018 Letter. supra footnotes 1081 and 1099. 1169 See, e.g., Lewis (2017), supra footnote 1099. 1170 See id. 1171 See EPI Letter. See also Former SEC Senior Economists Letter, stating that risk-adjusted returns are an appropriate measure of investor harm. 1172 See, e.g., Bergstresser et al. (2009), supra footnote 1048; Del Guercio & Reuter (2014), supra footnote 1081. 1173 See supra footnote 1097. jbell on DSK3GLQ082PROD with RULES2 1168 See VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 However, that benchmark does not necessarily reflect the appropriate alternative available to investors in broker-sold funds. Extrapolating from these studies leads to the conclusion that investors would do better investing on their own, yet there are other studies showing that is not the case, at least not for all investors.1174 We further note that calculating the investor harm against a benchmark that includes the fees retail customers would pay for equivalent advice could significantly reduce the magnitude of these estimates.1175 Finally, while risk-adjusted returns may be useful in comparing the performance of particular mutual funds, particularly when trying to evaluate fund manager skill, they do not necessarily reflect the utility that investors achieve from their investments.1176 Heterogeneous investors value investments and the services provided by financial professionals differently depending on their investment profile and preferences, and risk-adjusted returns do not necessarily represent aggregate utility across all investors in a way that permits us to arrive at an aggregate measure of investor harm. For example, consumers invest in various forms of insurance products in order to hedge their exposure to bad outcomes (e.g., home insurance policies), even though the expected returns on such investments are generally negative. The relative underperformance of brokersold mutual funds also may not capture any intangible benefits investors derive from receiving tailored financial advice.1177 Alternatively, the relative performance of mutual funds sold through these two channels may reflect other factors that are unrelated to conflicts of interest.1178 Accordingly, while we do not dispute the existence of broker-dealer behavior under the supra footnotes 1045–1048. also supra footnote 1103. 1176 Even in the context of evaluating fund manager skill, there is debate about whether riskadjusted returns are an appropriate measure of fund performance. See e.g., Vincent Glode, Why Mutual Funds ‘‘Under Perform’’, 99 J. Fin. Econ. 546 (2011); Jonathan B. Berk & Jules H. van Binsbergen, Measuring Skill in the Mutual Fund Industry, 118 J. Fin. Econ. 1 (2015). 1177 See, e.g., Bergstresser et al. (2009), supra footnote 1048, who note that ‘‘[o]ne possibility is that brokers provide other intangible benefits, which we cannot measure’’ when interpreting the relative performance of broker-sold versus directsold mutual funds. 1178 See, e.g., The DOL RIA, supra footnote 1002, at footnote 473, noting that the relative performance of broker-sold versus direct-sold funds ‘‘. . . is an imperfect measure of the impact of conflicts of interest; other factors, aside from conflicts of interest, affect the relative performance of mutual funds sold through the two distribution channels.’’ PO 00000 1174 See 1175 See Frm 00120 Fmt 4701 Sfmt 4700 baseline that is harmful to investors, based on our analysis, including our analysis of the comments received, we continue to believe that quantifying that harm, and therefore quantifying the benefits associated with reducing it, depends on many contingent factors that would render any estimates insufficiently precise to inform our policy choices.1179 With respect to the magnitude of the costs we assessed in the Proposing Release, some commenters asserted that our analysis underestimated the costs of complying with Regulation Best Interest, though only a few provided estimates of these costs.1180 Where commenters provided estimates for a specific component of Regulation Best Interest, particularly the Disclosure Obligation, we discuss those estimates when discussing that component of Regulation Best Interest below. Based on its experience with the DOL Rule, one commenter provided a broad estimate of the compliance costs associated with the entire package of rules we proposed, including Regulation Best Interest and Form CRS, indicating that the rule package would entail initial costs of $20 million and ongoing costs of $5 million per year for their firm, but that these costs would be manageable.1181 Another commenter stated that for a small broker-dealer with $500,000 in net capital, the compliance costs estimated in the Proposing Release could constitute 12% of that net capital, making compliance with Regulation Best Interest burdensome for such broker-dealers.1182 We acknowledge that the costs of Regulation Best Interest could be more burdensome for small broker-dealers and discuss any corresponding competitive effects in Section III.D.1. Although the majority of the industry studies provided by commenters focused on the effects of the DOL Fiduciary Rule on broker-dealers and their customers, one industry survey provided information about industry beliefs about potential effects of proposed Regulation Best Interest.1183 1179 See Discussion following footnote 1156 for a discussion of these factors. See also infra Section III.C.7, where we have endeavored to estimate some of the potential benefits of Regulation Best Interest based on many assumptions. 1180 See Schwab Letter; ICI Letter; Letter from James J. Angel, Associate Professor of Finance, Georgetown University (Aug. 7, 2018) (‘‘Angel Letter’’); LPL August 2018 Letter; NSCP Letter. 1181 See Raymond James Letter. 1182 See NSCP Letter. 1183 See Center for Capital Markets Competitiveness, SEC Regulation Best Interest Rule Proposals: Request for Information Analysis, FTI Consulting Report Presented to the U.S. Chamber of Commerce (Jul. 25, 2018), available at https:// E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 The survey consisted of approximately 30 individual financial professionals across a mix of 15 companies providing financial advisory services and products, including broker-dealers and dually registered firms, with $23 trillion in AUM and administration and nearly 79 million investment accounts. All of the participants surveyed stated that it was unlikely that they would reconsider their broker-dealer registration status, while nearly 40% stated that they may alter their investment choices and 35% could alter the services that they offer. With respect to the costs of Regulation Best Interest and Form CRS, approximately 36% of respondents stated that the implementation costs could be between 1% and 5% of annual profits; however, nearly 80% of respondents noted that costs are likely to decline over time.1184 We note that one of the cost estimates provided by a commenter above is consistent with this range.1185 One commenter suggested that for firms that offer access to thousands of unique securities, many of which likely have similar strategies (e.g., index mutual funds or ETFs), requiring broker-dealers to ‘‘consider reasonably available alternatives offered by the broker-dealer as part of having a reasonable basis for making the recommendation’’ would make it cost prohibitive for broker-dealers and financial professionals to evaluate the costs associated with ‘‘every similar investment product available through the broker-dealer’s platform.’’ 1186 Many survey participants, although they believed that the Commission underestimated the aggregate costs of Regulation Best Interest and Form CRS, agreed that the benefits to investors were likely to justify the costs. Other commenters stated that a number of elements of the Proposing Release potentially could increase litigation exposure for some brokerdealers. For example, one commenter discussed that, because proposed www.centerforcapitalmarkets.com/wp-content/ uploads/2018/08/Reg-BI-Rule-Proposal-Research_ 8.7.18_FTI-Updated_final.pdf. See CCMC Letters. Survey participants also addressed questions related to beliefs regarding investor protection, choices for retail customers, and the standard of conduct for broker-dealers. 1184 One commenter stated that the ‘‘costly’’ recordkeeping requirements described in the Proposing Release ‘‘are unnecessary as self-interest will lead firms to keep proof of compliance’’ and should be eliminated. See Angel Letter. 1185 See supra footnote 1181. Relative to this commenter’s 2018 fiscal year profits, its initial cost estimate of $20 million would represent approximately 2% of annual profits for this firm. See https://www.sec.gov/Archives/edgar/data/ 720005/000072000518000083/rjf20180930x10k.htm. 1186 See LPL December 2018 Letter. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 Regulation Best Interest did not ‘‘expressly define ‘financial incentive’’’ for purposes of the proposed requirement of policies and procedures designed to disclose and mitigate, or eliminate, conflicts arising from financial incentives, broker-dealers could face challenges to ‘‘design and maintain effective compliance programs that appropriately address the conflicts inherent in their particular business models’’ thereby potentially increasing litigation risks.1187 Another commenter indicated that, with respect to proprietary products, ‘‘[s]tate courts in enforcement actions and in review of such actions’’ may find it difficult to distinguish the best interest standard for broker-dealers from a fiduciary standard for investment advisers, and may cause certain associated persons of brokerdealers to ‘‘shy away from the risks of litigation in this regulatory environment, causing a substantial market contraction away from middle class investors.’’ 1188 In the Proposing Release, we were able to quantify costs for limited portions of Regulation Best Interest, particularly those stemming from requirements related to document creation for purposes of the Paperwork Reduction Act. While we have updated these estimates in Section IV.B, we continue to believe that it is not possible to meaningfully quantify the full costs and benefits of Regulation Best Interest because such analysis would depend on many contingent factors that render any estimate insufficiently precise to inform our policy choices.1189 So while we acknowledge, for example, that Regulation Best Interest may impose costs that are a significant portion of the estimate of initial and ongoing costs of $20 million and $5 million by the commenter cited above, we cannot anticipate the associated costs for all firms because of the wide variation in size and scope of business practices across firms as well as the many unknown factors associated with the principles-based nature of Regulation Best Interest. In discussing Regulation Best Interest’s component obligations below, we address any estimates provided by commenters where we can and otherwise explain the specific factors that preclude quantifying the costs of Regulation Best Interest with Primerica Letter. Letter from Douglas M. Ommen, Iowa Insurance Commissioner (Aug. 6, 2018) (‘‘Iowa Insurance Commissioner Letter’’). 1189 See Discussion following footnote 1156 for a discussion of these factors. See also infra Section III.C.7, where we have endeavored to estimate some of the potential benefits of Regulation Best Interest based on many assumptions. PO 00000 1187 See 1188 See Frm 00121 Fmt 4701 Sfmt 4700 33437 meaningful precision beyond our Paperwork Reduction Act estimates. b. Broad Investor Protection Benefits As discussed above, in addition to any enhancements provided above and beyond current requirements and market practices, each of the component obligations of Regulation Best Interest share features with market best practices under the baseline, as shaped by FINRA’s guidance on relevant rules or as described in its Report on Conflicts of Interest. Given this overlap, FINRA, in response to a congressional request, enumerated the ways it believes Regulation Best Interest enhances existing broker-dealer obligations under current FINRA rules.1190 In addition to the enhancements that each of Regulation Best Interest’s component obligations provide above and beyond existing broker-dealer obligations under the baseline, which we discuss below, Regulation Best Interest increases retail customer protections by establishing these obligations under the Exchange Act so that the Commission may enforce them directly and examine for compliance. Additionally, to the extent that market best practices may reflect some FINRA guidance that is not required by FINRA’s rules, some broker-dealers may not currently implement these practices. To the extent that broker-dealers and their associated persons do not currently implement existing best practices that will be codified in Regulation Best Interest, retail customers will benefit because it will increase the implementation of these best practices throughout the industry. 2. Disclosure Obligation As adopted, the Disclosure Obligation of Regulation Best Interest’s requires a broker-dealer, prior to or at the time of the recommendation, to provide to the retail customer, in writing, full and fair disclosure of all material facts relating to the scope and terms of the relationship and all material facts relating to conflicts of interest that are associated with the recommendation. Regulation Best Interest explicitly requires disclosure of ‘‘all material facts relating to the scope and terms of the relationship with the retail customer’’ including: (i) That the broker, dealer, or such natural person is acting as a broker, dealer, or an associated person of a broker or dealer with respect to the recommendation; (ii) the material fees and costs that apply to the retail customer’s transactions, holdings, and accounts; and (iii) the type and scope of 1190 See E:\FR\FM\12JYR2.SGM FINRA 2018 Letter. 12JYR2 33438 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 services provided to the retail customer, including any material limitations on the securities or investment strategies involving securities that may be recommended to the retail customer; and all material facts relating to conflicts of interest that are associated with the recommendation. Under the baseline, some disclosure obligations already exist, as do an array of market practices with respect to the disclosure of capacity, fees, services, and conflicts of interest.1191 The Disclosure Obligation will enhance disclosure obligations that exist under the baseline and bring greater alignment to market practices by establishing an explicit and broad disclosure requirement under the Exchange Act that applies to all broker-dealers when they make a recommendation to a retail customer. We expect this change to improve the quality and consistency of disclosures and thus (1) reduce the information asymmetry that may exist between a retail customer and her broker-dealer, and (2) facilitate customer comparisons of different broker-dealers which we expect will, in turn, increase competition among broker-dealers, including with respect to fees and costs, as discussed below.1192 Relative to the baseline, the Disclosure Obligation will change how broker-dealers disclose information to their retail customers in several specific ways. First, under the baseline, a brokerdealer and its associated persons are not explicitly required to disclose that they are acting in a broker-dealer capacity 1191 For instance, broker-dealers are subject to a number of disclosure obligations under the Exchange Act when they effect certain customer transactions. These disclosure obligations include written disclosure about capacity, compensation, and third-party remuneration related to the transaction, and disclosures about whether the broker-dealer has any control, affiliation, or interest in the security or the issuer of the security being offered. Broker-dealers also face liability under the antifraud provisions of the federal securities laws for failure to provide disclosure, such as disclosure of ‘‘honest and complete information’’ or any material adverse facts or materials conflicts of interest, including any economic self-interest, when recommending a security (see supra footnote 988). In addition, broker-dealers must comply with a number of SRO disclosure obligations—such as FINRA Rule 2124 (Net Transactions with Customers), FINRA Rule 2262 (Disclosure of Control Relationship with Issuer), and FINRA Rule 2269 (Disclosure of Participation or Interest in Primary or Secondary Distribution). Finally, brokerdealers may also adjust their practices consistent with existing SRO guidance on specific disclosures—such as FINRA Regulatory Notice 13– 23, Brokerage and Individual Retirement Account Fees (July 2013) on fee disclosure. See Proposing Release at footnotes 175, 176, 177, and 192; supra footnotes 303 and 985–988 for a more detailed discussion on existing disclosure practices. 1192 See supra footnote 1072 for a discussion of potential information asymmetries between brokerdealers and retail customers. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 when making a recommendation. We also clarify above that the use of the terms ‘‘adviser’’ or ‘‘advisor’’ in a name or title by (i) a broker-dealer that is not also registered as an investment adviser, or (ii) a financial professional that is not also a supervised person of an investment adviser would presumptively violate this particular disclosure requirement. Second, Regulation Best Interest requires that any disclosure made by a broker-dealer be ‘‘full and fair,’’ meaning that the broker-dealer is required to provide sufficient information to enable a retail investor to make an informed decision with regard to the recommendation, even where this information is about aspects of the relationship between a retail customer and a broker-dealer that may already require disclosure, implicitly or explicitly, under the baseline. We expect the ‘‘full and fair’’ requirement to benefit retail customers in cases where it results in disclosures that are not currently required under broker-dealer antifraud provisions. Finally, Regulation Best Interest requires that broker-dealers provide these disclosures to retail customers in writing at or before the time of a recommendation. However, we are permitting oral disclosures prior to or at the time of a recommendation and written disclosures after a recommendation under the circumstances outlined in Section II.C.1, Oral Disclosure or Disclosure After a Recommendation.1193 We focus our discussion of both the benefits and costs of the Disclosure Obligation on these changes relative to the baseline.1194 Regulation Best Interest’s Disclosure Obligation is different from the Proposing Release’s Disclosure Obligation in two ways. First, while the Proposing Release required that a broker-dealer ‘‘reasonably disclose’’ material facts to retail customers, Regulation Best Interest requires that a broker-dealer provide retail customers with ‘‘full and fair’’ disclosure of material facts. As discussed above, this change from the Proposing Release does not have a substantive effect on the expected economic effect of the Disclosure Obligation. Specifically, in both the Proposing Release and Regulation Best Interest, the formulation of the Disclosure Obligation, as 1193 For example, when oral disclosures are used prior to or at the time of a recommendation, brokerdealers must maintain a record of the fact that oral disclosure was provided. See supra footnotes 301 and 507–508 and surrounding discussion for more detail on when oral disclosure prior to or at the time of a recommendation and disclosure in writing after a recommendation are permitted. 1194 See supra footnotes 1157–1159. PO 00000 Frm 00122 Fmt 4701 Sfmt 4700 described in the release text, required that a broker-dealer provide sufficient information to enable a retail investor to make an informed decision with regard to a recommendation.1195 Therefore, we do not expect this change to affect our assessment of Regulation Best Interest’s costs and benefits. Second, whereas the Proposing Release’s Disclosure Obligation did not explicitly require a broker-dealer to disclose particular types of material facts relating to the scope and terms of its relationship with a retail customer, Regulation Best Interest explicitly requires that these material facts include the capacity in which the broker-dealer is acting, fees and costs, and the type and scope of services provided, including material limitations on the securities or investment strategies that may be recommended. We include any economic effects associated with this change in our discussion of Regulation Best Interest’s benefits and costs. Finally, while we discuss the direct benefits and costs of the Disclosure Obligation in this section, retail customers, broker-dealers, investment advisers, and their financial professionals may experience indirect benefits or costs due to competitive effects caused by the Disclosure Obligation. We discuss any competitive effects below in Section III.D.1. a. Benefits Regulation Best Interest requires that brokers, dealers, or natural persons associated with a broker-dealer disclose that they are acting as a broker, dealer, or an associated person of a brokerdealer prior to or at the time of a recommendation to a retail customer. Broker-dealers are not explicitly required to disclose this information prior to or at the time of a recommendation under the baseline, though they may disclose it to comply with other federal securities laws and SRO rules, or because they consider it to be a market best practice.1196 This requirement is most likely to have economic effects when retail customers have both brokerage and advisory accounts with the same financial professional, as may be the case if the financial professional is duallyregistered. It is designed to make all 1195 See Proposing Release at Section II.D.1.c. example, under the baseline, brokerdealers may decide that disclosing the capacity in which it is acting is necessary in order to meet its duty of fair dealing under the antifraud provisions of the federal securities laws. In addition, brokerdealers must disclose whether they effected the transaction as a principal or agent in the customer confirmation statement pursuant to Exchange Act Rule 10b–10, which a retail customer generally receives after the trade is completed. 1196 For E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 retail customers aware of the capacity in which their broker-dealer is acting when a recommendation is made, which may help the retail customer better evaluate the advice they receive. For instance, the cost to the retail customer of acting on such advice will typically depend on whether the advice is tied to the retail customer’s brokerage or advisory account. In addition, understanding the capacity in which a financial professional is acting may provide the retail customer with context for, and facilitate review of, other relevant disclosures by the broker-dealer. Knowing that she is receiving advice from a broker-dealer, or an associated person of a broker-dealer, may focus the retail customer’s attention on any potential conflicts of interest specifically associated with receiving a recommendation from a broker-dealer. For example, a disclosure that a firm is acting in the capacity of a broker-dealer may encourage a retail customer to seek additional information about commissions, which could give the firm or its financial professional an incentive to recommend transactions that may be inconsistent with the client’s most efficient investment strategy, such as a buy-and-hold strategy. While the capacity disclosure requirement and the disclosures investors will receive in Form CRS will increase the likelihood that retail customers understand the nature of their relationship with a broker-dealer or financial professional, and hence how this relationship might affect the recommendations retail customers receive, some investors may form beliefs about the nature of their relationship with a broker-dealer or financial professional based on their use of particular names and titles such as ‘‘adviser’’ or ‘‘advisor,’’ as well as how their services are marketed. In cases where these terms are used by (i) a broker-dealer that is not also registered as an investment adviser, or (ii) a financial professional that is not also a supervised person of an investment adviser, some retail customers may not fully understand that their broker-dealer or financial professional is not acting in the capacity of an investment adviser, even though investors receive some information about the capacity their broker-dealer or financial professional is acting in on Form CRS or other disclosures.1197 1197 Investors may not fully understand this capacity disclosure because, for example, their financial professional is not a supervised person of an investment adviser but works for a dualregistrant, and they interpret Form CRS as suggesting the financial professional also provides both types of services. Alternatively, even if an VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 To the extent that, despite the disclosures provided on Form CRS, the use of the titles ‘‘adviser’’ and ‘‘advisor’’ causes investor confusion about the nature of the relationship retail investors have, or will have, with a broker-dealer or financial professional, the presumption that the use of these titles by (i) a broker-dealer that is not also registered as an investment adviser, or (ii) a financial professional that is not also a supervised person of an investment adviser would violate the capacity disclosure requirement will potentially benefit investors in two ways.1198 First, certain investors may seek an advisory relationship and would be better off receiving advice from an investment adviser. In situations where confusion associated with titles might cause such an investor to mistakenly engage in a relationship with a brokerdealer or an associated person of a broker-dealer, the presumption should mitigate costs the investor might incur associated with receiving and, potentially, acting on recommendations from a broker-dealer, as well as costs associated with correcting this mismatch by switching to an investment adviser.1199 Second, to the extent that, as a result of the use of the titles ‘‘advisor’’ or ‘‘adviser,’’ any confusion might remain about the capacity in which a broker-dealer or its associated person is acting, the presumption should alleviate that confusion and thus increase the likelihood that retail customers focus their attention on any potential conflicts of interest specifically associated with receiving a recommendation from a broker-dealer. Any benefits associated with the presumption will apply for current and potential retail customers of the approximately 100 broker-dealers with retail customers that are not also investment advisers and use the terms ‘‘adviser’’ or ‘‘advisor’’ in their names, and for current and potential retail customers of the approximately 16% of all registered representatives that use these titles and are not dually investor’s broker-dealer or financial professional solely offers services in a broker-dealer capacity, the use of the titles ‘‘adviser’’ or ‘‘advisor’’ may leave her confused about the nature of the services provided, despite the capacity disclosure on Form CRS. See Relationship Summary Proposal at footnotes 411–412. 1198 Several commenters generally ascribed benefits to restricting the usage of the terms ‘‘adviser’’ and ‘‘advisor.’’ See supra footnotes 326– 330. 1199 See Relationship Summary Proposal at footnote 674 for further discussion of the costs associated with a mismatch between an investor and their preferred type of investment advice provider. PO 00000 Frm 00123 Fmt 4701 Sfmt 4700 33439 registered.1200 These benefits will be limited to the extent that broker-dealers and their financial professionals choose other names or titles that may indicate that they provide advisory services or use marketing materials that hold them out as providing advisory services but do not trigger the presumption or preclude application of the solely incidental prong of the broker-dealer exception to the definition of investment adviser.1201 As discussed above, under the baseline, broker-dealers may, in practice, already disclose information about the fees they charge, the type and scope of services they provide, and any conflicts of interest associated with their recommendations.1202 However, Regulation Best Interest’s explicit requirement that broker-dealers disclose all material facts related to the scope and terms of their relationship with a retail customer and all material facts relating to conflicts of interest that are associated with a recommendation may provide retail customers with useful information that they may not currently receive, enabling them to make more informed investment decisions. The magnitude and nature of this benefit will depend on the extent to which a broker-dealer already discloses these material facts and how broker-dealers choose to disclose this information. For example, if broker-dealers choose to disclose all material facts in one consolidated document, the disclosure may, depending on the facts and circumstances of the disclosure, be more informative to some retail customers than disclosures that are provided across many documents. In other cases, layered disclosures may allow brokerdealers to target their disclosures to their particular retail customer base at the relevant point in time, increasing 1200 Staff analysis found that 100 retail-facing broker-dealers as of December 2018 use either ‘‘adviser’’ or ‘‘advisor’’ in their firm names. See Relationship Summary Proposal at footnote 685 for more discussion of the estimate that approximately 16% of all registered representatives use these titles and are not dually registered. 1201 See supra footnotes 336–340. 1202 These disclosures may stem from implicit or explicit requirements under federal securities laws. For example, broker-dealers are explicitly required to disclose certain aspects of the fees their retail customers pay, directly and indirectly, under Exchange Act Rule 10b–10 (see, e.g., 913 Study at footnotes 256–259). In other cases, courts have found that broker-dealers may implicitly be required to disclose conflicts of interest or other material facts related to the scope and terms of their relationship with retail customers (see, e.g., 913 Study at footnotes 249–255). See also NASD Notice to Members 92–11. E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 33440 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations the likelihood that investors read these disclosures.1203 While the Proposing Release’s Disclosure Obligation did not explicitly require a broker-dealer to disclose particular types of material facts relating to the scope and terms of its relationship with a retail customer, Regulation Best Interest explicitly requires that these material facts include: (1) The capacity in which the broker-dealer is acting; (2) fees and costs; and (3) the type and scope of services provided, including material limitations on the securities or investment strategies that may be recommended. We generally anticipate greater benefits under Regulation Best Interest than under the Proposing Release. Specifically, to the extent that broker-dealers may not have disclosed the types of information we are requiring under Regulation Best Interest, Regulation Best Interest should increase the consistency of disclosure practices across broker-dealers, which may make it easier for investors to compare disclosures from and services offered by different broker-dealers or other firms. In addition, if some broker-dealers would not have disclosed the specific types of information required under Regulation Best Interest, and retail customers find that information useful, Regulation Best Interest may facilitate more informed decisions by retail customers when they are deciding whether or not to open an account or use a recommendation. For example, disclosures about the scope and terms of services offered by a broker-dealer or about their fees and costs may facilitate more informed decisions by retail customers as to which type of account is appropriate for them and whether they should open an account with a given broker-dealer. Alternatively, disclosures about conflicts of interest or fees and costs may facilitate more informed decisions by retail customers as to whether or not they should use a recommendation of a securities transaction or investment strategy. Regulation Best Interest also explicitly requires that disclosures be ‘‘full and fair,’’ and thus that a broker-dealer must provide sufficient information to enable a retail customer to make an informed decision with regard to a recommendation.1204 Broker-dealers may disclose, for example, certain conflicts of interest associated with their recommendations under the baseline. However, under existing federal 1203 See the discussion of layered disclosure in supra Section II.C.1.c. See also supra footnote 540 on the potential benefits of layered disclosure. 1204 See discussion at supra footnotes 463–469. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 securities laws and SRO rules, they are not expressly required to provide full and fair disclosure in the manner required under Regulation Best Interest. As a result, existing disclosure practices may not be designed to specifically help retail customers make informed decisions about the recommendations they receive. By explicitly requiring that broker-dealers provide sufficient information to enable retail investors to make an informed decision with regard to a recommendation, Regulation Best Interest imposes a minimum standard on disclosures that may increase the consistency of disclosure practices across broker-dealers relative to the baseline. This may also cause such disclosures to be more useful to retail customers in evaluating the advice they receive, thereby enabling them to make more informed decisions about the recommendations they receive. To the extent that disclosure obligations under the baseline already result in brokerdealers providing sufficient information to enable a retail customer to make an informed decision with regard to a recommendation, the magnitude of the benefits from this component of the Disclosure Obligation is likely to be correspondingly reduced.1205 Regulation Best Interest’s Disclosure Obligation also establishes a standard for the form and timing of disclosures by requiring that they be made in writing prior to or at the time of a recommendation. While broker-dealers may already disclose information on the fees they charge, the type and scope of services they provide, and any conflicts of interest associated with their recommendations under the baseline, federal securities laws and SRO rules may not explicitly specify the form and timing of such disclosures. In cases where these requirements are explicit, they may not require delivery at or prior to a retail customer’s evaluation of the recommendations they receive and any corresponding investment decision. In contrast, while broker-dealers will have some flexibility regarding the form and timing of their disclosures under Regulation Best Interest, retail customers will receive standardized disclosures about the fees and costs, as well as any conflicts of interest, associated with a recommendation prior to or at the time of receiving the recommendation. The Disclosure Obligation should increase the consistency of disclosure practices across broker-dealers and across different types of information relative to 1205 See supra footnote 1191 for more on disclosure obligations and requirements under the baseline. PO 00000 Frm 00124 Fmt 4701 Sfmt 4700 the baseline, thereby increasing the likelihood that retail customers have the information they need to make a more informed and efficient investment decision at the time they receive a recommendation. As noted above, we are permitting oral disclosure prior to or at the time of a recommendation and written disclosure after a recommendation has been made under the circumstances outlined in Section II.C.1, Oral Disclosure or Disclosure After a Recommendation.1206 Because oral disclosure is permitted in cases where written disclosure prior to or at the time of recommendation is not feasible or practical, investors may benefit by receiving information that otherwise may not have been available to them at the time they make an investment decision. In contrast, because written disclosure is permitted in instances where existing regulations permit disclosure after a recommendation, the benefits associated with the form and timing of disclosures under Regulation Best Interest may be reduced if the information in such disclosures would have been useful to investors in making an investment decision. However, for both oral disclosure prior to or at the time of a recommendation and written disclosure after a recommendation has been made as permitted under the circumstances outlined in Section II.C.1, Oral Disclosure or Disclosure After a Recommendation, retail customers will still receive disclosures in writing prior to a recommendation regarding the circumstances under which oral disclosure or disclosure after a recommendation will occur and the material facts that will be disclosed under these circumstances.1207 Several commenters stated that there are limits to the effectiveness of disclosure and cited a number of studies suggesting that disclosure alone is unlikely to solve the issues surrounding, for example, the conflicts of interest between a broker-dealer or the associated person of a broker-dealer and a retail customer.1208 Another commenter cited the 2008 RAND Study, concluding that investors do not have the education or background to understand financial disclosures and do not read long, formulaic documents.1209 Other commenters claimed that 1206 See supra footnote 1193. discussion following supra footnote 301. 1208 See Morningstar Letter; EPI Letter; Better Markets August 2018 Letter; St. John’s U. Letter; Letter from Tom C.W. Lin, Professor of Law, Temple University Beasley School of Law (Jul. 11, 2018) (‘‘Lin Letter’’). 1209 See Galvin Letter and discussion of 2008 RAND Study. 1207 See E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 numerous academic studies demonstrate that disclosing conflicts of interest does not adequately address the potential harm they cause to investors.1210 Another commenter provided studies showing that disclosure can encourage better behavior by broker-dealers, improving investor welfare.1211 As discussed above, we acknowledge studies showing disclosure can vary in its effectiveness depending on the issue it is intended to address, its intended audience, and the format in which it is delivered.1212 To the extent some retail customers are not able to understand the information disclosed by a broker-dealer regarding the scope of services it provides and the conflicts of interest associated with the recommendations it makes, the benefits of the Disclosure Obligation will not directly affect those investors, and may not increase the efficiency of their investment decisions. However, Regulation Best Interest is not limited to disclosure; rather, the Disclosure Obligation is just one component of Regulation Best Interest that as a whole will enhance the efficiency of recommendations that broker-dealers provide to retail customers, help retail customers evaluate the recommendations received, and improve retail customer protection when receiving recommendations from broker-dealers. In particular, in addition to the Disclosure Obligation, both the Care Obligation and the Conflict of Interest Obligation, discussed below, are designed to promote more efficient investment decisions by imposing affirmative obligations on the brokerdealer that cannot be fulfilled through disclosure alone, regardless of whether the retail customer fully incorporates disclosed information into its investment decisions. Additionally, to the extent that the information disclosed by broker-dealers as a result of Regulation Best Interest increases the comparability of the securities and services offered by different broker-dealers, it may foster competition between broker-dealers that benefits even those retail customers who are not able to understand the information disclosed by brokerdealers.1213 For example, if an increase in comparability promotes competition on the basis of recommendation quality, it may cause broker-dealers to mitigate 1210 See State Treasurers Letter; Better Markets August 2018 Letter; PIABA Letter. 1211 See Morningstar Letter. 1212 See supra Section III.B.4.c. 1213 See Relationship Summary Adopting Release at footnote 1035 for similar discussion of the potential benefits comparability can have on competition. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 or eliminate conflicts even in cases where the Conflict of Interest Obligation does not expressly require policies and procedures to mitigate or eliminate such conflicts. Because the Disclosure Obligation provides broker-dealers with some flexibility as to the form and timing of their disclosures, the magnitude of this benefit will depend on the extent to which these disclosures are comparable across broker-dealers or to which the disclosures made by one broker-dealer draw attention to practices at other broker-dealers that may not be in the best interest of retail customers. The magnitude of the Disclosure Obligation’s benefits will depend on a number of factors, including which facts about the scope and terms of their relationship with retail customers are material, the extent to which brokerdealers already disclose information in a manner that is consistent with the Disclosure Obligation under the baseline, the manner in which they choose to disclose this information, the extent to which retail customers understand such disclosures and would use them in making investment decisions, and the extent to which such disclosures would improve the efficiency of retail customers’ investment decisions, which varies with the specific circumstances of each retail customer. b. Costs We expect broker-dealers and their financial professionals to incur costs as a result of Regulation Best Interest’s Disclosure Obligation, and retail customers may incur indirect costs as well. In this section, we analyze these costs in terms of how Regulation Best Interest changes disclosure requirements for broker-dealers relative to the baseline. The requirement that broker-dealers or their associated persons disclose the capacity in which they or their associated persons are acting prior to or at the time of making a recommendation may be fulfilled by delivering the Relationship Summary, depending on the facts and circumstances.1214 For example, a standalone broker-dealer may satisfy this requirement of the Disclosure Obligation by delivering the Relationship Summary to the retail customer, as required pursuant to Form CRS. In contrast, for broker-dealers who are dually registered, and associated persons who are either dually registered or who are not dually registered but only offer broker-dealer services through a firm that is dually registered, 1214 See supra footnotes 320–321 and surrounding discussion. PO 00000 Frm 00125 Fmt 4701 Sfmt 4700 33441 delivering the Relationship Summary will not be sufficient to disclose the capacity in which they are acting. Thus, while standalone broker-dealers that deliver the Relationship Summary generally will not incur additional costs to comply with this requirement of the Disclosure Obligation, dual-registrants will incur additional costs, which could include the creation of disclosure materials as well as policies and procedures to assist their associated persons in determining when they are acting in a broker-dealer capacity. However, dual-registrants and their associated persons will have some flexibility with respect to the form, timing, or method of satisfying this requirement of the Disclosure Obligation when they or their associated persons make recommendations acting as brokers, dealers, or associated persons of a broker or dealer.1215 The presumption that the use of the titles ‘‘adviser’’ and ‘‘advisor’’ would violate the capacity disclosure requirement may impose costs on certain broker-dealers and their financial professionals, investors, and other affected parties. Broker-dealers and their associated persons currently using names and titles containing the terms ‘‘adviser’’ and ‘‘advisor’’ will incur direct costs, including those associated with changing firm names, written and/or electronic marketing materials, advertisements, and personal communication tools that use these titles, among other items, as well as any costs associated with voluntary outreach to customers to inform them of these changes.1216 While commenters did not provide specific estimates of these costs, they described them as ‘‘very real costs,’’ 1217 ‘‘significant costs and disruption,’’ 1218 and ‘‘burdensome and 1215 See supra footnote 306. e.g., HD Vest Letter (stating that ‘‘[t]he term ‘Advisor’ permeates nearly every HD Vest disclosure, representative agreement, selling agreement, client agreement, client communication, marketing piece, and website’’ and noting that broker-dealers would need to develop compliance policies to ensure oversight of the names and titles used by their financial professionals); LPL August 2018 Letter (stating that ‘‘legal entities with socalled ‘doing business as’ (d/b/a) names containing the term ‘advisor’ or ‘adviser’—through which many securities professionals operate their business practices—will be required to rename their businesses and incur significant costs and disruption in updating all marketing materials with the prior name.’’); SIFMA August 2018 Letter; Morgan Stanley Letter. 1217 See HD Vest Letter. 1218 See LPL August 2018 Letter. See also NAIFA Letter (noting the ‘‘significant costs to update all materials, marketing, signage, legally-required disclosure documents, etc. . . .’’); SIFMA August 2018 Letter (noting the ‘‘significant costs and burdens’’ that would be involved with ‘‘[e]xtensive repapering.’’). 1216 See E:\FR\FM\12JYR2.SGM 12JYR2 33442 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations costly.’’ 1219 To the extent that a brokerdealer’s company name that includes ‘‘adviser’’ or ‘‘advisor’’ is recognized as a brand in the market and therefore represents a valuable intangible asset to the broker-dealer, the broker-dealer may also incur indirect costs if some of its ‘‘brand value’’ is lost following a company name change.1220 Additionally to the extent that investors who have a preference for receiving advice from a broker-dealer or an associated person of a broker-dealer search exclusively for such advice using the terms ‘‘adviser’’ or ‘‘advisor,’’ they may experience a reduction in the choice of service providers available to them (e.g., they might only find dual-registrants).1221 Finally, organizations that award credentials or certifications to brokerdealers and financial professionals that include the terms ‘‘adviser’’ or ‘‘advisor’’ may lose revenues associated with a reduction in future demand for these credentials and certifications, or lose revenues associated with the maintenance of current credentials or certifications by awardees.1222 Relatedly, affected financial professionals may experience a loss associated with any value they currently derive from the use of these credentials or certifications.1223 Rather than incur any of the costs associated with changing names and titles discussed above, some broker-dealers may choose to register as investment advisers if they determine it will be less costly, in which case these broker-dealers will incur any costs associated with dual registration. The potential costs associated with the presumption apply for the approximately 100 brokerdealers, as of December 2018, with retail customers that are not also investment advisers and use either ‘‘adviser’’ or ‘‘advisor’’ in their firm names, and for the approximately 16% of all registered representatives that use these titles and 1219 See Morgan Stanley Letter. evidence suggest corporate brands are valuable intangible assets to firms. See, e.g., Mary E. Barth et al., Brand Values and Capital Market Valuation, 3 Rev. Acct. Stud. 41 (1998). 1221 The extent of this potential cost depends on how likely it is that investors rely on the titles ‘‘adviser’’ and ‘‘advisor’’ in finding a broker-dealer. For example, one survey suggests that 40–50% of investors find their financial professionals through personal recommendations, not via searches for these titles (see supra footnote 946 and discussion in Relationship Summary Adopting Release at Section IV.B.2.a). 1222 See IWI Letter (noting that ‘‘Title Restrictions, as proposed, have a potential to impact the longterm growth of two of the Institute’s registered marks.’’). This commenter did not provide specific data or estimates on the potential magnitude of this effect. 1223 See NAIFA Letter. This commenter did not provide specific data or estimates on the potential magnitude of this effect. jbell on DSK3GLQ082PROD with RULES2 1220 Academic VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 might be affected by the presumption.1224 The requirement that broker-dealers disclose material facts relating to the material fees and costs that apply to a retail customer’s transactions, holdings, and accounts may also be partially fulfilled by delivering the Relationship Summary. Form CRS will require broker-dealers to provide retail investors a high-level summary of principal fees and costs, including transaction-based fees, as well as a narrative discussion of other fees that retail investors will pay directly or indirectly. However, while providing such high-level summaries partially complies with the Disclosure Obligation, the Relationship Summary is unlikely to provide retail customers with all of the material facts about the fees and costs that apply to a particular recommendation.1225 As a result, Regulation Best Interest will impose costs on broker-dealers associated with assessing whether facts about the fees and costs that apply to a retail customer’s transactions, holdings, and accounts are material and delivering those material facts to retail customers. Broker-dealers will have some flexibility in how they comply with this requirement, which will allow them to tailor these disclosures to the needs of their retail customers and to implement them in a manner that is as cost efficient as possible, given their business models. In addition, the Disclosure Obligation may be satisfied by providing documents that broker-dealers are already required to produce or voluntarily produce under the baseline, such as prospectuses, in which case they may only incur costs associated with determining the timing and method by which they deliver these disclosures.1226 For example, under the baseline, broker-dealers may currently deliver prospectuses to retail customers after the completion of a transaction under the baseline, but would need to deliver them prior to or at the time of a recommendation under Regulation Best Interest, unless made under the circumstances outlined in Section II.C.1, Oral Disclosure or Disclosure After a Recommendation, allowing them to rely on delivery of information after the fact. In cases where required disclosures are already produced under the baseline, broker-dealers and their associated persons may still incur costs associated with delivering these disclosures prior to or at the time of a recommendation 1224 See 1225 See supra footnote 1200. the discussion following supra footnote if they are not delivered by that time under the baseline. Broker-dealers may also incur costs as a result of Regulation Best Interest’s requirement that they disclose material facts about the type and scope of services provided to a retail customer, including any material limitations on the securities or investment strategies involving securities that may be recommended to the retail customer. As discussed above, some broker-dealers may be able to fulfill their obligation to disclose these material facts, such as those related to account monitoring, account minimums, or material limitations on the securities or investment strategies that may be recommended, by complying with Form CRS or by using disclosures included in account opening agreements or other customer disclosures.1227 For these broker-dealers, this requirement of the Disclosure Obligation should not cause them to incur additional costs beyond an initial assessment of whether they can comply with the Disclosure Obligation using Form CRS or preexisting disclosures. In cases where a broker-dealer is not able to disclose all material facts relating to the type and scope of services they provide by complying with Form CRS or in combination with existing disclosures, broker-dealers will incur costs associated with assessing which facts about the type and scope of services provided to retail customers are material and delivering written disclosure of those material facts to retail customers. As discussed above, broker-dealers will have some flexibility in how they comply with this requirement, allowing them to tailor these disclosures to the needs of their retail customers and to their business models and to implement these disclosures in a cost efficient manner. While the Proposing Release’s Disclosure Obligation did not explicitly require broker-dealers or their associated persons to disclose particular types of material facts relating to the scope and terms of their relationship with a retail customer, Regulation Best Interest explicitly requires that these material facts include the capacity in which the broker-dealer or its associated person is acting; material fees and costs; the type and scope of services provided, including material limitations on the securities or investment strategies that may be recommended; and all material facts relating to conflicts of interest that are associated with a recommendation. To the extent that broker-dealers are not disclosing this information or are not 368. PO 00000 1226 See discussion at supra footnotes 495–496. Frm 00126 Fmt 4701 Sfmt 4700 1227 See E:\FR\FM\12JYR2.SGM supra footnote 1203. 12JYR2 jbell on DSK3GLQ082PROD with RULES2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations disclosing it by the time of a recommendation, broker-dealers may incur higher costs associated with disclosing these material facts under Regulation Best Interest compared to the baseline. In general, for any material facts relating to the scope and terms of its relationship with retail customers, a broker-dealer may have to determine how to disclose those facts in a manner that is ‘‘full and fair,’’ as required by Regulation Best Interest, which will cause it to incur costs. Similarly, the requirement that broker-dealers disclose all material facts in writing prior to or at the time of a recommendation may also impose costs on broker-dealers. For example, even if a broker-dealer currently discloses some information about its fees under the baseline, it may not currently disclose that information prior to the time of a recommendation, and may incur costs updating systems and processes to ensure the information is disclosed in a manner that complies with Regulation Best Interest’s requirements, including any costs associated with delivery of the information to retail customers. Broker-dealers may incur costs associated with the full and fair disclosure of all material facts relating to conflicts of interest that are associated with a recommendation. As discussed below in our analysis of the Conflict of Interest Obligation, brokerdealers currently have obligations to disclose certain material conflicts of interest under the baseline.1228 To the extent that broker-dealers will be required to disclose material facts about conflicts of interest that they do not currently disclose to retail customers under the baseline, broker-dealers will incur costs associated with assessing whether facts about these conflicts are material and delivering those facts to retail customers. They also may incur costs associated with identifying particular conflicts of interest to disclose.1229 As discussed above, there are circumstances where broker-dealers and their associated persons may make oral disclosures or written disclosures after the time of a recommendation under the circumstances outlined in Section II.C.1, Oral Disclosure or Disclosure After a Recommendation. Where oral disclosures are made, broker-dealers and their associated persons may incur costs associated with subsequently documenting such disclosures. These costs may include the time spent documenting such disclosures, the development of systems and processes necessary to document such disclosures, training associated persons to use these systems and processes, and supervising the compliance by associated persons with this obligation. For both oral disclosures and written disclosures made after a recommendation, brokerdealers and their associated persons may incur costs associated with developing initial disclosures about the material facts subject to oral disclosures and written disclosures after a recommendation, the circumstances under which such disclosures will be made, as well as costs associated with training financial professionals to make such disclosures in a manner that complies with Regulation Best Interest. While most of the costs associated with preparing and delivering disclosures are likely to be incurred by broker-dealers, their associated persons may incur costs as well. For example, when a financial professional is aware that the broker-dealer’s disclosure is insufficient to describe ‘‘all material facts,’’ the associated person must supplement that disclosure, and may incur costs in developing such disclosure on their own to ensure they are in compliance with the Disclosure Obligation.1230 The magnitude of this cost will depend on the extent to which the financial professional cannot rely on the disclosure made by the brokerdealer. As discussed above, while we are unable to quantify the full costs of Regulation Best Interest, including the Disclosure Obligation, we are able to estimate some of the costs associated with the Disclosure Obligation, specifically the costs related to information collection requirements as defined by the Paperwork Reduction Act. As discussed further below in Section IV.B.1, the Commission estimates that the preparation and delivery of standardized language, fee schedules, and standardized conflict disclosures that broker-dealers are required to provide to retail customers to comply with the Disclosure Obligation will impose on brokerdealers an initial aggregate burden of 6,216,125 hours and an additional initial aggregate cost of $42.84 million as well as an ongoing aggregate burden 1228 See infra footnote 1261. See also supra footnotes 985–988. 1229 See infra Section III.C.4 for a discussion of costs associated with identifying conflicts of interest as part of the Conflict of Interest Obligation. 1230 See discussion following supra footnote 307 for an example of a case where an associated person of a broker-dealer may be required to provide her own disclosures in order to comply with the Disclosure Obligation. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 PO 00000 Frm 00127 Fmt 4701 Sfmt 4700 33443 of 2,101,493 hours.1231 Thus, the Disclosure Obligation will impose an estimated initial aggregate cost of at least $1,508.88 million and an ongoing aggregate annual cost of at least $499.59 million on broker-dealers.1232 We note 1231 The estimate of the initial aggregate burden is based on the following calculation: 5,630 hours + 7,560 hours + 40,200 hours + 2,040,000 hours + 3,780 hours + 20,100 hours + 2,040,000 hours + 3,780 hours + 15,075 hours + 2,040,000 hours = 6,216,125 hours. As discussed in more detail in infra Section IV.B.1, 5,630, 7,560, and 40,200 hours are estimates of the initial aggregate burden for the preparation of disclosure of capacity, type, and scope, for dual-registrants and small and large broker-dealers, respectively. 2,040,000 hours is the estimate of the initial aggregate burden for the delivery of the disclosure of capacity, type, and scope to retail customers. 3,780 and 20,100 hours are estimates of the initial aggregate burden for the preparation of disclosure of fees for small and large broker-dealers, respectively. 2,040,000 hours is the estimate of the initial aggregate burden for the delivery of the disclosure of fees to retail customers. 3,780 and 15,075 hours are estimates of the initial aggregate burden for the preparation of disclosure of material conflicts of interest for small and large broker-dealers, respectively. 2,040,000 hours is the estimate of the initial aggregate burden for the delivery of the disclosure of material conflicts of interest to retail customers. The estimate of the initial aggregate cost is based on the following calculation: $2.80 million + $3.80 million + $15.00 million + $1.88 million + $9.99 million + $1.88 million + $7.49 million = $42.84 million. As discussed in more detail in supra Section V.D, $2.80 million, $3.80 million, and $15.00 million are estimates of the initial aggregate cost for the preparation of disclosure of capacity, type, and scope, for dual-registrants and small and large broker-dealers, respectively. $1.88 million and $9.99 million are estimates of the initial aggregate cost for the preparation of disclosure of fees for small and large broker-dealers, respectively. $1.88 million and $7.49 million are estimates of the initial aggregate cost for the preparation of disclosure of material conflicts of interest for small and large broker-dealers, respectively. The estimate of the ongoing aggregate burden is based on the following calculation: 3,941 hours + 3,024 hours + 40,200 hours + 408,000 hours + 1,512 hours + 8,040 hours + 816,000 hours + 756 hours + 4,020 hours + 816,000 hours = 2,101,493 hours. As discussed in more detail in supra Section V.D, 3,941, 3,024, and 40,200 hours are estimates of the ongoing aggregate burden for the preparation of disclosure of capacity, type, and scope, for dual-registrants and small and large broker-dealers, respectively. 408,000 hours is the estimate of the ongoing aggregate burden for the delivery of the disclosure of capacity, type, and scope to retail customers. 1,512 and 8,040 hours are estimates of the ongoing aggregate burden for the preparation of disclosure of fees for small and large broker-dealers, respectively. 816,000 hours is the estimate of the ongoing aggregate burden for the delivery of the disclosure of fees to retail customers. 756 and 4,020 hours are estimates of the ongoing aggregate burden for the preparation of disclosure of material conflicts of interest for small and large broker-dealers, respectively. 816,000 hours is the estimate of the ongoing aggregate burden for the delivery of the disclosure of material conflicts of interest to retail customers. 1232 These estimates are calculated as follows: (96,125 hours of in-house legal counsel) × ($415.72/ hour for in-house counsel) + (6,120,000 hours for delivery for each customer account) × ($233.02/ hour for registered representative) + (90,763 hours for outside legal counsel) × ($497/hour for outside legal counsel) = $1,508.88 million, and (35,056 hours of in-house legal counsel) × ($415.72/hour for E:\FR\FM\12JYR2.SGM Continued 12JYR2 33444 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 that these estimates assume brokerdealers are not currently producing and delivering documents associated with the Disclosure Obligation. To the extent that broker-dealers are already doing so, these estimates may overstate the costs associated with the information collection requirements as defined by the Paperwork Reduction Act. Several commenters stated that we underestimated the compliance costs of Regulation Best Interest in the Proposing Release, particularly with respect to the potential transactionbased nature of the Disclosure Obligation and the resultant recordmaking and recordkeeping requirements.1233 One commenter stated that if the Disclosure Obligation is a transaction-based requirement, its costs were significantly underestimated in the Proposing Release, citing an estimate that an earlier proposal of a point-of-sale disclosure requirement would cost between $1 million and $1.2 million per firm.1234 We first note that, given that there are approximately 2,766 brokerdealers with retail-facing operations, the commenter’s cited estimate implies initial costs of approximately $1.4 billion and ongoing costs of approximately $1.4 billion,1235 so the commenter’s implied estimate of $1.4 billion in initial costs associated with the Disclosure Obligation is consistent with our estimate of initial costs above.1236 Second, we note that, as discussed in more detail above in Section II.C.1.d, the Disclosure Obligation only requires that certain disclosures be made prior to or at the time of a recommendation, and brokerdealers may use standardized disclosures at an earlier point than the time of a recommendation to the extent in-house counsel) + (2,040,000 hours for delivery for each customer account) × ($233.02/hour for registered representative) + (26,437 hours for inhouse compliance counsel) × ($365.39/hour for outside legal counsel) = $499.59 million. The hourly wages for in-house legal and compliance counsel and registered representatives are obtained from SIFMA. The hourly rates for outside legal counsel are discussed in supra Section V.D. 1233 See Schwab Letter; ICI Letter; Angel Letter; Vanguard Letter; LPL August 2018 Letter; NSCP Letter. 1234 See Schwab Letter, citing April 12, 2004 comment letter from George Kramer of the Securities Industry Association (‘‘SIA’’). This estimate is based on a point-of-sale disclosure requirement in proposed rule 15c2–3, for which SIA estimated that implementation costs would be in the order of $500,000 per firm, as would annual costs associated with maintaining and updated necessary systems and procedures. See also SIFMA August 2018 Letter at footnote 38 referencing the same estimate. 1235 These estimates are calculated as follows: (2766 retail-facing broker-dealers) × ($500,000 per firm in initial costs) = $1.383 billion. Implied ongoing costs are calculated the same way. 1236 See supra footnote 1232. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 such disclosures satisfy the Disclosure Obligation. In this regard, while the commenter’s estimate may be indicative for some firms, the cost per firm will vary widely depending on the scope and business model of each broker-dealer. Because Regulation Best Interest provides broker-dealers with some flexibility regarding both the form and timing of the Disclosure Obligation, its costs are likely to be lower than a pure point-of-sale requirement.1237 Beyond the estimates provided above for that are derived from estimates developed for purposes of the Paperwork Reduction Act in Section IV.B.1, the Commission is unable to fully quantify the costs of the Disclosure Obligation because the magnitude of these costs depend on firm-specific factors that are inherently difficult to quantify given the principles-based nature of Regulation Best Interest.1238 These factors include the extent to which current disclosure practices under the baseline are different from the requirements of the Disclosure Obligation, the manner in which brokerdealers choose to comply with the Disclosure Obligation given the flexibility it provides, how brokerdealers assess whether facts relating to the scope and terms of their relationship with a retail customer are material, how they determine whether their disclosure of such material facts is full and fair, or the extent to which they will satisfy the Disclosure Obligation’s requirements by delivering the Relationship Summary or pre-existing documents. 3. Care Obligation Under the baseline, broker-dealers are subject to suitability obligations and requirements under the anti-fraud provisions of the federal securities laws and the Suitability Rule when making recommendations to retail customers. The Care Obligation incorporates and adds to existing suitability requirements applicable to broker-dealers, thereby reducing the incidence of inefficient recommendations to retail customers. FINRA rules require broker-dealers making recommendations to have, based on a particular customer’s investment profile, a reasonable basis to believe that the recommendation is suitable for that customer. In addition, FINRA guidance and Commission opinions interpret suitability as prohibiting a broker-dealer from placing its interests ahead of the customer’s interest and requiring the recommendations to be consistent with 1237 See supra footnotes 531–533 for a discussion of layered disclosure and footnotes 541–542 for a discussion of the Disclosure Obligation’s requirements with respect to timing of disclosures. 1238 See supra Section III.C.1. PO 00000 Frm 00128 Fmt 4701 Sfmt 4700 the customer’s best interest.1239 However, this obligation is not explicitly required by FINRA’s rule (or its supplementary material). Under the baseline, a recommendation by a brokerdealer or its associated persons may be consistent with a retail customer’s best interest but broker-dealers and their associated persons are not required to make recommendations in the best interest of these customers, as will be required under Regulation Best Interest. Relative to the baseline, the Care Obligation will change how brokerdealers and their associated persons make recommendations to retail customers in several ways, some of which differ from the Proposing Release. First, the Care Obligation explicitly includes cost as a factor for consideration when determining whether a recommendation is in a retail customer’s best interest. In contrast, the Proposing Release emphasized cost as an important factor to consider and stated that broker-dealers may be required to consider cost as a factor when making recommendations, but did not explicitly require its consideration when making a recommendation.1240 In addition, we clarify above in Section II.C.2 that, when determining whether a recommendation is in a retail customer’s best interest with respect to cost or other relevant factors, brokerdealers and their associated persons should consider reasonably available alternatives. Conversely, under FINRA suitability obligations, broker-dealers and their associated persons are not required to consider reasonably available alternatives when determining whether a recommendation is suitable for a retail customer.1241 Second, under the baseline, FINRA rules require that a broker-dealer or associated person who has actual or de facto control over a customer’s account must have a reasonable basis for believing that a series of recommended transactions, even if suitable when viewed in isolation, is not excessive and unsuitable for the customer when taken together in light of the customer’s investment profile. In contrast, the Care Obligation requires that a broker-dealer or its associated person has a reasonable basis to believe that a series of recommended transactions is not excessive and is in that retail customer’s best interest. This is the case at all times—when the broker-dealer or associated person has actual or de facto 1239 See supra footnote 570 and 913 Study at footnote 270. 1240 See supra footnote 572 and preceding text. 1241 See id. E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations control over a customer’s account as well as when no control exists (whether actual or de facto). Finally, FINRA’s suitability standard applies to recommendations of rollover decisions that involve securities transactions, but not necessarily in the absence of a securities transaction.1242 In addition, FINRA’s suitability standard does not explicitly apply to recommendations of account types and implicit hold recommendations resulting from agreed upon account monitoring.1243 In contrast, Regulation Best Interest explicitly applies to account recommendations as an ‘‘investment strategy involving securities,’’ including recommendations of securities account types, as well as rollovers or transfers of assets from one account to another. In addition, under Regulation Best Interest, implicit hold recommendations resulting from agreed upon account monitoring constitute recommendations of ‘‘any securities transaction or investment strategy involving securities,’’ and are therefore within the scope of Regulation Best Interest. Moreover, recommendations to open an IRA or to roll over assets into an IRA are subject to Regulation Best Interest, including the Care Obligation, thereby requiring a broker-dealer or its associated persons to have a reasonable basis to believe that the IRA or IRA rollover is in the best interest of the retail customer at the time of the recommendation, taking into consideration the retail customer’s investment profile and other relevant factors, as well as the potential risks, rewards, and costs of the IRA or IRA rollover compared to the retail customer’s existing 401(k) or other retirement account. We focus our discussion of both the benefits and costs of the Care Obligation under Regulation Best Interest on these changes relative to the baseline. Regulation Best Interest’s Care Obligation differs from the Proposing Release’s Care Obligation in two ways that respond to commenter concerns but that we do not expect to have significant economic effects.1244 First, the general best interest standard of conduct from the Proposing Release is incorporated into Regulation Best Interest’s Care Obligation, which, as adopted, also requires that a broker-dealer or its associated persons have a reasonable basis to believe that a recommendation, or series of recommendations, does not 1242 See FINRA Regulatory Notice 13–45 and supra footnote 172. 1243 See supra footnote 170. 1244 See discussion at supra footnotes 147, 606, and 577–584. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 place the financial or other interest of the broker-dealer or its associated persons ahead of the interest of the particular retail customer. Brokerdealers and their associated persons can comply with Regulation Best Interest as a whole by complying with its four component obligations, which now explicitly include the Proposing Release’s general best interest standard in elements of the Care Obligation. This change to the Care Obligation, as compared to the Proposing Release, is intended to emphasize the importance of determining that each recommendation is in the best interest of the retail customer and that it does not place the broker-dealer’s interests ahead of the retail customer’s interest; however, we do not believe there will be significant economic effects associated with this change from the Proposing Release.1245 Second, Regulation Best Interest, as adopted, does not explicitly require broker-dealers or their associated persons to exercise ‘‘prudence’’ in making recommendations. Instead they must exercise reasonable diligence, care, and skill in making such recommendations. While we removed the term ‘‘prudence’’ to address commenter concerns that it might create legal confusion and uncertainty, this does not change the requirements or obligations under the Care Obligation as compared to the Proposing Release.1246 Therefore, we do not expect this change to have a significant economic effect, as compared to the Proposing Release. a. Benefits As described in the Proposing Release, the Care Obligation did not explicitly require broker-dealers and their associated persons to consider the costs associated with a recommendation when determining whether it was in a retail customer’s best interest, though the Proposing Release discussed cost as a relevant factor in making this determination, and noted that brokerdealers might be required to consider cost as a factor when making recommendations under the baseline.1247 The Care Obligation under Regulation Best Interest includes an explicit requirement to consider the cost 1245 If anything, to the extent that broker-dealers or their associated persons might have misunderstood the Proposing Release with respect to their obligation to provide recommendations that are in the best interest of retail customers, Regulation Best Interest, as adopted, emphasizes the importance of determining that each recommendation is in the best interest of the retail customer will benefit retail customers. 1246 See supra footnotes 579–585 and surrounding discussion. 1247 See supra footnote 572. PO 00000 Frm 00129 Fmt 4701 Sfmt 4700 33445 of a recommendation. If this causes broker-dealers and their associated persons to more carefully consider cost in relation to other factors, compared to the baseline, it should reduce the incidence of recommendations of higher cost investments from a set of reasonably available alternatives that achieve the retail customer’s objective. If the explicit requirement to consider the cost of a recommendation encourages broker-dealers and their associated persons to more carefully consider cost, compared to the baseline, the final rule makes it less likely that a broker-dealer or its associated persons could have a reasonable basis to believe such investments are in the retail customer’s best interest because it would be difficult to have such a belief for investments that are identical beyond their costs. Therefore, including cost as a required factor in Regulation Best Interest should enhance the efficiency of recommendations to retail customers relative to the baseline.1248 As discussed above, while a ‘‘quantitative suitability’’ requirement applies to series of recommended transactions under the baseline, it only applies in cases where a broker-dealer has ‘‘control’’ over a customer account. Relative to the baseline, broker-dealers and their associated persons will be required to have a reasonable basis to believe that any series of recommended transactions is in the retail customer’s best interest, not just series of recommended transactions that occur in an account they control. This change relative to the baseline should enhance investor protection by reducing the incidence of cases where a broker-dealer or its associated persons recommend an excessively high rate of portfolio turnover, or ‘‘churn,’’ for accounts that they do not control. In addition, the discussion above regarding the potential benefits from the increased standard of conduct required by the Care Obligation in the context of individual recommendations also applies to series of recommended transactions. Enhancing the standard of conduct that applies to series of recommended transactions and reducing the incidence of recommendations that result in excess portfolio turnover should result in more efficient recommendations, benefiting retail customers. We are unable to specifically quantify these potential benefits because, in addition to the reasons cited above, we do not have and cannot reasonably obtain comprehensive data on how often broker-dealers, for accounts they do not 1248 See discussion surrounding supra footnotes 563–565. E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 33446 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations control, recommend series of transactions that result in excessive portfolio turnover and are therefore not in the best interest of their retail customers. Regulation Best Interest applies to account recommendations, including recommendations to open an IRA or to participate in an IRA rollover. Accordingly, these types of recommendations are subject to the Care Obligation (as well as the other components of Regulation Best Interest). Several commenters highlighted the heightened risk of harm associated with IRA and IRA rollover recommendations because the amount of assets associated with such recommendations can be a significant portion of a retail customer’s net worth, and one commenter cited academic and industry studies that identify activities that are particularly prone to conflicts of interest, including IRA rollovers.1249 We acknowledge the heightened effect that recommendations to open an IRA or to participate in an IRA rollover can have on the financial well-being of retail customers.1250 While FINRA’s suitability standard under the baseline applies to rollover recommendations involving securities transactions, the suitability standard does not necessarily apply to a rollover recommendation if that recommendation does not involve a securities transaction.1251 To the extent that broker-dealers and their associated persons currently make recommendations to open an IRA or to participate in an IRA rollover that do not involve securities transactions under the baseline, Regulation Best Interest should result in IRA and IRA rollover recommendations to retail customers that are more efficient because they will be in the retail customer’s best interest regardless of whether or not they involve securities transactions. Regulation Best Interest also applies to other account type recommendations. Broker-dealers may offer different types of brokerage accounts that include different levels of services and costs. The choice of account type can have a significant effect on the financial wellbeing of a retail customer. For example, a recommendation to open an advisory over a brokerage account, or vice versa, can have a substantial longterm effect on a retail customer’s assets. This effect may depend on the costs the retail customer incurs through the 1249 See CFA August 2018 Letter; AARP August 2018 Letter; Morningstar Letter; CFA Institute Letter. 1250 See supra footnotes 191–192. See also Fiduciary Benchmarks Letter. 1251 See supra footnote 1242. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 particular account as well as the retail customer’s investment profile.1252 Regulation Best Interest should result in recommendations regarding account type that are in the best interest of the retail customer, particularly with respect to cost, increasing the efficiency of the account type recommendations retail customers receive relative to the baseline. Finally, by clarifying that implicit hold recommendations resulting from agreed-upon account monitoring services constitute recommendations of ‘‘any securities transaction or investment strategy involving securities,’’ the Care Obligation will apply at the point in time at which their broker-dealer or associated person performs the agreed-upon monitoring, regardless of whether the broker-dealer or an associated person communicates any recommendation. This should increase the efficiency of the implicit hold recommendations retail customers receive relative to the baseline. b. Costs We expect broker-dealers and their associated persons to incur costs as a result of the Care Obligation, and, to the extent broker-dealers pass these costs on to retail customers, these customers may incur costs as well. In this section, we analyze these costs in terms of how Regulation Best Interest, as adopted, changes the required standard of care broker-dealers owe their retail customers relative to the baseline. We also highlight any changes in our assessment of these costs as compared to the Proposing Release. We discuss the costs of complying with the Care Obligation, such as those associated with training employees or developing policies and procedures, in Section III.C.5. To comply with the Care Obligation, some broker-dealers may stop offering certain securities to retail customers, or their associated persons may stop recommending certain securities to retail customers. These decisions may be based on determinations that offering or recommending those securities typically would not satisfy the Care Obligation. To the extent that they earn revenue from offering and recommending such securities, brokerdealers and their associated persons may incur costs associated with the determination to cease offering or recommending these products. Commenters stated that our analysis should not consider lost revenue as a cost of complying with Regulation Best Interest, except to the extent that the PO 00000 1252 See supra footnote 191. Frm 00130 Fmt 4701 Sfmt 4700 lost revenue is passed on to investors in the form of higher fees, because these types of costs are a direct result of policies that make investors better off.1253 As discussed above, our economic analysis must consider the costs Regulation Best Interest may impose on all affected parties, including broker-dealers. However, we believe that any loss of revenues associated with recommendations that would not satisfy the Care Obligation is compensated by the corresponding benefit to retail customers—namely the provision of more efficient recommendations by their financial professionals.1254 In addition, even if broker-dealers or their associated persons have a reasonable basis to believe that a certain investment could be in the best interest of some retail customers, they may forgo offering or recommending the investment if, for example, they think that it may increase their exposure to regulatory enforcement risk over their compliance with Regulation Best Interest.1255 This could result in costs to both the brokerdealer and any retail customers for whom the investment would be an efficient investment choice. Because the Care Obligation holds broker-dealers and their associated persons to an enhanced standard of conduct, they may incur costs associated with increased legal exposure if, for example, Regulation Best Interest results in increased retail customer arbitrations or litigation. For example, one commenter stated that the lack of clarity in how to weight various factors associated with the potential risks and rewards of a recommendation could lead to arbitrary claims regarding other alternative recommendations that, expost, would have performed better.1256 Similarly, because the Care Obligation also requires that a series of recommended transactions be in the best interest of a retail customer, regardless of whether a broker-dealer or an associated person controls the retail customer’s account, a broker-dealer could incur the same types of costs associated with increased arbitration or litigation risk relative to the baseline. We cannot anticipate the extent to which Regulation Best Interest will increase retail customer claims, but many retail customer arbitrations are already predicated in whole or in part on facts alleging that a broker-dealer 1253 See supra footnote 1164. supra Section III.A.2 for a more detailed discussion of efficient recommendations. 1255 See, e.g., Iowa Insurance Commissioner Letter. 1256 See CCMC Letters. 1254 See E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations breached a fiduciary duty or its suitability obligations. Additionally, the clarity in the rule text and this release regarding the Care Obligation, as well as the other aspects of Regulation Best Interest that bring enhanced conduct and clarity (e.g., the policies and procedures requirement and that Regulation Best Interest applies only at the time a recommendation is made) should mitigate against an increase in the likelihood and cost of such claims. The Care Obligation explicitly requires that cost be considered as a factor when determining whether a recommendation is in the best interest of a retail customer. Several commenters stated that the Proposing Release’s guidance emphasizing cost as a specific factor in the Care Obligation could create uncertainty around how the cost of a recommendation should be weighed with other factors.1257 As discussed above, the inclusion of cost as a factor in the Care Obligation does not require that the ‘‘least expensive’’ recommendation be made by a brokerdealer or its associated person; cost is one factor, but not the only relevant factor. Nonetheless, to the extent that the inclusion of cost as a factor in the Care Obligation increases the arbitration or litigation risk to which broker-dealers or their associated persons are exposed, this change could impose additional costs on broker-dealers. Regulation Best Interest also expressly applies to account recommendations, including recommendations of securities account types, as well as rollovers or transfers of assets from one account to another. We also clarify above that implicit hold recommendations resulting from agreedupon account monitoring are within the scope of Regulation Best Interest and are therefore subject to the Care Obligation. Should they choose to discontinue offering certain services, as a result of Regulation Best Interest, broker-dealers could lose revenue associated with making recommendations for account types (including IRAs). They may also decide to cease offering monitoring services on retail customer accounts. However, as we discussed above with respect to recommendations more generally, we believe that any loss of revenues associated with recommendations that would not satisfy the Care Obligation is compensated by the corresponding benefits to retail customers associated with more efficient account recommendations. The Commission is unable to fully quantify the costs that the Care 1257 See ICI Letter; CCMC Letters; LPL August 2018 Letter. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 Obligation will impose on brokerdealers, their associated persons, or their retail customers because the magnitude of these costs depends on firm-specific factors that are inherently difficult to quantify given the principles-based nature of Regulation Best Interest.1258 These factors include the extent to which broker-dealers and their associated persons currently engage in practices under the baseline that would satisfy the Care Obligation, either of their own volition or as a result of complying with other regulations; the extent to which broker-dealers and their associated persons will cease recommending certain securities or investment strategies; the likelihood that retail customers file more arbitration or litigation claims; and the extent to which broker-dealers pass on any cost increases to their retail customers.1259 4. Conflict of Interest Obligation The Conflict of Interest Obligation under Regulation Best Interest is intended to reduce the agency costs that arise when a broker-dealer and its associated persons provide a recommendation to a retail customer by addressing the effect of the associated person’s or broker-dealer’s conflicts of interest on the recommendation. The Conflict of Interest Obligation would require that broker-dealers establish, maintain, and enforce written policies and procedures that are reasonably designed to address the effect of the broker-dealer’s and the associated persons’ conflicts of interest on a recommendation. At a minimum, a broker-dealer is required to address the effect of conflicts of interest on a recommendation. At a minimum, a broker-dealer is required to address the effect of an identified conflict on a recommendation by disclosing the material facts associated with that conflict and by disclosing material limitations of the menu of securities when the conflict stems from such limitations. In certain cases, a brokerdealer is required to address the effect of an identified conflict by either mitigating the conflict, or, in certain cases, by eliminating certain sales practices. The Conflict of Interest Obligation is intended to reduce the information asymmetry between a retail customer and a broker-dealer and its associated persons with respect to the brokerdealer’s conflicts of interest or those of also supra Section III.C.1.a. discussion following infra footnote 1329 for discussion of factors affecting whether brokerdealers pass on costs to their retail customers and the resultant competitive effects. PO 00000 1258 See 1259 See Frm 00131 Fmt 4701 Sfmt 4700 33447 its associated persons that may have an effect on the recommendations provided to the retail customer. This disclosure may help the retail customer form a better assessment of the efficiency of the recommendation received. Moreover, reducing this information asymmetry may discourage broker-dealers from acting on incentives that differ from retail customer objectives. Similarly, by addressing the effect of certain conflicts of interest through mitigation, the Conflict of Interest Obligation is intended to reduce the effect incentives created by those conflicts may have on a recommendation provided to the retail customer. Depending on how effective the mitigation method is in reducing these incentives, the efficiency of the recommendation provided to the retail customer may increase. Similarly, by addressing the effect of certain conflicts of interest through elimination, the Conflict of Interest Obligation is intended to neutralize the effect of incentives created by those conflicts may have on a recommendation provided to the retail customer. In this case, the efficiency of the recommendations provided to the retail customer may increase. The conflicts of interest that the broker-dealer or its associated persons have, and the incentives that these conflicts create, arise from, among other things, the manner in which brokerdealers generate revenue and the manner in which broker-dealers compensate their associated persons with respect to their dealings with retail customers. The compensation arrangement between a broker-dealer and its associated persons may reflect the amount of revenues that the associated persons generate for the broker-dealer from activities performed, including providing recommendations to retail customers. Such arrangements between the broker-dealer and its associated persons may create incentives for the associated person to take actions consistent with maximizing the brokerdealer’s objectives (e.g., expected profits). For instance, if an associated person’s compensation from providing recommendations to retail customers is tied to the amount of revenues that the associated person generates for the broker-dealer, the associated person may have an incentive to recommend securities or investment strategies that would bring more revenue to the brokerdealer, relative to other comparable securities or investment strategies. Furthermore, even if the compensation arrangement does not create an explicit incentive for the associated person, the E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 33448 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations broker-dealer may direct the attention of the associated person to certain securities. For instance, even if the revenues that the broker-dealer receives when its associated persons provide recommendations to retail customers are not passed on to the associated persons, the broker-dealer’s receipt of compensation from some securities or their sponsors may lead the brokerdealer to emphasize to its associated persons the securities that are the source of such compensation. The revenues that a broker-dealer receives when a retail customer acts on an investment recommendation may depend on the broker-dealer’s compensation arrangement with the product sponsor. The broker-dealer may receive different compensation from different product sponsors for distributing comparable securities or investment strategies. If the objectives of the broker-dealer are tied to the amount of revenues it receives from recommended securities or investment strategies, the broker-dealer may have an incentive to advise only, or predominantly, on securities or investment strategies that come with attractive compensation arrangements and less so, or not at all, on other comparable securities or investment strategies. Accordingly, the incentives created by the compensation arrangements with the product sponsors may cause a broker-dealer to limit the menu of securities from which the broker-dealer or its associated persons make recommendations. The conflicts of interest that can arise from the compensation arrangement between the broker-dealer and its associated persons, and from the compensation arrangement between the broker-dealer and the product sponsors, can create incentives that may affect the broker-dealer’s or its associated persons’ recommendations to retail customers. In certain circumstances, a broker-dealer’s conflicts of interest, or its associated persons’ conflicts of interest, may result in recommendations that are not in the best interest of the retail customer.1260 As discussed above, in Section III.B.2, broker-dealers are currently subject to Commission and SRO regulations and rules that govern their business conduct. For example, with respect to the provision of advice, courts have found broker-dealers liable under the antifraud provisions of the federal securities laws for not giving ‘‘honest and complete information’’ or for not disclosing ‘‘material adverse facts of which it is aware’’ with regard to certain conflicts 1260 See FINRA Conflicts Report. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 of interest, in certain circumstances.1261 Furthermore, broker-dealers are generally prohibited from making an unsuitable recommendation to a customer.1262 In addition, broker-dealers may be liable under the Exchange Act for failure to supervise their associated persons when providing advice to retail customers.1263 Broker-dealers are generally required to establish policies and procedures that are reasonably designed to prevent and detect violations of the federal securities laws and regulations, as well as applicable SRO rules. Broker-dealers are also required to establish and maintain systems for applying these procedures (e.g., identifying and reviewing red flags with respect to the recommendations provided by their associated persons).1264 As discussed above, a number of studies and papers provide evidence suggesting that despite the current regulatory regime and observations that agency costs to retail customers from broker-dealer relationships may be trending downward, the effect of conflicts of interest on the provision of advice remains a concern.1265 We also noted in Section III.A.2 above that, more generally, the conflicts of interest of the broker-dealer and its associated persons and the incentives that these conflicts create may result in agency costs for the retail customers that persist despite the current regulatory regime. The Conflict of Interest Obligation in Regulation Best Interest is intended to reduce the agency costs associated with the conflicts of interest of the brokerdealers and its associated persons when they provide recommendations on securities transactions and investment strategies to retail customers. Below we discuss the economic implications of different requirements of this obligation, including their benefits and costs relative to the current regulatory regime. 1261 See the Suitability Rule; see also 913 Study at 55 for a detailed discussion of the broker-dealers’ disclosure obligations and liabilities under the current regulatory regime. 1262 See FINRA Rule 2111.03 (Recommended Strategies). 1263 See 913 Study at 74. 1264 Id. at 75. In addition, FINRA Rule 3010 requires broker-dealers to establish and maintain a system to supervise the activities of their associated persons that is reasonably designed to achieve compliance with the applicable securities laws and regulations and FINRA rules. FINRA Rule 3120 requires broker-dealers to have a system of supervisory control policies and procedures that tests and verifies supervisory procedures. 1265 See supra Section III.B.3.c. PO 00000 Frm 00132 Fmt 4701 Sfmt 4700 a. Overarching Obligation Related to Conflicts of Interest The overarching obligation of the Conflict of Interest Obligation states that broker-dealers must establish, maintain, and enforce written policies and procedures reasonably designed to identify and at a minimum disclose, or eliminate, all conflicts of interest associated with recommendations to retail customers. The requirement to establish written policies and procedures reasonably designed to identify conflicts of interest is a new requirement relative to the current regulatory regime. This requirement may impose costs on those broker-dealers that currently do not implement such policies and procedures voluntarily. These costs stem from the resources that a brokerdealer would have to expend to identify existing and potential conflicts of interest and to design policies and procedures that can reasonably identify and manage circumstances when a conflict of interest arises within the broker-dealer. These circumstances would have to take into account, among other things, how the broker-dealer generates revenue from providing recommendations to retail customers and how associated persons of the broker-dealer are compensated for providing recommendations. In addition, these circumstances would have to account for the limitations of the menu of securities from which brokerdealers provide recommendations. Furthermore, broker-dealers may incur costs of reviewing and updating such policies and procedures as new conflicts of interest arise or as new circumstances develop that may cause the brokerdealer to identify an existing conflict of interest. The Commission is providing below a quantitative estimate of the cost to broker-dealers associated with designing and updating such policies and procedures under certain assumptions The requirement to establish policies and procedures reasonably designed to identify conflicts of interest may also create benefits for retail customers. As noted above, the policies and procedures would require brokerdealers to: (1) Identify existing conflicts of interest and new circumstances in which an existing conflict of interest may arise, and (2) new conflicts of interest and the circumstances in which they may arise. Having a process in place to identify and address the conflicts of interest associated with a recommendation at the time the recommendation is made to a retail customer would reduce the likelihood E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations that a broker-dealer may fail to disclose material facts relating to conflicts of interest. Thus, the process a brokerdealer develops as a result of complying with the Conflict of Interest Obligation may improve the quality of the content of the disclosure of conflicts of interest that may affect a recommendation. To the extent such disclosure helps retail customers make a better assessment of the efficiency of the recommendation they receive, the requirement may benefit the retail customers. The Commission continues to believe that it is not possible to meaningfully quantify the potential costs and benefits of the Conflict of Interest Obligations because such analysis would depend on many contingent factors that render any estimate insufficiently precise to inform our policy choices.1266 For example, such an analysis of the Conflict of Interest Obligation would require strong assumptions about the circumstances under which a broker-dealer may fail to identify a given conflict of interest, and also about the extent to which the disclosure of the conflicts of interest may enhance decision making for retail customers. The requirement to establish policies and procedures reasonably designed to, at a minimum, disclose identified conflicts of interest may help a retail customer evaluate the efficiency of the recommendation provided by a brokerdealer and its associated persons, and may affect the retail customer’s decision of whether, and how, to act on the recommendation. As noted in Section III.A.2 above, reducing the information asymmetry between a retail customer and a broker-dealer and its associated persons may help the retail customer form a better assessment of the efficiency of the received recommendation. Disclosure requirements generally are intended to reduce information asymmetries between transacting parties. Whether such a reduction is likely to occur depends largely on the effectiveness of the disclosure. If the disclosure provides new information, transacting parties may make more informed decisions than they would without this new information, and, from this perspective, the disclosure may be effective. However, disclosure can be effective even if no new information is provided, to the extent the form and manner in which a disclosure requirement reaches the transacting 1266 See discussion following supra footnote 1156 for a general discussion of these factors. See also infra Section III.C.7, where we have endeavored to quantify some of the potential benefits of Regulation Best Interest based on many assumptions. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 parties facilitates a more informed decision. There is extensive academic literature on the factors that contribute to disclosure effectiveness.1267 Among these factors, those associated with bounded rationality, including financial literacy, are generally important.1268 In particular, disclosure effectiveness generally increases with the level of financial literacy of the transacting party.1269 It is also possible that if a broker-dealer’s retail customers have different degrees of financial literacy, the potential anticipated reaction of the retail customers that are financially literate to the disclosure of conflicts of interest may cause the broker-dealer to choose to eliminate certain conflicts, which, in turn, would benefit the population of retail customers that are less financially literate. Specifically, the requirement to establish policies and procedures reasonably designed to, at a minimum, disclose identified conflicts of interest may have a deterrent effect on some broker-dealers to the extent that they anticipate that disclosing material facts about certain conflicts of interest may be effective in dissuading certain retail customers from seeking or accepting recommendations from their associated persons in the future. As noted above, such broker-dealers may choose to eliminate those conflicts instead. i. Disclosing Conflicts of Interest The requirement under the Conflict of Interest Obligation to develop reasonably designed policies and procedures to, at a minimum, disclose identified conflicts of interest would obligate a broker-dealer to provide information (e.g., material facts) about its conflicts of interest and those that its associated persons have when making a recommendation to a retail customer. As discussed above, this information may already be disclosed under the regulatory baseline and by brokerdealers that adopt best practices. However, it is currently not clear in what form and what manner this disclosure reaches the retail customer.1270 Under Regulation Best Interest, the Conflict of Interest Obligation is intended to require that such disclosure reach the retail customer more directly and in a more timely manner.1271 In addition, the 1267 See supra Section III.B.4.c for a detailed discussion of the academic literature on disclosure effectiveness. 1268 Id. 1269 Id. 1270 See e.g., 913 Study. 1271 Broker-dealers satisfy their current disclosure obligations in the account opening agreement, PO 00000 Frm 00133 Fmt 4701 Sfmt 4700 33449 material facts disclosed may increase the salience of the conflicts of interest to retail customers as being a potential factor contributing to an associated person’s recommendation. Salience detection is a key feature of human cognition allowing individuals to focus their limited mental resources on a subset of the available information and causing them to over-weight this information in their decision making processes.1272 Limited attention among individuals increases the importance of focusing on salient disclosure signals. Research suggests that increasing signal salience is particularly helpful in reducing limited attention of consumers with lower education levels and financial literacy.1273 To the extent that this manner of disclosure and the associated increase in salience results in more informed decisions with respect to whether to act on a received recommendation, the disclosure requirement resulting from the Conflict of Interest Obligation will benefit retail customers. It is also possible that the disclosure of material facts about a broker-dealer’s conflicts of interest or those of its associated persons related to a recommendation may not benefit the retail customer receiving that recommendation. As noted by one commenter, the academic literature on disclosure effectiveness notes that in certain circumstances, disclosure of financial information may induce a ‘‘panhandler effect’’, whereby disclosure increases the pressure to comply with the advice if the advisee (e.g., the retail customer) feels obliged to satisfy the financial interest of the advice provider (e.g., the associated person).1274 account statements, and information made public on their websites. 1272 See Daniel Kahneman, Thinking, Fast and Slow (2013); Susan T. Fiske & Shelley E. Taylor, Social Cognition: From Brains to Culture (3rd ed. 2017). 1273 See, e.g., Victor Stango & Jonathan Zinman, Limited and Varying Consumer Attention: Evidence from Shocks to the Salience of Bank Overdraft Fees, 27 Rev. Fin. Stud. 990 (2014). 1274 See, e.g., EPI Letter at 11, noting that ‘‘[a]s the SEC itself noted in its analysis of one of the proposed regulations, disclosure may even induce a ‘panhandler effect,’ whereby clients may go through with a transaction in response to social pressure to meet the professional’s financial interests.’’ The Commenter also notes that generally disclosure may not incentivize a financial professional to change her behavior: ‘‘The SEC also noted that disclosure could have an effect on the behavior of financial professionals through ‘moral licensing’—the belief that they have already fulfilled their moral obligations through disclosure, and ‘strategic biasing’—the desire to compensate for an anticipated loss of profit from disclosure.’’ As discussed above, Regulation Best Interest recognizes that certain conflicts of interest cannot be reasonably addressed with disclosure alone. See E:\FR\FM\12JYR2.SGM Continued 12JYR2 33450 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 ii. Elimination of Conflicts of Interest The policies and procedures that broker-dealers will need to maintain and implement to comply with the Conflict of Interest Obligation will also give them the option of addressing conflicts of interest associated with recommendations by eliminating such conflicts entirely, rather than just disclosing them to the retail customer. Depending on the effectiveness of the policies and procedures that a brokerdealer implements to comply with the Conflict of Interest Obligation, conflicts of interest that are not required to be eliminated and that remain may still have a significant effect on an associated person’s recommendation. If a brokerdealer considers that the effect of a conflict of interest on the recommendations of its associated persons cannot be adequately addressed by the broker-dealer, as required by the Conflict of Interest Obligation (discussed further below), the brokerdealer may consider modifying its practices to eliminate that conflict. By eliminating a conflict, the broker-dealer would neutralize the effect of this conflict on the recommendations provided by the broker-dealer or its associated persons to retail customers. The absence of this conflict of interest when the associated person is considering reasonably available alternatives for a recommendation to a retail customer, as noted above in the discussion of the Care Obligation, would likely result in an increase in the efficiency of the customers. As discussed above in Section III.A.2, this outcome would be consistent with the goals of Regulation Best Interest by reducing the agency costs associated with an associated person’s incentives created by these conflicts of interest, which would benefit the retail customer. Furthermore, the option to address conflicts of interest through elimination allows broker-dealers to reduce the compliance costs associated with managing conflicts of interest. For example, if a broker-dealer determines it is too costly to just disclose a conflict of interest as required under the Conflict of Interest Obligation, the broker-dealer could choose to eliminate the conflict. On the other hand, by eliminating a conflict of interest, a broker-dealer may forgo the potential revenues associated with that conflict of interest. also supra Section III.B.4.c, which discusses in more detail these effects. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 b. Mitigation of Certain Incentives to the Associated Persons The requirement to establish, maintain, and enforce written policies and procedures reasonably designed to identify and mitigate conflicts of interest that create an incentive for the associated person of the broker-dealer to place the interest of the broker-dealer or the associated person ahead of the interest of the retail customer will likely affect the relationship between the broker-dealer and its associated persons, the menu of securities that the brokerdealer makes available to its associated persons, and the recommendations that the broker-dealer and its associated persons provide to retail customers. In the employment relationship between a broker-dealer and its associated persons, the broker-dealer generally hires and compensates associated persons to perform certain services (e.g., providing recommendations on securities transactions and investment strategies to retail customers) using the brokerdealer’s framework (e.g., policies and procedures to ensure compliance with applicable laws and rules, supervisory systems that monitor for potential violations of policies and procedures, etc.). The compensation that the associated person receives from the broker-dealer may reflect the level of effort that the broker-dealer expects the associated person to exert when performing a service, given the brokerdealer’s infrastructure. As noted above, the broker-dealer may also structure the associated person’s compensation to create incentives that are consistent with maximizing the broker-dealer’s objectives. The requirement to establish, maintain, and enforce written policies and procedures reasonably designed to identify and mitigate conflicts of interest that create an incentive for the associated person of the broker-dealer to put the interest of the broker-dealer or the associated person ahead of the interest of the retail customer may affect the employment relationship between the broker-dealer and the associated person in several ways. First, the requirement may change a brokerdealer’s existing policies and procedures that are designed to achieve compliance with the regulatory baseline as well as the supervisory systems that allow the broker-dealer to monitor for potential violations by the associated persons of these policies and procedures. To this end, broker-dealers will need to consider the amount of time and level of resources to devote to design and establish policies and procedures that seek to reduce the PO 00000 Frm 00134 Fmt 4701 Sfmt 4700 likelihood of an associated person placing its interest or the interest of the broker-dealer ahead of the interests of a retail customer when providing recommendations to retail customers. Another way that this requirement may affect the employment relationship between the broker-dealer and the associated person is by changing the level of effort that the associated person would have to exert to ensure that all recommendations supplied to retail customers are compliant with the Conflict of Interest Obligation. As a corollary, this requirement may also affect the level of effort that a supervisor would have to exert to ensure that the recommendations supplied by its associated persons to a retail customer comply with the obligations of Regulation Best Interest. As discussed above in the context of the Care Obligation, an associated person would have to not only consider a number of factors when making a recommendation to a retail customer, but also ensure that the recommendation is in the best interest of the retail customer. The determination that a recommendation is in the retail customer’s best interest may depend on the conflicts of interest that exist at the time the associated person makes the recommendation, and, importantly, on how the broker-dealer complies with the requirement to establish, maintain, and enforce policies and procedures reasonably designed to identify and mitigate or eliminate conflicts of interest that create an incentive for the associated person to put the interest of the broker-dealer or the associated person ahead of the interest of the retail customer. It is possible that more effective policies and procedures may lower the level of effort an associated person would have to exert to have a reasonable basis to believe that recommendations are compliant with Regulation Best Interest, in the sense that a supervisor or the broker-dealer would determine whether the effect of the associated person’s or the broker-dealer’s conflicts of interest is reduced to the point where the incentives created by these conflicts do not have a negative effect on the recommendations. However, the potential increase in the supervisor’s level of effort may substitute for the potential decrease in the associated person’s level of effort. One commenter had concerns about the discussion in the Proposing Release about the effect of the compensation arrangements between the broker-dealer and the associated person on the effort exerted by the associated person when E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations providing a recommendation.1275 This commenter stated that if the compensation leads to lower effort, the associated person would not make recommendations that are in the retail customer’s best interest. As discussed above, the Commission notes that the relationship between the effort exerted to make a recommendation and the efficiency of the recommendation is complex, and that lower effort may not necessarily be inconsistent with increasing the efficiency of the recommendation. Finally, the Conflict of Interest Obligation may affect the compensation arrangement between the broker-dealer and its associated persons. Certain compensation arrangements may create incentives for an associated person to place his or her interest of the interest of the broker-dealer ahead of the interest of the customer, and therefore create conflicts of interest for the brokerdealer’s associated persons. For example, as discussed above in Section III.B.1.f, broker-dealers commonly compensate their associated persons based on commissions and performance-based awards. These compensation arrangements create incentives for associated persons to recommend securities or investment strategies that generate more commissions to the broker-dealer and potentially themselves over other securities or investment strategies. The Conflict of Interest Obligation requires a broker-dealer to have policies and procedures that are reasonably designed to identify and disclose and mitigate, or eliminate, any conflicts of interest associated with recommendations that create an incentive for the associated person or the firm to place the interest of the associated person or the firm ahead of the interest of the retail customer, including conflicts of interest that arise from compensation arrangements between broker-dealers and their associated persons. Depending on how a broker-dealer complies with the Conflict of Interest Obligation, compensation arrangements between broker-dealers and their associated persons may change as a result of establishing these policies and procedures. For example, as discussed above in Section III.B.2.e, in response to the DOL Fiduciary Rule, which among other things, was designed to restrict broker-dealer activities and reduce the conflicts of interest of a broker-dealer and those of its associated persons, some broker-dealers altered the compensation for their associated 1275 See AARP August 2018 Letter. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 persons. Specifically, some brokerdealers chose to equalize commissions and deferred sales charges charged across similar securities or investment strategies. Others chose to restrict or eliminate sales quotas, contests, special awards, and bonuses, including deferred bonuses as part of the recruitment efforts.1276 It is possible that some broker-dealers may choose to comply with the Conflict of Interest Obligation by establishing policies and procedures that would address conflicts using these or similar methods. It is also possible that some broker-dealers may rely on existing policies and procedures that address conflicts through methods such as compliance and supervisory systems that are consistent with the Conflict of Interest Obligation. Some of these methods may reduce the overall compensation of the associated person from providing recommendations (e.g., altering certain bonuses). The same methods or others (e.g., altering deferred recruiting bonuses) may complicate a brokerdealer’s hiring of new associated persons. However, to the extent that these methods address the conflicts of interest of a broker-dealer or those of its associated persons in an effective manner, these methods may enhance the efficiency of the recommendations provided by a broker-dealer and its associated persons, and, therefore benefit retail customers. In general, if a broker-dealer implements policies and procedures pursuant to the Conflict of Interest Obligation that may result in a significant reduction in the overall compensation that an associated person receives from providing recommendations, the associated person may have an incentive to register as an investment adviser, if not already registered as one, and provide advice mostly or only in an investment adviser capacity. To the extent broker-dealers establish, maintain, and enforce policies and procedures that are effective at reducing the incentives of an associated person to put the interest of the broker-dealer or the associated person ahead of the interest of the retail customer, the Conflict of Interest Obligation would reduce the effect of these conflicts on the recommendations provided by associated persons to retail customers. 1276 However, we understand that following the decision by the Fifth Circuit to vacate the DOL Fiduciary Rule, some broker-dealers may have reverted back to compensation arrangements that they had in place prior to the DOL Fiduciary Rule. For instance, as discussed in Section III.B.2.e.ii, supra, some broker-dealers reinstated their deferred recruiting bonuses. PO 00000 Frm 00135 Fmt 4701 Sfmt 4700 33451 In this way, complying with the Conflict of Interest Obligation would increase the efficiency of the recommendations for retail customers, relative to the regulatory baseline. This, in turn, would reduce the agency costs associated with the broker-dealer’s and its associated persons’ incentives that are created by their conflicts of interest. Lower agency costs at these broker-dealers would benefit retail customers. One commenter noted that the size of these benefits of Regulation Best Interest should be quantified relative to the baseline that includes the current regulatory regime as well as current practices.1277 The Commission agrees with the commenter and notes that, as discussed in Section III.B, brokerdealers may already have compliance and supervisory systems in place that are effective at reducing to a reasonable extent the effect of an associated person’s conflicts of interest on the recommendations provided to retail customers.1278 Therefore, for the retail customers of these broker-dealers, the potential benefits above may be small. In contrast, for the retail customers of the broker-dealers that are not currently addressing conflicts of interest in a manner consistent with Regulation Best Interest, the potential benefits above may be large. This commenter further stated that the economic analysis in the Proposing Release did not provide a thorough discussion of the relationship between the broker-dealer and its associated persons with a focus on the incentives of the associated persons.1279 The Commission notes that the analysis above about the incentives of the associated persons expands the analysis in the Proposing Release and establishes a clear link between compensation and incentives. As noted in the economic analysis of the Proposing Release,1280 brokerdealers may also adjust their menus of securities in response to the requirement to establish, maintain, and enforce written policies and procedures reasonably designed to identify and mitigate conflicts of interest that create an incentive for the associated person to place his or her interest or the interest of the broker-dealer ahead of the interest of the retail customer. It is possible that some broker-dealers may decide to expand their offerings to better comply with the process required pursuant to the Conflict of Interest Obligation. For instance, broker-dealers that currently 1277 See CFA August 2018 Letter. FINRA Conflicts Report. 1279 See CFA August 2018 Letter. 1280 See Proposing Release at 21658. 1278 See E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 33452 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations offer advice only on a limited set of securities (e.g., proprietary securities) would have to disclose and evaluate their menu of securities to ensure that their policies and procedures regarding their limited menus of securities and the disclosures of any conflicts associated with such limitations do not result in recommendations that place the interest of the broker-dealer or its associated persons ahead of the retail customer’s interest. Broker-dealers may also manage conflicts of interest by limiting their menu of securities on which they offer recommendations. Broker-dealers may prefer a limited menu of securities to better mitigate the potential costs associated with compliance of Regulation Best Interest. For instance, a limited menu of securities may result in more homogenous product fees across comparable securities or investment strategies, which would help reduce the effect of certain conflicts of interest on the recommendations provided to retail customers. Broker-dealers may also respond by limiting their menus of securities because they may have conflicts of interest due to variation in the compensation they receive from product sponsors, as discussed above. It is possible that complying with the Conflict of Interest Obligation in this manner may result in securities menus that limit an associated person’s choices of investments when providing a recommendation to a retail customer.1281 However, as discussed below, the requirements of the Conflict of Interest Obligation and the Care Obligation are intended to reduce the likelihood that limitations on securities menus result in recommendations that are not in the best interest of the retail customer.1282 It is also possible that broker-dealers that limit their menus of securities in response to the Conflict of Interest Obligation may eliminate securities or investment strategies that are inferior relative to other securities or investment strategies in terms of performance and costs. Recommendations based on menus of securities that do not contain inferior securities or investment strategies are more likely to be efficient for the retail customer. To the extent broker-dealers eliminate inferior investments from their securities menus as a result of complying with the Conflict of Interest Obligation, Regulation Best Interest would provide 1281 See supra Section II.C.2. example, if none of the securities on the menu would be in the best interest of the retail customer in a given set of circumstances, the associated person may not recommend any of the securities on the menu to the retail customer. 1282 For VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 c. Material Limitations on Recommendations to Retail Customers The Conflict of Interest Obligation includes a requirement that specifically addresses material limitations on recommendations to retail customer (e.g., offering only proprietary or other limited range of securities). This provision requires broker-dealers to establish, maintain, and enforce written policies and procedures reasonably designed to identify and disclose any material limitations placed on securities or investment strategies that may be recommended to a retail investor and any conflicts of interest associated with such limitations in accordance with the Disclosure Obligation. It further requires such policies and procedures to be reasonably designed to prevent such limitations and associated conflicts of interest from causing the broker-dealer or its associated persons to make recommendations that place the interest of the broker-dealer or associated persons ahead of the interest of the retail customer. As noted above, broker-dealers may limit their menus of securities in response to certain requirements of the Conflict of Interest Obligation. The requirements that address limited menus of securities are designed to help ensure that these limitations and associated conflicts of interest do not create incentives for the broker-dealer or its associated persons to make recommendations that are not in the best interest of the retail customer. The second aspect of the requirement would seek to ensure that the menu of securities is not limited to the point where it restricts a broker-dealer and its associated persons from complying with the Care Obligation, and in particular with the requirement to provide recommendations that are in the customer’s best interest.1284 To the extent these requirements reduce the effect of the limitations of the menu of securities and the associated conflicts of interest on the recommendations provided by a broker-dealer or its associated persons, the Conflict of Interest Obligation would result in recommendations that are more likely to be efficient, relative to the baseline. The requirements that address limitations of the menu of securities may have additional implications for certain product markets, and ultimately, retail customers. To better understand these implications we focus the discussion on the market for mutual funds. As discussed in Section III.B.3, academic literature has noted that in certain product markets, such as mutual funds, the different distribution channels that product sponsors use to reach the retail customer may cause these markets to fragment. In the market for mutual fund products, some products are sold to retail customers only through broker-dealers—the socalled ‘‘broker-sold’’ distribution channel—while other products are sold 1283 See, e.g., CFA August 2018 Letter; AARP August 2018 Letter; EPI Letter; Better Markets August 2018 Letter. 1284 Broker-dealers that offer a limited menu of securities may not be able to offer recommendations to certain clients. See also supra footnote 1282. a benefit for the retail customers of these broker-dealers. Broker-dealers may pass on some of the compliance costs to their retail customers. For instance, broker-dealers may increase their fees on the services that they provide to retail customers as part of the relationship, or may adopt new fees. Alternatively, broker-dealers may seek to renegotiate their compensation arrangements with the product sponsors in the hopes of extracting greater compensation (e.g., more attractive revenue-sharing agreements), relative to current practices. The likelihood of a favorable outcome for the broker-dealers may depend on whether product sponsors can charge their retail customers higher fees. However, it is likely that product sponsors are already charging fees that are privately optimal (e.g., maximize their revenue net of costs), and thus any deviations from these fees would lead to a suboptimal outcome for the product sponsors. In other words, product sponsors may not have an incentive to increase their fees. A number of commenters stated that policies and procedures that address how broker-dealers manage conflicts of interest relating to limited menus of securities could impose costs on a retail customer when all securities on the menu have high fees or create a benefit for retail customers if securities with high fees are eliminated.1283 As noted in the Proposing Release and above, the Commission acknowledges the benefits to the retail customers of the brokerdealers that comply with Regulation Best Interest by eliminating inferior securities or investment strategies. The Commission also acknowledges the potential costs of limited menus of securities by expanding the Conflict of Interest Obligation to include requirements that would address specifically limited menus of securities and by providing a detailed analysis of the economic implications of these requirements, below. PO 00000 Frm 00136 Fmt 4701 Sfmt 4700 E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 directly to retail customers—the socalled ‘‘direct-sold’’ distribution channel.1285 The products that are sold through the broker-sold channel usually carry higher fees relative to comparable products that are sold through the direct-sold channel.1286 Higher fees on the broker-sold products reflect brokerdealers’ compensation for distributing the product. In general, all transactions linked to the broker-sold distribution channel are triggered by a recommendation provided by an associated person of the broker-dealer. Most product sponsors currently rely on one of the two channels to distribute their products, but not on both.1287 A retail customer that has an account with a broker-dealer that provides advice is not necessarily constrained to accessing products only through the broker-sold channel. A retail customer could access products from the directsold channel to transact on his or her own (for example, if the broker-dealer may not provide recommendations on a particular product).1288 A retail customer who has access to products from both distribution channels and who understands the effect of fees on a product’s performance may prefer to access a product through the broker-sold channel if, for example, the combined cost of identifying (e.g., search costs) and accessing comparable direct-sold products (e.g., product fee) is higher than the total cost of the broker-sold product recommended by the associated person of the broker-dealer.1289 As more direct-sold products enter the market,1290 the retail customer’s cost of identifying 1291 direct-sold products that 1285 In this discussion, the broker-sold distribution channel includes sales that are the result of a recommendation provided by the brokerdealer but may also include sales that are solicited by the retail customer where no advice or recommendation was provided by the broker-dealer (i.e., unadvised sales). The direct-sold distribution channel includes unadvised sales through brokerdealer open platforms as well as sales that the retail customer solicits directly from the product sponsor. Investment advisers may also access products through the direct-sold distribution channel. 1286 See, e.g., Del Guercio & Reuter (2014). 1287 See, e.g., Del Guercio & Reuter (2014), supra footnote 1081, and Reuter (2015), supra footnote 1095. 1288 A retail customer could also access securities through financial professionals that are not brokerdealers, including investment advisers. 1289 Some broker-dealers may offer securities to retail customers through both distribution channels, but these broker-dealers provide recommendations only on securities offered through the broker-sold channel. For example, some broker-dealers with open platforms may only provide recommendations on proprietary securities. 1290 See, e.g., ICI Letter, which shows an increasing trend in the number of mutual funds with no 12b-1 fees over the past 10 years. These funds are available through the direct-sold channel. 1291 Broker-dealers with open platforms that allow retail customers to access securities on this VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 are comparable alternatives to a brokersold product recommended by an associated person of the broker-dealer may become lower.1292 In turn, the retail customer’s demand for broker-sold products may decline.1293 According to economic first principles, when enough retail customers exhibit a preference for direct-sold products over broker-sold products, the aggregate demand for broker-sold products should decline. To remain competitive, product sponsors that rely on the broker-sold channel to distribute their products would have to lower the fees on their products. Lower fees on broker-sold products may result in lower compensation for brokerdealers and their associated persons from providing recommendations on these products. Lower fees on brokersold products would benefit retail customers who access mutual fund products through the broker-sold channel. This market mechanism would allow retail customers’ demand to affect how product sponsors compensate brokerdealers for recommending broker-sold products. While this mechanism is currently available to retail customers and is considered generally effective, it is not clear how effective this mechanism is in all aspects of the market, particularly in the short run.1294 platform without a recommendation from the broker-dealer and its associated persons generally provide extensive research and analytical tools. The Commission has recently adopted rule amendments that address research reports that broker-dealers make available to their retail customers. See Covered Investment Fund Research Reports, Release 33–10580 (Nov 30, 2018); 83 FR 64180 (Dec. 13, 2018). 1292 See, e.g., Ali Hortacsu & Chad Sylverson, Product Differentiation, Search Costs, and Competition in the Mutual Fund Industry: A Case Study of S&P 500 Index Funds, 119 Q. J. Econ. 403 (2004), who estimate an investor’s search costs for S&P500 index funds and show that, as the number of S&P500 index funds increased over their sample period spanning 1995 to 2000, the investor’s search costs generally declined. The authors further show that this downward trend was driven by funds that are in lower end of the search cost distribution and that these funds were mostly no-load funds. These no-load funds are usually available through the direct-sold channel. 1293 However, a retail customer may value the services provided by a broker-dealer that extend beyond the provision of recommendations on securities transactions and investment strategies and continue to maintain an account with the broker-dealer. To counter the potential decline in the demand for broker-sold products, a brokerdealer may respond by offering more services and increasing the fee for the package of services or by trying to shift the retail customer to a potentially more profitable advisory account (to the extent that the broker-dealer offers this type of accounts). 1294 Recent academic research questions the effectiveness of the market mechanism, at least in the short run. See. e.g., Yang Sun, Does Competition Protect Retail Investors? Role of Financial Advice (Working Paper, Apr. 2017), available at https:// PO 00000 Frm 00137 Fmt 4701 Sfmt 4700 33453 As noted by one commenter, the expense ratio for domestic equity mutual funds declined from 0.86 percent in 2007 to 0.59 percent in 2017, a 31% reduction over the ten year period.1295 This commenter further notes that this downward trend in expense ratios reflects, among other things, a ‘‘long-running shift by investors toward lower-cost funds.’’ Because the number of low-cost funds that enter the market over the period 2007–2017 has increased substantially, the assessment of this commenter would appear to be consistent with the market mechanism being effective in the long run.1296 As noted above, the effectiveness of the market mechanism may depend on a number of factors, including the retail customer’s ability to understand the effect of fees on the performance of a product and willingness to shop around for comparable products, the product sponsor’s ability to signal how its broker-sold products stand out among comparable products, and the brokerdealer’s menu and the disclosure about potential limitations of this menu.1297 The Conflict of Interest Obligation may improve the effectiveness of this market mechanism through the requirement that broker-dealers establish, maintain, and implement written policies and procedures reasonably designed to identify and disclose all material limitations of products that may be recommended and any associated conflicts of interest. This requirement would result in disclosures that, while not necessarily new relative to the regulatory baseline, may increase the salience of the limitations of product menus and the associated conflicts of coller.tau.ac.il/sites/coller-english.tau.ac.il/files/ media_server/Recanati/management/conferences/ finance/2017/61.pdf. This research shows that the sudden entry of several low-cost index funds caused direct-sold actively managed funds with similar investment objectives to cut their fees by 6.4 basis points. In contrast, broker-sold actively managed funds with similar investment objectives as the new entrant funds increased their fees by 12.2 basis points. The study further shows that while some of the fee increase in the broker-sold funds is accompanied by increased levels of active management, most of the fee increase (more than 60%) was passed on to broker-dealers. The author argues that the broker-sold actively managed funds are able to increase their fees only to the extent that they can signal to the market that they are not employing strategies that mimic index funds. 1295 See ICI Letter. 1296 Id. at 42. 1297 As noted in supra footnote 1292, the effectiveness of this market mechanism may also depend on whether broker-dealers offer advisory accounts and whether these broker-dealers can convince retail customers to switch to an advisory account rather than to a self-directed account. E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 33454 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations interest for the retail customers.1298 The added focus on these limitations may cause some retail customers to question whether the recommendations that they are receiving are taking into consideration a reasonable set of alternatives. Thus, this disclosure may encourage retail customers to shop for comparable products that they may prefer (e.g., based on cost factors) over the broker-sold products that are being recommended to them. As an example, a broker-dealer that is providing recommendations only for proprietary products would have to disclose, the material limitation that the products on the menu are all proprietary, and the material fact of the conflict of interest that the broker-dealer and its associated persons are being compensated for selling these products. As discussed above in Section II.C.3.f, there are a number of other potential conflicts of interest associated with proprietary products. While brokerdealers may disclose this information under the regulatory baseline, it is not clear the manner in which this disclosure currently reaches the retail customer.1299 The new required disclosure with respect to conflicts of interest (under the Disclosure Obligation) is intended to be more comprehensive and more specific, and is also intended to reach the retail customer more directly. From this perspective, the disclosure of the limitations of the product menu and its associated conflict of interest may better inform retail customers’ choices and, therefore, may be more effective, compared to current disclosure forms of the same information. While, generally, the effectiveness of disclosure depends on many factors that are well known in the academic literature, the disclosure requirement of the Conflict of Interest Obligation may also depend on the range of material facts that the brokerdealer deems necessary to disclose in order to be in compliance with the obligation.1300 The Conflict of Interest Obligation addresses limited product menus by requiring that broker-dealers take measures through reasonably designed written policies and procedures to evaluate and prevent the limitations and the associated conflicts of interest from causing associated persons of the broker-dealer to make recommendations that are inconsistent with the requirements of Regulation Best Interest. 1298 See supra footnote 1272 and accompanying text. 1299 See, e.g., 913 Study. supra Section III.B.4.c for a detailed discussion of the academic literature on disclosure effectiveness. The requirement seeks to address specific firm-level conflicts—namely, the conflicts associated with the establishment of a product menu— which are likely to affect recommendations made to retail customers and may result in recommendations that place the interest of the broker-dealer or its associated persons ahead of the interest of the retail customer. This requirement may have a direct effect on the relationship between broker-dealers and product sponsors. To the extent that enough broker-dealers decide to no longer offer recommendations on certain types of products that carry higher fees (i.e., exclude them from the menus), the aggregate demand for such products may decline. Product sponsors that face declining demand for some of their products may respond by lowering the fees on these products or by repackaging these products into new and more competitive products that may again draw the interest of the broker-dealers. d. Elimination of Certain Sales Practices As part of the Conflict of Interest Obligation in Regulation Best Interest, broker-dealers are required to establish, maintain, and enforce written policies and procedures reasonably designed to identify and eliminate any sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sales of specific securities or specific types of securities within a limited period of time. The Commission believes that the conflicts of interest associated with these practices that may create high-pressure situations for the associated persons of the broker-dealer to recommend a specific security over another cannot be reasonably addressed through disclosure and mitigation and should be addressed through elimination in order to comply with the requirements of Regulation Best Interest.1301 Relative to the regulatory baseline, this requirement would provide benefits to retail customers. Conflicts of interest that create incentives for the associated persons to recommend a specific security (or specific types of securities) over another are likely to have a significant effect on an associated person’s recommendation, even if such conflicts were disclosed and mitigated via policies and procedures established, maintained and enforced by the brokerdealer. By explicitly requiring policies and procedures reasonably designed to eliminate sales practices that may result 1300 See VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 1301 See also the discussion in Section II.C.3.g, supra. PO 00000 Frm 00138 Fmt 4701 Sfmt 4700 in such conflicts, the requirement should neutralize the effect of these conflicts on the recommendations provided by associated persons to retail customers. The absence of these conflicts when the associated person is considering reasonably available alternatives for a recommendation to a retail customer, as noted in the discussion of the Care Obligation, may increase the efficiency of the recommendation for their retail customers. As discussed above in Section III.A.2, this outcome is consistent with Regulation Best Interest reducing the agency costs associated with a broker-dealer’s incentives or the incentives of its associated persons created by these conflicts of interest, which, in turn, would benefit the retail customer. The requirement to establish policies and procedures reasonably designed to eliminate certain sales practices may reduce the total compensation that a broker-dealer and its associated person receives from providing recommendations to retail customers. As discussed above, to the extent that the reduction in an associated person’s total compensation is sufficiently large, the associated person may have an incentive to register as an investment adviser and provide investment advice only in his or her advisory capacity. Furthermore, the potential decline in the total compensation of an associated person of the broker-dealer due to this requirement may dissuade financial professionals from providing advice in the capacity of a broker-dealer, and as a result, broker-dealers may find it more difficult to hire new associated persons, relative to the baseline. In addition, the types of sales practices that this requirement is meant to address generally create incentives for associated persons to recommend certain types of securities or investment strategies over certain time periods over other types of securities or investment strategies. By requiring broker-dealers to establish policies and procedures reasonably designed to eliminate certain sales practices that create these types of incentives, broker-dealers may experience a reduction in the revenue stream associated with certain securities or investment strategies. Thus, through this requirement, Regulation Best Interest may impose a cost on the broker-dealers that currently rely on these types of practices in order to incentivize sales. On the other hand, retail customers who have born costs associated with such practices will benefit from the cessation of these sales practices. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 As discussed above, while we are unable to quantify the full costs of Regulation Best Interest, including the Conflict of Interest Obligation, we are able to estimate some of the costs associated with the Conflict of Interest Obligation, specifically the costs related to information collection requirements as defined by the Paperwork Reduction Act. As discussed further in Section IV.B.1, the Commission believes that broker-dealers would update their policies and procedures to comply with this requirement and would incur an initial aggregate burden of approximately 128,160 hours and an additional initial aggregate cost of approximately $25 million, as well as an ongoing aggregate annualized burden of approximately 27,900 hours, and an ongoing aggregate annualized cost of approximately $2.91 million.1302 Furthermore, the Commission believes that in order to identify conflicts of interest and determine whether the conflicts are material, broker-dealers would incur an initial aggregate burden of approximately 69,150 hours and an additional initial aggregate cost of approximately $15.71 million as well as an ongoing aggregate annualized burden of approximately 27,660 hours.1303 Thus, we estimate the Conflict of Interest Obligation of proposed Regulation Best Interest would impose an initial aggregate cost of at least $110.73 million and an ongoing aggregate annual cost of at least $20.44 million on broker-dealers.1304 1302 These estimates are based on the following calculations: 120,600 hours + 7,560 hours = 128,160 hours; $10 million + $15 million = $25 million; and 24,120 hours + 3,780 hours = 27,900 hours. As discussed in more detail in infra Section V.D, 120,600 hours and 7,560 hours are preliminary estimates for the initial aggregate burdens for large and small broker-dealers, respectively, $10 million and $15 million are preliminary estimates for the initial aggregate costs for large and small brokerdealers, respectively, and 24,120 hours and 3,780 hours are preliminary estimates for the ongoing aggregate burdens for large and small brokerdealers, respectively. 1303 The estimate of the initial aggregate burden is based on the following calculations: 13,830 hours + 55,320 hours = 69,150 hours, where, as discussed in more detail in Section V.D, 13,830 hours and 55,320 hours are estimates for the initial aggregate burdens for identifying conflicts of interest and determining whether the conflicts are material for all broker-dealers, respectively. 1304 These estimates are calculated as follows: (90,450 hours of in-house legal counsel) × ($415.72/ hour for in-house counsel) + (27,660 hours for inhouse compliance counsel) × ($365.39/hour for inhouse compliance counsel) + (27,660 hours for identifying conflicts of interest) × ($229.74/hour for business line personnel) + (51,540 hours for review of policies and procedures) × ($309.60/hour for inhouse compliance manager) + (50,302 hours for outside legal counsel) × ($497/hour for outside legal counsel) + (55,317 hours for modifying existing technology) × ($284/hour for outside senior programmer) = $110.73 million, and (8,040 hours of VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 5. Compliance Obligation The Compliance Obligation of Regulation Best Interest requires brokerdealers to establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest.1305 This obligation creates an affirmative obligation under the Exchange Act with respect to Regulation Best Interest as a whole, while providing sufficient flexibility to allow broker-dealers to establish compliance policies and procedures that accommodate a broad range of business models.1306 The Compliance Obligation is designed to ensure that broker-dealers have internal controls in place to prevent violations of Regulation Best Interest. The policies and procedures required to comply with this obligation would allow the Commission to identify and address potential compliance deficiencies or failures (such as inadequate or inaccurate policies and procedures, or failure to follow the policies and procedures) early on, reducing the chance of retail customer harm.1307 As discussed above in Section III.B.2.d, under the regulatory baseline, broker-dealers are subject to supervisory obligations that, among other things, require them to establish policies and procedures reasonably designed to prevent and detect violations of, and achieve compliance with, the federal securities laws and regulations,1308 as well as applicable SRO rules.1309 Broker-dealers would have the ability to update these policies and procedures to comply with the Compliance Obligation, rather than create new policies and procedures. in-house legal counsel) × ($415.72/hour for inhouse counsel) + (21,870 hours for in-house compliance counsel) × ($365.39/hour for in-house compliance counsel) + (21,870 hours for identifying conflicts of interest) × ($229.74/hour for business line personnel) + (3,780 hours for review of policies and procedures) × ($309.60/hour for compliance manager) + (3,783 hours for outside legal counsel) × ($497/hour for outside legal counsel) + (3,773 hours for outside compliance services) × ($273/hour for outside compliance services) = $20.44 million. The hourly wages for in-house legal and compliance counsel, registered representatives, senior business analyst, compliance manager, and business-line personnel are obtained from SIFMA. The hourly rates for outside legal counsel, outside senior programmer, systems analyst or programmer and outside compliance services are discussed in infra Section V.D. 1305 These policies and procedures are in addition to the policies and procedures required under the Conflict of Interest Obligation. 1306 See supra Section II.C.4. 1307 See supra Section II.C.4. 1308 See Section 15(b)(4)(E) of the Exchange Act. 1309 See FINRA Rule 3110 (Supervision). PO 00000 Frm 00139 Fmt 4701 Sfmt 4700 33455 The obligation indirectly benefits retail customers by ensuring that brokerdealers have sufficient internal controls in place to support compliance with Regulation Best Interest. The obligation will impose compliance costs on broker-dealers. However, these costs are likely to be smaller for those broker-dealers that already have effective compliance systems in place, including effective policies and procedures. Broker-dealers may incur operational costs related to training their associated persons and developing policies and procedures to ensure compliance with the Care Obligation. For example, broker-dealers may have to provide training to their employees and other associated persons on how to make recommendations that do not place the interest of the broker-dealer or their associated persons ahead of the interest of the retail customer. In the Proposing Release, these training costs were discussed as part of a separate general best interest obligation, and our assessment of those costs has not changed.1310 Broker-dealers also may incur costs related to training their associated persons on how to determine that they have a reasonable basis to believe that a recommendation is in a retail customer’s best interest. This may include training on how to evaluate the potential risks, rewards, and costs associated with a recommendation as well as how a retail customer’s investment profile affects this determination. Additionally, brokerdealers may incur costs related to training their associated persons on any relevant factors specific to making recommendations regarding IRAs, IRA rollovers, or other account types, as well as implicit hold recommendations resulting from agreed-upon account monitoring. These training costs will be lower for broker-dealers that already operate in a manner that is consistent with the requirements of the Care Obligation and higher for those that do not. Firms may already comply with the requirements of the Care Obligation, to varying degrees, either of their own volition or because they are already subject to and comply with similar obligations. As discussed above, while we are unable to quantify the full costs of Regulation Best Interest, including the Compliance Obligation, we are able to estimate some of the costs associated with the Compliance Obligation, specifically the costs related to information collection requirements as defined by the Paperwork Reduction 1310 See E:\FR\FM\12JYR2.SGM Proposing Release at Section IV.C.2.a. 12JYR2 33456 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations Act. As discussed further in Section IV.B.1, the Commission believes that broker-dealers would update their policies and procedures to comply with this requirement. We estimate that broker-dealers would incur an initial aggregate burden of 524,404 hours and an additional initial aggregate cost of approximately $76.3 million, as well as an ongoing aggregate annualized burden of 452,524 hours, and an ongoing aggregate annualized cost of approximately $2.91 million.1311 Thus, the Compliance Obligation of Regulation Best Interest would impose an initial aggregate cost of at least $214.66 million and an ongoing aggregate annual cost of at least $110.86 million on broker-dealers.1312 jbell on DSK3GLQ082PROD with RULES2 6. Record-Making and Recordkeeping Regulation Best Interest will also impose record-making and 1311 These estimates are based on the following calculations: 80,400 hours + 4,536 hours + 11,064 hours + 428,404 hours= 524,404 hours; $6 million + $7.5 million + $62.8 million = $76.3 million; and 24,120 hours + 428,404 hours = 452,524 hours. As discussed in more detail in infra Section V.D, 80,400 hours, 4,536 hours, 11,064 hours and 428,404 hours are estimates for the initial aggregate burdens for large and small broker-dealers, updating training module, and training, respectively. In addition, $6 million, $7.5 million, and $62.8 million are estimates for the initial aggregate costs for large and small broker-dealers and updating training modules, respectively. Furthermore, 24,120 hours and 428,404 hours are estimates for the ongoing aggregate burdens for large broker-dealers and training, respectively. Finally, $2.91 million is the estimate of the ongoing aggregate cost for small broker-dealers. 1312 These estimates are calculated as follows: (65,832 hours of in-house legal counsel) × ($415.72/ hour for in-house counsel) + (4,536 hours for inhouse compliance counsel) × ($365.39/hour for inhouse compliance counsel) + (10,050 hours for reviewing policies and procedures) × ($446.04/hour for in-house general counsel) + (15,582 hours for reviewing policies and procedures and update existing training systems) × ($309.60/hour for inhouse compliance manager) + (428,404 hours for training) × ($233.02/hour for registered representative) + (27,163 hours for outside legal counsel) × ($497/hour for outside legal counsel) + (221,127 hours for updating training module) × ($284/hour for outside senior programmer or systems analyst)= $214.66 million, and (8,040 hours of in-house legal counsel) × ($415.72/hour for inhouse counsel) + (8,040 hours for in-house compliance counsel) × ($365.39/hour for in-house compliance counsel) + (8,040 hours for updating policies and procedures) × ($229.74/hour for business line personnel) + (8,040 hours for reviewing policies and procedures) × ($309.60/hour for compliance manager) + (3,783 hours for outside legal counsel) × ($497/hour for outside legal counsel) + (3,773 hours for outside compliance services) × ($273/hour for outside compliance services) + (428,404 hours of training) × ($233.02/ hour for registered representative) = $110.86 million. The hourly wages for in-house legal and compliance counsel, registered representatives, senior business analyst, compliance manager, and business-line personnel are obtained from SIFMA. The hourly rates for outside legal counsel, outside senior programmer, systems analyst or programmer and outside compliance services are discussed in infra Section V.D. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 recordkeeping requirements on brokerdealers with respect to certain information collected from, or provided to, retail customers. The Commission is amending Rules 17a–3 and 17a–4 of the Exchange Act, which specify minimum requirements with respect to the records that broker-dealers must make, and how long those records and other documents must be kept, respectively. We are amending Rule 17a–3 by adding a new paragraph (a)(35) that requires a record of all information collected from, and provided to, the retail customer pursuant to Regulation Best Interest, as well as the identity of each natural person who is an associated person of a broker or dealer, if any, responsible for the account. This requirement applies to each retail customer to whom a recommendation of any securities transaction or investment strategy involving securities is provided. The neglect, refusal, or inability of a retail customer to provide or update any information about the customer investment profile will, however, excuse the broker-dealer from obtaining that information. Rule 17a–4(e)(5) will be amended to require that brokerdealers retain all records of the information collected from or provided to each retail customer pursuant to Regulation Best Interest for at least six years after the earlier of the date the account was closed or the date on which the information was last replaced or updated. The requirement to create certain written records of information collected from or provided to a retail customer under the Disclosure Obligation will trigger a record-making obligation under paragraph (a)(35) of Rule 17a–3 and a recordkeeping obligation under Rule 17a–4(e)(5) that may impose additional compliance costs on broker-dealers. In cases where broker-dealers choose to meet part of the Disclosure Obligation orally under the circumstances outlined above in Section II.C.1, Oral Disclosure or Disclosure After a Recommendation, the requirement to maintain a record of the fact that oral disclosure was provided to the retail customer will trigger a record-making obligation under paragraph (a)(35) of Rule 17a–3 and a recordkeeping obligation under Rule 17a–4(e)(5) that may impose additional compliance costs on broker-dealers. Furthermore, the Care Obligation may require creating new documents or modifying existing documents to reflect standardized questionnaires seeking customer investment profile information. These requirements will also trigger a record-making obligation under paragraph (a)(35) of Rule 17a–3 PO 00000 Frm 00140 Fmt 4701 Sfmt 4700 and a recordkeeping obligation under Rule 17a–4(e)(5) that will impose additional compliance costs on brokerdealers. Currently, under Rule 17a– 3(a)(17), broker-dealers that make recommendations for accounts with a natural person as customer or owner are required to create, and periodically update, specified customer account information. However, the information collection requirements of Rule 17a– 3(a)(17) do not cover all aspects of the ‘‘customer investment profile’’ that broker-dealers may attempt to obtain to make a customer-specific suitability determination under the Suitability Rule. As noted above, the Conflict of Interest Obligation requires brokerdealers to establish policies and procedures that are reasonably designed to address conflicts of interest, including disclosing material facts associated with the conflicts. The disclosures will be made pursuant to the Disclosure Obligation and are not expected to trigger record-making or recordkeeping obligations outside the Disclosure Obligation. The Commission is providing estimates of the initial and ongoing burden hours associated with the record-making and recordkeeping obligations of the Disclosure, Care, and Conflict of Interest Obligations, under certain assumptions. These estimates are discussed in Section IV.B.5. Based on these burden hours estimates, the Commission expects that the recordmaking and recordkeeping obligations of Regulation Best Interest will impose an initial aggregate burden of 17,684,020 hours and an additional initial aggregate cost of $375,732 as well as an ongoing aggregate annualized burden of 5,520,800 hours on broker-dealers.1313 1313 These estimates are based on the Commission’s estimates, discussed in Section IV.B.5, with respect to the initial and ongoing aggregate costs and burdens imposed on brokerdealers by the record-making obligation of proposed Rule 17a–3(a)(35) and the recordkeeping obligation of the proposed amendment to Rule 17a–4(e)(5) associated with all component obligations of Regulation Best Interest. The estimate of the initial aggregate burden is based on the following calculation: 4,020 hours + 4,080,000 hours + 13,600,000 hours = 17,684,020 hours, where, as discussed in more detail in Section IV.B.5, 4,020 hours is the estimate of amending the account disclosure agreement by large broker-dealers, 4,080,000 hours is the estimate of the burden associated with filling out the information disclosed pursuant to Regulation Best Interest in the account disclosure agreement, and 13,600,000 hours is the estimate of the burden to broker-dealers for adding new documents or modifying existing documents to the broker-dealer’s existing retention system. $375,732 is the estimate of amending the account disclosure agreement by small broker-dealers pursuant to the record-making obligation of Rule 17a–3(a)(35). The estimate of the ongoing annual burden is 3,400,00 hours + 1,060,000 hours + E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations After monetizing the burden hours, the record-making and recordkeeping obligations will impose an initial aggregate cost of at least $4,121.73 million and an ongoing aggregate annual cost of at least $1,736.52 million on broker-dealers.1314 7. Approaches to Quantifying the Potential Benefits jbell on DSK3GLQ082PROD with RULES2 As discussed above, several commenters suggested that we quantify the existing harm to investors under the baseline and the corresponding benefit resulting from Regulation Best Interest. We continue to believe that it is not possible to quantify, with meaningful precision, either the existing harm or the specific benefits we expect to flow from Regulation Best Interest. Such an analysis, including one that would produce ranges, depends on many contingent factors that render any estimate insufficiently precise to inform our policy choices.1315 Nonetheless, the Commission has endeavored to estimate some of the potential benefits that may result from Regulation Best Interest using a variety of methodologies, which are explained below in more detail along with certain caveats and the principal assumptions relied on. Specifically, we have attempted to estimate the benefit that may result from a reduction in fees due to increased competition; we also consider the potential benefit arising from a reduction in the relative performance 1,060,000 hours = 5,520,800 hours where 3,400,00 hours is the estimate of complying with the recordkeeping obligation of the amendment to Rule 17a–4(e)(5) and 1,060,000 hours are estimates of both the record-making and recordkeeping obligations associated with oral disclosure. 1314 These estimates are calculated as follows: (2,010 hours of in-house legal counsel) × ($415.72/ hour for in-house counsel) + (17,680,000 hours for entering and adding new or modifying existing documents in each customer account) × ($233.02/ hour for registered representative) + (2,010 hours for in-house compliance counsel) × ($365.39/hour for in-house compliance counsel) + (756 hours for outside legal counsel) × ($497/hour for outside legal counsel) = $4,121.73 million, and (3,400,000 hours for recordkeeping) × ($365.39/hour for in-house compliance counsel) + (1,060,000 hours for recordmaking associated with oral disclosure) × ($233.02/ hour for registered representative) + (1,060,000 hours for record-keeping associated with oral disclosure) × ($233.02/hour for registered representative) = $1,736.52 million. The hourly wages for in-house legal and compliance counsel and registered representatives are obtained from SIFMA. The hourly rates for outside legal counsel are discussed in infra Section IV.B.5. 1315 See supra footnote 1156 and subsequent text for a discussion of these factors. For these reasons and because we believe that quantification of the costs and benefits of the alternatives discussed in infra Section III.E would require still further assumptions, lead to additional imprecision, and yield less meaningful results, we have not included quantified estimates of the economic effects of these alternatives. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 differences of broker-sold and directsold mutual funds. The quantification exercise below provides an estimate for some of the potential benefits associated with Regulation Best Interest. For example, as discussed in more detail below, a potential reduction in fees can benefit retail customers in other ways beyond reducing the total dollar amount paid for investment services. Furthermore, as discussed elsewhere in this economic analysis, the rule is expected to generate other benefits for retail customers that we are not able to meaningfully quantify. a. Benefit to Investors Due to a Potential Reduction in Fees As discussed above, Regulation Best Interest may reduce the attractiveness of certain products to broker-dealers due to the Care Obligation (e.g., the emphasis on the need to consider cost, among other things) and the Conflict of Interest Obligation (e.g., addressing conflicts of interest, including product menu limitations) and/or may reduce retail customers’ aggregate demand for certain products due to the Disclosure Obligation (e.g., due to a reduction in any information asymmetry with respect to fees). To the extent that Regulation Best Interest produces these effects on certain products, the affected product sponsors may react by lowering the fees that they charge retail customers on these products to be more competitive, or by repackaging these products into new products that are more competitively priced. The increased competition generated by the lower fees for affected products may further incentivize other product sponsors (i.e., those not directly affected by Regulation Best Interest) to lower their fees as well.1316 Alternatively, a product sponsor may preempt the potential decline in the aggregate demand for its products by lowering the fees before other sponsors do. For the purposes of calculation, we assume that this potential competition in prices results in a new long-run equilibrium in this product market, in which product sponsors charge fees that are close to or equal to their marginal costs. Lower fees translate into direct savings to retail customers. If a portion of fees collected from retail customers serves to compensate broker-dealers for selling certain investment products, then lowering those fees could also 1316 A product sponsor that does not lower its fees on a given product may risk experiencing low retail customer aggregate demand or low demand from broker-dealers as a result of Regulation Best Interest. To stay competitive this product sponsor may have to lower the fees on its product. PO 00000 Frm 00141 Fmt 4701 Sfmt 4700 33457 translate into less severe conflicts of interest. Thus, a reduction in fees may improve the efficiency of the recommendations that broker-dealers make to retail customers. This potential increase in the efficiency of the recommendations received also benefits retail customers.1317 The market for mutual fund products may illustrate the potential for attaining such a new long-run equilibrium as a result of Regulation Best Interest. We focus on mutual funds for this analysis because of the available data for mutual funds, but we expect the same or similar dynamics could apply to other financial products. As this market transitions toward this new long-run equilibrium, total fund expenses (i.e., distribution expenses and management fees) that are in excess of the marginal cost of distributing and operating the fund may be reduced in a number of ways, including by lowering fees, reliance on alternative distribution channels, or exiting the market in whole or in part (i.e., by limitations on offerings). Below we attempt to quantify the benefits associated with this potential long-run equilibrium in the market for mutual fund products as a result of such reduction in fees, relative to the baseline, assuming all funds reduced fees to marginal costs. To this end, we start with the current distribution of fees of funds within each Center for Research in Security Prices (CRSP) objective class.1318 We focus on funds that have reported this information in 2018 in CRSP. We perform the analysis using total fees (i.e., fund expense ratios). As an alternative, we also perform the analysis using the component of the total fees that are allocated toward distribution and 1317 For purposes of this analysis, we assume that product sponsors respond to competitive pressures by lowering their fees. However, competition may affect quality in addition to price. For example, product sponsors may choose to offer higher quality products which may be costlier to produce (e.g., because they must hire more skilled managers or apply more costly technology) and as such require higher fees. Alternatively, product sponsors may lower fees by reducing the quality of their product (e.g., hiring fewer skilled managers) and, as a result, offering lower fee products that may produce lower average returns. Competition along both of these dimensions may allow retail customers to choose different combinations of quality and price, depending on their individual preferences. 1318 Calculated based on data from the Center for Research in Security Prices (CRSP), University of Chicago Booth School of Business. Funds with different objectives may incur different marginal costs due to the frequency of trading in the markets that are reflective of the objective of the fund, advertising to reach a certain clientele, distribution costs, etc. The CRSP Mutual Fund dataset includes a breakdown of mutual funds by their objective types. E:\FR\FM\12JYR2.SGM 12JYR2 33458 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 marketing expenses, and that we can observe, namely 12b–1 fees.1319 We estimate the marginal cost of distributing and operating a non-index fund in a given CRSP objective class (i.e., strategy) as the minimum total fee of the funds in that class, after excluding index funds. Similarly, we estimate the marginal cost of operating an index fund in a given CRSP objective class as the minimum total fee of the index funds in that class. We then calculate the maximum ‘‘excess fee’’ for a fund (index or non-index) as the difference between the actual total fee of the fund and the marginal cost of the CRSP objective class that contains the fund. By construction, the excess fee cannot be negative. We obtain an aggregate amount of reduced fees of approximatively $22.2 billion for non-index funds and $1.4 billion for index funds annually at the new potential equilibrium.1320 The aggregate amount of saved fees across index and non-index funds becomes approximatively $23.6 billion. Similarly, if we focus on 12b–1 fees only, the aggregate amount of saved fees are $9.13 billion for non-index funds and $0.32 billion for index funds, or $9.45 billion across both index and nonindex funds. Using certain assumptions to calculate the present value of this potential fee reduction,1321 we calculate 1319 12b–1 fees are paid out of fund assets to cover the costs of marketing and selling fund shares. ‘‘Distribution fees’’ include fees to compensate brokers and others who sell fund shares, and to pay for advertising and printing and mailing prospectuses to new investors. ‘‘Shareholder service fees’’ are fees that cover the cost of responding to investor inquiries and providing investors with information. This analysis excludes loads because, unlike 12b–1 fees, loads cannot be separately broken out. 1320 We calculate the dollar value associated with these excess fees by multiplying the excess fees of a fund with total net assets (TNA) of the fund and then aggregating across funds. This amount represents the capital that would be reallocated towards more efficient funds and can be thought of as ‘‘fees saved’’ by retail customer as this product market shifts from the baseline equilibrium to the new equilibrium. 1321 First, we note that expense ratios for equity mutual funds have declined at a rate of about 3% per year since 2000. This rate doubles to 6% if we focus on the period following FINRA’s adoption of the Suitability Rule in 2011. We assume that under the current equilibrium, or ‘‘baseline equilibrium,’’ excess fees—as defined above—would continue to decline at the rate of 3% per year. This rate of decay corresponds to a half-life of approximatively 23 years. We further assume that as the product market shifts towards the new equilibrium, excess fees decline at a rate that is at least as high as the post2011 rate. Because Regulation Best Interest enhances the broker-dealer standard of conduct established by the Suitability Rule—particularly with respect to the disclosure, mitigation, or elimination of conflicts of interest, which is not addressed by the Suitability Rule—and the federal securities laws, we believe that a rate of decay that VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 the net benefit of the new equilibrium as the difference between the two present values of declining perpetuities that pay the dollar value associated with excess fees under the baseline equilibrium and the new equilibrium, respectively, for each of the three scenarios. When using the total fees, we obtain an expected net benefit of $35.21 billion in the moderate decay scenario, $59.15 billion in the accelerated decay scenario, and $76.49 billion in the rapid decay scenario. Similarly, when using 12b–1 fees only, we obtain an expected net benefit of $14.10 billion in moderate decay scenario, $23.69 billion in the accelerated decay scenario, and $30.63 billion in the rapid decay scenario. b. Benefits to Investors Due to a Potential Reduction in the Relative Underperformance of Broker-Versus Direct Sold Mutual Funds Another way to estimate the potential benefits of Regulation Best Interest is to use aspects of the approach used in the CEA Study and the DOL RIA, as suggested by several commenters.1322 Specifically, we rely on academic literature claiming that, to varying degrees, broker-sold mutual funds underperform direct-sold mutual funds and assume that underperformance reflects agency costs associated with the conflicts of interest that may be present in recommendations provided by broker-dealers. Although this literature addresses only a portion of the AUM affected by Regulation Best Interest, we use methods from these studies to estimate the monetary effect the final rule might produce by reducing the effect that conflicts of interest have on the recommendations provided by broker-dealers. Total AUM of load and no-load longterm mutual funds in the U.S. as of the end of 2018 are approximately $12.4 trillion, with $10.4 trillion attributable to no-load funds and $2.1 trillion attributable to load funds.1323 To estimate the monetary effect of potential is at least as large as the one observed in the post2011 period is not unreasonable. Under this assumption, we consider three scenarios: (1) Moderate decay at 6%; (2) accelerated decay at 9%; and (3) rapid decay at 12%. The half-life for each of these scenarios is 11.5 years, 7.7 years, and 5.8 years, respectively. Finally, we assume that the opportunity cost of the excess fees is equal to the expected rate of return on the value-weighted market portfolio, as defined in CRSP, as these fees encumber capital that would have otherwise been invested in efficient funds. To estimate the expected return on the market portfolio, we assume that the discount rate is the geometric average of the annual rate of return on the market portfolio over the period 1927–2018, namely 9.76%. 1322 See supra footnote 1167. 1323 See Investment Company Institute 2019 Fact Book, Figure 6.12. PO 00000 Frm 00142 Fmt 4701 Sfmt 4700 conflicts of interest as they pertain to mutual funds, we use estimates of the difference in net returns (gross returns on a fund’s performance less fees and other expenses associated with the fund) between broker-sold funds and funds that are direct-sold from Reuter (2015).1324 We then apply this difference to the aggregate market capitalization of load funds, which we assume are sold with a recommendation from a broker-dealer because we cannot identify the channel through which mutual funds are sold or whether each sale through the broker-sold channel involves a recommendation. To the extent that no-load funds are also sold by broker-dealers, this assumption may cause us to underestimate the portion of mutual fund AUM that are sold with a recommendation from a brokerdealer.1325 Because the data in Reuter (2015) ends in 2012, for the purposes of this approach we assume that the relative underperformance of brokersold funds, and hence our application of this underperformance to load funds as a proxy for funds sold with a recommendation from a broker-dealer, remains unchanged from 2012.1326 Reuter (2015) employs a variety of methods in computing the difference in net returns between broker-sold and direct-sold actively managed funds, including different ways of computing net returns (e.g., net return, net return plus 12b–1 fees, net alphas, and ordinary least-squares and weighted least-squares regression methods), different samples (e.g. ‘‘non-specialized domestic equity’’), and different weighting schemes (e.g. equally weighted or value weighted returns). Reuter concludes by noting that the performance difference between brokersold and direct-sold actively managed mutual funds is likely to fall between 0.20% and 0.47%, depending whether or not 12b–1 fees are included in the estimation. Given that the underperformance only affects brokersold funds, and applying these underperformance estimates to load funds, the estimated monetized underperformance of broker-sold funds 1324 See Reuter (2015), supra footnote 1095. In contrast to the DOL RIA, we do not base our analysis on excess loads, as estimated in Christoffersen et al. (2013), supra footnote 1081. Prior commenters noted that the average excess load, by definition, is zero and would likely yield a much lower estimate of aggregate harm, than the estimate published by the CEA and include in the DOL RIA. See, e.g., Lewis (2017), supra footnote 1099. See also supra footnotes 1169 and 1170. 1325 Brokers may still be compensated for selling no-load funds by 12b–1 fees, revenue sharing, or other arrangements. 1326 See supra footnote 1102 for discussion of how trends in the relative performance of load funds may have changed in more recent years. E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations ranges from $4.1 billion per year to $9.7 billion per year. As discussed elsewhere in this release, we expect Regulation Best Interest will reduce the severity of conflicts of interest that may contribute to the underperformance between broker-sold and direct-sold mutual funds. However, the range noted above most likely overestimates the expected reduction in harm associated with broker-sold mutual funds due to Regulation Best Interest for a number of reasons. First, as discussed by Bergstresser et al. (2009), broker-sold funds can be sold by both broker-dealers and investment advisers (e.g., dually registered investment advisers), and the data these studies relied upon is not sufficiently granular to identify the fraction of broker-sold funds sold by each type of financial professional.1327 Because Regulation Best Interest applies to registered broker-dealers, this range would need to be narrowed to reflect the proportion of broker-sold funds sold by registered broker-dealers. Second, the estimated range fully attributes the differences between direct-sold funds and broker-sold funds to conflicts of interest between retail customers and broker-dealers. This might over-estimate the benefits of Regulation Best Interest because there might be other unobservable systematic differences between investors who choose direct-sold funds versus those who choose to employ a financial professional. For example, retail customers that buy broker-sold funds might be willing to pay more for those funds if they receive intangible benefits from a broker-dealer’s recommendation that are not reflected in the relative performance between funds sold through these two channels. Furthermore, not all sales in the brokersold channel are triggered by recommendations provided by brokerdealers or their associated persons. For example, customer-directed transactions may not involve a recommendation at all. Third, measuring a fund’s performance using its net return relative to a benchmark might not be the most accurate measure of a fund manager’s skill or the value created by a fund to an investor.1328 Therefore, estimating investor harm assuming this definition of the value created by a fund might potentially overstate or understate this harm. 1327 See Bergstresser et al. (2009), supra footnote 1048. 1328 See supra footnote 1176. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 Taking into account these caveats,1329 to the extent that Regulation Best Interest mitigates, and in the limit, eliminates the adverse effects of conflicts of interest on broker-dealers’ recommendations, we estimate that the benefits attributable to Regulation Best Interest could be as large as $4.1 billion per year to $9.7 billion per year when estimated assuming that the relative underperformance of broker-sold mutual funds estimated in the academic literature reflects conflicts of interest that will eventually be eliminated. As with our other estimates of the benefits above, we assume that there is already a decreasing trend in the underperformance gap under the baseline that is consistent with the decreasing trend in mutual fund expense ratios of 3%, and that Regulation Best Interest will accelerate this trend to a decay rate under three scenarios: (1) Moderate decay at 6%; (2) accelerated decay at 9%; and (3) rapid decay at 12%. Similarly, we assume a discount rate of 9.76% as above to value these cash flows. Under these assumptions, the present value of the potential benefits of Regulation Best Interest in the mutual fund sector, relative to the baseline, from limiting or eliminating the adverse effects of conflicts of interest could be as large as approximately $6.8 to $16 billion in the moderate decay scenario, $11.4 to $26.7 billion in the accelerated decay scenario, and $14.7 to $34.5 billion in the rapid decay scenario. Finally, we can obtain an approximate estimate of the present value of the costs associated with Regulation Best Interest using the costs estimated in Section IV for purposes of the Paperwork Reduction Act, which imply aggregate initial costs of approximately $5.96 billion and ongoing costs of $2.37 billion. Assuming the initial costs are incurred one year from the rule’s enactment, and using a discount rate of 9.76% as above, the present value of these costs is approximately $27.5 billion. Note that this cost estimate cannot be directly compared with the benefit estimates above as the benefits estimates are with respect to mutual funds only. D. Efficiency, Competition, and Capital Formation As discussed above, Regulation Best Interest is designed to address the agency costs that arise when an associated person of the broker-dealer 1329 See supra footnotes 1172–1178 for further discussion of the limitations that apply in using the relative underperformance of broker-sold mutual funds as an estimate of investor harm and, therefore, the benefits of Regulation Best Interest. PO 00000 Frm 00143 Fmt 4701 Sfmt 4700 33459 provides a recommendation to a retail customer that may not be fully addressed by the regulatory baseline. Regulation Best Interest is intended to reduce agency costs and other costs by enhancing the standard of conduct of broker-dealers, increasing the effectiveness of disclosure to allow retail customers to make a more informed decision with respect to the recommendation they receive and by requiring broker-dealers to implement policies and procedures reasonably designed to reduce the effect of conflicts of interest on recommendations to retail customers. Specifically, the Disclosure Obligation and Conflict of Interest Obligation require broker-dealers to disclose information that, while not necessarily new in all instances, will reach retail customers more directly and more timely than under the regulatory baseline. In addition, the disclosed information would raise a retail customer’s salience of fees, scope of the relationship, conflicts of interest, and limitations of the menu of securities from which the retail customer receives recommendations as potential factors affecting the recommendations of a broker-dealer or its associated persons. The content and form of disclosure may help some retail customers make more informed decisions with regards to whether to act on a recommendation provided by an associated person of the broker-dealer. Regulation Best Interest may also reduce the agency costs faced by these retail customers. The Conflict of Interest Obligation also requires broker-dealers to implement policies and procedures to reduce the effect of conflicts of interest and securities menu limitations on recommendations to retail customers. For broker-dealers that implement more effective policies and procedures, the obligation may increase the efficiency of the recommendations for their retail customers. As a result, Regulation Best Interest may reduce the agency costs faced by these retail customers. The Care Obligation requires a brokerdealer and its associated persons to have a reasonable basis to believe that a recommendation provided to a retail customer is in the customer’s best interest. This reasonable basis should include factors similar to those identified by the Suitability Rule of the current regulatory regime as well as additional factors. For example, relative to the regulatory baseline, the Care Obligation requires that a broker-dealer and its associated persons consider costs, among other factors, and establish a direct link between the attributes of a security or investment strategy and the retail customer’s best interest. By E:\FR\FM\12JYR2.SGM 12JYR2 33460 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 requiring consideration of costs and by including an explicit link between the investment-related factors and the best interest, the obligation may increase the efficiency of the recommendations for the retail customer. As a result, Regulation Best Interest may reduce the agency costs faced by these retail customers. Through these effects, as discussed below, Regulation Best Interest may have an effect on competition, capital formation, and efficiency. 1. Competition Regulation Best Interest may have competitive effects for the market for investment advice and may affect how broker-dealers compete with each for retail customers. As discussed in Section III.C, the brokerage industry currently recognizes that broker-dealers and their associated persons may have conflicts of interest that create incentives for broker-dealers or their associated persons to make recommendations that, while suitable for their retail customers, may not be in the best interest of (and may not be the most efficient recommendations for) such customers. As noted above in Section III.B.2.c, a FINRA survey suggested that broker-dealers currently employ different methods for managing conflicts of interest, with some methods being more effective than others at reducing the effect of conflicts of interest on recommendations. These methods generally depend on the size and complexity of a broker-dealer’s business model. Against this backdrop, the cost of complying with Regulation Best Interest, scaled by the size and complexity of a broker-dealer’s business activities, may be higher for brokerdealers that currently employ less effective methods for managing conflicts of interest. Relative to broker-dealers that face lower compliance costs, broker-dealers that face higher compliance costs may be at a disadvantage when competing for retail customers and may not be able to fully pass on these costs to their retail customers. For example, the presumption related to the titles ‘‘adviser’’ and ‘‘advisor’’ may impose higher costs on broker-dealers that use these terms in their names or titles, but that are not dual-registrants.1330 The extent to which broker-dealers are able to pass on costs to their retail customers depends on a number of factors that include the availability of close substitutes for the services provided by broker-dealers and the cost to retail customers of switching accounts to a 1330 See supra footnotes 1216–1220. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 competing broker-dealer, investment adviser, or other financial services provider. If broker-dealers are unable to pass costs through to customers, it is possible that some of the broker-dealers that face high compliance costs may decide to exit the market for investment advice in the capacity of a broker-dealer. The potential competitive effects associated with compliance costs could be further exacerbated by how brokerdealers choose to comply with the component obligations of Regulation Best Interest. As discussed in Section III.C.4, broker-dealers are given flexibility when addressing conflicts of interest through policies and procedures. Because Regulation Best Interest and the component obligations are generally principles-based, a brokerdealer would have to determine what constitutes effective means of addressing a given conflict of interest, and how it should relate to the size and complexity of a broker-dealer’s business model. For a broker-dealer that is dually registered or for a broker-dealer that is affiliated with an investment adviser, the overall costs of complying with Regulation Best Interest may encourage the broker-dealer to exit the market for providing investment advice in the capacity of a broker-dealer and, instead, provide advice only in the capacity of an investment adviser. Whereas brokerdealers have explicit requirements to establish written policies and procedures reasonably designed to disclose, mitigate or eliminate identified conflicts of interest that create an incentive for the associated persons to place their interest ahead of the retail customer, the fiduciary standard for investment advisers relies on full and fair disclosure and informed consent to address conflicts of interest.1331 Investment advisers must also adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act, including violations related to undisclosed conflicts of interest.1332 More generally, compliance costs may drive such firms to no longer offer advice in the capacity of a broker-dealer if firms anticipate the profitability of 1331 As discussed in supra Section I.C, some broker-dealer commenters also expressed the view that by requiring mitigation of financial incentives, Regulation Best Interest would require more of broker-dealers than what is required of investment advisers under their fiduciary duty, which could create a competitive issue for broker-dealers that could further encourage migration from the brokerdealer to investment adviser model and result in a loss of choice for retail customers. Because of this competitive issue, dually registered financial professionals could be incentivized to recommend advisory accounts through compensation. 1332 See Advisers Act Rule 206(4)–7. PO 00000 Frm 00144 Fmt 4701 Sfmt 4700 their broker-dealer business under Regulation Best Interest to be lower than the profitability of their advisory business. Similar concern over costs of complying with Regulation Best Interest may deter some broker-dealers from entering the market for investment advice. Higher entry costs may have long-run competitive effects on prices paid by retail customers, as incumbents adjust their strategic behavior to reflect a lower threat of competition from new entrants, relative to the baseline.1333 Regulation Best Interest may also encourage competition for retail customers to the extent that the Disclosure Obligation increases the retail customers’ salience to variables such as fees and conflicts of interest that would facilitate comparability across broker-dealers. For example, retail customers may form preferences over some or all of the disclosed variables, such as fees, securities or service offerings, and range of conflicts of interest, and may choose one brokerdealer over another or over an investment adviser based on these preferences. In turn, if firms anticipate that there is a possibility that retail customers may use the disclosed variables for comparability purposes, broker-dealers may compete over some or all of these variables to attract more retail customers. This potential competition may result in greater securities or service offerings, or lower fees for retail customers. Regulation Best Interest may also affect how broker-dealers compete with each other when negotiating with investment sponsors for access to securities. The findings of the aforementioned FINRA survey suggest that broker-dealers may face different degrees of competition when negotiating with product sponsors for access to certain securities. For instance, the survey observed that some product sponsors rate the broker-dealers that are interested in distributing their securities based on criteria such as product expertise and experience, the quality of the control environment, and the strength of their sales practices. Brokerdealers that have higher ratings, based on these criteria may be given access to a broader range of securities, including more complex securities. In contrast, broker-dealers that have lower ratings may be given access to a narrower range of securities. To the extent Regulation Best Interest has the effect of increasing and homogenizing the product expertise and experience (e.g., the Care Obligation) and the quality of the 1333 See, E:\FR\FM\12JYR2.SGM e.g., Mas-Colell et al. (1995). 12JYR2 jbell on DSK3GLQ082PROD with RULES2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations control environment (e.g., the Conflict of Interest Obligation) across the complying broker-dealers, the final rule may increase the competition across firms when negotiating with product sponsors. This increased competition may allow product sponsors to economize on the distribution costs, and may result in lower fees for retail customers. Regulation Best Interest may also have competitive effects for the market for investment advice, more generally. Regulation Best Interest may affect how broker-dealers compete with firms that provide advice in a capacity other than as a broker-dealer, such as an investment adviser. Under the regulatory baseline, investment advisers owe a fiduciary duty to their clients. Some commenters describe this standard of conduct as a ‘‘higher’’ standard compared to the standard of conduct applies to broker-dealers under the regulatory baseline.1334 For some retail customers the duty owed to them by their firm or financial professional may be a determining factor when deciding which type of firm or financial professional they want to use. As previously noted, key elements of the standard of conduct that applies to broker-dealers, at the time a recommendation is made, under Regulation Best Interest will be substantially similar to key elements of the standard of conduct that applies to investment advisers pursuant to their fiduciary duty under the Advisers Act. As such, the standard of conduct under Regulation Best Interest may make broker-dealers more attractive to certain retail customers who seek recommendations for securities transactions or investment strategies in a more cost effective manner, but worry about the duties owed to them by their financial professional. As a result, Regulation Best Interest may increase the competition between broker-dealers and investment advisers for retail customers interested in obtaining investment advice. In competing for business, broker-dealers and investment advisers may lower their fees, resulting in retail customers paying less for obtaining investment advice. To the extent that this potential lower cost causes an increase in the demand for investment advice in the capacity of a broker-dealer, this positive competitive effect may offset some of the negative potential competitive effects of Regulation Best Interest, such as higher 1334 See Letter from Ken Fisher, Fisher Investments (Jul. 31, 2018) (‘‘Fisher Letter’’); PIABA Letter; FPC Letter; NASAA August 2018 Letter; U. of Miami Letter; Rhoades August 2018 Letter. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 cost of entry in the market for investment advice in the capacity of a broker-dealer relative to the baseline, as discussed above. The Disclosure Obligation may also encourage competition for retail customers across broker-dealers and investment advisers. As noted above, the Disclosure Obligation would require broker-dealers to make full and fair disclosure of all material facts relating to the scope and terms of the relationship with the retail customer and all material facts relating to conflicts of interest that are associated with a recommendation. Investment advisers are also required to provide full and fair disclosure of material facts about similar elements under the current regulatory regime. To the extent that the Disclosure Obligation raises the salience of variables that may facilitate comparison across broker-dealers and investment advisers, Regulation Best Interest may encourage competition between broker-dealers and investment advisers. Regulation Best Interest may also have competitive effects for financial professionals that offer investment advice in a capacity other than that of a broker-dealer (e.g., investment advisers and other financial professionals that are not registered with the Commission, such as insurance companies, banks, and trust companies). As discussed above in Section III.C.4, depending on the effectiveness of disclosure and the effectiveness of policies and procedures that address securities menu limitations (e.g., the Disclosure Obligation and Conflict of Interest Obligation), Regulation Best Interest may reduce the retail customers’ aggregate demand for certain securities that are distributed by broker-dealers and securities on which broker-dealers or their associated persons provide recommendations. Instead, retail customers may access some of these or comparable securities from other financial professionals. For example, a retail customer may access certain securities offered by broker-dealers through corporate fiduciaries such as commercial banks or trust companies. Alternatively, a retail customer may open an advisory account and access securities that are comparable to those offered by the broker-dealer. To the extent that Regulation Best Interest causes a potential reduction in the retail customers’ aggregate demand for securities offered by broker-dealers, retail customers’ aggregate demand may increase for securities offered by nonbroker-dealers. Regulation Best Interest may also affect how product sponsors compete for flows from retail customers. PO 00000 Frm 00145 Fmt 4701 Sfmt 4700 33461 As discussed above in Section III.C.4, depending on the effectiveness of disclosure and the effectiveness of policies and procedures that address limitations of the menu of securities (e.g., Disclosure and Conflict of Interest Obligations), Regulation Best Interest may reduce the aggregate demand for certain sponsors’ securities. To remain competitive, product sponsors that face decreased demand as a result of Regulation Best Interest may reprice their securities (e.g., by offering different share classes), lower their fees, or seek alternative distribution channels that are not affected by Regulation Best Interest. For example, product sponsors may choose to distribute their securities through investment advisers or through commercial banks to the extent that the banks can engage in limited brokerdealer activity, subject to certain conditions, without having to register as broker-dealers.1335 Finally, product sponsors may choose to distribute their securities directly to retail investors rather than indirectly, through brokerdealers. The potential competitive effect of Regulation Best Interest on product sponsors may manifest itself in lower product fees for retail customers. 2. Capital Formation and Efficiency Regulation Best Interest is designed to reduce the agency and other costs to retail customers associated with obtaining recommendations from broker-dealers. As discussed above, to reduce these costs, Regulation Best Interest would impose obligations on broker-dealers that are designed to increase the efficiency of the recommendations to retail customers relative to the recommendations that broker-dealers and their associated persons provide to retail customers under the regulatory baseline. To the extent retail customers receive recommendations that are more efficient relative to the baseline, Regulation Best Interest would increase the efficiency of the portfolio allocation that a retail customer makes as a result of the recommendation received. As discussed above in Sections III.A.2 and III.C, this would occur when a retail customer increases the allocative efficiency of his or her portfolio when the recommendation leads to a reallocation of resources across time and market and economic conditions that generate a higher net benefit to the retail customer, relative to the baseline. Thus, to the extent that Regulation Best Interest 1335 See Exchange Act Sections 3(a)(4)(B) and 3(a)(5)(B) and rules thereunder (providing banks exceptions from ‘‘broker’’ and ‘‘dealer’’ status for specified securities activities). E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 33462 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations increases the efficiency of the associated persons’ recommendations to retail customers, the final rule would have a positive effect on the retail customers’ allocative efficiency. Regulation Best Interest may also increase the efficiency of the recommendations involving rollovers or transfers of assets from retirement accounts to other taxable or non-taxable accounts, relative to the baseline. As noted above, the incentives associated with this type of recommendation are particularly acute because of the size of the transaction and the importance to the retail customer (e.g., given that the amount of assets associated with such recommendations can be a significant portion of a retail customer’s net worth). The potential increase in the efficiency of this type of recommendation may improve the allocative efficiency of assets held in retirement accounts, and may encourage retail customers to consider a rollover or transfer of assets recommendation to potentially increase the efficiency of their retirement asset allocation. Similarly, Regulation Best Interest may increase the efficiency of the recommendations regarding account types. As discussed above, currently, a dual-registrant may have an incentive to recommend the account type that benefits the dual-registrant at the expense of the retail customer. The potential increase in the efficiency of this type of recommendation under Regulation Best Interest relative to a similar recommendation that the dualregistrant may provide under the baseline may improve the allocative efficiency of the retail customer’s assets held in this account. The possibility that Regulation Best Interest may increase the efficiency of the recommendations provided by the associated persons of the broker-dealer may enhance the attractiveness of broker-dealer services for those investors who currently do not invest through broker-dealers. Although there are costs associated with these requirements, the protections deriving from these requirements may benefit investors, issuers, and intermediaries by helping to create a marketplace where a higher number of retail customers invest through broker-dealers, relative to the current regulatory regime. If retail customers are more willing to participate in the securities markets through broker-dealers, Regulation Best Interest would have a positive effect on capital formation. E. Reasonable Alternatives Regulation Best Interest establishes a new standard of conduct for broker- VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 dealers under the Exchange Act that is intended to address the agency costs that retail customers face when obtaining recommendations of securities transactions and investment strategies from broker-dealers and their associated persons. This new standard is intended to enhance investor protection, while preserving, to the extent possible, retail investor access (in terms of choice and cost) to differing types of investment services and securities. As noted above, the Commission considered several reasonable alternative policy choices, including (1) applying the fiduciary standard under the Advisers Act to broker-dealers, and (2) adopting a ‘‘new’’ uniform fiduciary standard of conduct applicable to both brokerdealers and investment advisers, such as that recommended by the staff in the 913 Study. The Commission also considered adopting similar standards to those the DOL had provided under its fiduciary rule to broker-dealers and investment advisers.1336 We examine the effects of these primary alternatives, as well as several other alternatives that we considered both in the Proposing Release and in response to comments. 1. Fiduciary Standard for Broker-Dealers As discussed in the Proposing Release and as raised by commenters, instead of adopting our approach in Regulation Best Interest, the Commission could have alternatively imposed a form of fiduciary standard on broker-dealers providing recommendations to retail customers. The Commission recognized that fiduciary standards vary among investment advisers, banks acting as trustees or fiduciaries, or ERISA plan providers, but fiduciaries are generally required to act in the best interest of their clients.1337 Under any of the options considered, the Commission would have to craft a mechanism to apply a uniform standard of conduct to all financial professionals regardless of how they engage with their retail customers. This approach was advocated by certain commenters, many of whom asserted that it would reduce retail investor confusion as it would ensure that investors are provided the 1336 We had additionally discussed in the Proposing Release an alternative of a principlesbased best interest standard. See Proposing Release at 21663. Some of the economic effects of this alternative would be similar to the economic effects of any of the fiduciary alternatives, which would also be principles-based. 1337 See Proposing Release at footnotes 328–329. For example, an investment adviser’s fiduciary duty under the Advisers Act comprises a duty of care and a duty of loyalty. This combination of care and loyalty obligations has been characterized as requiring the investment adviser to act in the ‘‘best interest’’ of its client at all times. See Fiduciary Interpretation. PO 00000 Frm 00146 Fmt 4701 Sfmt 4700 same standard of care and loyalty regardless of what type of financial professional they engage.1338 As discussed above and in detail further below we believe, in practice, that such uniformity would be difficult to implement and disruptive to pursue as a result of various factors, including the key differences in the ways brokerdealers and investment advisers engage with retail clients. Achieving such uniformity could require narrowing the type and scope of services permitted to be provided by various types of financial professionals. If we were to pursue such an approach, it could reduce retail customers’ confusion with respect to the duties owed to them by the broker-dealers and investment advisers and could reduce potential costs to some investors associated with choosing a type of relationship that is not well suited to them, because under a uniform standard, retail customers of each type of financial professional would be subject to the same standard of conduct. However, this uniformity could come at a cost to both investors and financial service providers. Such an approach could result in a standard of conduct for broker-dealers that is not appropriately tailored to the structure and characteristics of the broker-dealer model (i.e., transaction specific recommendations and compensation), and might not properly take into account, or build upon, existing obligations that apply to broker-dealers, including under FINRA rules.1339 A potential implication of this paradigm shift would be that broker-dealers would face significant compliance costs, at least in the short run, relative to the regulatory baseline. Potentially higher compliance costs could increase the incentive to offer investment advice in the capacity of investment adviser and could decrease the incentive to offer investment advice in the capacity of broker-dealer. To the extent brokerdealers act on the increased incentives and decide to participate in the market for investment advice only in the capacity of investment advisers, retail customers could experience an increase in the cost of obtaining investment advice, relative to the baseline. Furthermore, as noted above, the potential exit of broker-dealers from the market for investment advice in the broker-dealer capacity could limit how retail customers would access certain securities or investment strategies and how they would pay for investment advice, which, in turn, could increase 1338 See, 1339 See E:\FR\FM\12JYR2.SGM e.g., Better Markets Letter at 24. also 913 Study at 139–143. 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations their costs of obtaining investment advice, relative to the baseline.1340 To the extent broker-dealers decide to continue to participate in the market for investment advice in the capacity of broker-dealers, they could pass on increased compliance costs, in full or in part, to their retail customers. As a result, retail customers could experience an increase in the cost of obtaining investment advice, relative to the baseline. The potential increase in the cost of accessing investment advice could push some retail customers outside the market for investment advice from Commission-registered broker-dealers and investment advisers.1341 We discuss each of the three options for applying a uniform fiduciary standard in more detail below. We compare each of the three alternatives against the regulatory baseline, which is the current broker-dealer regulatory regime. In addition, we briefly discuss the differences between the standard of conduct imposed by Regulation Best Interest and the fiduciary standard under the Advisers Act. As discussed above in Section I, we believe that our approach in adopting Regulation Best Interest will best achieve the Commission’s important goals of enhancing retail investor protection and decision making, while preserving, to the extent possible, retail investor access (in terms of choice and cost) to differing types of investment services and securities. jbell on DSK3GLQ082PROD with RULES2 a. Fiduciary Standard Under the Advisers Act Applied to Broker-Dealers A number of commenters discussed the viability of this alternative and stated that it would provide superior investor protection benefits relative to the standard that the Commission proposed.1342 At the outset, we note that, at the time a recommendation is made, key elements of the standard of conduct that applies to broker-dealers under Regulation Best Interest will be substantially similar to key elements of the standard of conduct that applies to investment advisers pursuant to their fiduciary duty under the Advisers Act. Both standards of conduct require that, when making a recommendation or providing advice, firms and financial professionals act in the best interest of the retail investor and not place the financial professionals’ interests ahead 1340 See supra Section III.D.1. supra Section I.A for a discussion of access to investment advice in the context of the DOL Fiduciary Rule. 1342 See Betterment Letter; Warren Letter; Fein Letter; State Treasurers Letter; AARP August 2018 Letter; ACLI Letter; Schwab Letter. 1341 See VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 of the retail investor.1343 Both standards provide methods for addressing conflicts of interest, although the mechanics of those methods and their outcomes may be different,1344 and both standards require full and fair disclosure of material facts that affect the relationship, including costs. Both standards allow each type of financial professional to agree to provide account monitoring services to retail investor accounts, although continuous monitoring is embedded in the regulatory regime and market practices for investment advisers, whereas a broker-dealer may agree to provide account monitoring services only to the extent that it is solely incidental to the primary brokerage business.1345 We recognize that there are certain notable differences between the Advisers Act fiduciary standard and the Regulation Best Interest standard we are adopting. In particular, the investment adviser fiduciary duty is generally principles-based, in keeping with the regulatory tradition and market practices for advisers,1346 whereas Regulation Best Interest, while also largely principles-based, establishes minimum, obligations that are generally more prescriptive than the fiduciary obligations under Advisers Act. Further, advisers are able to address conflicts of interest through full and fair disclosure and informed consent,1347 while brokerdealers must have policies and procedures that are reasonably designed to identify and disclose and mitigate, or eliminate, any conflicts of interest associated with recommendations that create an incentive for the broker-dealer or its associated persons to place the interest of the broker-dealer or its associated persons ahead of the interest of the retail customer. With regard to the substance of both standards, the investment adviser fiduciary duty generally is broader and applies to the entire relationship between adviser and client, including providing nonsecurities advice,1348 whereas supra Section I.A. pursuant to Regulation Best Interest, broker-dealers are required to (i) to establish written policies and procedures reasonably designed to identify and at a minimum, disclose, or eliminate, all conflicts of interest; and (ii) to establish written policies and procedures reasonably designed to mitigate or eliminate identified conflicts of interest, the fiduciary standard for investment adviser relies on full and fair disclosure and informed consent. 1345 See Solely Incidental Interpretation. See also supra Section II.B.2.b. 1346 See Fiduciary Interpretation. 1347 See id. 1348 For example, an investment adviser may consider both securities annuity products (e.g., variable annuities) and non-securities annuity products (e.g., fixed annuities) when providing PO 00000 1343 See 1344 Whereas, Frm 00147 Fmt 4701 Sfmt 4700 33463 Regulation Best Interest only applies at the time of a recommendation of any securities transaction or investment strategy by a broker-dealer to its retail customers.1349 Where application of the Advisers Act fiduciary standard to broker-dealers would impose on brokerdealers obligations similar to those of Regulation Best Interest, we anticipate similar economic effects; in contrast, where this alternative would result in different obligations, it would generate economic effects distinct from those of Regulation Best Interest. i. Fiduciary Standard Under the Advisers Act Relative to the Baseline Relative to the regulatory baseline, the fiduciary standard of this alternative applied to broker-dealers could benefit retail customers in some circumstances by extending the obligations of all firms and financial professionals to act in the best interest of retail customers (and to not place the interest of the firm or the interest of the financial professionals ahead of those of the retail customers) to aspects of the relationship other than providing personalized investment advice through recommendations. For example, retail customers might benefit if broker-dealers were required (as advisers are under their current fiduciary standard) to disclose any material conflicts related to their execution of trades for retail customers in the case when the broker-dealer has not provided a recommendation regarding the transaction (e.g., selfdirected trade). In addition, under the fiduciary standard that applies to investment advisers, if an investment adviser cannot fully and fairly disclose a material conflict of interest to a client such that the client could reasonably be expected to provide informed consent, the investment adviser would be expected to either eliminate the conflict or adequately mitigate (i.e., modify its practices to reduce) the conflict to the point where full and fair disclosure of the conflict to the client and informed advice on annuity products to a client with an advisory retirement account. 1349 However, under the current legal and regulatory regime, broker-dealers are subject to other rules that apply outside the context of a recommendation, including rules regarding how broker-dealers market securities and services (communications with the public), how they execute trades (best execution), and the fees that they charge (fair and reasonable compensation obligations). Moreover, broker-dealers always a have a duty of fair dealing with their retail customers under SRO rules. In addition, brokerdealers are subject to a number of obligations that attach when a broker-dealer makes a recommendation to a customer, as well as general and specific requirements aimed at addressing certain conflicts of interest, including requirements to eliminate, mitigate, or disclose certain conflicts of interest. See Proposing Release Section I.A.1. E:\FR\FM\12JYR2.SGM 12JYR2 33464 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations consent is possible.1350 To the extent that this approach of addressing conflicts of interest would extend to the fiduciary standard in this alternative, a broker-dealer would also have to eliminate or modify a conflict of interest to the point where full and fair disclosure and informed consent is possible. The potential reduction in the effect of conflicts of interest on recommendations and the potential reduction in the information asymmetry between a retail customer and a brokerdealer would likely increase the efficiency of the recommendation provided by the firm to the retail customer, relative to the baseline. Thus, this alternative may reduce the agency costs of the relationship between a broker-dealer and a retail customer, which would benefit retail customers, relative to the baseline. However, any such benefits would come at a cost. As an initial matter, the fiduciary standard under this alternative is a principles-based regime and shaped by decades of case law specific to investment advisory model. In contrast, the standard of conduct that applies to broker-dealers under the baseline is more prescriptive, and governed by detailed SRO rules. Therefore, if this alternative were adopted, broker-dealers would face increased compliance costs resulting from having to conform their advice models to a regulatory regime that was not formed for a transactionbased model governed by detailed SRO rules. The potential increased compliance costs associated with applying the fiduciary standard in this alternative to broker-dealers would likely increase the broker-dealers’ incentives to offer investment advice in the capacity of investment adviser and may decrease their incentive to continue offering investment advice in the capacity of broker-dealer dealer (on a transactionby-transaction basis), relative to the baseline.1351 For example, if this 1350 See Fiduciary Interpretation. Vivek Bhattacharya, Gaston Illanes, & Manisha Padi, Fiduciary Duty and the Market for Financial Advice (Working Paper, Apr. 2019) for a recent paper providing an empirical analysis on the effect of state-level standards of conduct on the structure of the market for investment advice in the context of variable annuities. The study finds differences in broker-dealer behavior when comparing states with and without a fiduciary obligation for broker-dealers. The states with the obligation are associated with fewer variable annuity sales and are also associated with some broker-dealers exiting the industry. Specifically, the paper observes, among other things, that a statelevel obligation reduces the number of brokerdealers that are not dually registered by about 16% but has no meaningful effect on the number of dualregistrants. The authors argue that this compositional shift in the number of broker-dealers jbell on DSK3GLQ082PROD with RULES2 1351 See VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 alternative were to create situations where the compensation to a brokerdealer for providing a recommendation in a commission-based brokerage account would be less than the compensation under a fee-based advisory account and/or where the perceived regulatory burden for an investment adviser is lower, relative to the baseline, a broker-dealer’s incentive to offer advice in the capacity of investment adviser would likely increase, relative to the baseline.1352 To the extent broker-dealers act on the increased incentives and decide to participate in the market for investment advice only in the capacity of investment advisers—for example, dualregistrants may prefer to offer investment advice only in the capacity of investment adviser—retail customers may experience an increase in the cost of obtaining investment advice, relative to the baseline. Furthermore, as noted above, the potential exit of brokerdealers from the market for investment advice in the capacity of broker-dealer may limit how retail customers can access certain securities or investment strategies and how they can pay for investment advice, which, in turn, may further increase the cost of obtaining investment advice, relative to the baseline.1353 Alternatively, to the extent is due to firms exiting the market. The paper also observes that a state-level obligation on brokerdealers may cause a compositional shift in the pool of variable annuities sold by broker-dealers toward annuities that offer a larger and more diverse set of investment options, which, in certain circumstances, may also generate higher expected returns for retail customers. The paper also observes that under certain circumstances a state-level obligation on broker-dealers may increase the quality of the variable annuities sold by brokerdealers. ‘‘Quality’’ is defined by the authors as ‘‘the return on variable annuities assuming optimal allocation.’’ The authors interpret these results as suggesting that a state-level obligation on brokerdealers may (i) cause some broker-dealers to exit the market, and (ii) cause a compositional shift in the variable annuities sold by the broker-dealers that do not exit the market toward annuities of higher quality as defined in the paper. However, the limitations of the data sample and of the empirical methodology make it difficult to (i) generalize these results to the entire market of annuities sold by broker-dealers, (ii) extrapolate these results to the entire universe of securities that broker-dealers offer advice on, (iii) extrapolate the results to the population of broker-dealers not captured by the data sample, or (iv) use the results as a basis for comparing the investor protections offered by statelevel standards of conduct, SRO rules, existing federal standards of conduct, and Regulation Best Interest. See also supra footnote 1163 and surrounding discussion noting that there is substantial variation in the sources, scope, and application of state fiduciary law. 1352 Broker-dealers that choose to deregister would eliminate the costs of complying with FINRA rules, which are broader than retail customer sales practice obligations, and submitting to FINRA examinations as well as compliance with other specific rules, which do not apply to advisers. 1353 See supra Section III.D.1. PO 00000 Frm 00148 Fmt 4701 Sfmt 4700 broker-dealers decide to continue to participate in the market for investment advice in the capacity of broker-dealers, they may pass on the increased compliance costs, in full or in part, to their retail customers in the form of higher prices for services rendered. In particular, retail customers may experience an increase in the cost of obtaining investment advice, relative to the baseline. It is also possible that the fiduciary standard of this alternative may result in a different menu of choices that allows retail customers to access investment advice in a more cost-efficient manner relative to the baseline. For example, if more financial professionals decide to participate in the market for investment advice in the capacity of investment advisers, competitive pressure may result in investment advisers providing better pricing and/or more choices of accessing investment advice for retail customers. To the extent that the cost of accessing investment advice increases under the fiduciary standard of this alternative, some retail customers may be pushed outside the market for investment advice. For example, currently, a retail customer that prefers to receive recommendations from a broker-dealer or its associated persons to implement a buy-and-hold strategy may find a brokerage account to be better suited to his or her needs compared to an advisory account.1354 Under the fiduciary standard in this alternative, this retail customer may have to pay more for the broker-dealer services that come with his or her account, including obtaining investment advice, relative to the baseline. If this increase in the cost for broker-dealer services outweighs the benefits of the potential improved efficiency of the recommendations provided by the 1354 For example, Del Guercio & Reuter (2014), supra footnote 1081, document (Table 1 on page 1682) that retail customers can access index funds through both broker-dealers (i.e., the broker-sold channel, as discussed above) and directly from the fund sponsor (i.e., the direct-sold channel). Furthermore, in their sample, the average expense ratio for an index fund is 0.86 if sold through the broker-sold channel and 0.44 if sold through the direct channel. Assuming that a retail customer is interested in implementing a buy-and-hold strategy using index funds that carry no loads, the cost to the retail customer of implementing this strategy through a broker-dealer would be on average 86 basis points of the assets invested per year. In contrast, the cost to the retail customer of implementing the same strategy through an investment adviser would be on average 44 basis points plus the investment adviser’s AUM-based fee per year. Assuming that in the investment adviser’s fee is 100 basis points of AUM per year, the cost to the retail customer of implementing his or her strategy with an investment adviser would be on average 144 basis points. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations broker-dealer for this retail customer, as noted above, the retail customer may prefer to switch to a more-limited brokerage account that does not come with personalized investment advice (e.g., an execution-only brokerage account).1355 Alternatively, and as noted by one commenter, the retail customer may switch to a light version of an advisory account that implements automated investment strategies tailored around a retail customer’s goals.1356 However, this type of advisory account may not offer the flexibility of personalized investment advice to the evolving needs of the customer and may not be as responsive to market movements not anticipated by the automated investment strategies. jbell on DSK3GLQ082PROD with RULES2 b. Uniform Fiduciary Standard Under 913(g) Another alternative approach to the standard of conduct imposed by Regulation Best interest is a ‘‘new’’ uniform fiduciary standard of conduct applicable to both broker-dealers and investment advisers, such as that recommended by the staff in the 913 Study.1357 The fiduciary standard under this alternative would require firms ‘‘to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice.’’ Based on the Commission staff’s recommendations about ways in which the fiduciary standard proposed 1355 Relative to a brokerage account that offers personalized investment advice, execution-only brokerage accounts may also come with enhanced research tools, more investment choices, and, potentially, other forms of impersonal advice. 1356 See, e.g., CFA August 2018 Letter at 79, noting that ‘‘[f]or example, Vanguard charges 0.30% for its Personal Advisor Services, Schwab charges 0.28% for its Intelligent Advisory Services, and Betterment charges 0.25% for its Digital offering and 0.40% for its Premium offering.’’ 1357 One of the staff’s primary recommendations was that the Commission engage in rulemaking to adopt and implement a uniform fiduciary standard of conduct for broker-dealers and investment advisers when providing personalized investment advice about securities to retail customers. The staff’s recommended standard would require firms ‘‘to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice.’’ The staff made a number of specific recommendations for implementing the uniform fiduciary standard of conduct, including that the Commission should: (1) Require firms to eliminate or disclose conflicts of interest; (2) consider whether rulemaking would be appropriate to prohibit certain conflicts, to require firms to mitigate conflicts through specific action, or to impose specific disclosure and consent requirements; and (3) consider specifying uniform standards for the duty of care owed to retail customers, such as specifying what basis a brokerdealer or investment adviser should have in making a recommendation to a retail customer by referring to and expanding upon broker-dealers’ existing suitability requirements. See 913 Study. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 by the 913 study could be implemented, the fiduciary standard under this alternative could have imposed any or all of the following requirements: (1) Eliminate or disclose conflicts of interest; (2) prohibit certain conflicts of interest by requiring firms to mitigate conflicts through specific action, or to impose specific disclosure and consent requirements; and (3) specify the basis a broker-dealer or investment adviser has in making a recommendation to a retail customer by referring to and expanding upon broker-dealers’ existing suitability requirements. Some of the benefits of the investment advisers’ fiduciary standard of the previous alternative would carry over to the new uniform standard of this alternative. In particular, relative to the baseline, the new fiduciary standard of this alternative applied to broker-dealers could benefit retail customers in some circumstances by extending the obligations of all firms and financial professionals to act in the best interest of retail customers (and to not place the interest of the firm or those of the financial professionals ahead of the interest of the retail customer) to aspects of the relationship other than providing personalized investment advice through recommendations. In addition, the new fiduciary standard of this alternative applied to broker-dealers may create additional benefits for their retail customers, relative to the baseline. For example, requirements (1) and (2) may enhance the obligations under the baseline by requiring broker-dealers to disclose conflicts of interest and to take actions to mitigate or eliminate certain conflicts of interest. To the extent that these requirements reduce of the effect of the conflicts of interest on the recommendation provided by a brokerdealer or its associated persons and reduce the information asymmetry between retail customers and brokerdealers, the new fiduciary standard of this alternative may increase, relative to the baseline, the efficiency of the recommendations made by brokerdealers and their associated persons. Furthermore, requirement (3) may enhance the existing suitability requirements that apply to brokerdealers and, to the extent that this requirement results in recommendations that are better aligned with the objectives of the retail customers, the new fiduciary standard of conduct of this alternative may further increase, relative to the baseline, the efficiency of the recommendations provided by broker-dealers and their associated persons. The potential increase in the efficiency of the recommendations PO 00000 Frm 00149 Fmt 4701 Sfmt 4700 33465 provided by broker-dealers and their associated persons under the new fiduciary standard of this alternative would benefit retail customers, relative to the baseline. Similarly, the new fiduciary standard of this alternative applied to investment advisers may create benefits for their clients, relative to the baseline. Requirements (1) and (2) would enhance the obligations of the investment advisers under the current fiduciary standard that applies to investment advisers by requiring investment advisers to take actions to mitigate or eliminate certain conflicts of interest. To the extent that these requirements reduce of the effect of the conflicts of interest on the recommendation provided by an investment adviser or its associated persons and reduce the information asymmetry between retail customers and investment advisers, the new fiduciary standard under this alternative may increase the efficiency of the recommendations made by investment advisers and their associated persons, relative to the baseline. The new fiduciary duty of this alternative may also result in increased competition across financial professionals for retail customers or clients, relative to the baseline. This potential increase in competition, relative to the baseline, may benefit retail customers of broker-dealers and clients of investment advisers in the form of lower prices for investment advice. Turning to the potential costs imposed by this alternative, we note that some of the costs of the investment advisers’ fiduciary standard of the previous alternative carry over to the new fiduciary standard of this alternative. As noted above, this alternative would impose a new regulatory paradigm on broker-dealers relative to the baseline. The fiduciary standard of this alternative would be principles-based and shaped by common law. In contrast, the standard of conduct that applies to broker-dealers under the baseline is more prescriptive and governed by detailed SRO rules. A paradigm shift from the standards of conduct under the current baseline to the uniform standard in this alternative may increase compliance costs relative to the baseline.1358 Furthermore, the potential increased compliance costs associated with applying the fiduciary standard of this alternative to broker-dealers may increase, relative to the baseline, a broker-dealer’s incentives to offer investment advice in the capacity of an 1358 See E:\FR\FM\12JYR2.SGM also 913 Study at 156–159. 12JYR2 jbell on DSK3GLQ082PROD with RULES2 33466 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations investment adviser and may decrease their incentive to offer investment advice in the capacity of broker-dealer. For example, if this alternative creates situations where the compensation to a broker-dealer for providing a recommendation in a commission-based brokerage account would be less than the compensation under a fee-based advisory account while the perceived regulatory burden is equal to that of an investment adviser, a broker-dealer’s incentive to offer advice in the capacity of investment adviser may increase, relative to the baseline.1359 To the extent broker-dealers act on the increased incentives and decide to participate in the market for investment advice only in the capacity of investment advisers—for example, dualregistrants may prefer to offer investment advice only in the capacity of investment adviser—retail customers may experience an increase in the cost of obtaining investment advice, relative to the baseline. Alternatively, to the extent broker-dealers decide to continue to participate in the market for investment advice in the capacity of broker-dealers, they may pass on the increased compliance costs, in full or in part, to their retail customers in the form of higher prices for services rendered, relative to the baseline. In particular, retail customers may experience an increase in the cost of obtaining investment advice, relative to the baseline.1360 Similarly, the new fiduciary standard of this alternative may also impose additional compliance costs for investment advisers relative to the baseline.1361 For example, to the extent that investment advisers currently provide investment advice to their clients in a manner that is not fully consistent with the requirements (2) and (3), investment advisers may incur compliance costs in adhering to these potentially more stringent requirements. Investment advisers would likely pass on the potential increase in the costs of complying with the new fiduciary standard of this alternative to their clients. In turn, under the new fiduciary standard of this alternative, clients may experience an increase in the cost of obtaining investment advice, relative to the baseline. It is also possible that the new fiduciary standard of this alternative may result in a different menu of choices that allows retail customers and clients to access investment advice in a more cost-efficient manner relative to 1359 See supra footnote 1351. also 913 Study at 159–162. 1361 See id. at 159. 1360 See VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 the baseline. For example, if more financial professionals decide to participate in the market for investment advice as investment advisers, competitive pressure may result in better pricing and/or greater choice in accessing investment advice for retail customers and clients that choose to use an investment adviser. However, to the extent that the cost of accessing investment advice increases under the new fiduciary standard of this alternative, some retail customers may be pushed outside the market for investment advice, relative to the baseline. For example, currently, a retail customer who prefers to receive recommendations from a broker-dealer or its associated persons to implement a buy-and-hold strategy may find a brokerage account to be better suited to his or her needs than an advisory account. Under the new fiduciary standard of this alternative, this retail customer may have to pay more for the broker-dealer services that come with his or her account, including obtaining investment advice, relative to the baseline. If, from the perspective of a retail customer, this increase in the cost for broker-dealer services outweighs the expected benefits of the potential improved efficiency of the recommendations provided by the broker-dealer, the retail customer may prefer to switch to a more limited brokerage account that does not come with personalized investment advice (e.g., an execution-only brokerage account).1362 Alternatively, and as noted by one commenter, the retail customer may switch to an advisory account that implements automated investment strategies.1363 However, this type of advisory account may not offer the flexibility of personalized investment advice to the evolving needs of the customer, the level of contact a retail customer seeks from a relationship with a financial professional, and may not be as responsive to market movements not anticipated by the automated investment strategies. Similarly, under the new fiduciary standard of this alternative, clients of investment advisers may experience an increase in the cost of obtaining investment advice. Some of these clients may not be able to afford the additional cost and may be pushed outside the market for investment advice, relative to the baseline. As noted above, the options available to these clients may not offer the flexibility of tailored investment advice that may benefit a client with evolving needs. 1362 Relative to a brokerage account that offers personalized investment advice, execution-only brokerage accounts may also come with enhanced research tools, more investment choices, and, potentially, other forms of impersonal advice. 1363 See, e.g., CFA August 2018 Letter at 79, noting that ‘‘[f]or example, Vanguard charges 0.30% for its Personal Advisor Services, Schwab charges 0.28% for its Intelligent Advisory Services, and Betterment charges 0.25% for its Digital offering and 0.40% for its Premium offering.’’ 1364 For a discussion of key conditions of the BIC Exemption, see Section I.A.2 of the Proposing Release at 21581. As discussed above, the DOL Fiduciary Rule—including the BIC Exemption—was vacated by the United States Court of Appeals for the Fifth Circuit on March 15, 2018, although some firms may continue to seek comply with certain of its conditions under a DOL temporary enforcement policy. See also supra Section III.B.2.e. See also supra footnote 32. 1365 See Galvin Letter. PO 00000 Frm 00150 Fmt 4701 Sfmt 4700 c. Fiduciary Standard Under the DOL Rule and BIC Exemption A third alternative approach to addressing the agency costs associated with obtaining advice from brokerdealers is a fiduciary standard coupled with a series of disclosures and other requirements akin to the full complement of conditions of the DOL’s BIC Exemption adopted in connection with the DOL Fiduciary Rule. This alternative would mirror the key conditions that apply to an ‘‘adviser’’ under the BIC Exemption.1364 This alternative approach would apply to broker-dealers when providing recommendations to retail customer for all types of retail accounts rather than retirement accounts only. At least one commenter signaled support for this alternative.1365 Unlike other alternatives considered in this section, or Regulation Best Interest, this alternative can be analyzed, at least in part, based upon its previous adoption by the DOL and partial implementation. Because this alternative was already partly implemented, the market for investment advice, the securities market, and, ultimately investors have had an opportunity to partially adjust to it. Section III.B.2.e.ii summarizes the evidence about the response of firms, investors and product markets in response to the DOL Fiduciary Rule. The requirements of the standard of conduct in this alternative would enhance the obligations under the baseline by requiring broker-dealers to adhere to the impartial conduct standard, which included requirements to act in their retail customers’ best interest, disclose material conflicts of interest and designate a person responsible for addressing material conflicts of interest and monitoring the adherence of the associated persons of the broker-dealer to the impartial conduct standard. To the extent that E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations these requirements reduce the effect of the conflicts of interest on the recommendation provided by a brokerdealer or its associated persons and reduce the information asymmetry between retail customers and brokerdealers, the new standard of conduct in this alternative would increase the efficiency of the recommendations made by broker-dealers and their associated persons, relative to the regulatory baseline. Furthermore, the requirement to act in the retail customers’ best interest would enhance the existing suitability standard that applies to broker-dealers and, to the extent that the new standard of conduct of this alternative would result in recommendations that are better aligned with the objectives of the retail customers, this new standard would further increase the efficiency of the recommendations provided by brokerdealers and their associated persons, relative to the regulatory baseline. The potential increase in the efficiency of the recommendations provided by broker-dealers and their associated persons under the new standard in this alternative would benefit retail customers, relative to the baseline. This alternative may also affect product markets. As discussed above in Section III.B.2.ii, certain product sponsors introduced new products in the market for mutual funds, such as clean and T shares that were designed to facilitate compliance with various anticipated regulations, including the DOL Fiduciary Rule. In certain circumstances, these products may come with lower fees for retail customers. To the extent that this alternative would enhance this trend in product innovation, retail customers may benefit from this trend. However this alternative would also impose costs on broker-dealers and retail customers. Compliance costs would include costs associated with the contract provision, and the disclosure, policies and procedure, and record-making and recordkeeping requirements. It is possible that broker-dealers would pass on these direct compliance costs, in part or in full, to retail customers. In addition to these costs, this alternative would likely cause some broker-dealers to change their current practices, which, in turn, may impose further costs on them or their retail customers. As discussed above in Section III.B.2.e.ii some studies find evidence suggesting that firms have adjusted their practices, at least in the short-run, in response to the DOL fiduciary Rule. In particular, certain of these studies observe that in certain VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 cases some broker-dealers have either eliminated or reduced access to brokerage advice services. Other studies observe that some broker-dealers migrated toward fee-based advisory services or limited brokerage services (i.e., no provision of advice) and, in the process, offered their retail customers the option to shift from commissionbased brokerage accounts to fee-based accounts, automated investment accounts or self-directed accounts. Some of their customers chose to not move to a fee-based account. Certain studies provide evidence suggesting that some broker-dealers adjusted the range of their offerings.1366 Specifically, according to these studies, some of the respondents reduced or eliminated access to certain assets or share classes, such as certain mutual funds or mutual fund share classes, and or annuity securities offered. Finally, there is some anecdotal evidence that suggests that certain firms changed the compensation structure for their associated persons.1367 Specifically, some firms equalize commissions and deferred sales charges across similar securities, while other firms banned sales quotas, contests, and certain bonuses. To the extent that the fiduciary standard in this alternative would result in similar responses by broker-dealers, the alternative would impose cost on retail customers relative to the baseline. For example, switching a retail customer from a commission-based brokerage account to a different type of account, such as fee-based advisory account, may leave a customer worse off in certain circumstances. For instance, a retail customer who is a buy-and-hold investor may overpay for the advice typically associated with this type of investment strategy if the retail customer were to shift from a brokerage account to a fee-based account.1368 As another example, a retail customer would lose access to occasional personalized advice if he or she were to shift from his or her brokerage account to a self-directed account. The cost to retail customers from switching to a suboptimal account is particularly important in the context of IRA brokerage accounts, because of the larger size of these accounts and the importance of these accounts for retail investors to meet their retirement needs. These costs may also be higher for IRA brokerage accounts than for other account types to the extent that these accounts include long-term, buy-and- PO 00000 1366 See supra Section III.B.2.e.ii. id. 1368 See supra footnote 1354. 1367 See Frm 00151 Fmt 4701 Sfmt 4700 33467 hold investments. As discussed in Section III.B.2.e.ii, one study provided an estimate for this potential cost.1369 However, as discussed above, the estimates provided by various studies, including this one, or by commenters are generally subject to assumptions or methodological limitations which may affect the inferences based on such estimates. In addition to the evidence discussed above, there are other potential economic implications of this alternative. For instance, this alternative may exclude from the market for investment advice those retail customers that have account balances that are below the account minimum for typical advisory accounts. The investment advisory industry might adjust to a lack of supply by accommodating lower account balances. However, because investment advisers have a fiduciary duty to all their clients, and because they have limited time and resources, there is likely a limit to how much an investment adviser can lower his or her account minimum to accommodate more advisory clients. Similarly, the product market may adjust by innovating new products to accommodate retail customers with account balances that are below the typical advisory account minimum. For example, hybrid products that implement automated investment strategies tailored to a retail customer’s goals may substitute for the services of an investment adviser for customers with lower account balances. 2. Prescribed Format for Disclosure Although Regulation Best Interest specifies the required content of disclosure necessary to meet a brokerdealer’s Disclosure Obligation, it does not prescribe a specific format for that disclosure. As an alternative, and as suggested by commenters,1370 we 1369 See SIFMA Study. e.g., LPL August 2018 Letter that notes that ‘‘all investors should be provided with general disclosures somewhat akin to those contained in Form ADV Part 2A—e.g., which set forth the ranges of remuneration payable to a broker-dealer in connection with its recommendations of different products . . . [W]e believe that detailed productspecific disclosures should be required prior to or at the time of a recommendation only in instances where the remuneration associated with the recommendation exceeds the previously disclosed range or where the recommendation implicates a conflict of interest that has not previously been disclosed. In all other cases, a broker-dealer should be permitted to satisfy its Disclosure Obligation by directing an investor in writing to review the recommended product’s offering documents and providing hyperlinks to those documents (or providing a hyperlink to a central page on the broker-dealer’s website that contains hyperlinks to the product documents), either prior to the 1370 See, Continued E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 33468 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations considered requiring broker-dealers to use a specific form similar to, for example, Form ADV. Because this alternative would still impose all the obligations of Regulation Best Interest, all the benefits and the costs identified in Regulation Best Interest would carry over to this alternative as well. However, by changing the way broker-dealers would meet the Disclosure Obligation, this alternative may create additional benefits and impose additional costs. The requirement to use a form similar to Form ADV to meet the Disclosure Obligation would put more structure on the disclosure of material facts relating to the scope and terms of the relationship with the retail customer and material facts relating to conflicts of interest that are associated with a recommendation. This added structure would facilitate retail customers’ comparison of multiple broker-dealers, which would benefit retail customers. For example, the evidence provided by the investor testing surveys suggests that retail customers form preference over various variables that are being disclosed.1371 On the backdrop of this evidence, the structured disclosure provided by a specific form may enhance a retail customer’s ability to select a broker-dealer in a manner consistent with his or her preferences. In addition, the structured disclosure provided by a form may allow a third party to collect the information disclosed by firms, process it, and present it to retail customers in a way that would make it easier for the retail customer to select a broker-dealer. To the extent the format of disclosure under this alternative would result in this potential outcome, the alternative would further benefit retail customers. However, the requirement to use a form similar to Form ADV to meet the Disclosure Obligation may also impose costs on broker-dealers, at least in the short run, to the extent that this form of disclosure is different from the form of disclosure that firms employ currently to satisfy their disclosure obligations and liabilities under the baseline. In general it may be difficult to design a form that, while comprehensive in terms of capturing the diversity of business practices that broker-dealers employ, remains easy to understand for retail customers. In general, given that there is a wide variety of business models and practices, there is value in providing broker-dealers with flexibility to enable them to better tailor disclosure and information that their retail customers can understand and may be more likely to read at relevant points in time, rather than, for example, mandating a standardized all-inclusive (and likely lengthy) disclosure. Depending on the specific form that is eventually mandated, some firms may incur more costs than others. To the extent firms pass on those costs to retail customers, the alternative would impose a cost on retail customers. recommendation via a general Form ADV Part 2Alike disclosure document or shortly thereafter via a trade confirmation.’’ See also Morningstar Letter, noting ‘‘publicly available disclosures with a standard taxonomy work best because they empower third parties such as ‘fintech’ and ‘regtech’ firms to analyze and contextualize critical information and amplify a call to action for ordinary investors.’’ See also Letter from Peter J. Chepucavage (May 31, 2018) (‘‘Chepucavage Letter’’), noting that ‘‘[c]osts for the small bd’s however can be reduced with a commission approved standard disclosure which would add certainty and ought to be considered especially for the small investor. [. . .] A standard disclosure document would also be useful for the small bd that cannot afford the legal assistance needed to evaluate this 1,000 page proposal and draft appropriate documents. [. . .] The Commission should therefore reconsider the impact of its proposal on small investors and small bd’s with the assumption that retirement accounts are significantly more important than regular brokerage accounts especially for small and elderly investors. A standard disclosure for small firms would reduce costs for the firms and their customers.’’ 1371 See Relationship Summary Adopting Release for a discussion of the evidence provided by the investor testing surveys. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 3. Disclosure-Only Another potential alternative to addressing the agency costs of obtaining advice from broker-dealers is a disclosure-only alternative, which would require that broker-dealers satisfy only the Disclosure Obligation of Regulation Best Interest. In other words, broker-dealers would be required to provide the retail customer, in writing, full and fair disclosure of all material facts relating to the scope of the relationship with the retail customer and all material facts relating to the conflicts of interest associated with the recommendations to the retail customer, prior to or at the time of the recommendation. However, this alternative would not impose either the Care Obligation or the Conflict of Interest Obligation. As discussed in Sections III.C.2 and III.C.4, there may be substantial overlap between the disclosure requirements of Regulation Best Interest and the disclosure requirements under the regulatory baseline. From this perspective, relative to the regulatory baseline, the cost of this alternative to the broker-dealers may be small, at least for some broker-dealers. However, as pointed out above, a disclosure-only alternative is not likely to address the agency costs associated with obtaining PO 00000 Frm 00152 Fmt 4701 Sfmt 4700 advice from broker-dealers. As a result, the Commission believes both specific disclosure and mitigation requirements are needed to address those conflicts. Also, we noted above that sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sales of specific securities within a limited period of time create highpressure situations for associated persons to increase the sales of specific securities by compromising the best interest of their customers; the Commission does not believe such conflicts of interest can be reasonably mitigated, let alone disclosed, in a manner that adequately prevents harm to retail customers and, accordingly, believes that these conflicts must be eliminated in their entirety. Finally, as we discussed earlier, commenters noted that there are limits to the effectiveness of disclosure and cited a number of studies suggesting that disclosure alone is unlikely to solve the issues surrounding, for example, the conflicts of interest between a brokerdealer (or their associated persons) and a retail customer.1372 IV. Paperwork Reduction Act Certain provisions of Regulation Best Interest and the rule amendments that we are adopting today contain ‘‘collection of information’’ requirements within the meaning of the Paperwork Reduction Act of 1995 (‘‘PRA’’).1373 The Commission submitted Regulation Best Interest and the rule amendments to the Office of Management and Budget (‘‘OMB’’) for review and approval in accordance with the PRA.1374 The Commission’s earlier PRA assessments have been revised to reflect the modifications to the rule and amendments from the Proposing Release, as well as additional information and data provided to the Commission by commenters. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a currently valid OMB control number. The titles and OMB control numbers for the collections of information are: 1372 See supra footnote 1208 and accompanying text. See also supra Section III.B.4.c for a discussion of the literature on the effectiveness of disclosure. 1373 44 U.S.C. 3501 et seq. 1374 See 44 U.S.C. 3507(d); 5 CFR 1320.11. 1375 See 17 CFR 240.17a–3. The addition of paragraph (a)(35) to Rule 17a–3 would amend the existing PRA for Rule 17a–3. 1376 See 17 CFR 240.17a–4. The amendment to Rule 17a–4(e)(5) would amend the existing PRA for Rule 17a–4. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 OMB control No. Rule Rule title Rule 15l–1 ............... Rule 17a–3 .............. Rule 17a–4 .............. Regulation Best Interest. Records to be made by certain exchange members, brokers and dealers 1375 ........................................... Records to be preserved by certain exchange members, brokers and dealers 1376 .................................... Regulation Best Interest enhances the broker-dealer standard of conduct beyond existing suitability obligations, and aligns the standard of conduct with retail customers’ reasonable expectations by requiring brokerdealers, among other things, to: (1) Comply with specific obligations to make recommendations that are in the best interest of the retail customer, and that do not place the broker-dealer’s interests ahead of the interests of the retail customer; and (2) address conflicts of interest by fully and fairly disclosing material facts about conflicts of interest, and in instances where we believe disclosure is insufficient to reasonably address the conflict, establish, maintain and enforce policies and procedures reasonably designed to mitigate or, in certain instances, eliminate the conflict. Generally, in crafting Regulation Best Interest, we aimed to provide brokerdealers flexibility in determining how to satisfy the component obligations. For purposes of this analysis, we have made assumptions regarding how a brokerdealer would comply with the obligations of Regulation Best Interest, as well as the amendments under Rule 17a–3(a)(35) and Rule 17a–4(e)(5). In the Proposing Release, we requested comment on the matters discussed in the PRA, including our estimates for the new and recurring burdens and associated costs described in connection with Regulation Best Interest and the amendments under Rule 17a–3(a)(35) and Rule 17a– 4(e)(5).1377 In particular, we sought comment on estimates as to: (1) The number of natural persons who are associated persons; (2) the number of broker-dealers that make securitiesrelated recommendations to retail customers; (3) the number of natural persons who are associated persons that make securities-related recommendations to retail customers; and (4) any other costs or burdens 1378 associated with proposed Regulation 1377 The Proposing Release proposed to add new paragraph (a)(25) of Rule 17a–3. As noted above, we are adopting the provision substantially as proposed but redesignating it as new paragraph (a)(35) of Rule 17a–3. See supra footnote 820 and accompanying text. 1378 Throughout the PRA analysis in the Proposing Release, the burdens on in-house personnel were measured in terms of burden hours, and external costs were expressed in dollar terms. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 Best Interest that had not been identified in the Proposing Release. As discussed in Sections I, II, and III, we received comments that addressed whether we could minimize the burden of the proposed collections of information. We received several comments suggesting that our estimated burdens and costs for the rule as a whole were too low.1379 In addition, the Commission received some comments specifically addressing the costs to smaller broker-dealers.1380 Also, as discussed in the Economic Analysis section above, we received comments regarding the potential costs and burdens of proposed Regulation Best Interest on broker-dealers.1381 In response, we have modified several substantive requirements to the rule by, among other things, providing more specificity in the rule text in the Disclosure and Conflict of Interest Obligations, which we believe will mitigate some of these burdens and costs relative to the Proposing Release.1382 At the same time, certain modifications, such as maintaining a written record of oral disclosure, resulted in new burdens and costs, relative to those addressed in the Proposing Release, which are reflected below. 1379 See, e.g., NSCP Letter; see also CCMC Letters (costs to implement the proposal were underestimated and greater than 40% of firms surveyed anticipate having to spend a moderate or substantial amount to implement Regulation Best Interest and Form CRS); Raymond James Letter (noting the significant implementation costs of Regulation Best Interest and Form CRS for the industry); SIFMA August 2018 Letter (stating that implementation costs of Regulation Best Interest and Form CRS would be significant). 1380 See, e.g., Chepucavage Letter (finding that the estimates in the proposal are severely understated unless they are excluding time needed for review of the proposal and final rule and suggesting the Commission reconsider the impact on small investors and small broker-dealers); NSCP Letter (requesting the Commission to consider the financial and operational impacts of the proposed rule, particularly on small firms, and to minimize those impacts, given that small firms do not have compliance departments adequate to deal with increasing regulatory demands). See also, e.g., Iowa Insurance Commissioner Letter; Letter from David S. Addington, National Federation of Independent Business (May 30, 2018) (‘‘NFIB Letter’’). 1381 See supra Section III. 1382 Throughout this PRA analysis, the burdens on in-house personnel are measured in terms of burden hours, and external costs are expressed in dollar terms. PO 00000 Frm 00153 Fmt 4701 Sfmt 4700 33469 3235–0033 3235–0279 A. Respondents Subject to Regulation Best Interest and Amendments to Rule 17a–3(a)(35) and Rule 17a–4(e)(5) 1. Broker-Dealers Regulation Best Interest imposes a best interest obligation on a brokerdealer when making recommendations of any securities transaction or investment strategy involving securities to retail customers. Except where noted, we have assumed that a dually registered firm, already subject to the Advisers Act, would be subject to new, distinct burdens under Regulation Best Interest. As of December 31, 2018, 3,764 broker-dealers were registered with the Commission, either as standalone broker-dealers or as dually registered entities.1383 Based on data obtained from Form BR, the Commission believes that approximately 73.5% of this population, or 2,766 broker-dealers, have retail customers and therefore would be subject to Regulation Best Interest and the amendments under Rules 17a–3(a)(35) and 17a–4(e)(5).1384 Further, based on FOCUS Report data,1385 the Commission estimates that as of December 31, 2018, approximately 985 broker-dealers may be deemed small entities under the Regulatory Flexibility Act.1386 Of these, 1383 The Commission estimated the number of respondents in the Proposing Release as of December 31, 2017. The Commission is updating its estimated number of broker-dealers to reflect the number of broker-dealers registered with the Commission as of December 31, 2018. 1384 As of December 31, 2018, 3,764 brokerdealers filed Form BD. Retail sales by broker-dealers were obtained from Form BR. As discussed above in Section III.B.1.a, the number of broker-dealers that serve retail customers (i.e., 2,766) likely overstates the number of broker-dealers that will be subject to Regulation Best Interest, because not all broker-dealers that serve retail investors provide recommendations to retail investors. We do not have reliable data to determine the precise number of broker-dealers that provide recommendations, and as a result, we have assumed, for purposes of this analysis that 2,766 broker-dealers will be subject to Regulation Best Interest. 1385 FOCUS Reports, or ‘‘Financial and Operational Combined Uniform Single’’ Reports, are monthly, quarterly, and annual reports that broker-dealers are generally required to file with the Commission and/or SROs pursuant to Exchange Act Rule 17a–5. See 17 CFR 240.17a–5. 1386 See infra Section V for an explanation of which brokers-dealers, subject to Regulation Best Interest, are ‘‘small entities,’’ for purposes of the Regulatory Flexibility Act analysis. E:\FR\FM\12JYR2.SGM Continued 12JYR2 33470 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations approximately 756 have retail business.1387 Therefore, we estimate that 2,010 broker-dealers would qualify as large broker-dealers with retail customers for purposes of this analysis.1388 2. Natural Persons Who Are Associated Persons of Broker-Dealers As with broker-dealers, Regulation Best Interest imposes a best interest obligation on natural persons who are associated persons of broker-dealers when making recommendations of any securities transaction or investment strategy involving securities to retail customers. The Commission believes that approximately 428,404 natural persons would qualify as retail-facing, registered representatives at standalone brokerdealers or dually registered firms,1389 and would therefore be subject to Regulation Best Interest.1390 jbell on DSK3GLQ082PROD with RULES2 B. Summary of Collections of Information Regulation Best Interest requires broker-dealers and their associated persons 1391 when making a recommendation of any securities The Commission’s estimate is obtained from Form BD filings. Although Form BD filings are updated on a more frequent basis than annually, FOCUS data, which also informs this baseline with respect to broker-dealers, is only sparsely updated throughout the year. Moreover, instead, brokerdealers tend to make their most complete updates in the fourth calendar quarter of each year. Therefore, in order to minimize discrepancies in the broker-dealer data between Form BD and FOCUS data, we have normalized all of the data to the most recently complete FOCUS data, which is for December 2018. 1387 Id. 1388 This calculation was made as follows: (2,766 total retail broker-dealers)¥(756 total small retail broker-dealers) = 2,010 large retail broker-dealers. 1389 See supra Section III.B.1 at Table 5. This estimate is based on the following calculation: (504,005 total licensed representatives (including representatives of investment advisers)) × (15% (the percentage of total licensed representatives who are standalone investment adviser representatives)) = approximately 75,601 representatives at standalone investment advisers. To isolate the number of representatives at standalone broker-dealers and dually registered firms, we have subtracted 75,601 from 504,005, for a total of 428,404 retail-facing, licensed representatives at standalone brokerdealers or dually registered firms. 1390 Unless otherwise noted, for purposes of the PRA, we use the term ‘‘registered representatives’’ to refer to associated persons of broker-dealers who are registered, have series 6 or 7 licenses, and are retail-facing, and we use the term ‘‘dually registered representatives of broker-dealers’’ to refer to registered representatives who are dually registered and are associated persons of a standalone brokerdealer (who may be associated with an unaffiliated investment adviser) or a dually registered brokerdealer. 1391 However, in certain instances, as described more fully below, the Commission assumes that broker-dealers will undertake certain Disclosure Obligations on behalf of their registered representatives. See, e.g., infra footnote 1396. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 transaction or investment strategy involving securities to a retail customer to act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker-dealer ahead of the interest of the retail customer. As discussed above, Regulation Best Interest specifically provides that this best interest obligation shall be satisfied if the broker-dealer complies with the specific Disclosure, Care, Conflict of Interest, and Compliance Obligations. Rule 17a–3 requires a broker-dealer to make and keep current certain records. The Commission is amending this rule by adding new paragraph (a)(35) to impose new record-making obligations on broker-dealers subject to Regulation Best Interest. Rule 17a–4 requires a broker-dealer to preserve certain records if it makes or receives them. The Commission is amending Rule 17a– 4(e)(5) to impose new record retention obligations on broker-dealers subject to Regulation Best Interest. The obligations arising under Regulation Best Interest and the amendments under Rule 17a–3(a)(35) and Rule 17a–4(e)(5) would give rise to distinct collections of information and associated costs and burdens for brokerdealers subject to the rules. The collections of information associated with Regulation Best Interest and rule amendments are described below. 1. Disclosure Obligation The Disclosure Obligation under Regulation Best Interest requires a broker, dealer, or natural person who is an associated person of a broker or dealer, prior to or at the time of recommending a securities transaction or strategy involving securities to a retail customer, to provide the retail customer, in writing, full and fair disclosure of: (1) All material facts relating to the scope and terms of the relationship with the retail customer, including (a) that the broker, dealer, or such natural person is acting as a broker, dealer, or an associated person of a broker or dealer with respect to the recommendation, (b) the fees and costs that apply to the retail customer’s transactions, holdings, and accounts, and (c) the type and scope of services provided to the retail customer, including any material limitations on the securities or investment strategies involving securities that may be recommended to the retail customer; and (2) all material facts relating to conflicts of interest that are associated with the recommendation. The Commission believes that requiring broker-dealers to disclose to a retail PO 00000 Frm 00154 Fmt 4701 Sfmt 4700 customer, in writing, all material facts relating to the scope and terms of the relationship with the retail customer would facilitate the retail customer’s understanding of the nature of his or her account, the broker-dealer’s fees and costs, as well as the nature of services that the broker-dealer provides, as well as any limitations to those services. It would also provide retail customers with information to better understand the differences among certain financial service providers, such as brokerdealers, investment advisers, and dually registered firms and dually registered financial professionals. In addition, the obligation to disclose all material facts relating to conflicts of interest that are associated with a recommendation would raise retail customers’ awareness of the potential effects of conflicts of interest, and increase the likelihood that broker-dealers would make recommendations that are in the retail customer’s best interest. We are explicitly requiring in the rule text of Regulation Best Interest, items that the Proposing Release had only provided as examples of ‘‘material facts relating to the scope and terms of the relationship with the retail customer’’ that must be disclosed, namely: (1) That the broker, dealer or such natural person is acting as a broker, dealer or an associated person of a broker-dealer with respect to the recommendation; (2) the material fees and costs that apply to the retail customer’s transactions, holdings, and accounts; and (3) the type and scope of services provided to the retail customer, including: any material limitations on the securities or investment strategies involving securities that may be recommended to the retail customer. We generally believe the proposed burdens and costs identified in the Proposing Release were accurate but have updated estimates to reflect changes in the number of brokerdealers and costs of certain services since the last estimate. The collections of information associated with the Disclosure Obligation, as well as the associated record-making and recordkeeping obligations are addressed below. a. Obligation To Provide to the Retail Customer Full and Fair Disclosure, in Writing, of all Material Facts Relating to the Scope and Terms of the Relationship With the Retail Customer The Commission assumes for purposes of this analysis that brokerdealers would meet the obligation to disclose to the retail customer, in writing, the material facts related to the scope and terms of the relationship with the retail customer through a E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations combination of delivery of the Relationship Summary, creating account disclosures to include standardized language related to capacity and type and scope of services, and the development of fee schedules. jbell on DSK3GLQ082PROD with RULES2 (1) Disclosure of Capacity As discussed above, the Commission believes that a standalone broker-dealer would be able to satisfy its obligation to disclose that it is acting in a brokerdealer capacity by providing the retail customer with the Relationship Summary in the manner prescribed by the rules and guidance in the Relationship Summary Adopting Release.1392 We assume, for purposes of this PRA analysis, that a dually registered brokerdealer would satisfy its obligation to disclose it is acting in a broker-dealer capacity by creating an account disclosure with standardized language, and by providing it to the retail customer at the beginning of the relationship. The account disclosure would set forth when the broker-dealer would be acting in a broker-dealer capacity, and the method the brokerdealer planned to use to clarify its capacity at the time of the recommendation. We understand that many broker-dealers already include such information in account disclosures. (2) Disclosure of Fees and Costs and Type and Scope of Services, Including Any Material Limitations on the Securities or Investment Strategies That may be Recommended While many broker-dealers provide fee information to retail customers in a fee schedule, the Commission believes that to comply with the Disclosure Obligation broker-dealers will either amend their existing schedules or develop a new standardized fee schedule to disclose the fees and costs applicable to retail customers’ transactions, holdings, and accounts. This fee schedule would be delivered to retail customers at the beginning of a relationship. If, at the time the recommendation is made, the disclosure made to the retail customer is not current or does not contain all material facts regarding the fees and costs of the particular recommendation, the brokerdealer would need to deliver an amended fee schedule or provide an oral update, under the circumstances outlined in Section II.C.1. With respect to disclosure of the type and scope of services provided by the broker-dealer, including any material 1392 See Relationship Summary Adopting Release. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 limitations on the securities or investment strategies that may be recommended to the retail customer, we assume for purposes of this PRA analysis that a broker-dealer would satisfy the Disclosure Obligation by including this information in the account disclosure provided to the retail customer at the beginning of the relationship, as described above. The broker-dealer would need to deliver an amended account disclosure to the retail customer in the case of any material changes made to the type and scope of services or provide an oral update, under the circumstances outlined in Section II.C.1. b. Obligation To Provide to the Retail Customer Full and Fair Disclosure, in Writing, of All Material Facts Relating to Conflicts of Interest That are Associated With the Recommendation Regulation Best Interest requires a broker-dealer to provide the retail customer, in writing, full and fair disclosure of all material facts relating to conflicts of interest that are associated with a recommendation. As discussed above, we assume that broker-dealers will satisfy the obligation to disclose all material facts relating to conflicts of interest through the use of: (1) A standardized, written disclosure document provided to all retail customers and (2) supplemental disclosure provided to certain retail customers for recommendations of specific products. We assume for purposes of this analysis that delivery of written disclosure will occur at the beginning of a relationship, such as together with the account opening agreement. For existing retail customers, the disclosure will need to occur ‘‘prior to or at the time’’ of a recommendation. Subsequent disclosures may be delivered or the broker-dealer may provide an oral update, under the circumstances outlined in Section II.C.1, in the event of a material change or if the brokerdealer determines additional disclosure is needed for certain types of products. The corresponding estimated total annual reporting costs and burdens are addressed below.1393 c. Estimated Costs and Burdens (1) Disclosure of Capacity, Type and Scope of Services Standalone broker-dealers will satisfy the obligation to disclose the capacity in 1393 The costs and burdens arising from the obligation to identify all material conflicts of interest that are associated with the recommendation are addressed below, in the context of the Conflict of Interest Obligation, in Section V.B.1. PO 00000 Frm 00155 Fmt 4701 Sfmt 4700 33471 which they are acting through the delivery to retail customers of the Relationship Summary, in accordance with the rules and guidance set forth in the Relationship Summary Adopting Release. Additionally, although we understand that many dual-registrants and standalone broker-dealers, as a matter of best practice, already disclose the capacity in which they are acting as well as the and type and scope of services they offer to retail customers, for purposes of this analysis, we assume that dual-registrants would create new account disclosure related to capacity and all broker-dealers would create or update account disclosure related to type and scope of services specifically for purposes of compliance with Regulation Best Interest. The Commission assumes that brokerdealers would provide the account disclosure to each retail customer account, regardless of whether the retail customer has multiple accounts with the broker-dealer. While the Commission recognizes that the Disclosure Obligation applies to the broker-dealer entity and its associated persons, we do not expect associated persons to incur any initial or ongoing burdens with respect to the scope and terms of the relationship, as we assume for purposes of this analysis that this information would be addressed by the broker-dealer entity’s account disclosure.1394 With regard to disclosure of the capacity in which the associated person is acting, the Commission believes that dually registered representatives of broker-dealers will incur initial and ongoing burdens.1395 Following is a discussion of the estimated initial and ongoing burdens and costs. i. Initial Costs and Burdens Because, as noted above, standalone broker-dealers will satisfy the obligation to disclose the capacity in which they are acting through the delivery to retail customers of the Relationship Summary, we estimate zero burden hours for standalone broker-dealers to disclose the capacity in which they are acting. 1394 A broker-dealer or an associated person may satisfy the Disclosure Obligation by using oral disclosure if it has previously provided written disclosure to the retail customer beforehand as well as the method it planned to use to clarify the disclosure at the time of the recommendation. In addition, a record of the fact of such oral disclosure having been made must be created and retained. We assume that any disclosure required of a registered representative will be made orally, and that any ongoing costs and burdens will be associated with the record-making memorializing the fact of the oral disclosure. See Section IV.B.5 (discussing the costs and burdens associated with record-making). 1395 See supra Section IV.B.5 (discussing the costs and burdens associated with record-making). E:\FR\FM\12JYR2.SGM 12JYR2 33472 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 We estimate that a dually registered firm will incur an initial internal burden of 10 hours for in-house counsel and inhouse compliance 1396 to draft language regarding the capacity in which they are acting for inclusion in the standardized account disclosure that is delivered to the retail customer.1397 In addition, we estimate that dualregistrants will incur an estimated external cost of $4,970 for the assistance of outside counsel in the preparation and review of standardized language regarding capacity.1398 For the estimated 563 dually registered firms with retail business,1399 we project an aggregate initial burden of 5,630 hours,1400 and $2.8 million in aggregate initial costs relating to disclosure of the capacity in which they are acting.1401 Similarly, to comply with Regulation Best Interest, we believe that brokerdealers 1402 will draft standardized language for inclusion in the account disclosure to provide the retail customer with more specific information regarding the type and scope of services 1396 The ten hour estimate includes five hours for in-house counsel to draft and review the standardized language, and five hours for consultation and review of compliance personnel. 1397 As discussed above, the following estimates include the costs and burdens that broker-dealers would incur in drafting standardized account disclosure language related to the scope and terms of the relationship on behalf of their dually registered representatives. For purposes of this analysis, the Commission assumes that brokerdealers will undertake these tasks on behalf of their registered representatives. See Section IV.B.5 (discussing the costs and burdens associated with record-making). 1398 Data from the Securities Industry Financial Markets Association’s Management & Professional Earnings in the Securities Industry 2013 (‘‘SIFMA Management and Professional Earnings Report’’), modified by Commission staff to account for an 1,800-hour work-year and inflation, and multiplied by 5.35 (professionals) or 2.93 (office) to account for bonuses, firm size, employee benefits, and overhead, suggests that costs for this position is $497 per hour. The SIFMA Management and Professional Earnings Report was updated in 2019 to reflect inflation. The numbers in the report are higher than the numbers we used in the Proposing Release. This estimate is based on the following calculation: (10 hours for outside counsel review/ drafting) × ($497/hour for outside counsel services) = $4,970 in initial outside counsel costs. 1399 See supra Section III.B.1.a, at Table 1, Panel B. The number of dually registered broker-dealers includes broker-dealers that are also Commissionand state-licensed investment advisers. 1400 This estimate is based on the following calculation: (563 dually registered retail firms) × (10 hours) = 5,630 initial aggregate burden hours. 1401 This estimate is based on the following calculation: (563 dually registered retail firms) × ($4,970 in external cost per firm) = $2.8 million in aggregate initial costs. 1402 In the Proposing Release, we inadvertently referred to ‘‘standalone broker-dealers’’ in this discussion, but our subsequent references and estimates reflected our intent to capture initial costs and burdens relating to disclosure of type and scope of services on all broker-dealers (distinguishing between small and large). VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 that they provide. We expect that the associated costs and burdens will differ between small and large broker-dealers, as large broker-dealers generally offer more products and services and therefore will need to evaluate a larger number of products and services. Given these assumptions, we estimate that a small broker-dealer will incur an internal initial burden of 10 hours for in-house counsel and in-house compliance to draft this standardized language.1403 In addition, a small broker-dealer will incur an estimated external cost of $4,970 for the assistance of outside counsel in the preparation and review of this standardized language.1404 For the estimated 756 small broker-dealers,1405 we project an aggregate initial burden of 7,560 hours,1406 and aggregate initial costs of $3.8 million.1407 Given the broader array of products and services offered, we estimate that a large broker-dealer will incur an internal burden of twenty hours to draft this standardized language.1408 A large broker-dealer will also incur an estimated cost of $7,470 for the assistance of outside counsel in the preparation and review of this standardized language.1409 For the estimated 2,010 large retail brokerdealers, we estimate an aggregate initial burden of 40,200 hours 1410 and $15 million in aggregate initial costs.1411 We estimate that all broker-dealers will each incur approximately 0.02 1403 The 10-hour estimate includes 5 hours for inhouse counsel to draft and review the standardized language, and 5 hours for consultation and review by in-house compliance. 1404 This estimate is based on the following calculation: (10 hours for outside counsel review/ drafting) × ($497/hour for outside counsel services) = $4,970 in initial outside counsel costs. 1405 See supra footnote 1384 and accompanying text. 1406 This estimate is based on the following calculation: (756 small broker-dealers) × (10 hours per small broker-dealer) = 7,560 initial aggregate burden hours. 1407 This estimate is based on the following calculation: (756 small broker-dealers) × ($4,970 in external cost per small broker-dealer) = $3.8 million in aggregate initial outside counsel costs. 1408 The 20-hour estimate includes 10 hours for in-house counsel to draft and review the standardized language, and 10 hours for consultation and review by in-house compliance. 1409 This estimate is based on the following calculation: (15 hours for outside counsel review/ drafting) × ($497/hour for outside counsel services) = $7,455 in initial outside counsel costs. 1410 This estimate is based on the following calculation: (2,010 large broker-dealers) × (20 burden hours) = 40,200 aggregate initial burden hours. 1411 This estimate is based on the following calculation: (2,010 large broker-dealers) × ($7,455 initial outside counsel costs) = $15 million in aggregate initial costs. PO 00000 Frm 00156 Fmt 4701 Sfmt 4700 burden hours 1412 for delivery of the account disclosure document.1413 Based on FOCUS data, we estimate that the 2,766 broker-dealers that report retail activity have approximately 139 million customer accounts, and that approximately 73.5%, or 102 million, of those accounts belong to retail customers.1414 We therefore estimate that broker-dealers will have an aggregate initial burden of 2,040,000 hours, or approximately 738 hours 1415 per broker-dealer for the first year after Regulation Best Interest is in effect.1416 We estimate a total initial aggregate burden for all broker-dealers to develop and deliver to retail customers account disclosures relating to capacity and type and scope of services of 2,093,390 burden hours.1417 We estimate a total initial aggregate cost of $21.6 million.1418 1412 This is the same estimate the Commission makes in the Relationship Summary Adopting Release. It is also the same estimate the Commission made in the Amendments to Form ADV Adopting Release, and for which we received no comment. See Amendments to Form ADV, 17 CFR parts 275 and 279 at 49259. We expect that delivery requirements will be performed by a general clerk. The general clerk’s time is included in the initial burden estimate. 1413 As noted above, for new retail customers, we expect delivery to occur at the beginning of the relationship; for existing customers, we expect delivery to occur prior to or at the time of a recommendation. 1414 We have revised our estimates from the Proposing Release to reflect the updated FOCUS Report data. Therefore, the 2,766 broker-dealers (including dual-registrants) with retail customers report 139 million customer accounts. See Section III.B.1.a, at Table 1, Panel B. Assuming the amount of retail customer accounts is proportionate to the percentage of broker-dealers that have retail customers, or 73.5% of broker-dealers, then the number of retail customer accounts would be 73.5% of 139 million accounts = 102 million retail customer accounts. This number likely overstates the number of deliveries to be made due to the double-counting of deliveries to be made by dualregistrants to a certain extent, and the fact that one customer may own more than one account. 1415 These estimates are based on the following calculations: (0.02 hours per customer account × (102 million retail customer accounts) = 2,040,000 aggregate burden hours. Conversely, (2,040,000 hours)/(2,766 broker-dealers) = approximately 738 burden hours per broker-dealer for the first year after Regulation Best Interest is in effect. 1416 We estimate that broker-dealers will not incur any incremental postage costs because we assume that they will make such deliveries with another mailing the broker-dealer was already delivering to retail customers. 1417 This estimate is based on the following calculation: (5,630 aggregate initial burden hours for dual-registrants) + (7,560 aggregate initial burden hours for small broker-dealers) + (40,200 burden hours for large broker-dealers) + (2,040,000 aggregate initial burden hours for all broker-dealers to deliver the account disclosures) = 2,093,390 total aggregate initial burden hours. 1418 This estimate is based on the following calculation: ($2.8 million in initial aggregate costs for dual-registrants) + ($3.8 million in initial aggregate costs for small broker-dealers) + ($15 million in initial aggregate costs for large broker- E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 ii. Ongoing Costs and Burdens For purposes of this analysis, we assume that broker-dealers will review and amend the standardized language in the account disclosure, on average, once a year.1419 Further, we assume that broker-dealers will not incur outside costs in connection with updating account disclosures, as in-house personnel will be more knowledgeable about changes in capacity, and the type and scope of services offered by the broker-dealer. Additionally, with respect to standalone broker-dealers, because they will meet their obligation to disclose capacity by delivering the Relationship Summary, and will be subject to requirements to amend the Relationship Summary consistent with Form CRS, we estimate zero burden hours annually for ongoing costs relating to disclosure of capacity under the Disclosure Obligation. We estimate that each dually registered broker-dealer will incur approximately five burden hours annually for in-house compliance and business-line personnel to review changes in the dual-registrant’s capacity,1420 and another two burden hours annually for in-house counsel to amend the account disclosure to disclose material changes to the dualregistrant’s capacity, for a total of seven burden hours. The estimated ongoing aggregate burden to amend dualregistrants’ account disclosures to reflect changes in capacity is therefore 3,941 hours per year.1421 dealers) = $21.6 million in total initial aggregate costs. 1419 We believe this annual timeframe is consistent with other obligations imposed on broker-dealers. For example, FINRA rules set an annual supervisory review as a minimum threshold for broker-dealers, for example, in FINRA Rules 3110 (requiring an annual review of the businesses in which the broker-dealer engages), 3120 (requiring an annual report detailing a broker-dealer’s system of supervisory controls, including compliance efforts in the areas of antifraud and sales practices); and 3130 (requiring each broker-dealer’s CEO or equivalent officer to certify annually to the reasonable design of the policies and procedures for compliance with relevant regulatory requirements). 1420 In the Proposing Release, we referred to capacity and type and scope of services, however, we captured the ongoing costs and burdens relating to disclosure of type and scope of services in the paragraphs that followed, where we inadvertently referred to ‘‘small standalone broker-dealers’’ and ‘‘large standalone broker-dealers,’’ but where our calculations reflected the burdens on all ‘‘small broker-dealers’’ and all ‘‘large broker-dealers.’’ See Proposing Release, footnotes 600–601. We believe it is appropriate to distinguish between standalone and dually registered broker-dealers in assessing the costs and burdens relating to disclosure of capacity, and to distinguish between small and large firms in assessing the costs and burdens relating to disclosure of type and scope of services, as reflected in this section. 1421 This estimate is based on the following calculation: (7 burden hours per dually registered VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 With respect to small broker-dealers, we estimate an internal burden of two hours for in-house compliance and business-line personnel to review and update changes in types or scope of services, and another two burden hours annually for in-house counsel to amend the account disclosure to disclose material changes to type and scope of services—for a total of four burden hours. The estimated ongoing aggregate burden for small broker-dealers to amend account disclosures to reflect changes in type and scope of services is therefore 3,024 hours per year.1422 We estimate that large broker-dealers would incur ten burden hours annually for in-house compliance and businessline personnel to review and update changes the type and scope of services, and another ten burden hours annually for in-house counsel to amend the account disclosure to disclose material changes to the type and scope of services, for a total of twenty burden hours. We therefore believe the ongoing, aggregate burden is 40,200 hours per year for large broker-dealers.1423 With respect to delivery of the amended account agreements in the event of material changes to the capacity disclosure or disclosure related to type and scope of services, we estimate that this would take place among 20% of a broker-dealer’s retail customer accounts annually. We therefore estimate brokerdealers to incur a total annual aggregate burden of 408,000 hours, or 148 hours per year per broker-dealer.1424 The total ongoing aggregate burden for all broker-dealers to review, amend, and deliver updated account disclosures to reflect changes in capacity, type and scope of services would be 455,165 burden hours per year.1425 The Commission acknowledges that the types of services and product firm per year) × (563 dually registered brokerdealers) = 3,941 ongoing aggregate burden hours per year. 1422 This estimate is based on the following calculation: (4 burden hours per broker-dealer per year) × (756 small broker-dealers) = 3,024 ongoing aggregate burden hours per year. 1423 This estimate is based on the following calculation: (20 burden hours per broker-dealer per year) × (2,010 large broker-dealers) = 40,200 ongoing aggregate burden hours per year. 1424 (20%) × (102 million retail customer accounts) × (.02 hours for delivery to each customer account) = 408,000 aggregate burden hours. Conversely, 408,000 aggregate burden hours/2,766 broker-dealers = 148 burden hours per year per broker-dealer. 1425 This estimate is based on the following calculation: (3,941 ongoing aggregate burden hours for dually registered broker-dealers) + (3,024 ongoing aggregate burden hours for small brokerdealers) + (40,200 ongoing aggregate burden hours for large broker-dealers) + (408,000 ongoing aggregate burden hours for delivery of amended account disclosures) = 455,165 total ongoing aggregate burden hours per year. PO 00000 Frm 00157 Fmt 4701 Sfmt 4700 33473 offerings vary greatly by broker-dealer, and therefore the costs and burdens associated with updating the account disclosure might also vary. (2) Disclosure of Fees and Costs The Commission assumes for purposes of this analysis that a brokerdealer will disclose its fees and costs through a standardized fee schedule, delivered to the retail customer at the beginning of the relationship, or, for existing retail customers, prior to or at the time of a recommendation and, as discussed below, will amend such fee schedules in the event of material changes. Although we understand that many broker-dealers already provide fee schedules to retail customers, we are assuming for purposes of this analysis that a fee schedule would be created specifically for purposes of compliance with Regulation Best Interest.1426 While the Commission recognizes that the fee disclosure included in Disclosure Obligation applies to the broker-dealer entity and its associated persons, we do not expect any burdens or costs on associated persons related to the fees and costs as this information would be addressed in the broker-dealer entity’s fee schedule. i. Initial Costs and Burdens We assume that, for purposes of this analysis, the associated costs and burdens will differ between small and large broker-dealers, as large brokerdealers generally offer more products and services and therefore will need to evaluate a wider range of fees in their fee schedules. As stated above, while we anticipate that many broker-dealers may already create fee schedules, we believe that small broker-dealers will initially spend five hours for in-house compliance and large broker-dealers will spend ten hours for in-house compliance to internally create a new fee schedule in consideration of the requirements of Regulation Best Interest. We additionally estimate a one-time external cost of $2,485 for small brokerdealers 1427 and $4,970 for larger brokerdealers for outside counsel to review the fee schedule.1428 We therefore estimate the initial aggregate burden for small broker-dealers to be 3,780 burden 1426 Our estimates may be higher than actual, since firms may be able to use or simply update existing disclosures depending on the facts and circumstances. 1427 This cost estimate is based on the following calculation: (5 hours of review) × ($497/hour for outside counsel services) = $2,485 outside counsel costs. 1428 This cost estimate is based on the following calculation: (10 hours of review) × ($497/hour for outside counsel services) = $4,970 outside counsel costs. E:\FR\FM\12JYR2.SGM 12JYR2 33474 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations hours,1429 and the initial aggregate cost to be $1.88 million.1430 We estimate the aggregate burden for large broker-dealers to be 20,100 burden hours,1431 and the aggregate cost to be $9.99 million.1432 Similar to delivery of the account disclosure regarding capacity and type and scope of services, we estimate the burden for broker-dealers to make the initial delivery of the fee schedule to new retail customers, at the beginning of the relationship, and existing retail customers, prior to or at the time of a recommendation, will require approximately 0.02 hours to deliver to each retail customer.1433 As stated above, we estimate that the 2,766 broker-dealers that report retail activity have approximately 139 million customer accounts, and that approximately 73.5%, or 102 million, of those accounts belong to retail customers.1434 We therefore estimate that broker-dealers will have an aggregate initial burden of 2,040,000 hours, or approximately 738 hours per broker-dealer for the first year after Regulation Best Interest is in effect.1435 The total aggregate initial burden for broker-dealers is therefore estimated at 2,063,880 1436 hours, and the total aggregate initial cost is estimated at $11.87 million.1437 jbell on DSK3GLQ082PROD with RULES2 ii. Ongoing Costs and Burdens For purposes of this PRA analysis, we assume that broker-dealers will review and amend the fee schedule on average, 1429 This estimate is based on the following calculation: (5 burden hours of review per small broker-dealer) × (756 small broker-dealers) = 3,780 aggregate initial burden hours. 1430 This estimate is based on the following calculation: ($2,485 for outside counsel costs per small broker-dealer) × (756 small broker-dealers) = $1.88 million in aggregate initial outside costs. 1431 This estimate is based on the following calculation: (10 burden hours of review per large broker-dealer) × (2,010 large broker-dealers) = 20,100 aggregate initial burden hours. 1432 This estimate is based on the following calculation: ($4,970 for outside counsel costs per large broker-dealer) × (2,010 large broker-dealers) = $9.99 million in aggregate initial costs. 1433 See supra footnote 1411. 1434 See supra footnote 1412. 1435 This estimate is based on the following calculation: (102 million retail customer accounts) × (.02 hours for delivery to each customer account) = 2,040,000 aggregate burden hours. Conversely, (2,040,000 aggregate burden hours)/(2,766 brokerdealers) = 738 burden hours per broker-dealer for the first year after Regulation Best Interest is in effect. 1436 This estimate is based on the following calculations: (3,780 aggregate burden hours for small broker-dealers) + (20,100 burden hours for large broker-dealers) + (2,040,000 burden hours for delivery) = 2,063,880 total aggregate initial burden hours. 1437 This estimate is based on the following calculation: ($1.88 million for small broker-dealer costs) + ($9.99 million large broker-dealer costs) = $11.87 million in total initial aggregate costs. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 once a year. With respect to small broker-dealers, we estimate that reviewing and updating the fee schedule will require approximately two hours for in-house compliance per year, and for large broker-dealers, we estimate that the recurring, annual burden to review and update the fee schedule will be four hours for in-house compliance for each large broker-dealer. Based on these estimates, we estimate the recurring, aggregate, annualized burden will be 1,512 hours for small broker-dealers 1438 and 8,040 hours for large brokerdealers.1439 We do not anticipate that small or large broker-dealers will incur outside legal, compliance, or consulting fees in connection with updating their standardized fee schedule since inhouse personnel would be more knowledgeable about these facts, and we therefore do not expect external costs associated with updating the fee schedule. With respect to delivery of the amended fee schedule in the event of a material change, we estimate that this would take place among 40% of a broker-dealer’s retail customer accounts annually, and that broker-dealers will require approximately 0.02 hours to deliver the amended fee schedule to each retail customer.1440 We therefore estimate broker-dealers would incur a total annual aggregate burden of 816,000 hours, or 295 hours per brokerdealer.1441 The total ongoing aggregate burden for all broker-dealers to review, amend, and deliver updated account disclosures to reflect changes in fees and costs would be 825,552 burden hours per year.1442 The Commission acknowledges that the type of fee schedule may vary greatly by broker-dealer, and therefore that the costs or burdens associated with updating the standardized fee schedule might similarly vary. 1438 This estimate is based on the following calculation: (2 burden hours per broker-dealer) × (756 small broker-dealers) = 1,512 aggregate burden hours per broker-dealer per year. 1439 This estimate is based on the following calculation: (4 burden hours per broker-dealer) × (2,010 large broker-dealers) = 8,040 aggregate burden hours per broker-dealer per year. 1440 See supra footnote 1411. 1441 This estimate is based on the following calculation: (40% of 102 million retail customer accounts) × (.02 hours) = 816,000 aggregate burden hours. Conversely, (816,000 aggregate burden hours)/(2,766 broker-dealers) = 295 burden hours per broker-dealer per year. 1442 This estimate is based on the following calculation: (1,512 ongoing aggregate burden hours for small broker-dealers) + (8,040 ongoing aggregate burden hours for large broker-dealers) + (816,000 ongoing aggregate burden hours for delivery of amended account disclosures) = 825,552 total ongoing aggregate burden hours per year. PO 00000 Frm 00158 Fmt 4701 Sfmt 4700 (3) Disclosure of All Material Facts Relating to Conflicts of Interest Associated With the Recommendation Regulation Best Interest requires broker-dealers to provide a retail customer, in writing, full and fair disclosure of all material facts relating to conflicts of interest that are associated with the recommendation. Because the Disclosure Obligation applies to both the broker-dealer entity and its associated persons, the Commission expects that the brokerdealer entity and its associated persons will incur initial and ongoing burdens. However, as with the disclosure of the capacity in which they are acting and type and scope of services, we assume for purposes of this analysis that the broker-dealer entities will incur the costs and burdens of disclosing material conflicts of interest on behalf of their associated persons.1443 i. Initial Costs and Burdens The Disclosure Obligation provides broker-dealers with the flexibility to choose the form and manner of conflict disclosure. However, we believe that many or most broker-dealers will develop a standardized conflict disclosure document and deliver it to their retail customers.1444 We also assume for purposes of this PRA analysis that broker-dealers will update and deliver the standardized conflict disclosure document yearly on an ongoing basis, following the brokerdealer’s annual conflicts review process. For purposes of this PRA analysis, we assume that a standardized conflict disclosure document will be developed by in-house counsel and reviewed by outside counsel. For small brokerdealers, we estimate it will take inhouse counsel, on average, five burden hours to create the standardized conflict disclosure document and outside counsel five hours to review and revise the document. We estimate that the initial aggregate burden for the development of a standardized disclosure document, based on an estimated 756 small broker-dealers, will be 3,780 burden hours.1445 We additionally estimate an initial cost of 1443 See Section IV.B.5 (discussing the costs and burdens associated with record-making, including for associated persons of a broker-dealer). 1444 As noted above, we assume that delivery for new customers will occur at the beginning of the relationship, and that delivery for existing customers will occur prior to or at the time a recommendation is made. 1445 This estimate is based on the following calculation: (5 hours) × (756 small broker-dealers) = 3,780 aggregate initial burden hours. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 $2,485 per small broker-dealer,1446 and an aggregate initial cost of $1.88 million for all small broker-dealers.1447 We expect the development and review of the standardized conflict disclosure document to take longer for large broker-dealers because, as discussed above, we believe large broker-dealers generally offer more products and services and employ more individuals, and therefore will need to disclose a larger number of conflicts. We estimate that for large broker-dealers, it will take 7.5 burden hours for in-house counsel to create the standardized conflict disclosure document, and outside counsel will take another 7.5 hours to review and revise the disclosure document. As a result, we estimate the initial aggregate burden, based on an estimated 2,010 large broker-dealers, to be approximately 15,075 burden hours.1448 We additionally estimate initial costs of $3,728 per broker-dealer,1449 and an aggregate initial cost for large brokerdealers of approximately $7.49 million.1450 We assume that broker-dealers will deliver the standardized conflict disclosure document to new retail customers at the inception of the relationship, and to existing retail customers prior to or at the time of a recommendation. We estimate that broker-dealers will require approximately 0.02 hours to deliver the standardized conflict disclosure document to each retail customer.1451 We therefore estimate that brokerdealers will incur an aggregate initial burden of 2,040,000 hours, or approximately 738 hours per brokerdealer for delivery of the standardized conflict disclosure document the first year after Regulation Best Interest is in effect.1452 1446 This estimate is based on the following calculation: ($497/hour) × (5 hours) = $2,485 in initial costs. 1447 This estimate is based on the following calculation: ($497/hour × 5 hours) × (756 small broker-dealers) = $1.88 million in aggregate initial costs. 1448 This estimate is based on the following calculation: (7.5 hours × 2,010 large broker-dealers) = 15,075 aggregate initial burden hours. 1449 This estimate is based on the following calculation: ($497/hour) × (7.5 hours) = $3,728 in initial costs per broker-dealer. 1450 This estimate is based on the following calculation: ($497/hour) × (7.5 hours) × 2,010 large broker-dealers) = $7.49 million in aggregate costs. 1451 See supra footnote 1411. For purposes of this PRA analysis, we have assumed any initial disclosures made by the broker-dealer related to material conflicts of interest will be delivered together. 1452 These estimates are based on the following calculations: (0.02 hours per customer account × 102 million retail customer accounts) = 2,040,000 aggregate initial burden hours. Conversely, VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 The total aggregate initial burden for broker-dealers is therefore estimated at 2,058,855 1453 hours, and the total aggregate initial cost is estimated at $9.37 million.1454 ii. Ongoing Costs and Burdens We believe that broker-dealers will incur ongoing annual burdens and costs to update the disclosure document to include newly identified conflicts. We assume for purposes of this analysis that broker-dealers will update their conflict disclosure document annually, after conducting an annual conflicts review. We estimate that the conflicts disclosures will be updated internally by both small and large broker-dealers. We estimate that in-house counsel at a small broker-dealer will require approximately one hour per year to update the standardized conflict disclosure document, for an ongoing aggregate, annual burden of approximately 756 hours.1455 For large broker-dealers, we estimate that the ongoing, aggregate annual burden would be two hours for each broker-dealer: One hour for in-house compliance and one hour for in-house counsel for legal personnel. We therefore estimate the ongoing, aggregate burden for large broker-dealers to be approximately 4,020 burden hours.1456 We do not anticipate that small or large brokerdealers will incur outside legal, compliance, or consulting fees in connection with updating their standardized conflict disclosure document, since in-house personnel would presumably be more knowledgeable about conflicts of interest. With respect to ongoing delivery of the updated conflict disclosure document, we estimate that this will take place among 40% of a brokerdealer’s retail customer accounts annually, and that broker-dealers will require approximately 0.02 hours to deliver the updated conflict disclosure (2,040,000 hours)/(2,766 broker-dealers) = 738 burden hours per broker-dealer. 1453 This estimate is based on the following calculations: (3,780 aggregate burden hours for small broker-dealers) + (15,075 burden hours for large broker-dealers) + (2,040,000 burden hours for delivery) = 2,058,855 total aggregate initial burden hours. 1454 This estimate is based on the following calculation: ($1.88 million for small broker-dealer costs) + ($7.49 million large broker-dealer costs) = $9.37 million in total aggregate initial costs. 1455 This estimate is based on the following calculation: (1 hour per broker-dealer) × (756 small broker-dealers) = 756 aggregate burden hours per year. 1456 This estimate is based on the following calculation: (2 hours per broker-dealer) × (2,010 large broker-dealers) = 4,020 aggregate burden hours per year. PO 00000 Frm 00159 Fmt 4701 Sfmt 4700 33475 document to each retail customer.1457 We therefore estimate that brokerdealers will incur an ongoing, aggregate annual burden of 816,000 hours, or 295 burden hours per broker-dealer.1458 The total aggregate ongoing burden for broker-dealers is therefore estimated at 820,776 hours.1459 Based on the calculation describe above, we estimate that broker-dealers will incur an aggregate total initial burden of 6,216,125 hours 1460 and a total initial cost of $42.84 million,1461 as well as an aggregate total ongoing annual burden of 2,101,493 hours 1462 to comply with the Disclosure Obligation. 2. Care Obligation The Care Obligation requires a brokerdealer to have a reasonable basis to believe, based on its understanding of the potential risks, rewards, and costs of the recommended security or investment strategy involving securities, 1457 See supra footnote 1411. The Commission estimates that broker-dealers will update their disclosures of fees and costs and material facts relating to conflicts of interest that are associated with their recommendation more frequently than disclosure related to capacity or type and scope of services. 1458 This estimate is based on the following calculation: (40% of 102 million retail customer accounts) × (.02 hours) = 816,000 aggregate burden hours per year. Conversely, (816,000 aggregate burden hours)/(2,766 broker-dealers) = 295 hours per broker-dealer per year. 1459 This estimate is based on the following calculations: (756 aggregate burden hours for small broker-dealers) + (4,020 aggregate burden hours for large broker-dealers) + (816,000 aggregate burden hours for delivery) = 820,776 total aggregate ongoing burden hours. 1460 This estimate is based on the following calculation: (2,093,390 aggregate initial burden hours for initial compliance with disclosure of capacity and type and scope of services) + (2,063,880 aggregate initial burden hours for initial compliance with disclosure of fees and costs) + (2,058,855 aggregate initial burden hours for initial compliance with disclosure of all material facts regarding disclosure of conflicts of interest associated with the recommendation) = 6,216,125 total aggregate initial burden hours for compliance with the Disclosure Obligation. 1461 This estimate is based on the following calculation: ($21.6 million aggregate initial cost for compliance with disclosure of capacity and type and scope of services) + ($11.87 million aggregate initial cost for compliance with disclosure of fees and costs) + ($9.37 aggregate initial cost for compliance with disclosure of all material facts regarding disclosure of conflicts of interest associated with the recommendation) = $42.84 million total aggregate initial cost for compliance with the Disclosure Obligation. 1462 This estimate is based on the following calculation: (455,165 aggregate annual burden hours for ongoing compliance with disclosure of capacity and type and scope of services) + (825,552 aggregate annual burden hours for ongoing compliance with disclosure of fees and costs) + (820,776 aggregate annual burden hours for ongoing compliance with disclosure of all material facts regarding disclosure of conflicts of interest associated with the recommendation) = 2,101,493 total aggregate burden hours per year for ongoing compliance with the Disclosure Obligation. E:\FR\FM\12JYR2.SGM 12JYR2 33476 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 and in light of the retail customer’s investment profile, that the recommendation is in the best interest of the particular retail customer and does not place the broker-dealer’s interest ahead of the retail customer’s interest. However, any PRA burdens or costs associated with the Care Obligation are duplicative of costs associated with other obligations in Regulation Best Interest, including the Disclosure Obligation and the RecordMaking Obligation under Rule 17a– 3(a)(35) and Recordkeeping Obligation under Rule 17a–4(e)(5). 3. Conflict of Interest Obligation The Conflict of Interest Obligation creates an overarching obligation to require broker-dealers 1463 to establish written policies and procedures reasonably designed to identify and at a minimum disclose, pursuant to the Disclosure Obligation, or eliminate all conflicts of interest associated with a recommendation. More specifically, broker-dealers are specifically required to establish, maintain, and enforce written policies and procedures reasonably designed to: (i) Identify and mitigate any conflicts of interest associated with recommendations that create an incentive for a natural person who is an associated person of a broker or dealer to place the interest of the broker or dealer, or such natural person making the recommendation, ahead of the interest of the retail customer; (ii) (A) identify and disclose any material limitations placed on the securities or investment strategies involving securities that may be recommended to a retail customer and any conflicts of interest associated with such limitations, in accordance with the Disclosure Obligation, and (B) prevent such limitations and associated conflicts of interest from causing the broker, dealer, or a natural person who is an associated person of the broker or dealer to make recommendations that place the interest of the broker, dealer, or such natural person ahead of the interest of the retail customer; and (iii) identify and eliminate sales contests, bonuses, and non-cash compensation that are based on the sales of specific securities or specific types of securities within a limited period of time.1464 Written policies and procedures developed pursuant to the Conflict of Interest Obligation of Regulation Best Interest would help a broker-dealer to develop a process reasonably designed 1463 As discussed above, the Conflict of Interest Obligation and Compliance Obligation apply solely to the broker or dealer entity, and not to the associated persons of a broker or dealer. 1464 Rule 15l–1 under the Exchange Act. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 for its business, for identifying conflicts of interest, and then determining whether to eliminate, or disclose and/or mitigate the conflict and the appropriate means of eliminating, disclosing and/or mitigating the conflict. In addition, establishing and maintaining written policies and procedures would generally (1) assist a broker-dealer in supervising its associated persons and assessing compliance with the Conflict of Interest Obligation; and (2) assist the Commission and SRO staff in connection with examinations and investigations.1465 In light of the modifications to several substantive requirements of the rule relative to the Proposing Release, including the Conflict of Interest Obligation, as discussed in more detail above, we believe these changes will allow broker-dealers’ to more easily incorporate the requirements of Regulation Best Interest into existing supervisory and compliance systems and streamline compliance with Regulation Best Interest.1466 Therefore, we generally believe our proposed burdens and costs are accurate but have updated estimates to reflect changes in the number of broker-dealers and costs of certain services since the last estimate in the Proposing Release. Following is a detailed discussion of the estimated costs and burdens associated with the Conflict of Interest Obligation. a. Written Policies and Procedures i. Initial Costs and Burdens We believe that most broker-dealers have policies and procedures in place to address conflicts of interest, but do not necessarily have written policies and procedures regarding the identification and management of conflicts as required by Regulation Best Interest. To comply with the Conflict of Interest Obligation, we believe that broker-dealers would utilize a combination of in-house and outside legal and compliance counsel to update existing policies and procedures.1467 We assume that, for Section II.C.3.a. Any written policies and procedures developed pursuant to Regulation Best Interest would be required to be retained pursuant to Exchange Act Rule 17a–4(e)(7), which requires broker-dealers to retain compliance, supervisory, and procedures manuals (and any updates, modifications, and revisions thereto) describing the policies and procedures of the broker-dealer with respect to compliance with applicable laws and rules, and supervision of the activities of each associated, for a specified period of time. The record retention requirements of Rule 17a–4(e)(7) include any written policies and procedures that broker-dealers may produce pursuant to the Conflict of Interest Obligation of Regulation Best Interest. 1466 See Section II.C.3. 1467 See footnote 1381 and accompanying text. PO 00000 1465 See Frm 00160 Fmt 4701 Sfmt 4700 purposes of this analysis, the associated costs and burdens would differ between small and large broker-dealers, as large broker-dealers generally offer more products and services and therefore would need to evaluate and address a greater number of potential conflicts of interest. As discussed above, we estimate that 2,010 broker-dealers would qualify as large broker-dealers for purposes of this analysis and 756 would qualify as small broker-dealers that have retail business.1468 In the Proposing Release, we estimated that a large broker-dealer would incur a one-time internal burden of 60 hours for in-house legal and inhouse compliance counsel to update existing policies and procedures to comply with Regulation Best Interest.1469 We also estimated a cost of $4,720 for outside counsel to review updated policies and procedures on behalf of a large broker-dealer, with an aggregate initial burden of 123,300 burden hours and aggregate initial cost of $9.70 million for large brokerdealers.1470 In the Proposing Release, we assumed that small broker-dealers would primarily rely on outside counsel to update existing policies and procedures, as small broker-dealers generally have fewer in-house legal and compliance personnel. Given that smaller brokerdealers generally have fewer conflicts of interest, we estimated that 40 hours of outside legal counsel services would be required, for a one-time cost of $18,800 per small broker-dealer, and an aggregate cost of $15.1 million for all small broker-dealers, and we also expected that in-house compliance personnel would require 10 hours to review and approve the updated policies and procedures, for an aggregate burden of 8,020 hours.1471 Therefore, we estimated the total initial aggregate burden to be 131,320 hours and the total initial aggregate cost to be $24.8 million.1472 We believe our estimates are generally accurate in light of the increased specificity in Regulation Best Interest as to how a broker-dealer must address specified conflicts of interest but due to changes in the number of broker-dealers and cost estimates for certain services, we are revising our burden and cost estimates.1473 1468 See 1469 See footnote 1387 and accompanying text. Proposing Release at 21666. 1470 Id. 1471 Id. 1472 Id. 1473 We have revised our cost estimates to reflect the updated SIFMA Management and Professional Earnings Report which was updated in 2019 to reflect inflation. Therefore, the hourly rates used E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations jbell on DSK3GLQ082PROD with RULES2 For purposes of Regulation Best Interest as adopted, we estimate that a large broker-dealer would incur an initial burden of 50 hours for in-house counsel and in-house compliance to update existing policies and procedures to comply with Regulation Best Interest and an initial burden of 5 hours for general counsel and 5 hours for a Chief Compliance Officer to review and approve the updated policies and procedures, for a total of 60 burden hours.1474 We also estimate ten hours of outside counsel services will be required at a cost of $4,970 to review updated policies and procedures on behalf of a large broker-dealer.1475 We therefore estimate the aggregate initial burden for large broker-dealers to be of 120,600 burden hours 1476 and initial aggregate cost of approximately $10.0 million for large broker-dealers.1477 For small broker-dealers, we believe that they would primarily rely on outside counsel to update existing policies and procedures, as small broker-dealers generally have fewer inhouse legal and compliance personnel. Given that smaller broker-dealers generally have fewer conflicts of interest, we estimate that 40 hours of outside legal counsel would be required to update existing policies and procedures, for a one-time cost of $19,880 per small broker-dealer,1478 and an aggregate cost of $15.0 million for all small broker-dealers.1479 We also expect that in-house compliance would require 10 hours to review and approve the here for certain services, for example, outside legal counsel and outside compliance costs, are higher than the numbers in the Proposing Release. 1474 This estimate is based on the following calculation: (50 hours of review for in-house counsel and in-house compliance counsel) + (5 hours of review for general counsel) + (5 hours of review for Chief Compliance Officer) = 60 initial burden hours per large broker-dealer. 1475 Data from the SIFMA Management and Professional Earnings Report suggests that the average hourly rate for legal services is $497/hour. This cost estimate is therefore based on the following calculation: (10 hours of review) × ($497/ hour for outside counsel services) = $4,970 in outside counsel costs per large broker-dealer. 1476 This estimate is based on the following calculation: (60 burden hours of review per large broker-dealer) × (2,010 large broker-dealers) = 120,600 aggregate burden hours for large brokerdealers. 1477 This estimate is based on the following calculation: ($4,970 for outside counsel costs per large broker-dealer) × (2,010 large broker-dealers) = approximately $10.0 million in outside counsel costs for large broker-dealers. 1478 This cost estimate is based on the following calculation: (40 hours of review) × ($497/hour for outside counsel services) = $19,880 in outside counsel costs per small broker-dealer. 1479 This cost estimate is based on the following calculation: ($19,880 for outside attorney costs per small broker-dealer) × (756 small broker-dealers) = approximately $15.0 million in outside counsel costs for small broker-dealers. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 updated policies and procedures, for an aggregate burden of 7,560 hours.1480 Therefore, we estimate the total initial aggregate burden to be 128,160 hours 1481 and the total initial aggregate cost to be approximately $25.0 million.1482 ii. Ongoing Costs and Burdens For purposes of this analysis, we assume that small and large brokerdealers would review and update policies and procedures on an annual basis to accommodate the addition of, for example, new products or services, new business lines, and/or new personnel. We also assume that brokerdealers would review and update their policies and procedures for compliance with the Conflict of Interest Obligation on an annual basis, and in-house personnel would perform the review and make any updates. In the Proposing Release, we estimated that large broker-dealers would incur an annual internal burden of 12 hours to review and update existing policies and procedures to identify new conflicts for an ongoing, aggregate burden of 24,660 hours with no ongoing costs as they would rely on internal personnel.1483 We assumed small broker-dealers would rely on outside legal counsel and compliance consultants to review and update policies and procedures, with final review and approval from in-house compliance 1484 with an aggregate, annual ongoing cost of $3.08 million per year.1485 In addition to these costs, we believed that small broker-dealers would incur an internal an ongoing, aggregate burden of 28,670 hours. While the Commission believes our time estimates from the Proposing Release are generally accurate, we have revised our burdens and estimates to account for changes in both the number of broker-dealers and external costs of services. We estimate that large broker-dealers, which generally have more numerous and complex products and services, as well as and higher rates of hiring and 1480 This estimate is based on the following calculation: (10 burden hours) × (756 small brokerdealers) = 7,560 aggregate burden hours. 1481 This estimate is based on the following calculation: (120,600 aggregate burden hours for large broker-dealers) + (7,560 aggregate burden hours for small broker-dealers) = 128,160 total aggregate burden hours. 1482 This estimate is based on the following calculation: ($10 million in aggregate costs for large broker-dealers) + ($15.0 million in aggregate costs for small broker-dealers) = $25.0 million total aggregate costs. 1483 Proposing Release at 21667. 1484 Id. 1485 Id. PO 00000 Frm 00161 Fmt 4701 Sfmt 4700 33477 turnover would incur an annual internal burden of 12 hours to review and update existing policies and procedures: Four hours for in-house counsel, four hours for in-house compliance, and four hours for business-line personnel to identify new conflicts. We therefore estimate an ongoing, aggregate burden for large broker-dealers of approximately 24,120 hours.1486 Because we assume that large brokerdealers would rely on internal personnel to update policies and procedures on an ongoing basis, we do not believe large broker-dealers would incur ongoing external costs. We assume for purposes of this analysis that small broker-dealers, generally have fewer and less complex products and lower rates of hiring. We also assume they would primarily rely on outside legal counsel and outside compliance consultants for review and update of their policies and procedures, with final review and approval from an in-house compliance manager. We estimate that outside legal counsel would require approximately five hours per year to update policies and procedures, for an annual cost of $2,485 for each small broker-dealer.1487 The projected aggregate, annual ongoing cost for outside legal counsel to update policies and procedures for small broker-dealers would be $1.88 million per year.1488 In addition, we expect that small broker-dealers would require five hours of outside compliance services per year to update their policies and procedures, for an ongoing cost of $1,365 per year,1489 and an aggregate ongoing cost of $1.03 million.1490 The total aggregate, ongoing cost for small 1486 This estimate is based on the following calculation: (12 burden hours per large brokerdealer) × (2,010 large broker-dealers) = 24,120 aggregate ongoing burden hours. 1487 This estimate is based on the following calculation: (5 hours per small broker-dealer) × ($497/hour for outside counsel services) = $2,485 in outside counsel costs. 1488 This estimate is based on the following calculation: ($2,485 in outside counsel costs per small broker-dealer) × (756 small broker-dealers) = $1.88 million in aggregate, ongoing outside legal costs per year. 1489 We believe that performance of this function will most likely be equally allocated between a senior compliance examiner and a compliance manager. Data from the SIFMA Management and Professional Earnings Report suggests that costs for these positions are $237 and $309 per hour, respectively for an average of $273 per hour. This cost estimate is based on the following calculation: (5 hours of review) × ($273/hour for outside compliance services) = $1,365 in outside compliance service costs. 1490 This estimate is based on the following calculation: ($1,365 in outside compliance costs per small broker-dealer) × (756 small broker-dealers) = $1.03 million in aggregate, ongoing outside compliance costs per year. E:\FR\FM\12JYR2.SGM 12JYR2 33478 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations broker-dealers is therefore projected at $2.91 million per year.1491 In addition to the costs described above, we additionally believe small broker-dealers would incur an internal burden of approximately 5 hours for an in-house compliance manager to review and approve the updated policies and procedures per year. The ongoing, aggregate burden for small brokerdealers would be 3,780 hours for inhouse compliance manager review.1492 We therefore estimate the total ongoing aggregate ongoing burden to be 27,900 hours per year 1493 and the total ongoing aggregate cost to be $2.91 million per year.1494 The Commission acknowledges that policies and procedures may vary greatly by broker-dealer, given the differences in size and the complexity of broker-dealer business models. Accordingly, we expect that the need to update policies and procedures might also vary greatly. b. Identification and Management of Conflicts of Interest With respect to identifying and determining whether a conflict of interest exists in connection with a recommendation and whether it needs to be addressed through disclosure, mitigation and/or elimination, a brokerdealer would first need to establish mechanisms to proactively and systematically identify conflicts of interest in its business on an ongoing or periodic basis.1495 For purposes of this analysis, we assume that most brokerdealers already have an existing technological infrastructure in place, and we assume it would need to be modified to comply with the Conflict of Interest Obligation. jbell on DSK3GLQ082PROD with RULES2 i. Initial Costs and Burdens As stated in the Proposing Release, we believed that costs and burdens may vary greatly depending on the size of the 1491 This estimate is based on the following calculation: ($1.88 million for outside legal counsel costs) + ($1.03 million for outside compliance costs) = $2.91 million total aggregate ongoing costs per year. 1492 This estimate is based on the following calculation: (5 hours compliance manager review per small broker-dealer) × (756 small brokerdealers) = 3,780 aggregate ongoing burden hours per year. 1493 This estimate is based on the following calculation: (24,120 aggregate ongoing burden hours for large broker-dealers) + (3,780 aggregate ongoing burden hours for small broker-dealers) = 27,900 total aggregate ongoing burden hours per year. 1494 This estimate is based on the following calculation: ($2.91 million per year in total aggregate ongoing costs for small broker-dealers) + ($0 projected ongoing costs for large broker-dealers) = $2.91 million per year in total aggregate ongoing costs. 1495 See supra Section III.C.3. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 broker-dealer, but we expected that modification of a broker-dealer’s existing technology would initially require the retention of an outside programmer as well as coordination between the programmer and the broker-dealer’s in-house compliance manager. The costs and burdens for this process were estimated to be $15.43 million and 14,285 burden hours.1496 In addition to these costs and burdens, we expected that a broker-dealer would spend time to determine whether the conflict of interest identified were material and would have required an additional 14,285 burden hours for all broker-dealers for an aggregate burden of 28,570 hours for identification of conflicts of interest.1497 As stated above, we believe the process would be largely the same as set forth in the Proposing Release but have revised our estimates and costs below to account for changes in the number of broker-dealers and external costs as well as to account for some changes to the structure of the Conflict of Interest Obligation. To comply with the Conflict of Interest Obligation, we expect that broker-dealers will modify existing technology through the work of an outside programmer which would require, on average, an estimated 20 hours, for an estimated cost per brokerdealer of $5,680.1498 We additionally continue to estimate (as was set forth in the Proposing Release) that coordination between the programmer and the broker-dealer’s compliance manager would involve five burden hours.1499 The aggregate initial costs and burdens for the modification of existing technology to identify conflicts of interest would therefore be $15.71 million,1500 and 13,830 burden hours.1501 As a result of the changes made to the rule text of the Conflict of Interest Obligation, we believe that brokerdealers would incur burdens to: (1) Identify conflicts of interest and determine whether the conflict involves 1496 Proposing Release at 21667. 1497 Id. 1498 Data from the SIFMA Management and Professional Earnings Report suggests that the average hourly rate for technology services in the securities industry is $284. This cost estimate is based on the following calculation: (20 hours of review) × ($284/hour for technology services) = $5,680. 1499 1500 This cost estimate is based on the following calculation: ($5,680 in outside programmer costs per broker-dealer) × (2,766 broker-dealers) = $15.71 million in aggregate outside programmer costs. 1501 This burden estimate is based on the following calculation: (5 burden hours for in-house compliance manager) × (2,766 broker-dealers) = 13,830 aggregate burden hours. PO 00000 Frm 00162 Fmt 4701 Sfmt 4700 an incentive to an associated person to place the interest of the broker-dealer or natural person making the recommendation ahead of the interest of the retail customer, a material limitation on the product menu, or a sales practice that is based on the sales of specific securities or specific types of securities within a limited period of time and (2) determine whether and how the conflict would be disclosed, disclosed and mitigated, or eliminated in accordance with the Conflict of Interest Obligation. In order to complete this process, we believe a broker-dealer, on average, would require approximately 20 hours 1502 of review per brokerdealer,1503 for an aggregate of 55,320 burden hours for all broker-dealers.1504 We therefore estimate the total initial aggregate burden for identification and management of conflicts of interest is 69,150 hours.1505 ii. Ongoing Costs and Burdens To maintain compliance with the Conflict of Interest Obligation, we assume for purposes of this analysis that a broker-dealer would seek to identify additional conflicts of interest as its business evolves. As noted above, the Commission recognizes that brokerdealers vary in the types of services and product offerings and therefore vary in the types of conflicts of interest that exist within and across brokerdealers.1506 However, for purposes of the PRA analysis in the Proposing Release, we assumed that broker-dealers would, at a minimum, engage in a material conflicts identification process on an annual basis, and we estimated that in the aggregate broker-dealers would spend approximately 28,570 hours each to complete this process per year.1507 Similar to the Proposing Release, we believe that for purposes of this analysis, broker-dealers would, through the help of the business line and compliance personnel, spend on average 10 hours 1508 to perform an annual 1502 In light of the changes made to the rule text of the Conflict of Interest Obligation and the comments received, we have increased our estimate to 20 burden hours per broker-dealer. 1503 This burden estimate consists of 10 hours for review by business line personnel, and 10 hours for review by in-house compliance manager. 1504 This burden estimate is based on the following calculation: (20 burden hours) × (2,766 broker-dealers) = 55,320 aggregate burden hours. 1505 This burden estimate is based on the following calculation: (13,830 burden hours for modification of technology) + (55,320 burden hours for evaluation of managing conflicts) = 69,150 total aggregate burden hours. 1506 See supra Section II.C.3. 1507 See Proposing Release at 21668. 1508 This burden estimate consists of five hours for review by business line personnel, and five E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations conflicts review using the modified technology infrastructure.1509 Therefore, the Commission estimates that the aggregate ongoing burden for an annual conflicts review, based on an estimated 2,766 retail broker-dealers, would be approximately 27,660 burden hours per year.1510 Because we assume that broker-dealers would use in-house personnel to identify and evaluate new, potential conflicts, we continue to believe they would not incur additional ongoing external costs. jbell on DSK3GLQ082PROD with RULES2 c. Training As discussed in the Proposing Release, we expect that broker-dealers would develop training programs to comply with Regulation Best Interest, including the Conflict of Interest Obligation. However, we believe that any burdens and costs associated with a training program would fall under the new Compliance Obligation as it would be developed to comply with Regulation Best Interest as a whole, including each of the component obligations. In total, to comply with the Conflict of Interest Obligation, the Commission estimates that the total initial burdens and costs to be 197,310 hours 1511 and $40.71 million,1512 and the total ongoing burdens and costs to be 55,560 hours 1513 per year and $2.91 million per year.1514 hours for review by an in-house compliance manager. 1509 FINRA rules set an annual supervisory review as a minimum threshold for broker-dealers. See, e.g., FINRA Rules 3110 (requiring an annual review of the businesses in which the broker-dealer engages); 3120 (requiring an annual report detailing a broker-dealer’s system of supervisory controls, including compliance efforts in the areas of antifraud and sales practices); and 3130 (requiring each broker-dealer’s CEO or equivalent officer to certify annually to the reasonable design of the policies and procedures for compliance with relevant regulatory requirements). 1510 This estimate is based on the following calculation: (10 hours per retail broker-dealer) × (2,766 retail broker-dealers) = 27,660 aggregate burden hours per year. 1511 This estimate is based on the following calculation: (128,160 initial burden hours for policies and procedures) + (69,150 initial burden hours for identification and management of conflicts of interest) = 197,310 initial burden hours to comply with the Conflict of Interest Obligation. 1512 This estimate is based on the following calculation: ($25.0 million initial costs for policies and procedures) + ($15.71 million initial costs for identification and management of conflicts of interest) = $40.71 million initial total costs to comply with the Conflict of Interest Obligation. 1513 This estimate is based on the following calculation: (27,900 ongoing burden hours for policies and procedures) + (27,660 ongoing burden hours for identification and management of conflicts of interest) = 55,560 aggregate ongoing burden hours per year to comply with Conflict of Interest Obligation. 1514 This estimate is based on the following calculation: ($2.91 million ongoing costs for policies and procedures) + ($0 ongoing costs for VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 4. Compliance Obligation As discussed above, in response to comments that we should require policies and procedures to comply with Regulation Best Interest as a whole, we are adopting the Compliance Obligation.1515 The Compliance Obligation requires that the brokerdealer 1516 establish, maintain and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest. This Compliance Obligation creates an explicit obligation under the Exchange Act with respect to Regulation Best Interest as a whole. Similar to the policies and procedures requirement of the Conflict of Interest Obligation, broker-dealers will have flexibility to design policies and procedures that are reasonable for the scope, size and risks associated with the operations of the firm and the types of business in which the broker-dealer engages. Because we did not include the Compliance Obligation in the Proposing Release, we did not previously include costs and burdens associated with the Compliance Obligation, but we have provided a detailed explanation of these costs and burdens below.1517 a. Written Policies and Procedures i. Initial Costs and Burdens While the Compliance Obligation creates an explicit requirement under the Exchange Act, we believe that broker-dealers would likely establish policies and procedures to comply with Regulation Best Interest pursuant to Section 15(b)(4)(E) and SRO rules by adjusting their current systems of supervision and compliance, as opposed to creating new systems. While brokerdealers must already have policies and procedures in place to address other Commission and SRO rules, they would need to update their systems of supervision and compliance to account for Regulation Best Interest. To comply with the Compliance Obligation, we believe that brokerdealers would employ a combination of in-house and outside legal and compliance counsel to update existing policies and procedures to account for the Disclosure and Care Obligations.1518 We assume that, for purposes of this identification and management of conflicts of interest) = $2.91 million aggregate ongoing total costs per year to comply with the Conflict of Interest Obligation. 1515 Section II.C.4. 1516 See supra footnote 1462 and accompanying text. 1517 We note that any burdens and costs to comply with the Conflict of Interest Obligation are included in the estimates in Section IV.B.3 above. 1518 Id. PO 00000 Frm 00163 Fmt 4701 Sfmt 4700 33479 analysis, the associated costs and burdens would differ between small and large broker-dealers, as large brokerdealers generally offer more products and services and employ more individuals and therefore would need to evaluate and update a greater number of systems. As discussed above, we estimate that 2,010 broker-dealers would qualify as large broker-dealers for purposes of this analysis and 756 would qualify as small broker-dealers that have retail business.1519 For purposes of this analysis we estimate that a large broker-dealer would incur a one-time average internal burden of 30 hours for in-house legal personnel and in-house compliance counsel to update existing policies and procedures to comply with the Compliance Obligation and a one-time burden of five hours for general counsel and five hours for a Chief Compliance Officer to review and approve the updated policies and procedures, for a total of 40 burden hours.1520 We also estimate six hours of outside counsel services a cost of $2,982 for outside counsel to review updated policies and procedures on behalf of a large brokerdealer.1521 We therefore estimate the aggregate burden for large broker-dealers to be of 80,400 burden hours 1522 and aggregate cost of $6.0 million for large broker-dealers.1523 For small broker-dealers, we believe that they would primarily rely on outside counsel to update existing policies and procedures, as small broker-dealers generally have fewer inhouse legal and compliance personnel. We estimate that only 20 hours of outside legal counsel services would be required, for a one-time cost of $9,940 per small broker-dealer,1524 and an aggregate cost of $7.5 million for all 1519 See supra footnote 1387 and accompanying text. 1520 This estimate is based on the following calculation: (30 hours of review for in-house legal and in-house compliance) + (5 hours of review for general counsel) + (5 hours of review for Chief Compliance Officer) = 40 burden hours. 1521 Data from the SIFMA Management and Professional Earnings Report suggests that the average hourly rate for legal services is $497/hour. This cost estimate is therefore based on the following calculation: (6 hours of review) × ($497/ hour for outside counsel services) = $2,982 in outside counsel costs. 1522 This estimate is based on the following calculation: (40 burden hours of review per large broker-dealer) × (2,010 large broker-dealers) = 80,400 aggregate burden hours. 1523 This estimate is based on the following calculation: ($2,982 for outside counsel costs per large broker-dealer) × (2,010 large broker-dealers) = $6.0 million in outside counsel costs. 1524 This cost estimate is based on the following calculation: (20 hours of review) × ($497/hour for outside counsel services) = $9,940 in outside counsel costs. E:\FR\FM\12JYR2.SGM 12JYR2 33480 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations small broker-dealers.1525 We also expect that in-house compliance personnel would require 6 hours to review and approve the updated policies and procedures, for an aggregate burden of 4,536 hours.1526 Therefore, we estimate the total initial aggregate burden to be 84,936 hours 1527 and the total initial aggregate cost to be $13.5 million.1528 ii. Ongoing Costs and Burdens jbell on DSK3GLQ082PROD with RULES2 For purposes of this analysis, we assume that small and large brokerdealers would review and update policies and procedures on a periodic basis to accommodate the addition of, among other things, new products or services, new business lines, and/or new personnel. We also assume that broker-dealers would review and update their policies and procedures for compliance with Regulation Best Interest on an annual basis, and for purposes of this analysis, we assume they would perform the review and update using in-house personnel. Under the Compliance Obligation, we do not believe that broker-dealers would incur any costs or burdens associated with compliance with the Conflict of Interest Obligation, as those are included in the discussion above, but would for ongoing compliance with the Disclosure and Care Obligations. For large broker-dealers with more numerous and complex products and services, as well as higher rates of hiring and turnover, we estimate that each broker-dealer would annually incur an internal burden of 12 hours to review and update existing policies and procedures: four hours for legal personnel, four hours for compliance personnel, and four hours for businessline personnel. We therefore estimate an ongoing, aggregate burden for large broker-dealers of approximately 24,120 hours per year.1529 We assume for purposes of this analysis that small broker-dealers, who 1525 This cost estimate is based on the following calculation: ($9,940 for outside counsel costs per small broker-dealer) × (756 small broker-dealers) = $7.5 million in outside counsel costs. 1526 This estimate is based on the following calculation: (6 burden hours) × (756 small brokerdealers) = 4,536 initial aggregate burden hours. 1527 This estimate is based on the following calculation: (80,400 aggregate burden hours for large broker-dealers) + (4,536 aggregate burden hours for small broker-dealers) = 84,936 total initial aggregate burden hours. 1528 This estimate is based on the following calculation: ($6 million in aggregate costs for large broker-dealers) + ($7.5 million in aggregate costs for small broker-dealers) = $13.5 million total initial aggregate costs. 1529 This estimate is based on the following calculation: (12 burden hours per large brokerdealer) × (2,010 large broker-dealers) = 24,120 aggregate ongoing burden hours per year. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 generally have fewer and less complex products, and lower rates of hiring and turnover, would mostly rely on outside legal counsel and compliance consultants for review and update of their policies and procedures, with final review and approval from an in-house compliance manager. We estimate that outside counsel would require approximately five hours per year to update policies and procedures, for an annual cost of $2,485 for each small broker-dealer.1530 The projected aggregate, annual ongoing cost for outside legal counsel to update policies and procedures for small broker-dealers would be $1.88 million.1531 In addition, we expect that small broker-dealers would require five hours of outside compliance services per year to update their policies and procedures, for an ongoing cost of $1,365 per year,1532 and an aggregate ongoing cost of $1.03 million.1533 The Commission estimates the total aggregate, ongoing cost for small broker-dealers is therefore $2.91 million per year.1534 b. Training Pursuant to the Compliance Obligation’s requirement to ‘‘maintain and enforce’’ written policies and procedures, we additionally believe broker-dealers will develop training programs that promote compliance with Regulation Best Interest. We believe that a training program would cover compliance with Regulation Best Interest as a whole and would therefore cover the Disclosure, Care and Conflict of Interest Obligations. The initial and 1530 Data from the SIFMA Management and Professional Earnings Report suggests that the average hourly rate for legal services is $497/hour. This estimate is therefore based on the following calculation: (5 hours per small broker-dealer) × ($497/hour for outside counsel services) = $2,485 in outside counsel costs per year. 1531 This estimate is based on the following calculation: ($2,485 in outside counsel costs per small broker-dealer) × (756 small broker-dealers) = $1.88 million in aggregate, ongoing legal costs per year. 1532 We believe that performance of this function will most likely be equally allocated between a senior compliance examiner and a compliance manager. Data from the SIFMA Management and Professional Earnings Report suggests that costs for these positions are $237 and $309 per hour, respectively for an average of $273 per hour. This estimate is therefore based on the following calculation: (5 hours per small broker-dealer) × ($273/hour for outside counsel services) = $1,365 in outside compliance service costs per year. 1533 This estimate is based on the following calculation: ($1,365 in outside compliance costs per small broker-dealer) × (756 small broker-dealers) = $1.03 million in aggregate, ongoing outside compliance costs per year. 1534 This estimate is based on the following calculation: ($1.88 million for outside legal counsel costs) + ($1.03 million for outside compliance costs) = $2.91 million total aggregate ongoing costs per year. PO 00000 Frm 00164 Fmt 4701 Sfmt 4700 ongoing costs and burdens associated with such a training program are estimated below. i. Initial Costs and Burdens We believe that broker-dealers would likely use a computerized training model to train their associated persons regarding the policies and procedures pertaining to Regulation Best Interest. We estimate that a broker-dealer would retain an outside systems analyst, outside programmer, and an outside programmer analyst to create the training module, at 20 hours, 40 hours, and 20 hours, respectively. The total cost to develop the training module would be approximately $20,920,1535 for an aggregate initial cost of $62.8 million.1536 Additionally, we expect that the training module would require the approval of the Chief Compliance Officer, as well as in-house counsel, each of whom would require approximately 2 hours to review and approve the training module. The initial aggregate burden for broker-dealers is therefore estimated at 11,064 burden hours.1537 In addition, broker-dealers would incur an initial cost for associated persons to undergo training through the training module. We estimate the training time at one hour per associated person, for an aggregate burden of 428,404 burden hours, or an initial burden of 154.9 hours per brokerdealer.1538 We estimate the total initial aggregate burden to approve the training module and implement the training program would be 439,486 burden hours.1539 1535 Data from the SIFMA Management and Professional Earnings Report suggests that the average hourly rate in the securities industry is $263 for a systems analyst, $271 for a programmer, and $241 for a programmer analyst.. This cost estimate is based on the following calculation: ((20 hours for a systems analyst) × ($263/hour)) + ((40 hours of labor for a programmer) × ($271/hour)) + ((20 hours of labor for a programmer analyst) × ($241/hour)) = $20,920 in external technology costs per broker-dealer. 1536 This estimate is based on the following calculation: (2,766 broker-dealers) × ($20,920in external technology costs per broker-dealer) = $57.9 million in aggregate costs for technology services. 1537 This estimate is based on the following calculation: (2,766 broker-dealers) × (4 burden hours per broker-dealer) = 11,064 burden hours. 1538 This estimate is based on the following calculation: (1 burden hour) × (428,404 registered representatives at standalone or dually registered broker-dealers) = 428,404 aggregate burden hours. Conversely, (428,404 aggregate burden hours)/ (2,766 retail broker-dealers) = 154.9 initial burden hours per broker-dealer per year. 1539 This estimate is based on the following calculation: (428,404 burden hours for training of registered representatives) + (11,064 burden hours to approve training program) = 439,468 total aggregate burden hours per year. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations ii. Ongoing Costs and Burdens We believe that, as a matter of best practice, broker-dealers would likely require registered representatives to repeat the training module for Regulation Best Interest on an annual basis. The ongoing aggregate cost for the one-hour training would be 428,404 burden hours per year, or 154.9 burden hours per broker-dealer per year.1540 In total, to comply with the Compliance Obligation, the Commission estimates the total initial burdens and costs to be 524,414 hours 1541 and $71.4 million,1542 and the total ongoing burdens and costs to be 463,588 hours 1543 and $2.91 million.1544 5. Record-Making and Recordkeeping Obligations The record-making and recordkeeping obligations will impose record-making and recordkeeping requirements on broker-dealers with respect to certain information collected from, or provided to, retail customers. Specifically, the Commission is amending Rules 17a–3 and 17a–4 of the Exchange Act, which set forth minimum requirements with respect to the records that brokerdealers must make, and how long those records and other documents must be kept, respectively. Records made and retained in accordance with the amendments to Rule 17a–3(a)(35) and 17a–4(e)(5) will (1) assist a broker-dealer in supervising and assessing internal compliance with Regulation Best Interest; and (2) assist the Commission and SRO staff in connection with examinations and investigations. Due to changes in the number of broker-dealers and costs estimated for certain services, we are revising our estimates from those in the Proposing jbell on DSK3GLQ082PROD with RULES2 1540 This estimate is based on the following calculation: (1 burden hour) × (428,404 registered representatives at standalone or dually registered broker-dealers) = 428,404 burden hours. Conversely, (428,404 aggregate burden hours) / (2,766 retail broker-dealers) = 154.9 initial burden hours per broker-dealer. 1541 This estimate is based on the following calculation: (84,946 initial burden hours for policies and procedures) + (439,468 initial burden hours training) = 524,414 initial burden hours to comply with the Compliance Obligation. 1542 This estimate is based on the following calculation: ($13.5 million initial costs for policies and procedures) + ($57.9 million initial costs for training) = $71.4 million initial total costs to comply with the Compliance Obligation. 1543 This estimate is based on the following calculation: (24,120 ongoing burden hours for policies and procedures) + (439,468 ongoing burden hours for training) = 463,588 ongoing burden hours to comply with Compliance Obligation. 1544 This estimate is based on the following calculation: ($2.91 million ongoing costs for policies and procedures) + ($0 million ongoing costs for training) = $2.91 million ongoing costs to comply with the Compliance Obligation. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 Release. However, while we understand commenters’ concerns that the estimates are lower than what would actually be required to comply with Regulation Best Interest, we believe the estimates are generally accurate in light of the increased specificity in Regulation Best Interest on how to comply with the component obligations, including the Disclosure Obligation.1545 The recordmaking and recordkeeping costs and burdens associated with the amendments to Rule 17a–3(a)(35) and Rule 17a–4(e)(5) are addressed below. a. Record-Making Obligation We are amending Rule 17a–3 by adding a new paragraph (a)(35) that requires a record of all information collected from, and provided to, the retail customer pursuant to Regulation Best Interest, as well as the identity of each natural person who is an associated person of a broker or dealer, if any, responsible for the account.1546 This requirement applies with respect to each retail customer to whom a recommendation of any securities transaction or investment strategy involving securities is provided. The neglect, refusal, or inability of a retail customer to provide or update any such information will, however, excuse the broker-dealer from obtaining that information. We indicated in the Proposing Release, and we continue to believe that broker-dealers currently make records of relevant customer investment profile information, and we therefore assume that no additional record-making obligations would arise as a result of broker-dealers’ or their registered representatives’ collection of information from retail customers.1547 1545 See, e.g., Raymond James Letter; CCMC Letters; SIFMA August 2018 Letter. 1546 As indicated in the Proposing Release, we understand that broker-dealers likely make such records in the ordinary course of their business pursuant to Exchange Act Rules 17a–3(a)(6) and (7). We continue to believe, for purposes of compliance with Rule 17a–3(a)(35), that broker-dealers would need to create a record, or modify an existing record, to identify the associated person, if any, responsible for the account in the context of Regulation Best Interest. See Proposing Release at 21673. 1547 The PRA burdens and costs arising from the requirement that a record be made of all information provided to the retail customer are accounted for in Regulation Best Interest and the Relationship Summary Adopting Release. With respect to the requirement that a record be made of all information from the retail customer, we believe that Rule 17a–3(a)(35) will not impose any new substantive burdens on broker-dealers. As discussed above, we continue to believe that the obligation to exercise reasonable diligence, care, and skill will not require a broker-dealer to collect additional information from the retail customer beyond that currently collected in the ordinary course of business even though a broker-dealer’s PO 00000 Frm 00165 Fmt 4701 Sfmt 4700 33481 In addition, we continue to believe that broker-dealers likely make records of the ‘‘identity of each natural person who is an associated person, if any, responsible for the account.’’ However, we are assuming, for purposes of compliance with Rule 17a–3(a)(35), that broker-dealers will need to create a record, or modify an existing record, to identify the associated person, if any, responsible for the account in the context of Regulation Best Interest. In addition, in cases where broker-dealers choose to meet part of the Disclosure Obligation orally under the circumstances outlined in Section II.C.1, Oral Disclosure or Disclosure After a Recommendation, we believe the requirement to maintain a record of the fact that oral disclosure was provided to the retail customer will trigger a recordmaking obligation under paragraph (a)(35) of Rule 17a–3 and a recordkeeping obligation under paragraph (e)(5) of Rule 17a–4 that may impose additional compliance costs and burdens on broker-dealers. i. Initial Costs and Burdens In the Proposing Release, we assumed that broker-dealers would satisfy the record-making requirement of the proposed amendment to Rule 17a– 3(a)(25) by amending an existing account disclosure document to include the ‘‘identity of each natural person who is an associated person, if any, responsible for the account.’’ We estimated that the inclusion of this information in an account disclosure document would require an approximate total aggregate initial burden of 3,808,000 hours, or approximately 1,333 hours per brokerdealer for the first year after Regulation Best Interest is in effect.1548 As discussed above, we continue to believe that broker-dealers will satisfy the record-making requirements of the amendment to Rule 17a–3(a)(35) by amending an existing account disclosure document to include the ‘‘identity of each natural person who is an associated person, if any, responsible for the account.’’ We believe that the inclusion of this information in an account disclosure document will require, on average, approximately 1 analysis of that information and any resulting recommendations will need to adhere to the enhanced best interest standard of Regulation Best Interest. See supra Section II.C.2. 1548 These estimates were based on the following calculations: (0.04 hours per customer account) × (95.2 million retail customer accounts) = 3,808,000 aggregate burden hours. Conversely, (3,808,000 aggregate burden hours)/(2,857 broker-dealers) = 1,333 hours per broker dealer for the first year after Regulation Best Interest is in effect. See Proposing Release at 21673. E:\FR\FM\12JYR2.SGM 12JYR2 33482 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations hour per year for outside legal counsel at small broker-dealers, at an updated average rate of $497/hour, for an average annual cost of $497 for each small broker-dealer to update an account disclosure document. The projected aggregate initial cost for small brokerdealers is therefore estimated to be $375,732 per year.1549 For brokerdealers that are not small entities, we estimate that the initial burden will be 2 hours for each broker-dealer: 1 hour for compliance personnel and 1 hour for legal personnel. We therefore estimate the aggregate initial burden for brokerdealers that are not small entities to be approximately 4,020 burden hours.1550 Finally, we estimate it will require an additional 0.04 hours for the registered representative responsible for the information (or other clerical personnel) to fill out that information in the account disclosure document, for an approximate total aggregate initial burden of 4,080,000 hours, or approximately 1,475 hours per brokerdealer for the first year after Regulation Best Interest is in effect.1551 Because we have already included the costs and burdens associated with the creation of a record to memorialize an oral disclosure, and the delivery of the amended account disclosure document discussed above, they are not included in this section of the analysis.1552 The total aggregate initial burden for broker-dealers is therefore estimated at 4,084,020 hours,1553 and the total aggregate initial cost is estimated at $375,732.1554 jbell on DSK3GLQ082PROD with RULES2 ii. Ongoing Costs and Burdens We do not believe that the identity of the registered representative responsible for the retail customer’s account will change. Accordingly, we continue to 1549 This estimate is based on the following calculation: (1 hour per small broker-dealer) × (756 small broker-dealers) × ($497/hour) = $375,732 in aggregate costs per year. 1550 This estimate is based on the following calculation: (2 burden hours per broker-dealer) × (2,010 large broker-dealers) = 4,020 aggregate burden hours per year. 1551 These estimates are based on the following calculations: (0.04 hours per customer account) × (102 million retail customer accounts) = 4,080,000 aggregate burden hours. Conversely, (4,080,000 burden hours)/(2,766 broker-dealers) = 1,475 hours per broker-dealer for the first year after Regulation Best Interest is in effect. 1552 See supra Section IV.B.1. 1553 This estimate is based on the following calculation: (0 aggregate burden hours for small broker-dealers) + (4,020 burden hours for large broker-dealers) + (4,080,000 burden hours for personnel to fill out information in the account disclosure document) = 4,080,000 initial burden hours. 1554 This estimate is based on the following calculation: ($375,732 for small broker-dealer costs) + ($0 for large broker-dealer costs) = ($375,732 in total aggregate initial costs). VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 believe that there are no ongoing costs and burdens associated with this recordmaking requirement of the amendment to Rule 17a–3(a)(35). With respect to memorializing oral disclosures in cases where brokerdealers choose to meet part of the Disclosure Obligation orally under the circumstances outlined in Section II.C.1, Oral Disclosure or Disclosure After a Recommendation, we estimate that this would take place among 52% of a broker-dealer’s retail customer accounts (and thus 52% of a registered representative’s retail customer accounts) annually.1555 We therefore estimate broker-dealers to incur a total annual aggregate burden of 1.06 million hours, or 383.5 burden hours per year per broker-dealer.1556 b. Recordkeeping Obligation We are amending Rule 17a–4(e)(5) to require that broker-dealers retain all records of the information collected from or provided to each retail customer pursuant to Regulation Best Interest for at least six years after the earlier of the date the account was closed or the date on which the information was last replaced or updated. We assume that, for purposes of this analysis, the following records would likely be retained pursuant to amended Rule 17a– 3(a)(35): (1) Existing account disclosure documents; (2) comprehensive fee schedules; (3) disclosures identifying material conflicts; and (4) memorialized oral disclosures under the circumstances outlined in Section II.C.1, Oral Disclosure or Disclosure After a Recommendation.1557 1555 We believe (and our experience indicates) that broker-dealers will use oral disclosure rarely, and primarily when making disclosures regarding a change in capacity. We do not have reliable data to determine the precise number of retail customers that have both a brokerage and an advisory account with a dually registered associated person. As indicated above, approximately 52% of registered representatives were dually registered as investment adviser representatives at the end of 2018. See supra footnote 945 and accompanying text. As a result, we have assumed for purposes of this analysis that this will take place among 52% of all retail customer accounts at broker-dealers annually. This estimate is likely over inclusive, as it includes all retail customer accounts at all brokerdealers (as opposed to only retail customer accounts where the retail customer has both a brokerage and advisory account with a dually registered financial professional), and under inclusive, as it assumes that such an oral disclosure will happen annually (as opposed to multiple times a year). 1556 (52%) × (102 million retail customer accounts) × (0.02 hours for recording each oral disclosure relating to a retail customer’s account) = 1,060,800 aggregate burden hours. Conversely, 1,060,800 aggregate burden hours/2,766 brokerdealers = 383.5 burden hours per broker-dealer per year. 1557 In the Proposing Release, we identified four records that would likely need to be retained pursuant to amended Rule 17a–3(a)(25) (now PO 00000 Frm 00166 Fmt 4701 Sfmt 4700 i. Initial Costs and Burdens We believe that, to reduce costs and for ease of compliance, broker-dealers will utilize their existing recordkeeping systems in order to retain the forgoing records made pursuant to Regulation Best Interest, and as required to be kept under the amendment to Rule 17a– 4(e)(5). As noted above, broker-dealers currently are subject to recordkeeping obligations pursuant to Rule 17a–4, which require, for example, brokerdealers to ‘‘preserve for a period of not less than six years, the first two years in an easily accessible place, all records required to be made pursuant to’’ Rule 17a–3(a)(1), (a)(2), (a)(3), (a)(5), (a)(21), (a)(22), and analogous records created pursuant to paragraph 17a–3(f). Thus, for example, broker-dealers are already required to maintain documents such as account blotters and ledgers for six years. We continue to believe that brokerdealers will utilize their existing recordkeeping systems to include any additional or amended records required by Regulation Best Interest or pursuant to the amendment to Rule 17a–4(e)(5), and would similarly utilize their existing recordkeeping systems to account for any differences in the retention period. Thus, where brokerdealers currently retain documents on an electronic database to satisfy existing Rule 17a–4 or otherwise, we continue to expect broker-dealers to maintain any additional documents required by Regulation Best Interest or the amendment to Rule 17a–4(e)(5) by the same means. Likewise, where brokerdealers maintain documents required by existing Rule 17a–4 by paper, we would expect broker-dealers to continue to do so. Based on our belief that brokerdealers will rely on existing infrastructures to satisfy the recordkeeping obligations of Regulation Best Interest and the amendment to Rule 17–a(4)(e)(5), we believe the burden for broker-dealers to add new documents or reflected as Rule 17a–3(a)(35)): (1) A standardized Relationship Summary document; (2) existing account disclosure documents; (3) a comprehensive fee schedule; and (4) disclosures identifying material conflicts. However, in calculating the estimated burden for broker-dealers to add new documents or modify existing documents to the broker-dealer’s existing retention system, we erroneously assumed a broker-dealer would upload or file five account documents, as opposed to the four account documents identified in the Proposing Release. See Proposing Release at 21673–21674. In addition, while the burden for broker-dealers to retain a standardized relationship summary was included in the Regulation Best Interest Proposing Release, it is excluded here because its associated burden is reflected in the Relationship Summary Proposal and Relationship Summary Adopting Release. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations modify existing documents to the broker-dealer’s existing retention system will be approximately 13.6 million burden hours for all broker-dealers, assuming a broker-dealer will need to upload or file each of the four account documents discussed above for each retail customer account.1558 We do not believe there will be additional substantive internal or external costs relating to the uploading or filing of the documents. In addition, because we have already included the costs and burdens associated with the delivery of the amended account opening agreement and other documents above, we do not include them in this section of the analysis. ii. Ongoing Costs and Burdens We estimate that the approximate ongoing burden associated with the recordkeeping requirement of the amendment to Rule 17a–4(e)(5) is 4.46 million burden hours per year.1559 We do not believe that the ongoing costs associated with ensuring compliance with the retention schedule would change from the current costs of ensuring compliance with existing Rule 17a–4 and as outlined above. V. Final Regulatory Flexibility Act Analysis jbell on DSK3GLQ082PROD with RULES2 The Commission has prepared this Final Regulatory Flexibility Analysis 1558 This estimate is based on the following calculation: (4 documents per customer account) × (102 million retail customer accounts) × (2 minutes per document)/60 minutes = 13,600,000 aggregate burden hours. As indicated above, the following records would likely need to be retained: (1) Existing account disclosure documents; (2) comprehensive fee schedules; (3) disclosures identifying material conflicts; and (4) memorialized oral disclosures under the circumstances outlined in Section II.C.1, Disclosure Obligation, Oral Disclosure or Disclosure After a Recommendation. 1559 This estimate is based on the percentage of account records we expect would be updated each year as described in Section IV.B.1, supra, and the following calculation: (40% of fee schedules × 102 million retail customer accounts) × (2 minutes per document) + (40% of conflict disclosure forms × 102 million retail customer accounts) × (2 minutes per document) + (20% of account opening documents × 102 million retail customer accounts) × (2 minutes per document) = 204 million minutes/ 60 minutes = 3.4 million aggregate ongoing burden hours. In addition, with respect to ongoing memorialization of the updated oral disclosures, we estimate that this will take place among 52% of a broker-dealer’s retail customer accounts annually. We therefore estimate that broker-dealers will incur an aggregate ongoing burden of 1.06 million hours per year (calculated as follows: (52% of updated oral disclosures x 102 million retail customer accounts) × (1.2 minutes per document) = 63.6 million minutes/60 minutes = 1.06 million aggregate ongoing burden hours); or 383.5 burden hours per broker-dealer (1.06 million hours/2,766 broker-dealers = 383.5). 3.4 million burden hours per year + 1.06 million burden hours per year = 4,460,000 total aggregate ongoing burden hours per year. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 (‘‘FRFA’’) in accordance with the provisions of the Regulatory Flexibility Act (‘‘RFA’’) 1560 relating to Regulation Best Interest. An Initial Regulatory Flexibility Analysis (‘‘IRFA’’) was prepared in accordance with the RFA and included in the Proposing Release.1561 A. Need for and Objectives of the Rule Broker-dealers play an important role in helping Americans organize their financial lives, accumulate and manage retirement savings, and invest toward other important long-term goals, such as buying a house or funding a child’s college education. As discussed in Section I, concerns exist regarding: (1) The potential harm to retail customers resulting from broker-dealer recommendations provided in the presence of conflicts of interest and (2) the insufficiency of existing broker-dealer regulatory requirements to address these conflicts when broker-dealers make recommendations to retail customers. More specifically, there are concerns that existing requirements do not require a broker-dealer’s recommendations to be in the retail customer’s best interest. As a result, we are adopting Regulation Best Interest, which creates an enhanced standard of conduct applicable to broker-dealers at the time they recommend to a retail customer a securities transaction or investment strategy involving securities. This includes recommendations of account types and rollovers or transfers of assets and also covers implicit hold recommendations, resulting from agreed-upon account monitoring. When making a recommendation, a brokerdealer must act in the retail customer’s best interest and cannot place its own interests ahead of the customer’s interests. This General Obligation is satisfied only if the broker-dealer complies with four specified component obligations: (1) Disclosure Obligation, (2) Care Obligation, (3) Conflict of Interest Obligation, and (4) Compliance Obligation. In addition, the Commission is amending Rules 17a–3 and 17a–4 of the Exchange Act, which set forth minimum requirements with respect to the records that broker-dealers must make, and how long those records and other documents must be kept, respectively. First, as described in Section II.C.1, under the Disclosure Obligation, before or at the time of making a U.S.C. 603. Proposing Release, supra footnote 7, at Section VII. PO 00000 1560 5 1561 See Frm 00167 Fmt 4701 Sfmt 4700 33483 recommendation, a broker-dealer must disclose, in writing,1562 material facts about the scope and terms of its relationship with the customer. This includes a disclosure that the brokerdealer or associated person is acting in a broker-dealer capacity; the material fees and costs the customer will incur; and the type and scope of the services to be provided, including any material limitations on the recommendations that could be made to the retail customer. Moreover, the broker-dealer must disclose all material facts relating to conflicts of interest associated with the recommendation that might incline a broker-dealer to make a recommendation that is not disinterested, including, for example, proprietary products, payments from third parties, and compensation arrangements. Second, as described in Section II.C.2, under the Care Obligation, a brokerdealer must exercise reasonable diligence, care, and skill when making a recommendation to a retail customer. The broker-dealer must understand potential risks, rewards, and costs associated with the recommendation. The broker-dealer must then consider those risks, rewards, and costs in light of the retail customer’s investment profile and have a reasonable basis to believe that the recommendation is in the customer’s best interest and does not place the broker-dealer’s interest ahead of the retail customer’s interest. When recommending a series of transactions, the broker-dealer must have a reasonable basis to believe that the transactions taken together are not excessive, even if each is in the retail customer’s best interest when viewed in isolation. Third, as described in Section II.C.3, under the Conflict of Interest Obligation, a broker-dealer must establish, maintain, and enforce reasonably designed written policies and procedures addressing conflicts of interest associated with its recommendations to retail customers. These policies and procedures must be reasonably designed to identify all such conflicts and at a minimum disclose or eliminate them. Additionally, the policies and procedures must be reasonably designed to mitigate conflicts of interests that create an incentive for an associated person of the broker-dealer to place its interests or the 1562 As discussed above, there are circumstances where broker-dealers and their associated persons may make oral disclosures or written disclosures after the time of a recommendation under the circumstances outlined in Section II.C.1, Disclosure Obligation, Oral Disclosure or Disclosure After a Recommendation. E:\FR\FM\12JYR2.SGM 12JYR2 jbell on DSK3GLQ082PROD with RULES2 33484 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations interest of the firm ahead of the retail customer’s interest. Moreover, when a broker-dealer places material limitations on recommendations that may be made to a retail customer (e.g., offering only proprietary or other limited range of products), the policies and procedures must be reasonably designed to disclose the limitations and associated conflicts and to prevent the limitations from causing the associated person or brokerdealer to place the associated person’s or broker-dealer’s interests ahead of the customer’s interest. Finally, the policies and procedures must be reasonably designed to identify and eliminate sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sale of specific securities or specific types of securities within a limited period of time. Fourth, as described in Section II.C.4, under the Compliance Obligation, a broker-dealer must also establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest as a whole. Thus, a brokerdealer’s policies and procedures must address not only conflicts of interest but also compliance with its Disclosure and Care Obligations under Regulation Best Interest. The enhancements contained in Regulation Best Interest will improve investor protection by enhancing the quality of broker-dealer recommendations to retail customers and reducing the potential harm to retail customers that may be caused by conflicts of interest. Regulation Best Interest will complement the related rules, interpretations, and guidance that the Commission is concurrently issuing.1563 Individually and collectively, these actions are designed to help retail customers better understand and compare the services offered by broker-dealers and investment advisers and make an informed choice of the relationship best suited to their needs and circumstances, provide clarity with respect to the standards of conduct applicable to investment advisers and broker-dealers, and foster greater consistency in the level of protections provided by each regime, particularly at the point in time that a recommendation is made. All of these requirements are discussed in detail in Section II above. The costs and burdens of these requirements on small broker-dealers are discussed below as well as above in our Economic Analysis and PRA 1563 See Relationship Summary Adopting Release; Fiduciary Interpretation; Solely Incidental Interpretation. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 Analysis, that discuss the costs and burdens on all broker-dealers. B. Significant Issues Raised by Public Comments The Commission is sensitive to the burdens that the new rule may have on small entities. In the Proposing Release, we requested comment on matters discussed in the IRFA. In particular, we sought comments on the number of small entities that may be affected by proposed Regulation Best Interest, and whether proposed Regulation Best Interest would have an effect on small entities that had not been considered. We requested that commenters describe the nature of any impact on small entities and provide empirical data to support the extent of such impact. We also requested comment on the proposed compliance burdens and the effects these burdens would have on smaller entities. As discussed in the Economic Analysis and PRA Analysis above, we received comments regarding the potential costs and burdens of the proposal on broker-dealers, including those that are small entities.1564 Additionally, the Commission received some comments specifically addressing the costs to smaller broker-dealers. One commenter stated that for a small firm with $500,000 in net capital, a compliance cost of $60,000 1565 could constitute 12% of that net capital, making compliance with the rule burdensome for such firms and potentially forcing many small firms to hire additional compliance personnel.1566 Another commenter raised concerns that replacing the term supra Sections III and IV. NSCP Letter (‘‘Consider the estimated $60,000 in additional compliance costs referenced in the Release which would represent 12% of net capital of a $500,000 firm.’’) 1566 See id (‘‘Several small firms estimate that they incur approximately $80,000 in compliance costs to meet basic ongoing regulatory requirements. Notably, this amount does not include expenses associated with new rules, regulatory changes, regulatory exams or running a compliance department. In isolation, it may seem that this single proposal by one regulatory agency would have manageable marginal impact on costs. But in fact, it would be one of many changes (and importantly, a major change) that smaller firms must address. Many small firms do not have large Compliance Departments adequate to shoulder these ever increasing regulatory demands. In fact, many small firm Compliance Departments are comprised of just one or two persons.’’). See also, generally, NFIB Letter (‘‘America’s small and independent businesses in the financial industry cannot afford the army of lawyers and clerks needed to comply with the welter of complex rules issued or proposed by the U.S. Department of Labor (DOL) (Reference 1 above), the U.S. Securities and Exchange Commission (SEC) (Reference 2 above), and the several states to govern the duties of financial businesses toward their retail customers.’’) PO 00000 1564 See 1565 See Frm 00168 Fmt 4701 Sfmt 4700 ‘‘suitable’’ with ‘‘best interest’’ could create legal risk and cause smaller and mid-sized professional firms to leave the market.1567 As noted above in Section III, we acknowledge that the costs of the rule could be more burdensome for small firms and discuss any corresponding competitive effects in Section III.D.1.1568 Further, as described above, we acknowledge the requests by commenters for further clarity on what it means to ‘‘act in the best interest’’ of the retail customer, and particularly what it means to make a recommendation in a retail customer’s ‘‘best interest’’ under the Care Obligation. Consequently, in Section II.A, and in the detailed discussion of each of the Disclosure, Care, Conflict of Interest, and Compliance Obligations in Section II.C, we have provided further clarity on how a broker-dealer can comply with Regulation Best Interest. However, with respect to the comment concerning the term ‘‘suitable,’’ we are adopting a ‘‘best interest’’ standard as proposed—which enhances the brokerdealer standard of conduct beyond existing suitability obligations—in light of our goal to enhance retail investor protection and decision making. Another commenter stated that costs for small broker-dealers could be reduced if the Commission approved a standard disclosure, which would add certainty and reduce costs for small firms and their customers.1569 We 1567 See Iowa Insurance Commissioner Letter (‘‘Striking ‘‘suitability,’’ and its history and legal precedence, will usher in an age of legal and marketing confusion. Additionally, smaller and mid-sized professional firms, to avoid the risks of this confusion and the resulting litigation, will leave the market, and the larger firms will remain, increasing market concentration. A decision to replace the term ‘‘suitable’’ in the text of traditional suitability rules with the phrase ‘‘best interest’’ will disrupt the market, decrease competition, increase the price of services out of the reach of thousands of middle class Americans, and significantly reduce consumer options for selecting valuable professional services.’’) But see NAIFA Letter (‘‘NAIFA supports a best interest standard of conduct for securities-licensed firms and individuals, and we appreciate the SEC’s considerable efforts to establish such a standard without imposing unduly prescriptive or burdensome implementation or compliance requirements. The SEC’s general approach, we believe, will preserve choices for consumers at all income levels and account sizes—and should not unnecessarily increase costs for consumers or businesses.’’) 1568 See also infra Section V.E., noting that we believe that Regulation Best Interest will result in multiple investor protection benefits, and these benefits should apply to retail customers of smaller entities as well as retail customers of large brokerdealers. 1569 See Chepucavage Letter (‘‘Costs for the small bd’s however can be reduced with a commission approved standard disclosure which would add certainty and ought to be considered especially for the small investor. [. . .] A standard disclosure document would also be useful for the small bd that E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations considered, as an alternative to the Disclosure Obligation, mandating a standardized disclosure.1570 However, as described in Section II.C.1, after careful consideration of the comments concerning the proposed Disclosure Obligation, we have decided not to require any standard written disclosures under Regulation Best Interest at this time. We recognize the wide variety of business models and practices and we continue to believe it is important to provide broker-dealers with flexibility to enable them to better tailor disclosure and information that their retail customers can understand and may be more likely to read at relevant points in time, rather than, for example, mandating a standardized all-inclusive (and likely lengthy) disclosure. The vast majority of commenters supported the Commission’s rulemaking efforts to address the standards of conduct that apply to broker-dealers when making recommendations, but nearly all commenters suggested modifications to proposed Regulation Best Interest. These suggestions touch on almost every aspect of the proposal, as summarized in Section I.C above and as discussed in more detail, along with explanations of modifications made in light of the comments, throughout the release. jbell on DSK3GLQ082PROD with RULES2 C. Small Entities Subject to the Rule For purposes of a Commission rulemaking in connection with the RFA, a broker-dealer will be deemed a small entity if it: (i) Had total capital (net worth plus subordinated liabilities) of less than $500,000 on the date in the prior fiscal year as of which its audited financial statements were prepared pursuant to Rule 17a–5(d) under the Exchange Act,1571 or, if not required to file such statements, had total capital (net worth plus subordinated liabilities) of less than $500,000 on the last business day of the preceding fiscal year (or in the time that it has been in business, if shorter); and (ii) is not affiliated with any person (other than a natural person) that is not a small business or small organization.1572 As discussed in Section IV above, the Commission estimates that as of cannot afford the legal assistance needed to evaluate this 1,000 page proposal and draft appropriate documents. [. . .] The Commission should therefore reconsider the impact of its proposal on small investors and small bd’s with the assumption that retirement accounts are significantly more important than regular brokerage accounts especially for small and elderly investors. A standard disclosure for small firms would reduce costs for the firms and their customers.’’) 1570 See supra Section III.E and infra Section V.E. 1571 17 CFR 240.17a–5(d). 1572 See 17 CFR 240.0–10(c). VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 December 31, 2018, approximately 2,766 retail broker-dealers will be subject to Regulation Best Interest and the amendments to Rules 17a–3 and 17a–4.1573 Based on FOCUS Report data,1574 the Commission estimated that as of December 31, 2018, approximately 756 of those retail broker-dealers might be deemed small entities for purposes of this analysis.1575 For purposes of this RFA analysis, we refer to broker-dealers that might be deemed small entities under the RFA as ‘‘small entities,’’ and we continue to use the term ‘‘brokerdealers’’ to refer to broker-dealers generally, as the term is used elsewhere in this release.1576 Of these 756 small entities, the Commission estimates that 623 are standalone broker-dealers and 133 are dually registered as investment advisers.1577 D. Projected Reporting, Recordkeeping, and Other Compliance Requirements The new requirements impose certain reporting and compliance requirements on certain broker-dealers, including those that are small entities. The new requirements are summarized in this FRFA (Section V.A. above). All of these requirements are also discussed in detail, in Section II above, and these requirements as well as the costs and burdens on broker-dealers, including those that are small entities, are discussed above in Sections III and IV (the Economic Analysis and PRA Analysis) and below. 1. Disclosure Obligation The Disclosure Obligation under Regulation Best Interest requires a broker-dealer or its associated persons, prior to or at the time of recommending a securities transaction or strategy involving securities to a retail customer, to provide the retail customer, in writing, full and fair disclosure of: (1) All material facts relating to the scope and terms of the relationship with the retail customer, including: (a) That the broker, dealer, or such natural person is acting as a broker, dealer, or an associated person of a broker or dealer with respect to the recommendation, (b) the fees and costs that apply to the retail customer’s transactions, holdings, and accounts, and (c) the type and scope of services provided to the retail customer, 1573 As noted above, this estimate likely overstates the number that would be impacted by Regulation Best Interest. See supra Section III.C.1.a. 1574 See supra footnote 1384. 1575 See supra footnote 1386. 1576 Consistent with the PRA, unless otherwise notes, we use the terms ‘‘registered representative’’ and ‘‘dually registered representative of a brokerdealer’’ herein. 1577 These estimate are based on FOCUS Report Data, see supra footnote 1384 PO 00000 Frm 00169 Fmt 4701 Sfmt 4700 33485 including any material limitations on the securities or investment strategies involving securities that may be recommended to the retail customer; and (2) all material facts relating to conflicts of interest that are associated with the recommendation. The estimated costs and burdens incurred by small entities in relation to this Disclosure Obligation are discussed in detail below.1578 a. Obligation To Provide to the Retail Customer Full and Fair Disclosure, in Writing, of All Material Facts Relating to the Scope and Terms of the Relationship With the Retail Customer The Commission assumes for purposes of this analysis that small entities would meet the obligation to disclose to the retail customer, in writing, the material facts related to the scope and terms of the relationship with the retail customer through a combination of delivery of the Relationship Summary,1579 creating account disclosures to include standardized language related to the capacity in which they are acting and type and scope of services, and the development of fee schedules. b. Estimated Costs and Burdens In addition to the costs described below, additional costs associated with Regulation Best Interest are described above in Section III.C.1580 (1) Disclosure of Capacity, Type and Scope of Services As explained above, standalone broker-dealers that are small entities will satisfy the obligation to disclose the capacity in which they acting through the delivery to the retail customer of the Relationship Summary, and accordingly, we estimate zero burden hours for standalone broker-dealers that are small entities to disclose the capacity in which they are acting. We estimate that a dually registered firm that is a small entity will incur an initial internal burden of 10 hours for in-house counsel and in-house compliance to draft language regarding the capacity in which it is acting for inclusion in the standardized account disclosure that is delivered to the retail customer.1581 In addition, we estimate 1578 For a discussion of additional costs and burdens as well as monetized burdens, related to the Disclosure Obligation, see supra Section III.C.2.b. 1579 See Exchange Act Rule 17a–14 and Relationship Summary Adopting Release, supra footnote 12. 1580 See Sections III.C.2.b, III.C.3.b, III.C.4, III.C.5, and III.C.6. 1581 See supra footnotes 1395–1396. E:\FR\FM\12JYR2.SGM 12JYR2 33486 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations that dual-registrants that are small entities will incur an estimated external cost of $4,970 for the assistance of outside counsel in the preparation and review of standardized language regarding capacity.1582 For the estimated 133 dually registered brokerdealers that are small entities, we project an aggregate initial burden of 1,330 hours,1583 and $661,010 in aggregate initial costs for drafting language regarding capacity.1584 Similarly, to comply with Regulation Best Interest, we believe that small entities will draft standardized language for inclusion in the account disclosure to provide the retail customer with more specific information regarding the type and scope of services that they provide. We estimate that a small entity will incur an internal initial burden of 10 hours for in-house counsel and in-house compliance to draft this standardized language.1585 In addition, a small entity will incur an estimated external cost of $4,970 for the assistance of outside counsel in the preparation and review of this standardized language.1586 For the estimated 756 small entities,1587 we project an aggregate initial burden of 7,560 hours,1588 and aggregate initial costs of $3.8 million for drafting language regarding type and scope of services.1589 We estimate that small entities will each incur approximately 0.02 burden hours 1590 for delivery of the account disclosure document.1591 Based on FOCUS data, we believe that the 756 small entities have a total of 5,281 customer accounts, and that approximately all of those accounts belong to retail customers.1592 We therefore estimate that small entities will have an aggregate initial burden of 106 hours, or approximately 0.14 1582 See supra footnote 1397. supra footnote 1395. This estimate is based on the following calculation: (133 dually registered retail firms that are small entities) × (10 hours) = 1,330 initial aggregate burden hours.) The professional skills associated with the estimated burden hours are specified in Section IV above. 1584 This estimate is based on the following calculation: (133 dually registered retail firms that are small entities) × ($4,970 in external cost per firm) = $661,010 in aggregate initial costs. 1585 See supra footnote 1402. 1586 See supra footnote 1403. 1587 See supra footnote 1385 and accompanying text. 1588 See supra footnote 1405. 1589 See supra footnote 1406. 1590 See supra footnote 1411. 1591 See supra footnote 1412. 1592 This estimate may overstate the number of retail customer accounts at small entities and/or may overstate the number of deliveries to be made due to the double-counting of deliveries to be made by dual-registrants to a certain extent, and the fact that one customer may own more than one account. jbell on DSK3GLQ082PROD with RULES2 1583 See VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 hours 1593 per small entity for the first year after Regulation Best Interest is in effect for delivery of the account disclosure document.1594 We therefore estimate a total initial aggregate burden for small entities to develop and deliver to retail customers account disclosures relating to the capacity in which they are acting and type and scope of services of 7,666 burden hours.1595 In terms of ongoing costs, we estimate that each dually registered broker-dealer that is a small entity will incur approximately 5 burden hours annually for in-house compliance and businessline personnel to review changes in the dual-registrant’s capacity, and another 2 burden hours annually for in-house counsel to amend the account disclosure to disclose material changes to the dual-registrant’s capacity, for a total of 7 burden hours. The estimated ongoing aggregate burden to amend account disclosures of dual-registrants that are small entities to reflect changes in capacity is therefore 931 hours per year.1596 With respect to small entities, we estimate an internal burden of 2 hours for in-house compliance and businessline personnel to review and update changes in types or scope of services,1597 and another 2 burden hours annually for in-house counsel to amend the account disclosure to disclose material changes to type and scope of services—for a total of 4 burden hours per year. The estimated ongoing aggregate burden for standalone brokerdealers that are small entities to amend account disclosures to reflect changes in type and scope of services is therefore 2,492 hours per year.1598 1593 These estimates are based on the following calculations: (0.02 hours per customer account × (5,281 retail customer accounts) = 106 aggregate burden hours. Conversely, (106 hours) / (756 small entities) = approximately 0.14 burden hours per small entity for the first year after Regulation Best Interest is in effect. 1594 See supra footnote 1415. 1595 This estimate is based on the following calculation: (1,330 aggregate initial burden hours for dually registered broker-dealers that are small entities) + (6,230 aggregate initial burden hours for standalone broker-dealers that are small entities) + (106 aggregate initial burden hours for small entities to deliver the account disclosures) = 7,666 total aggregate initial burden hours. 1596 This estimate is based on the following calculation: (7 burden hours per dually registered firm per year) × 133 dually registered broker-dealers that are small entities) = 931 ongoing aggregate burden hours per year. 1597 As noted above, we estimate zero burden hours annually for standalone broker-dealers that are small entities relating to disclosure of capacity under the Disclosure Obligation. See supra Section IV.B.1.a.ii. 1598 This estimate is based on the following calculation: (4 burden hours per small entity per year) × (623 standalone broker-dealers that are small PO 00000 Frm 00170 Fmt 4701 Sfmt 4700 With respect to delivery of the amended account agreements in the event of material changes to the capacity disclosure or disclosure related to type and scope of services, we estimate that this would take place among 20% of a small entity’s retail customer accounts annually. We therefore estimate small entities to incur a total annual aggregate burden of 21 hours, or 0.03 hours per small entity per year.1599 The total ongoing aggregate burden for small entities to review, amend, and deliver updated account disclosures to reflect changes in capacity, type and scope of services would be 3,444 burden hours per year.1600 The Commission acknowledges that the types of services and product offerings vary greatly by broker-dealer, and therefore the costs or burdens associated with updating the account disclosure might also vary. (2) Disclosure of Fees and Costs As stated above, while we anticipate that many small entities may already create fee schedules, we believe that small entities will initially spend 5 hours to internally create a new fee schedule in consideration of the requirements of Regulation Best Interest. We additionally estimate a one-time external cost of $2,485 for small entities.1601 We therefore estimate the initial aggregate burden for small entities to be 3,780 burden hours,1602 and the initial aggregate cost to be $1.88 million.1603 Similar to delivery of the account disclosure regarding capacity and type and scope of services, we estimate the burden for small entities to make the initial delivery of the fee schedule to new retail customers, at the inception of the relationship, and existing retail customers, prior to or at the time of a recommendation, will require approximately 0.02 hours to deliver to each retail customer.1604 We therefore estimate that small entities will have an aggregate initial burden of 106 hours, or entities) = 2,492 ongoing aggregate burden hours per year. 1599 (20%) × (5,281 retail customer accounts) × (0.02 hours for delivery to each customer account) = 21 aggregate burden hours per year. Conversely, 21 aggregate burden hours/756 small entities = 0.03 burden hours per small entity per year. 1600 This estimate is based on the following calculation: (931 ongoing aggregate burden hours for dually registered broker-dealers that are small entities) + (2,492 ongoing aggregate burden hours for standalone broker-dealers that are small entities) + (21 ongoing aggregate burden hours for delivery of amended account disclosures) = 3,444 total ongoing aggregate burden hours per year. 1601 See supra footnote 1426. 1602 See supra footnote 1428. 1603 See supra footnote 1429. 1604 See supra footnote 1411. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations approximately 0.14 hours per small entity for the first year after Regulation Best Interest is in effect.1605 With respect to small entities, we estimate that reviewing and updating the fee schedule will require approximately 2 hours per year. Based on these estimates, we estimate the recurring, aggregate, annualized burden will be 1,512 hours for small entities.1606 We do not anticipate that small entities will incur outside legal, compliance, or consulting fees in connection with updating their standardized fee schedule since inhouse personnel would be more knowledgeable about these facts, and we therefore do not expect external costs associated with updating the fee schedule. With respect to delivery of the amended fee schedule in the event of a material change, we estimate that this would take place among 40% of a small entity’s retail customer accounts annually, and that small entities will require approximately 0.02 hours to deliver the amended fee schedule to each retail customer. We therefore estimate small entities would incur a total annual aggregate burden of 42 hours, or 0.06 hours per small entity.1607 The Commission acknowledges that the type of fee schedule may vary greatly by small entity and therefore that the costs or burdens associated with updating the standardized fee schedule might similarly vary. (3) Disclosure of All Material Facts Relating to Conflicts of Interest Associated With the Recommendation jbell on DSK3GLQ082PROD with RULES2 We believe that many or most small entities will develop a standardized conflict disclosure document and deliver it to their retail customers.1608 For small entities, we estimate it will take in-house counsel, on average, 5 burden hours to create the standardized conflict disclosure document and outside counsel 5 hours to review and revise the document. We estimate that the initial aggregate burden for the development of a standardized 1605 This estimate is based on the following calculation: (5,281 retail customer accounts) × (0.02 hours for delivery to each customer account) = 106 aggregate burden hours. Conversely, (106 aggregate burden hours) / (756 small entities) = 0.14 burden hours per small entity for the first year after Regulation Best Interest is in effect. 1606 See supra footnote 1437. 1607 This estimate is based on the following calculation: (40% of 5,281 retail customer accounts) × (0.02 hours) = 42 aggregate burden hours. Conversely, (42 aggregate burden hours)/(756 small entities) = 0.06 burden hours per small entity per year. 1608 See supra footnote 1443. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 disclosure document, based on an estimated 756 small entities, will be 3,780 burden hours.1609 We additionally estimate an initial cost of $2,485 per small entity,1610 and an aggregate initial cost of $1.88 million for all small broker-dealers.1611 We assume that small entities will deliver the standardized conflict disclosure document to new retail customers at the inception of the relationship, and to existing retail customers prior to or at the time of a recommendation. We estimate that small entities will require approximately 0.02 hours to deliver the standardized conflict disclosure document to each retail customer.1612 We therefore estimate that small entities will incur an aggregate initial burden of 106 hours, or approximately 0.14 hours per small entity for delivery of the standardized conflict disclosure document the first year after Regulation Best Interest is in effect.1613 Accordingly, the total aggregate initial burden for small entities is estimated at 3,886 hours,1614 and the total aggregate initial cost is estimated at $1.88 million.1615 We believe that small entities will incur ongoing annual burdens and costs to update the disclosure document to include newly identified conflicts. We estimate that in-house counsel at a small entity will require approximately 1 hour per year to update the standardized conflict disclosure document, for an ongoing aggregate burden of approximately 756 hours per year.1616 We do not anticipate that small entities will incur outside legal, compliance, or consulting fees in connection with updating their standardized conflict disclosure document, since in-house personnel would presumably be more knowledgeable about conflicts of interest. supra footnote 1444. supra footnote 1445. 1611 See supra footnote 1446. 1612 See supra footnote 1411. For purposes of this analysis, we have assumed any initial disclosures made by the small entities related to material conflicts of interest will be delivered together. 1613 These estimates are based on the following calculations: (0.02 hours per customer account × 5,281 retail customer accounts) = 106 aggregate burden hours. Conversely, (106 hours)/(756 small entities) = 0.14 burden hours per small entity for the first year after Regulation Best Interest is in effect. 1614 This estimate is based on the following calculation: (3,780 aggregate initial burden hours for the development of a standardized conflict disclosure document) + (106 burden hours for delivery of the standardized conflict disclosure document) = 3,886 aggregate initial burden hours. 1615 See supra footnote 1429. 1616 See supra footnote 1453. PO 00000 1609 See 1610 See Frm 00171 Fmt 4701 Sfmt 4700 33487 With respect to ongoing delivery of the updated conflict disclosure document, we estimate that this will take place among 40% of a small entity’s retail customer accounts annually, and that small entities will require approximately 0.02 hours to deliver the updated conflict disclosure document to each retail customer.1617 We therefore estimate that small entities will incur an aggregate ongoing burden of 42 hours, or 0.06 burden hours per small entity per year.1618 2. Care Obligation As discussed above in Section IV.B.2, we believe that any burdens or costs associated with the Care Obligation are accounted for in other obligations under Regulation Best Interest, including the Disclosure Obligation and the Recordmaking Obligation under Rule 17a– 3(a)(35) and Recordkeeping Obligation under Rule 17a–4(e)(5). Other costs applicable to broker-dealers, including small entities, associated with the Care Obligation are discussed above in Section III.C.3.b. 3. Conflict of Interest Obligation As described more fully above in Section IV.B.3, the Conflict of Interest Obligation would generally include the obligation to: (1) Update written policies and procedures to comply with Regulation Best Interest and (2) establish mechanisms to proactively and systematically identify and manage conflicts of interest in its business on an ongoing or periodic basis.1619 a. Written Policies and Procedures i. Initial Costs and Burdens To initially comply with this obligation, we believe that small entities would primarily rely on outside counsel to update existing policies and procedures, as small broker-dealers generally have fewer in-house legal and compliance personnel. We estimate that 40 hours of outside legal counsel services would be required, for a onetime initial cost of $19,880 per small entity,1620 and an aggregate initial cost of $15.0 million for all small entities.1621 We also expect that in1617 See supra footnote 1455. estimate is based on the following calculation: (40% of 5,281 retail customer accounts) × (0.02 hours) = 42 aggregate burden hours. Conversely, (42 aggregate burden hours per year)/ (756 small entities) = 0.06 hours per small entity per year. 1619 See supra Section IV.B.3. For a discussion of additional costs and burdens, as well as monetized burdens, related to the Conflict of Interest Obligation, see supra Section III.C.4. 1620 See supra footnote 1477. 1621 See supra footnote 1478. 1618 This E:\FR\FM\12JYR2.SGM 12JYR2 33488 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations house compliance would require 10 hours to review and approve the updated policies and procedures, for an initial aggregate burden of 7,560 hours.1622 Therefore, we estimate the total initial aggregate burden for small entities to be 128,160 hours 1623 and the total initial aggregate cost to be $25.0 million.1624 We believe that the related ongoing costs for small entities (relating to outside counsel reviewing and updating policies and procedures on a periodic basis) would be $2,485 annually for each small entity,1625 and the projected aggregate, annual ongoing cost for small entities (relating to outside legal counsel) would be $1.88 million.1626 In addition, we expect that small entities would require five hours of outside compliance services per year to update their policies and procedures, for an ongoing cost of $1,365 per year per small entity,1627 and an aggregate ongoing cost of $1.03 million per year.1628 The total aggregate, ongoing cost for small entities is therefore projected at $2.91 million per year.1629 In addition to the costs described above, we additionally believe small broker-dealers would incur an internal burden of approximately five hours for an in-house compliance manager to review and approve the updated policies and procedures per year. The ongoing, aggregate burden for small broker-dealers would be 3,780 hours for in-house compliance manager review per year.1630 b. Identification and Management of Conflicts of Interest To comply with Regulation Best Interest, we expect that small entities would modify existing technology through an outside programmer which would require, on average, an estimated 20 hours, for an estimated initial cost per small entity of $5,680.1631 We additionally continue to project that coordination between the programmer and the small entity’s compliance manager would involve five initial burden hours. The aggregate initial costs and burdens for small entities for the modification of existing technology to identify conflicts of interest would 1622 See supra footnote 1479. supra footnote 1480. 1624 See supra footnote 1481. 1625 See supra footnote 1486. 1626 See supra footnote 1487. 1627 See supra footnote 1488. 1628 See supra footnote 1489. 1629 See supra footnote 1490. 1630 See supra footnote 1491. 1631 See supra footnote 1497. jbell on DSK3GLQ082PROD with RULES2 1623 See VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 therefore be $4.29 million,1632 and 3,780 burden hours.1633 As a result of the changes made to the rule text of the Conflict of Interest Obligation of Regulation Best Interest, we believe that small entities would incur burdens to determine how to manage the conflict of interest. We believe that small entities would require approximately 20 hours per small entity,1634 for an aggregate of 15,120 initial burden hours for all small entities.1635 The total initial aggregate burden for small entities for identification and management of conflicts of interest is therefore 18,900 initial burden hours.1636 To maintain compliance with the Conflict of Interest Obligation, we believe that for purposes of this analysis, small entities would, through the help of the business line and compliance personnel, spend on average 10 hours 1637 to perform an annual conflicts review using the modified technology infrastructure.1638 Therefore, the aggregate ongoing burden for an annual conflicts review, based on an estimated 756 small entities, would be approximately 7,560 burden hours per year.1639 Because we assume that small entities would use in-house personnel to identify and evaluate new, potential conflicts, we continue to believe they would not incur additional ongoing costs. c. Training As discussed in the Proposing Release, we expect that small entities would develop training programs to comply with Regulation Best Interest, including the Conflict of Interest Obligation. However, we believe that any burdens and costs associated with a training program would fall under the new Compliance Obligation as it would be developed to comply with the rule as 1632 This cost estimate is based on the following calculation: ($5,680 in outside programmer costs per broker-dealer) × (756 small entities) = $4.29 million in aggregate initial outside programmer costs. 1633 This burden estimate is based on the following calculation: (5 burden hours) × (756 small entities) = 3,780 aggregate initial burden hours. 1634 See supra footnotes 1501 and 1502. 1635 This burden estimate is based on the following calculation: (20 burden hours) × (756 small entities) = 15,120 aggregate initial burden hours. 1636 This burden estimate is based on the following calculation: (3,780 burden hours for modification of technology) + (15,120 burden hours for evaluation of managing conflicts) = 18,900 total aggregate initial burden hours. 1637 See supra footnote 1507. 1638 See supra footnote 1508. 1639 This estimate is based on the following calculation: (10 hours of labor per small entity per year) × (756 small entities) = 7,560 aggregate burden hours per year. PO 00000 Frm 00172 Fmt 4701 Sfmt 4700 a whole, including each of the component obligations. In total, to comply with the Conflict of Interest Obligation, the Commission estimates that the total initial burdens and costs for small entities to be 135,720 hours 1640 and $29.29 million 1641 and the total ongoing burdens and costs for small entities to be 11,340 hours 1642 and $2.91 million.1643 4. Compliance Obligation As discussed above, in response to comments that we should require policies and procedures to comply with the rule as a whole, we are adopting the Compliance Obligation.1644 Because we did not include the Compliance Obligation in the Proposing Release, we did not include costs and burdens associated with the Compliance Obligation, but have provided a detailed explanation in Section IV.B.4 above, and a summary below. To comply with the Compliance Obligation, we believe that small entities would primarily rely on outside counsel to update existing policies and procedures, and that 20 hours of outside legal counsel services would be required, for a one-time cost of $9,940 per small entity,1645 and an aggregate initial cost of $7.5 million for all small entities.1646 We also expect that inhouse compliance personnel would require 6 hours to review and approve the updated policies and procedures, for an aggregate initial burden of 4,536 hours.1647 In terms of ongoing costs, we assume for purposes of this analysis that small entities would mostly rely on outside legal counsel and compliance consultants for review and update of their policies and procedures, with final review and approval from an in-house compliance manager. We estimate that outside counsel would require approximately five hours per year to update policies and procedures, for an 1640 This estimate is based on the following calculation: (128,160 burden hours for written policies and procedures) + (7,560 burden hours for identification and management of conflicts of interest) = 135,720 hours. 1641 This estimate is based on the following calculation: ($25 million initial aggregate costs relating to written policies and procedures) + ($4.29 million initial aggregate costs for modification of existing technology to identify conflicts of interest) = $29.29 million initial aggregate costs. 1642 This estimate is based on the following calculation: (3,780 burden hours for reviewing and approving the updated policies and procedures) + (7,560 burden hours for annual conflicts review) = 11,340 initial aggregate burden hours. 1643 See supra footnote 1629. 1644 Section II.C.4. 1645 See supra footnote 1523. 1646 See supra footnote 1524. 1647 See supra footnote 1525. E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations annual cost of $2,485 for each small entity.1648 The projected aggregate, annual ongoing cost for outside legal counsel to update policies and procedures for small entities would be $1.88 million per year.1649 In addition, we expect that a small entity would require five hours of outside compliance services per year to update its policies and procedures, for an ongoing cost of $1,365 per year,1650 and an aggregate ongoing cost of $1.03 million per year.1651 The total aggregate, ongoing cost for small entities is therefore projected at $2.91 million per year.1652 a. Training Pursuant to the obligation to ‘‘maintain and enforce’’ written policies and procedures, we additionally believe small entities will develop training programs that promote compliance with Regulation Best Interest. We estimate that a small entity would retain an outside systems analyst, outside programmer, and an outside programmer analyst to create a training module, at 20 hours, 40 hours, and 20 hours, respectively. The total cost to develop the training module would be approximately $20,920 per small entity,1653 for an aggregate initial cost to small entities of $17.18 million.1654 Additionally, we expect that the training module would require the approval of the Chief Compliance Officer, as well as in-house counsel, each of whom would require approximately 2 hours to review and approve the training module. The initial aggregate burden for small entities is therefore estimated at 3,024 initial burden hours.1655 In addition, small entities would incur an initial cost for registered representatives to undergo training through the training module. We estimate the training time at one hour per associated person, for an aggregate initial burden of 5,094 burden hours, or an initial burden of 6.7 hours per small entity.1656 The total aggregate burden to 1648 See supra footnote 1529. supra footnote 1530. 1650 See supra footnote 1531. 1651 See supra footnote 1532. 1652 See supra footnote 1533. 1653 See supra footnote 1534. 1654 This estimate is based on the following calculation: (756 small entities) × ($20,920 initial costs per broker-dealer) = $15.81 million in aggregate initial costs for technology services. 1655 This estimate is based on the following calculation: (756 small entities) × (4 initial burden hours per small entity) = 3,024 initial burden hours. 1656 This estimate is based on the following calculation: (1 burden hour) × (5,094 registered representatives at small entities) = 5,094 aggregate initial burden hours. Conversely, (5,094 aggregate burden hours)/(756 small entities) = 6.7 initial burden hours per broker-dealer. jbell on DSK3GLQ082PROD with RULES2 1649 See VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 approve the training module and implement the training program would be 8,118 initial burden hours.1657 For purposes of this analysis, we assume that small entities would likely require registered representatives to repeat the training module for Regulation Best Interest on an annual basis. The ongoing aggregate cost for the one-hour training would be 5,094 burden hours per year, or 6.7 burden hours per small entity per year.1658 In total, for small entities to comply with the Compliance Obligation, the Commission estimates the total initial burdens and costs to be 12,654 hours 1659 and $23.31 million,1660 and the total ongoing burdens and costs to be 5,094 hours 1661 and $2.91 million.1662 5. Record-Making and Recordkeeping Obligations The record-making and recordkeeping obligations will impose record-making and recordkeeping requirements on broker-dealers with respect to certain information collected from, or provided to, retail customers. a. Record-Making Obligation As discussed above, we continue to believe that small entities will satisfy the record-making requirements of the amendment to Rule 17a–3(a)(35) by amending an existing account disclosure document to include certain information.1663 We believe that the inclusion of this information in an account disclosure document will require, on average, approximately 1 hour per year for outside counsel at small entities, at an updated average rate of $497/hour, for an annual cost of $497 for each small entity to update an account disclosure document. The 1657 This estimate is based on the following calculation: (5,094 burden hours for training of registered representatives) + (3,024 burden hours to approve training program) = 8,118 total aggregate initial burden hours. 1658 See supra footnote 1656. 1659 This estimate is based on the following calculation: (4,536 initial burden hours for policies and procedures) + (8,118 initial burden hours training) = 12,654 initial burden hours to comply with Compliance Obligation. 1660 This estimate is based on the following calculation: ($7.5 million initial costs for policies and procedures) + ($15.81 million initial costs for training) = $23.31 million initial total costs to comply with Compliance Obligation. 1661 This estimate is based on the following calculation: (0 ongoing burden hours for policies and procedures) + (5,094 ongoing burden hours for training) = 5,094 ongoing burden hours to comply with Compliance Obligation. 1662 This estimate is based on the following calculation: ($2.91 million ongoing costs for policies and procedures) + ($0 ongoing costs for training) = $2.91 million ongoing total costs to comply with Compliance Obligation. 1663 See supra Section IV.B.5.a.i. PO 00000 Frm 00173 Fmt 4701 Sfmt 4700 33489 projected initial, aggregate cost for small entities is therefore estimated to be $375,732.1664 Finally, we estimate it will require an additional 0.04 hours for the registered representative responsible for the information (or other clerical personnel) to fill out that information in the account disclosure document, for an approximate total aggregate initial burden of 211 hours, or approximately 0.28 hours per small entity for the first year after the rule is in effect.1665 Because we have already included the costs and burdens associated with the creation of a record to memorialize an oral disclosure, and the delivery of the amended account disclosure document in Section V.D.1., we need not include them in this section of the analysis. We do not believe that the identity of the registered representative responsible for the retail customer’s account will change. Accordingly, we continue believe that there are no ongoing costs and burdens associated with this recordmaking requirement of the amendment to Rule 17a–3(a)(35). With respect to memorializing oral disclosures, we estimate that this would take place among 52% of a small entity’s retail customers (and thus 52% of a registered representative’s retail customer accounts) annually.1666 We therefore estimate that small entities will incur a total annual aggregate ongoing burden of 55 hours or 0.07 hours per small entity per year.1667 b. Recordkeeping Obligation For purposes of this analysis, we assume the following records would likely be retained pursuant to amended Rule 17a–3(a)(35): (1) Existing account disclosure documents; (2) comprehensive fee schedules; (3) disclosures identifying material conflicts; and (4) memorialized oral disclosures under the circumstances outlined in Section II.C.1, Oral Disclosure or Disclosure After a Recommendation. Based on our belief that small entities will rely on existing infrastructures to satisfy the recordkeeping obligations of Regulation Best Interest and the amendment to Rule 17–a(4)(e)(5), we 1664 See supra footnote 1548. estimates are based on the following calculations: (0.04 hours per customer account) × (5,281 retail customer accounts at small entities) = 211 aggregate initial burden hours. Conversely, (211 burden hours)/(756 small entities) = 0.28 initial burden hours per broker-dealer. 1666 See supra footnote 1554. 1667 (52%) × (5,281 retail customer accounts at small entities) × (0.02 hours for recording each oral disclosure relating to a retail customer’s account) = 55 aggregate burden hours per year. Conversely, 55 aggregate burden hours/756 small entities = 0.07 ongoing burden hours per small entity per year. 1665 These E:\FR\FM\12JYR2.SGM 12JYR2 33490 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations believe the burden for small entities to add new documents or modify existing documents to the small entity’s existing retention system will be approximately 704 burden hours for small entities, assuming a small entity will need to upload or file each of the four account documents discussed above for each retail customer account.1668 We do not believe there will be additional internal or external costs relating to the uploading or filing of the documents. In addition, because we have already included the costs and burdens associated with the delivery of the amended account opening agreement and other documents in Section V.D.1 above, we do not include them in this section of the analysis. We estimate that the approximate ongoing burden associated with the recordkeeping requirement of the amendment to Rule 17a–4(e)(5) is 231 burden hours per year.1669 We do not believe that the ongoing costs associated with ensuring compliance with the retention schedule would change from the current costs of ensuring compliance with existing Rule 17a–4 and as outlined above. jbell on DSK3GLQ082PROD with RULES2 E. Agency Action To Minimize Effect on Small Entities The RFA directs the Commission to consider significant alternatives that would accomplish the stated objective, while minimizing any significant adverse impact on small entities. As described in the Proposing Release we considered the following alternatives for small entities in relation to the new requirements: (1) The establishment of differing compliance or reporting 1668 This estimate is based on the following calculation: (4 documents per customer account) × (5,281 retail customer accounts at small entities) × (2 minutes per document)/60 minutes = 704 aggregate burden hours. 1669 This estimate is based on the percentage of account records we expect would be updated each year as described in Section IV.B.1, supra, and the following calculation: ((40% of fee schedules × 5,281 retail customer accounts at small entities) × (2 minutes per document) + (40% of conflict disclosure forms × 5,281 retail customer accounts at small entities) × (2 minutes per document) + (20% of account opening documents × 5,281 retail customer accounts at small entities) × (2 minutes per document)) = 10,560 minutes/60 minutes = 176 aggregate ongoing burden hours. In addition, with respect to ongoing memorialization of the updated oral disclosures, we estimate that this will take place among 52% of a small entity’s retail customer accounts annually. We therefore estimate that small entities will incur an aggregate ongoing burden of 55 hours, or 0.07 burden hours per broker-dealer (calculated as follows: (52% of updated oral disclosures × 5,281 retail customer accounts at small entities) × (1.2 minutes per document) = 3,295 minutes/60 minutes = 55 aggregate ongoing burden hours (or 55 aggregate burden hours/756 small entities = 0.07 burden hours per small entity)). 176 hours + 55 hours = 231 total aggregate ongoing burden hours. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 requirements or timetables that take into account the resources available to small entities; (2) the clarification, consolidation, or simplification of compliance and reporting requirements for small entities; (3) the use of performance rather than design standards; and (4) an exemption from coverage of the new requirements, or any part thereof, for such small entities. Regarding the first alternative, the Commission does not believe that we could effectively achieve our stated objectives by establishing different requirements applicable to brokerdealers of different sizes. We considered adopting tiered compliance dates so that smaller broker-dealers would have had more time to comply. However, as discussed in Section II.E above, we believe the operational capability needed to develop processes to comply with Regulation Best Interest is sufficiently established by firms of all sizes and resources. The Commission has determined, in light of the importance of the protections afforded by Regulation Best Interest to retail customers, that a Compliance Date of one year after the Effective Date is an appropriate timeframe for firms to conduct the requisite operational changes to their systems to establish internal processes to comply with Regulation Best Interest. Further, as discussed above in Section III, each of the component obligations in Regulation Best Interest shares features with existing market best practices, as shaped by FINRA’s guidance on relevant rules or as described in its Report on Conflicts of Interest.1670 To the extent that brokerdealer (and small entity) practices are already aligned with the requirements of Regulation Best Interest, the anticipated magnitude of the costs associated with a given component of the rule will be correspondingly reduced.1671 As discussed above, we believe that Regulation Best Interest will result in important investor protection benefits, and these benefits apply to retail customers of smaller entities as well as retail customers of large broker-dealers. For example, a primary objective of this rulemaking is to enhance the quality of recommendations provided by brokerdealers to retail customers, by establishing under the Exchange Act a ‘‘best interest’’ obligation. We do not believe that the interest of investors who are retail customers would be served by establishing differing compliance or reporting requirements or timetables for broker-dealers that are small entities under Regulation Best Interest and the PO 00000 1670 See 1671 See supra Section III.C.1.b. supra text following footnote 1159. Frm 00174 Fmt 4701 Sfmt 4700 amendments to Rules 17a–3 and 17a– 4(e)(5). Moreover, we continue to believe that providing an exemption or different requirements for small entities would be inconsistent with our goal of facilitating more consistent regulation, in recognition of the importance for both investors and broker-dealers of having the applicable standards for brokerage recommendations be clear, understandable, and as consistent as possible across a brokerage relationship (i.e., whether for retirement or nonretirement purposes) and better aligned with other advice relationships (e.g., a relationship with an investment adviser). Further, as discussed above, broker-dealers are subject to regulation under the Exchange Act and the rules of each SRO of which the broker-dealer is a member, including a number of obligations that attach when a brokerdealer makes a recommendation to a customer, as well as general and specific requirements aimed at addressing certain conflicts of interest. We note that these existing requirements do not generally distinguish between small entities and other broker-dealers. For the same reasons as described in the Proposing Release, we still do not believe that additional clarification, consolidation, or simplification of compliance and reporting requirements would be appropriate for small entities. We note, however, in crafting Regulation Best Interest, we generally aimed to provide broker-dealers flexibility in determining how to satisfy the component obligations. We continue to believe that this flexibility reflects a general performance-based approach, rather than design-based approach. As discussed in the Economic Analysis in Section III.E above, the Commission also considered a number of alternatives as they affect all firms, including small entities. Specifically, the Commission considered three different options for imposing a fiduciary standard on broker-dealers: (1) Applying the fiduciary standard under the Advisers Act to broker-dealers; (2) adopting a ‘‘new’’ uniform fiduciary standard of conduct applicable to both broker-dealers and investment advisers, such as that recommended by the staff in the 913 Study, and, or (3) adopting similar standards to what the DOL had provided under its fiduciary rule to broker-dealers and investment advisers. The Commission further considered requiring broker-dealers to use a specific form for disclosure, similar to, for example, Form ADV Part II in lieu of the flexible approach of the Disclosure Obligation, or in the alternative, developing a disclosure-only standard, E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations which would require that broker-dealers satisfy only the Disclosure Obligation of the final rule. We acknowledge certain commenters urged the Commission to take additional or different regulatory actions than the approach we have adopted, including the alternatives discussed above. We do not believe that any rulemaking governing retail investor-advice relationships can solve for every issue presented. After careful consideration of the comments and additional information we have received, we believe that Regulation Best Interest, as modified, appropriately balances the concerns of the various commenters in a way that will best achieve the Commission’s important goals of enhancing retail investor protection and decision making, while preserving, to the extent possible, retail investor access (in terms of choice and cost) to differing types of investment services and products. VI. Statutory Authority and Text of the Rule Pursuant to Dodd-Frank Wall Street Reform and Consumer Protection Act Section 913(f), Public Law 111–203, 124 Stat. 1376, 1827 (2010), and Exchange Act sections 3, 10, 15, 15(c)(6), 15(l), 17, 23 and 36 thereof, 15 U.S.C. 78c, 78j, 78o, 78o(c)(6), 78o(l), 78q, 78w and 78mm, the Commission is adopting § 240.15l–1 and adopting amendments to § 240.17a–3 by adding new paragraph (a)(25), and to revise § 240.17a–4(e)(5) of Title 17 of the Code of Federal Regulations in the manner set forth below. List of Subjects in 17 CFR Part 240 Brokers, Reporting and recordkeeping requirements, Securities. Text of the Rule In accordance with the foregoing, Title 17, Chapter II of the Code of Federal Regulations is amended as follows: PART 240—GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934 1. The authority citation for part 240 is amended by adding sectional authorities for section 240.15l–1 to read as follows: jbell on DSK3GLQ082PROD with RULES2 ■ Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z–2, 77z–3, 77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c–3, 78c–5, 78d, 78e, 78f, 78g, 78i, 78j, 78j–1, 78k, 78k–1, 78l, 78m, 78n, 78n–1, 78o, 78o–4, 78o–10, 78p, 78q, 78q–1, 78s, 78u–5, 78w, 78x, 78ll, 78mm, 80a–20, 80a–23, 80a–29, 80a–37, 80b–3, 80b– 4, 80b–11, 7201 et seq.; and 8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 1350; and Pub. L. 111–203, 939A, 124 Stat. 1887 (2010); and secs. 503 and 602, Pub. L. 112–106, 126 Stat. 326 (2012), unless otherwise noted. * * * * * Section 240.15l–1 is also issued under Pub. L. 111–203, sec. 913, 124 Stat. 1376, 1827 (2010). * ■ * * * * 2. Add § 240.15l–1 to read as follows: § 240.15l–1 Regulation Best Interest. (a) Best interest obligation. (1) A broker, dealer, or a natural person who is an associated person of a broker or dealer, when making a recommendation of any securities transaction or investment strategy involving securities (including account recommendations) to a retail customer, shall act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker, dealer, or natural person who is an associated person of a broker or dealer making the recommendation ahead of the interest of the retail customer. (2) The best interest obligation in paragraph (a)(1) of this section shall be satisfied if: (i) Disclosure obligation. The broker, dealer, or natural person who is an associated person of a broker or dealer, prior to or at the time of the recommendation, provides the retail customer, in writing, full and fair disclosure of: (A) All material facts relating to the scope and terms of the relationship with the retail customer, including: (1) That the broker, dealer, or such natural person is acting as a broker, dealer, or an associated person of a broker or dealer with respect to the recommendation; (2) The material fees and costs that apply to the retail customer’s transactions, holdings, and accounts; and (3) The type and scope of services provided to the retail customer, including any material limitations on the securities or investment strategies involving securities that may be recommended to the retail customer; and (B) All material facts relating to conflicts of interest that are associated with the recommendation. (ii) Care obligation. The broker, dealer, or natural person who is an associated person of a broker or dealer, in making the recommendation, exercises reasonable diligence, care, and skill to: (A) Understand the potential risks, rewards, and costs associated with the recommendation, and have a reasonable PO 00000 Frm 00175 Fmt 4701 Sfmt 4700 33491 basis to believe that the recommendation could be in the best interest of at least some retail customers; (B) Have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer based on that retail customer’s investment profile and the potential risks, rewards, and costs associated with the recommendation and does not place the financial or other interest of the broker, dealer, or such natural person ahead of the interest of the retail customer; (C) Have a reasonable basis to believe that a series of recommended transactions, even if in the retail customer’s best interest when viewed in isolation, is not excessive and is in the retail customer’s best interest when taken together in light of the retail customer’s investment profile and does not place the financial or other interest of the broker, dealer, or such natural person making the series of recommendations ahead of the interest of the retail customer. (iii) Conflict of interest obligation. The broker or dealer establishes, maintains, and enforces written policies and procedures reasonably designed to: (A) Identify and at a minimum disclose, in accordance with paragraph (a)(2)(i) of this section, or eliminate, all conflicts of interest associated with such recommendations; (B) Identify and mitigate any conflicts of interest associated with such recommendations that create an incentive for a natural person who is an associated person of a broker or dealer to place the interest of the broker, dealer, or such natural person ahead of the interest of the retail customer; (C)(1) Identify and disclose any material limitations placed on the securities or investment strategies involving securities that may be recommended to a retail customer and any conflicts of interest associated with such limitations, in accordance with subparagraph (a)(2)(i), and (2) Prevent such limitations and associated conflicts of interest from causing the broker, dealer, or a natural person who is an associated person of the broker or dealer to make recommendations that place the interest of the broker, dealer, or such natural person ahead of the interest of the retail customer; and (D) Identify and eliminate any sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sales of specific securities or specific types of securities within a limited period of time. (iv) Compliance obligation. In addition to the policies and procedures E:\FR\FM\12JYR2.SGM 12JYR2 33492 Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules and Regulations required by paragraph (a)(2)(iii) of this section, the broker or dealer establishes, maintains, and enforces written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest. (b) Definitions. Unless otherwise provided, all terms used in this rule shall have the same meaning as in the Securities Exchange Act of 1934. In addition, the following definitions shall apply for purposes of this section: (1) Retail customer means a natural person, or the legal representative of such natural person, who: (i) Receives a recommendation of any securities transaction or investment strategy involving securities from a broker, dealer, or a natural person who is an associated person of a broker or dealer; and (ii) Uses the recommendation primarily for personal, family, or household purposes. (2) Retail customer investment profile includes, but is not limited to, the retail customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the retail customer may disclose to the broker, dealer, or a natural person who is an associated person of a broker or dealer in connection with a recommendation. (3) Conflict of interest means an interest that might incline a broker, dealer, or a natural person who is an associated person of a broker or dealer —consciously or unconsciously—to make a recommendation that is not disinterested. ■ 3. Amend § 240.17a–3 by adding reserved paragraphs (a)(24) through (34) and paragraph (a)(35) to read as follows: jbell on DSK3GLQ082PROD with RULES2 § 240.17a–3 Records to be made by certain exchange members, brokers and dealers. (a) * * * (24)–(34) [Reserved]. (35) For each retail customer to whom a recommendation of any securities transaction or investment strategy involving securities is or will be provided: (i) A record of all information collected from and provided to the retail customer pursuant to § 240.15l–1, as well as the identity of each natural person who is an associated person, if any, responsible for the account. (ii) For purposes of this paragraph (a)(35), the neglect, refusal, or inability of the retail customer to provide or update any information described in paragraph (a)(35)(i) of this section shall excuse the broker, dealer, or associated VerDate Sep<11>2014 19:21 Jul 11, 2019 Jkt 247001 person from obtaining that required information. * * * * * ■ 4. Amend § 240.17a–4 by revising paragraph (e)(5) to read as follows: § 240.17a–4 Records to be preserved by certain exchange members, brokers and dealers. * * * * * (e) * * * (5) All account record information required pursuant to § 240.17a–3(a)(17) and all records required pursuant to § 240.17a–3(a)(35), in each case until at least six years after the earlier of the date the account was closed or the date on which the information was collected, provided, replaced, or updated. * * * * * By the Commission. Dated: June 5, 2019. Vanessa Countryman, Acting Secretary. [FR Doc. 2019–12164 Filed 7–11–19; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 200, 240, 249, 275, and 279 [Release Nos. 34–86032; IA–5247; File No. S7–08–18] RIN 3235–AL27 Form CRS Relationship Summary; Amendments to Form ADV Securities and Exchange Commission. ACTION: Final rule. AGENCY: The Securities and Exchange Commission (the ‘‘Commission’’ or the ‘‘SEC’’) is adopting new rules and forms as well as amendments to its rules and forms, under both the Investment Advisers Act of 1940 (‘‘Advisers Act’’) and the Securities Exchange Act of 1934 (‘‘Exchange Act’’) to require registered investment advisers and registered broker-dealers (together, ‘‘firms’’) to provide a brief relationship summary to retail investors. The relationship summary is intended to inform retail investors about: The types of client and customer relationships and services the firm offers; the fees, costs, conflicts of interest, and required standard of conduct associated with those relationships and services; whether the firm and its financial professionals currently have reportable legal or disciplinary history; and how to obtain additional information about the firm. The relationship summary will also SUMMARY: PO 00000 Frm 00176 Fmt 4701 Sfmt 4700 reference Investor.gov/CRS, a page on the Commission’s investor education website, Investor.gov, which offers educational information to investors about investment advisers, brokerdealers, and individual financial professionals and other materials. Retail investors will receive a relationship summary at the beginning of a relationship with a firm, communications of updated information following a material change to the relationship summary, and an updated relationship summary upon certain events. The relationship summary is subject to Commission filing and recordkeeping requirements. DATES: Effective dates: The rules and form are effective September 10, 2019. Compliance dates: The applicable compliance dates are discussed in section II.D. FOR FURTHER INFORMATION CONTACT: : Gena Lai, James McGinnis, Elizabeth Miller, Sirimal R. Mukerjee, Olawale´ Oriola, Alexis Palascak, Benjamin Tecmire, Roberta Ufford, Jennifer Porter (Branch Chief), Investment Adviser Regulation Office at (202) 551–6787 or IArules@sec.gov; Benjamin Kalish and Parisa Haghshenas (Branch Chief), Chief Counsel’s Office at (202) 551–6825 or IMOCC@sec.gov, Division of Investment Management; Alicia Goldin, Emily Westerberg Russell, Lourdes Gonzalez (Assistant Chief Counsel), Office of Chief Counsel, Division of Trading and Markets, at (202) 551–5550 or tradingandmarkets@sec.gov, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549. SUPPLEMENTARY INFORMATION: The Commission is adopting new rule 17 CFR 275.204–5 [rule 204–5] under the Investment Advisers Act of 1940 [15 U.S.C. 80b] 1 and is adopting amendments to Form ADV to add a new Part 3: Form CRS [17 CFR 279.1] under the Advisers Act. The Commission is also adopting amendments to rules 17 CFR 275.203–1 [rule 203–1], 17 CFR 275.204–1 [rule 204–1], and 17 CFR 275.204–2 [rule 204–2] under the Advisers Act. The Commission is adopting new rule 17 CFR 240.17a–14 [rule 17a–14] 2 under the Securities 1 15 U.S.C. 80b. Unless otherwise noted, when we refer to the Advisers Act, or any paragraph of the Advisers Act, we are referring to 15 U.S.C. 80b, at which the Advisers Act is codified, and when we refer to rules under the Advisers Act, or any paragraph of these rules, we are referring to Title 17, part 275 of the Code of Federal Regulations [17 CFR 275], in which these rules are published. 2 15 U.S.C. 78a. Unless otherwise noted, when we refer to the Exchange Act, or any paragraph of the Exchange Act, we are referring to 15 U.S.C. 78a, at which the Exchange Act is codified, and when we E:\FR\FM\12JYR2.SGM 12JYR2

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 84, Number 134 (Friday, July 12, 2019)]
[Rules and Regulations]
[Pages 33318-33492]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-12164]



[[Page 33317]]

Vol. 84

Friday,

No. 134

July 12, 2019

Part II





Securities and Exchange Commission





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17 CFR Part 240





Regulation Best Interest: The Broker-Dealer Standard of Conduct; Form 
CRS Relationship Summary; Amendments to Form ADV; Commission 
Interpretation Regarding Standard of Conduct for Investment Advisers; 
Commission Interpretation Regarding the Solely Incidental Prong of the 
Broker-Dealer Exclusion From the Definition of Investment Adviser; 
Final Rule

Federal Register / Vol. 84, No. 134 / Friday, July 12, 2019 / Rules 
and Regulations

[[Page 33318]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-86031; File No. S7-07-18]
RIN 3235-AM35


Regulation Best Interest: The Broker-Dealer Standard of Conduct

AGENCY:  Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY:  The Securities and Exchange Commission (the ``Commission'') 
is adopting a new rule under the Securities Exchange Act of 1934 
(``Exchange Act''), establishing a standard of conduct for broker-
dealers and natural persons who are associated persons of a broker-
dealer (unless otherwise indicated, together referred to as ``broker-
dealer'') when they make a recommendation to a retail customer of any 
securities transaction or investment strategy involving securities 
(``Regulation Best Interest''). Regulation Best Interest enhances the 
broker-dealer standard of conduct beyond existing suitability 
obligations, and aligns the standard of conduct with retail customers' 
reasonable expectations by requiring broker-dealers, among other 
things, to: Act in the best interest of the retail customer at the time 
the recommendation is made, without placing the financial or other 
interest of the broker-dealer ahead of the interests of the retail 
customer; and address conflicts of interest by establishing, 
maintaining, and enforcing policies and procedures reasonably designed 
to identify and fully and fairly disclose material facts about 
conflicts of interest, and in instances where we have determined that 
disclosure is insufficient to reasonably address the conflict, to 
mitigate or, in certain instances, eliminate the conflict. The standard 
of conduct established by Regulation Best Interest cannot be satisfied 
through disclosure alone. The standard of conduct draws from key 
principles underlying fiduciary obligations, including those that apply 
to investment advisers under the Investment Advisers Act of 1940 
(``Advisers Act''). Importantly, regardless of whether a retail 
investor chooses a broker-dealer or an investment adviser (or both), 
the retail investor will be entitled to a recommendation (from a 
broker-dealer) or advice (from an investment adviser) that is in the 
best interest of the retail investor and that does not place the 
interests of the firm or the financial professional ahead of the 
interests of the retail investor.

DATES: 
    Effective date: This rule is effective September 10, 2019.
    Compliance date: The compliance date is discussed in Section II.E 
of this final release.

FOR FURTHER INFORMATION CONTACT:  Lourdes Gonzalez, Assistant Chief 
Counsel--Office of Sales Practices; Emily Westerberg Russell, Senior 
Special Counsel; Alicia Goldin, Senior Special Counsel; John J. Fahey, 
Branch Chief; Daniel Fisher, Branch Chief; Bradford Bartels, Special 
Counsel; and Geeta Dhingra, Special Counsel, Office of Chief Counsel, 
Division of Trading and Markets, at (202) 551-5550, Securities and 
Exchange Commission, 100 F Street NE, Washington, DC 20549-8549.

SUPPLEMENTARY INFORMATION:  The Commission is adopting new rule 17 CFR 
240.15l-1 under the Exchange Act to establish a standard of conduct for 
broker-dealers and natural persons who are associated persons of a 
broker-dealer when they make a recommendation to a retail customer of 
any securities transaction or investment strategy involving securities. 
The Commission is also adopting amendments to rules 17 CFR 240.17a-3 
and 17 CFR 240.17a-4 to establish new record-making and recordkeeping 
requirements for broker-dealers with respect to certain information 
collected from or provided to retail customers.

Table of Contents

I. Introduction
    A. Background
    B. Overview of Regulation Best Interest
    C. Overview of Modifications to the Proposed Rule Text and 
Guidance Provided
    D. Overview of Key Enhancements
II. Discussion of Regulation Best Interest
    A. General Obligation
    1. Commission's Approach
    2. General Obligation To ``Act in Best Interest''
    B. Key Terms and Scope of Best Interest Obligation
    1. Natural Person Who Is an Associated Person
    2. Recommendation of Any Securities Transaction or Investment 
Strategy Involving Securities
    3. Retail Customer
    C. Component Obligations
    1. Disclosure Obligation
    2. Care Obligation
    3. Conflict of Interest Obligation
    4. Compliance Obligation
    D. Record-Making and Recordkeeping
    E. Compliance Date
III. Economic Analysis
    A. Introduction and Primary Goals of the Regulation, Comments on 
Market Failure and Quantification, and Broad Economic Considerations
    1. Introduction and Primary Goals of the Regulation
    2. Broad Economic Considerations
    3. Comments on Market Failure of the Principal-Agent 
Relationship and Quantification; Comments That the Broker-Dealer, 
Commission-Based Model Should Be Severely Restricted or Eliminated
    B. Economic Baseline
    1. Providers of Financial Services
    2. Regulatory Baseline and Current Market Practices
    3. Investment Advice and Evidence of Potential Investor Harm
    4. Trust, Financial Literacy, and the Effectiveness of 
Disclosure
    C. Benefits and Costs
    1. General
    2. Disclosure Obligation
    3. Care Obligation
    4. Conflict of Interest Obligation
    5. Compliance Obligation
    6. Record-Making and Recordkeeping
    7. Approaches To Quantifying the Potential Benefits
    D. Efficiency, Competition, and Capital Formation
    1. Competition
    2. Capital Formation and Efficiency
    E. Reasonable Alternatives
    1. Fiduciary Standard for Broker-Dealers
    2. Prescribed Format for Disclosure
    3. Disclosure-Only
IV. Paperwork Reduction Act
    A. Respondents Subject to Regulation Best Interest and 
Amendments to Rule 17a-3(a)(35) and Rule 17a-4(e)(5)
    1. Broker-Dealers
    2. Natural Persons Who Are Associated Persons of Broker-Dealers
    B. Summary of Collections of Information
    1. Disclosure Obligation
    2. Care Obligation
    3. Conflict of Interest Obligation
    4. Compliance Obligation
    5. Record-Making and Recordkeeping Obligations
V. Final Regulatory Flexibility Act Analysis
    A. Need for and Objectives of the Rule
    B. Significant Issues Raised by Public Comments
    C. Small Entities Subject to the Rule
    D. Projected Reporting, Recordkeeping, and Other Compliance 
Requirements
    1. Disclosure Obligation
    2. Care Obligation
    3. Conflict of Interest Obligation
    4. Compliance Obligation
    5. Record-Making and Recordkeeping Obligations
    E. Agency Action To Minimize Effect on Small Entities
VI. Statutory Authority and Text of the Rule

I. Introduction

    We are adopting a new rule 15l-1 under the Exchange Act 
(``Regulation Best Interest'') that will improve investor protection 
by: (1) Enhancing the obligations that apply when a broker-dealer makes 
a recommendation to a retail customer and natural persons

[[Page 33319]]

who are associated persons of a broker-dealer (``associated persons'') 
(unless otherwise indicated, together referred to as ``broker-dealer'') 
and (2) reducing the potential harm to retail customers from conflicts 
of interest that may affect the recommendation. Regulation Best 
Interest enhances the broker-dealer standard of conduct beyond existing 
suitability obligations, and aligns the standard of conduct with retail 
customers' reasonable expectations by requiring broker-dealers, among 
other things, to: (1) Act in the best interest of the retail customer 
at the time the recommendation is made, without placing the financial 
or other interest of the broker-dealer ahead of the interests of the 
retail customer; and (2) address conflicts of interest by establishing, 
maintaining, and enforcing policies and procedures reasonably designed 
to identify and fully and fairly disclose material facts about 
conflicts of interest, and in instances where we have determined that 
disclosure is insufficient to reasonably address the conflict, to 
mitigate or, in certain instances, eliminate the conflict. Regulation 
Best Interest establishes a standard of conduct under the Exchange Act 
that cannot be satisfied through disclosure alone.

A. Background

    Broker-dealers play an important role in helping Americans organize 
their finances, accumulate and manage retirement savings, and invest 
toward other important long-term goals, such as buying a house or 
funding a child's college education. Broker-dealers offer a wide 
variety of brokerage (i.e., agency) services and dealer (i.e., 
principal) services and products to both retail and institutional 
customers.\1\ Specifically, the brokerage services provided to retail 
customers range from execution-only services to providing personalized 
investment advice in the form of recommendations of securities 
transactions or investment strategies involving securities to 
customers.\2\
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    \1\ See Regulation Best Interest, Release No. 34-83062 (Apr. 18, 
2018) [83 FR 21574] (May 9, 2018) (``Proposing Release'') at 21574-
75; see also Staff of the U.S. Securities and Exchange Commission, 
Study on Investment Advisers and Broker-Dealers As Required by 
Section 913 of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (Jan. 2011) (``913 Study'') at 8-12, available at 
www.sec.gov/news/studies/2011/913studyfinal.pdf (discussing the 
range of brokerage and dealer services provided by broker-dealers).
    \2\ See Proposing Release at 21574-21575; see also 913 Study.
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    Investment advisers play a similarly important, though distinct, 
role. As described in the Fiduciary Interpretation, investment advisers 
provide a wide range of services to a large variety of clients, from 
retail clients with limited assets and investment knowledge and 
experience to institutional clients with very large portfolios and 
substantial knowledge, experience, and analytical resources.\3\
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    \3\ See Commission Interpretation Regarding Standard of Conduct 
for Investment Advisers, Advisers Act Release No. 5248 (June 5, 
2019) (``Fiduciary Interpretation'').
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    As a general matter, broker-dealers and investment advisers have 
different types of relationships with investors, offer different 
services, and have different compensation models when providing 
investment recommendations or investment advisory services to 
customers. Broker-dealers typically provide transaction-specific 
recommendations and receive compensation on a transaction-by-
transaction basis (such as commissions) (``transaction-based'' 
compensation or model). A broker-dealer's recommendations may include 
recommending transactions where the broker-dealer is buying securities 
from or selling securities to retail customers on a principal basis or 
recommending proprietary products.\4\ Investment advisers, on the other 
hand, typically provide ongoing, regular advice and services in the 
context of broad investment portfolio management, and are compensated 
based on the value of assets under management (``AUM''), a fixed fee or 
other arrangement (``fee-based'' compensation or model).\5\ This 
variety is important because it presents investors with choices 
regarding the types of relationships they can have, the services they 
can receive, and how they can pay for those services. It is also common 
for a firm to provide both broker-dealer and investment adviser 
services.
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    \4\ See Proposing Release at 21574-21575; see also 913 Study.
    \5\ See 913 Study.
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    Like many principal-agent relationships--including the investment 
adviser-client relationship--the relationship between a broker-dealer 
and a customer has inherent conflicts of interest, including those 
resulting from a transaction-based (e.g., commission) compensation 
structure and other broker-dealer compensation.\6\ These and other 
conflicts of interest may provide an incentive to a broker-dealer to 
seek to increase its own compensation or other financial interests at 
the expense of the customer to whom it is making investment 
recommendations.
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    \6\ The investment adviser-client relationship also has inherent 
conflicts of interest, including those resulting from an asset-based 
compensation structure that may provide an incentive for an 
investment adviser to encourage its client to invest more money 
through an adviser in order increase its AUM at the expense of the 
client. See Fiduciary Interpretation at footnotes 53-72 and 
accompanying text for a discussion of how investment advisers 
satisfy their fiduciary duty when conflicts of interest are present.
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    Notwithstanding these inherent conflicts of interest in the broker-
dealer-customer relationship, there is broad acknowledgment of the 
benefits of, and support for, the continuing existence of the broker-
dealer business model, including a commission or other transaction-
based compensation structure, as an option for retail customers seeking 
investment recommendations.\7\ For example, retail customers that 
intend to buy and hold a long-term investment may find that paying a 
one-time commission to a broker-dealer recommending such an investment 
is more cost effective than paying an ongoing advisory fee to an 
investment adviser merely to hold the same investment. Retail customers 
with limited investment assets may benefit from broker-dealer 
recommendations when they do not qualify for advisory accounts because 
they do not meet the account minimums often imposed by investment 
advisers. Other retail customers who hold a variety of investments, or 
prefer differing levels of services (e.g., both episodic 
recommendations from a broker-dealer and continuous advisory services 
including discretionary asset management from an investment adviser), 
may benefit from having access to both brokerage and advisory accounts. 
Nevertheless, concerns exist regarding (1) the potential harm to retail 
customers resulting from broker-dealer recommendations provided where 
conflicts of interest exist and (2) the insufficiency of existing 
broker-dealer regulatory requirements to address these conflicts when 
broker-dealers make recommendations to retail customers.\8\ More 
specifically, there are concerns that existing requirements do not 
require a broker-dealer's recommendations to be in the retail 
customer's best interest.\9\
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    \7\ See Proposing Release at 21579.
    \8\ Id. at 21577-21579.
    \9\ Id. See also Section I.C, Overview of Modifications to the 
Proposed Rule Text and Guidance Provided.
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B. Overview of Regulation Best Interest

    On April 18, 2018, we proposed enhancements to the standard of 
conduct that applies when broker-dealers make recommendations to retail 
customers.\10\ Specifically, the proposal would have established an 
express best interest obligation that would require all broker-dealers 
and associated persons,

[[Page 33320]]

when making a recommendation of any securities transaction or 
investment strategy involving securities to a retail customer, to act 
in the best interest of the retail customer at the time the 
recommendation is made without placing the financial or other interest 
of the broker-dealer or associated person making the recommendation 
ahead of the interest of the retail customer.
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    \10\ Proposing Release at 21575.
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    The Commission received substantial comment on proposed Regulation 
Best Interest. We received over 6,000 comment letters in connection 
with the Proposing Release, of which approximately 3,000 are unique 
comment letters, from a variety of commenters including individual 
investors, consumer advocacy groups, financial services firms 
(including broker-dealers, investment advisers, and insurance 
companies), investment professionals, industry and trade associations, 
state securities regulators, bar associations, and others.\11\
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    \11\ Comments received in response to the Proposing Release are 
available at: https://www.sec.gov/comments/s7-07-18/s70718.htm.
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    The Commission also solicited individual investors' input through a 
number of forums in addition to the traditional requests for comment in 
the Proposing Release. Among other things, seven investor roundtables 
were held in different locations across the country to solicit further 
comment on the proposed relationship summary,\12\ and the Commission 
and its staff received in-person feedback from almost 200 attendees in 
total.\13\ The Commission also received input and recommendations from 
a majority of its Investor Advisory Committee (``IAC'') on proposed 
Regulation Best Interest.\14\
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    \12\ In a separate, concurrent rulemaking, the Commission 
proposed to, among other things, require broker-dealers and 
investment advisers to deliver to retail investors a short 
relationship summary (``Relationship Summary''). See Form CRS 
Relationship Summary; Amendments to Form ADV; Required Disclosures 
in Retail Communications and Restrictions on the use of Certain 
Names or Titles, Release No. 34-83063, IA-4888, File No. S7-08-18 
(Apr. 18, 2018), 83 FR 23848 (May 23, 2018) (``Relationship Summary 
Proposal'').
     Along with adopting Regulation Best Interest, the Commission is 
adopting Exchange Act Rule 17a-14 (CFR 240.17a-14) and Form CRS (17 
CFR 249.640) under the Exchange Act (``Form CRS''). See Form CRS 
Relationship Summary; Amendments to Form ADV Exchange Act Release 
No. 86032, Advisers Act Release No. 5247, File No. S7-08-18 (June 5, 
2019) (``Relationship Summary Adopting Release''). The Commission is 
also providing interpretations: (1) Clarifying standards of conduct 
for investment advisers, and (2) regarding when a broker-dealer's 
advisory services are solely incidental to the conduct of the 
business of a broker or dealer. See Fiduciary Interpretation; 
Commission Interpretation Regarding the Solely Incidental Prong of 
the Broker-Dealer Exclusion to the Definition of Investment Adviser, 
Advisers Act Release No. 5249 (June 5, 2019) (``Solely Incidental 
Interpretation'').
    \13\ The transcripts from the seven investor roundtables, which 
took place in Atlanta, Baltimore, Denver, Houston, Miami, 
Philadelphia, and Washington DC, are available in the comment file 
at https://www.sec.gov/comments/s7-08-18/s70818.htm#transcripts.
    The Commission also used a ``feedback form'' designed 
specifically to solicit input from retail investors with a set of 
questions requesting both structured and narrative responses, and 
received more than 90 responses from individuals who reviewed and 
commented on the sample proposed relationship summaries published in 
the proposal. The feedback forms are available in the comment file 
at https://www.sec.gov/comments/s7-08-18/s70818.htm.
    Finally, the Commission's Office of the Investor Advocate 
engaged the RAND Corporation to conduct investor testing of the 
proposed relationship summary. Angela A. Hung, et al., RAND 
Corporation, Investor Testing of Form CRS Relationship Summary 
(2018), available at https://www.sec.gov/about/offices/investorad/investor-testing-form-crs-relationship-summary.pdf (``RAND 2018''). 
See also Investor Testing of the Proposed Relationship Summary for 
Investment Advisers and Broker-Dealers, Commission Press Release 
2018-257 (Nov. 7, 2018), available at https://www.sec.gov/news/press-release/2018-257. As noted in the Relationship Summary 
Adopting Release, the amount of information available from the 
various investor surveys and investor testing described in this 
release is extensive. We considered all of this information 
thoroughly, using our decades of experience with investor 
disclosures, when evaluating changes to the disclosure required by 
Regulation Best Interest, as well as to the Relationship Summary. 
See Relationship Summary Adopting Release.
    \14\ Recommendation of the Investor as Purchaser Subcommittee 
Regarding Proposed Regulation Best Interest, Form CRS, and 
Investment Advisers Act Fiduciary Guidance, Nov. 7, 2018, available 
at https://www.sec.gov/spotlight/investor-advisory-committee-2012/iac110718-investor-as-purchaser-subcommittee-recommendation.pdf 
(``IAC 2018 Recommendation''). Generally, a majority of the IAC made 
the following recommendations related to Regulation Best Interest: 
(1) That the meaning of the best interest obligation should be 
clarified to require both broker-dealers, investment advisers, and 
their associated persons to recommend the investments, investment 
strategies, accounts, or services, from among those they have 
reasonably available to recommend, that they reasonably believe 
represent the best available options for the investor; (2) that the 
best interest obligation be expanded to apply to the implicit ``no 
recommendation'' recommendation that a broker makes when reviewing 
an account and recommending no change, to rollover recommendations 
and recommendations by dual registrant firms regarding account 
types; and (3) that the best interest obligation should be 
explicitly characterized as the fiduciary duty that it is, while 
making clear that the specific obligations that flow from that duty 
will vary based on differences in business models. The Commission is 
statutorily obligated to respond to the recommendations of the IAC, 
which we are doing in this section and throughout the adopting 
release in the relevant sections, for example, in the discussion of 
the General Obligation in Section II.A.1, the discussion of 
recommendations in Section II.B.1, Recommendation of Any Securities 
Transaction or Investment Strategy Involving Securities, and the 
Care Obligation in Section II.C.2.
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    After careful review and consideration of comments received and 
upon further consideration, the Commission is adopting Regulation Best 
Interest, with certain modifications as compared to the Proposing 
Release. As discussed below, while the Commission is generally 
retaining the overall structure and scope set forth in the Proposing 
Release, we are making modifications to the text of the rule and also 
providing interpretations and guidance to address points raised during 
the comment process.
    The Commission has crafted Regulation Best Interest to draw on key 
principles underlying fiduciary obligations, including those that apply 
to investment advisers under the Advisers Act, while providing specific 
requirements to address certain aspects of the relationships between 
broker-dealers and their retail customers. Regulation Best Interest 
enhances the existing standard of conduct applicable to broker-dealers 
and their associated persons at the time they recommend to a retail 
customer a securities transaction or investment strategy involving 
securities. This includes recommendations of account types and 
rollovers or transfers of assets and also covers implicit hold 
recommendations resulting from agreed-upon account monitoring. When 
making a recommendation, a broker-dealer must act in the retail 
customer's best interest and cannot place its own interests ahead of 
the customer's interests (hereinafter, ``General Obligation'').\15\ The 
General Obligation is satisfied only if the broker-dealer complies with 
four specified component obligations. The obligations are: (1) 
Providing certain prescribed disclosure before or at the time of the 
recommendation, about the recommendation and the relationship between 
the retail customer and the broker-dealer (``Disclosure Obligation''); 
(2) exercising reasonable diligence, care, and skill in making the 
recommendation (``Care Obligation''); (3) establishing, maintaining, 
and enforcing policies and procedures reasonably designed to address 
conflicts of interest (``Conflict of Interest Obligation''), and (4) 
establishing, maintaining, and enforcing policies and procedures 
reasonably designed to achieve compliance with Regulation Best Interest 
(``Compliance Obligation'').\16\
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    \15\ See generally Section II.A, General Obligation.
    \16\ As discussed in further detail below, although Regulation 
Best Interest identifies specified obligations with which a broker-
dealer must comply in order to meet its General Obligation, 
compliance with each of the component obligations of Regulation Best 
Interest will be principles-based. In other words, whether a broker-
dealer has acted in the retail customer's best interest will turn on 
an objective assessment of the facts and circumstances of whether 
the specific components of Regulation Best Interest are satisfied at 
the time that the recommendation is made.

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[[Page 33321]]

    First, under the Disclosure Obligation,\17\ before or at the time 
of the recommendation, a broker-dealer must disclose, in writing, all 
material facts about the scope and terms of its relationship with the 
customer. This includes a disclosure that the firm or representative is 
acting in a broker-dealer capacity; the material fees and costs the 
customer will incur; and the type and scope of the services to be 
provided, including any material limitations on the recommendations 
that could be made to the retail customer. Moreover, the broker-dealer 
must disclose all material facts relating to conflicts of interest 
associated with the recommendation that might incline a broker-dealer 
to make a recommendation that is not disinterested, including, for 
example, conflicts associated with proprietary products, payments from 
third parties, and compensation arrangements.
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    \17\ See generally Section II.C.1, Disclosure Obligation.
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    Second, under the Care Obligation,\18\ a broker-dealer must 
exercise reasonable diligence, care, and skill when making a 
recommendation to a retail customer. The broker-dealer must understand 
potential risks, rewards, and costs associated with the recommendation. 
The broker-dealer must then consider those risks, rewards, and costs in 
light of the customer's investment profile and have a reasonable basis 
to believe that the recommendation is in the customer's best interest 
and does not place the broker-dealer's interest ahead of the retail 
customer's interest. A broker-dealer should consider reasonable 
alternatives, if any, offered by the broker-dealer in determining 
whether it has a reasonable basis for making the recommendation. 
Whether a broker-dealer has complied with the Care Obligation will be 
evaluated as of the time of the recommendation (and not in hindsight). 
When recommending a series of transactions, the broker-dealer must have 
a reasonable basis to believe that the transactions taken together are 
not excessive, even if each is in the customer's best interest when 
viewed in isolation.
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    \18\ See generally Section II.C.2, Care Obligation.
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    Third, under the Conflict of Interest Obligation,\19\ a broker-
dealer must establish, maintain, and enforce reasonably designed 
written policies and procedures addressing conflicts of interest 
associated with its recommendations to retail customers. These policies 
and procedures must be reasonably designed to identify all such 
conflicts and at a minimum disclose or eliminate them. Importantly, the 
policies and procedures must be reasonably designed to mitigate 
conflicts of interests that create an incentive for an associated 
person of the broker-dealer to place its interests or the interest of 
the firm ahead of the retail customer's interest. Moreover, when a 
broker-dealer places material limitations on recommendations that may 
be made to a retail customer (e.g., offering only proprietary or other 
limited range of products), the policies and procedures must be 
reasonably designed to disclose the limitations and associated 
conflicts and to prevent the limitations from causing the associated 
person or broker-dealer from placing the associated person's or broker-
dealer's interests ahead of the customer's interest. Finally, the 
policies and procedures must be reasonably designed to identify and 
eliminate sales contests, sales quotas, bonuses, and non-cash 
compensation that are based on the sale of specific securities or 
specific types of securities within a limited period of time.
---------------------------------------------------------------------------

    \19\ See generally Section II.C.3, Conflict of Interest 
Obligation.
---------------------------------------------------------------------------

    Fourth, under the Compliance Obligation,\20\ a broker-dealer must 
also establish, maintain, and enforce written policies and procedures 
reasonably designed to achieve compliance with Regulation Best Interest 
as a whole. Thus, a broker-dealer's policies and procedures must 
address not only conflicts of interest but also compliance with its 
Disclosure and Care Obligations under Regulation Best Interest.
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    \20\ See generally Section II.C.4, Compliance Obligation.
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    The enhancements contained in Regulation Best Interest are designed 
to improve investor protection by enhancing the quality of broker-
dealer recommendations to retail customers and reducing the potential 
harm to retail customers that may be caused by conflicts of interest. 
Regulation Best Interest will complement the related rules, 
interpretations, and guidance that the Commission is concurrently 
issuing.\21\ Individually and collectively, these actions are designed 
to help retail customers better understand and compare the services 
offered by broker-dealers and investment advisers and make an informed 
choice of the relationship best suited to their needs and 
circumstances, provide clarity with respect to the standards of conduct 
applicable to investment advisers and broker-dealers, and foster 
greater consistency in the level of protections provided by each 
regime, particularly at the point in time that a recommendation is 
made.\22\
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    \21\ See Relationship Summary Adopting Release; Fiduciary 
Interpretation; Solely Incidental Interpretation.
    \22\ We believe each rule and interpretation stands on its own 
and enhances the effectiveness of existing rules, and is reinforced 
by the other rules and interpretations being adopted 
contemporaneously.
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    At the time a recommendation is made, key elements of the 
Regulation Best Interest standard of conduct that applies to broker-
dealers will be similar to key elements of the fiduciary standard for 
investment advisers.\23\ Importantly, regardless of whether a retail 
investor chooses a broker-dealer or an investment adviser (or both), 
the retail investor will be entitled to a recommendation (from a 
broker-dealer) or advice (from an investment adviser) that is in the 
best interest of the retail investor and that does not place the 
interests of the firm or the financial professional ahead of the 
interests of the retail investor.
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    \23\ Specifically, an investment adviser's fiduciary duty under 
the Advisers Act comprises a duty of care and a duty of loyalty. 
This combination of care and loyalty obligations has been 
characterized as requiring the investment adviser to act in the 
``best interest'' of its client at all times. See Fiduciary 
Interpretation.
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    There are also key differences between Regulation Best Interest and 
the Advisers Act fiduciary standard that reflect the distinction 
between the services and relationships typically offered under the two 
business models. For example, an investment adviser's fiduciary duty 
generally includes a duty to provide ongoing advice and monitoring,\24\ 
while Regulation Best Interest imposes no such duty and instead 
requires that a broker-dealer act in the retail customer's best 
interest at the time a recommendation is made. In addition, the new 
obligations applicable to broker-dealers under Regulation Best Interest 
are more prescriptive than the obligations applicable to investment 
advisers under the Advisers Act fiduciary duty and reflect the 
characteristics of the generally applicable broker-dealer business 
model.\25\
---------------------------------------------------------------------------

    \24\ See Fiduciary Interpretation, Section II.B.3 (Duty to 
Provide Advice and Monitoring over the Course of the Relationship).
    \25\ See, e.g., Sections II.A and III.E.
---------------------------------------------------------------------------

    The Commission has been studying and carefully considering the 
issues related to the standard of conduct for broker-dealers for many 
years, which led to the development of Regulation Best Interest.\26\ In 
designing Regulation Best Interest, we considered a number of options 
to enhance 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. There

[[Page 33322]]

were several options, including, among others: (1) Applying the 
fiduciary standard under the Advisers Act to broker-dealers; (2) 
adopting a ``new'' uniform fiduciary standard of conduct that would 
apply equally to both broker-dealers and investment advisers, such as 
that recommended by the staff in the 913 Study; \27\ and (3) the path 
we ultimately chose, adopting a new standard of conduct specifically 
for broker-dealers, which draws from key principles underlying 
fiduciary obligations, including those that apply to investment 
advisers under the Advisers Act.\28\ The standard also provides 
specific requirements to address certain aspects of the relationships 
between broker-dealers and their retail customers, including certain 
conflicts related to compensation of associated persons.\29\
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    \26\ Proposing Release at 21579-21583.
    \27\ One of the staff's primary recommendations was that the 
Commission engage in rulemaking to adopt and implement a uniform 
fiduciary standard of conduct for broker-dealers and investment 
advisers when providing personalized investment advice about 
securities to retail customers. The staff's recommended standard 
would require firms ``to act in the best interest of the customer 
without regard to the financial or other interest of the broker, 
dealer or investment adviser providing the advice.'' The staff made 
a number of specific recommendations for implementing the uniform 
fiduciary standard of conduct, including that the Commission should: 
(1) Require firms to eliminate or disclose conflicts of interest; 
(2) consider whether rulemaking would be appropriate to prohibit 
certain conflicts, to require firms to mitigate conflicts through 
specific action, or to impose specific disclosure and consent 
requirements; and (3) consider specifying uniform standards for the 
duty of care owed to retail customers, such as specifying what basis 
a broker-dealer or investment adviser should have in making a 
recommendation to a retail customer by referring to and expanding 
upon broker-dealers' existing suitability requirements. See 
generally 913 Study.
    \28\ See supra footnote 23.
    \29\ In addition to these alternatives, we also considered 
several other reasonable alternatives. See Section III.E.
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    We have declined to subject broker-dealers to a wholesale and 
complete application of the existing fiduciary standard under the 
Advisers Act because it is not appropriately tailored to the structure 
and characteristics of the broker-dealer business model (i.e., 
transaction-specific recommendations and compensation), and would not 
properly take into account, and build upon, existing obligations that 
apply to broker-dealers, including under FINRA rules.\30\ Moreover, we 
believe (and our experience indicates), that this approach would 
significantly reduce retail investor access to differing types of 
investment services and products, reduce retail investor choice in how 
to pay for those products and services, and increase costs for retail 
investors of obtaining investment recommendations.\31\
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    \30\ See also 913 Study at 139-143.
    \31\ See, e.g., Section 913 Study. at 143-159 for the study's 
consideration of the potential costs, expenses, and impacts of 
various regulatory changes related to the provision of personalized 
investment advice to retail investors. See also Section II.A.1, 
Commission's Approach.
---------------------------------------------------------------------------

    We have also declined to craft a new uniform standard that would 
apply equally and without differentiation to both broker-dealers and 
investment advisers. Adopting a ``one size fits all'' approach would 
risk reducing investor choice and access to existing products, 
services, service providers, and payment options, and would increase 
costs for firms and for retail investors in both broker-dealer and 
investment adviser relationships. Moreover, applying a new uniform 
standard to advisers would mean jettisoning to some extent the 
fiduciary standard under the Advisers Act that has worked well for 
retail clients and our markets and is backed by decades of regulatory 
and judicial precedent.
    Our concerns about the ramifications for investor access, choice, 
and cost from adopting either of these approaches are not theoretical. 
With the adoption of the now vacated Department of Labor (``DOL'') 
Fiduciary Rule,\32\ there was a significant reduction in retail 
investor access to brokerage services,\33\ and we believe that the 
available alternative services were higher priced in many 
circumstances.\34\ Moreover, because key elements of the standard of 
conduct that Regulation Best Interest applies to broker-dealers at the 
time that a recommendation is made to a retail customer will be 
substantially similar to key elements of the standard of conduct that 
applies to investment advisers pursuant to their fiduciary duty under 
the Advisers Act, we do not believe that applying the existing 
fiduciary standard under the Advisers Act to broker-dealers or adopting 
a new uniform fiduciary standard of conduct applicable to both broker-
dealers and investment advisers would provide any greater investor 
protection (or, in any case, that any benefits would justify the costs 
imposed on retail investors in terms of reduced access to services, 
products, and payment options, and increased costs for such services 
and products).
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    \32\ As discussed in more detail in the Proposing Release, on 
April 8, 2016, the DOL adopted a new, expanded definition of 
``fiduciary'' that treats persons who provide investment advice or 
recommendations for a fee or other compensation with respect to 
assets of a plan subject to the Employee Retirement Income Security 
Act of 1974 (``ERISA'') (an ``ERISA plan'') or individual retirement 
account (``IRA'') as fiduciaries in a wider array of advice 
relationships than under the previous regulation and issued certain 
related prohibited transaction exemptions (``PTEs'') (together, the 
``DOL Fiduciary Rule''). The rule was subsequently vacated in toto 
by the United States Court of Appeals for the Fifth Circuit. See 
Chamber of Commerce v. U.S. Dep't of Labor, 885 F.3d 360 (5th Cir. 
2018).
    We understand that in the absence of a PTE, broker-dealers that 
would be considered to be a ``fiduciary'' for purposes of ERISA and 
the Internal Revenue Code (the ``Code'') would be prohibited from 
engaging in purchases and sales of certain investments for their own 
account (i.e., engaging in principal transactions) and would be 
prohibited from receiving common forms of broker-dealer compensation 
(notably, transaction-based compensation). See DOL, Best Interest 
Contract Exemption, 81 FR 21002 (Apr. 8, 2016) (``BIC Exemption 
Release''). To avoid this result, the DOL published, among other 
PTEs, the Best Interest Contract Exemption (``BIC Exemption''), 
which would have provided conditional relief for an ``adviser,'' as 
that term is used in the context of the BIC Exemption, and the 
adviser's firm, to receive common forms of ``conflicted'' 
compensation, such as commissions and third-party payments (such as 
revenue sharing), provided that the adviser's firm met certain 
conditions. See id. Generally, the BIC Exemption and other PTEs 
required that, among other things, the advice be provided pursuant 
to a written contract that commits the firm and the adviser to 
adhere to standards of impartial conduct, including providing advice 
in the investor's best interest; charging only reasonable 
compensation; and avoiding misleading statements about fees and 
conflicts of interest) (``Impartial Conduct Standards''). See 
generally id. See also Proposing Release at 21580-21582.
    \33\ While the full effects of the DOL Fiduciary Rule were not 
realized as it was vacated during the transition period, a number of 
industry studies indicated that, as a result of the DOL Fiduciary 
Rule, industry participants had already or were planning to alter 
services and products available to retail customers. For example, of 
the 21 members of the Securities Industry and Financial Markets 
Association (``SIFMA'') that participated in the SIFMA Study, 53% 
eliminated or reduced access to brokerage advice services and 67% 
migrated away from open choice to fee-based or limited brokerage 
services. See SIFMA & Deloitte, The DOL Fiduciary Rule: A Study on 
How Financial Institutions Have Responded and the Resulting Impacts 
on Retirement Investors (Aug. 9, 2017), available at https://www.sifma.org/wp-content/uploads/2017/08/Deloitte-White-Paper-on-the-DOL-Fiduciary-Rule-August-2017.pdf (``SIFMA Study''). Other 
studies also saw shifts from commission-based accounts to fee-based 
accounts. See infra footnote 1009. In addition, an industry study 
found that some customers were shifted from commission-based 
brokerage accounts to self-directed accounts, while the same study 
observed that 29% of their survey participants expected to move 
clients, particularly those with low account balances, to robo-
advisors. See infra footnote 1010.
    \34\ It was widely reported that a number of firms responded to 
the DOL Fiduciary Rule by either requiring customers to enter into 
more expensive advice relationships or by passing through higher 
compliance costs to customers, which altered many retail customer 
relationships with their financial professionals. See infra footnote 
1007. From the SIFMA Study, for those firms whose retail customers 
faced eliminated or reduced brokerage advice services, 63% of firms 
had customers that chose to move to self-directed accounts rather 
than fee-based accounts and cited the customers' reasons as ``not 
wanting to move to a fee-based model, not in the best interest to 
move to a fee-based model, did not meet account minimums, or wanted 
to maintain positions in certain asset classes prohibited by the 
fee-based models.''
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    We acknowledge certain commenters urged the Commission to take 
additional

[[Page 33323]]

or different regulatory actions than the approach we have adopted, 
including the alternatives discussed above. We do not believe that any 
rulemaking governing retail investor-advice relationships can solve for 
every issue presented. After careful consideration of the comments and 
additional information we have received,\35\ we believe that Regulation 
Best Interest, as modified, appropriately balances the concerns of the 
various commenters in a way that will best achieve the Commission's 
important goals of enhancing retail investor protection and decision 
making, while preserving, to the extent possible, retail investor 
access (in terms of choice and cost) to differing types of investment 
services and products.\36\
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    \35\ See supra footnotes 11-13 and accompanying text.
    \36\ If any of the provisions of these rules, or the application 
thereof to any person or circumstance, is held to be invalid, such 
invalidity shall not affect other provisions or application of such 
provisions to other persons or circumstances that can be given 
effect without the invalid provision or application.
---------------------------------------------------------------------------

    The Commission's staff will offer firms significant assistance and 
support during the transition period and thereafter with the aim of 
helping to ensure that the investor protections and other benefits of 
the final rule are implemented in an efficient and effective manner. 
Further, we will continue to monitor the effectiveness of Regulation 
Best Interest in achieving the Commission's goals.

C. Overview of Modifications to the Proposed Rule Text and Guidance 
Provided

    The vast majority of commenters supported the Commission's 
rulemaking efforts to address the standards of conduct that apply to 
broker-dealers when making recommendations, but nearly all commenters 
suggested modifications to proposed Regulation Best Interest.\37\ These 
suggestions touch on almost every aspect of the proposal, as discussed 
in more detail below. A variety of commenters offered suggestions on 
the overall structure and scope of the proposed rule, including: 
whether the standard should be a fiduciary standard; \38\ whether the 
standard should apply to both investment advisers and broker-dealers; 
\39\ whether the standard should be principles-based or more 
prescriptive; \40\ whether the standard should define ``best 
interest;'' \41\ whether the standard is or should be a safe harbor; 
\42\ what should be considered a recommendation, including whether 
Regulation Best Interest should apply to recommendations to roll over 
or transfer assets or take plan distributions, and to recommendations 
of particular account types (i.e., brokerage or advisory); \43\ whether 
Regulation Best Interest should apply to account monitoring services 
provided by a broker-dealer, or impose a continuing duty; \44\ and 
whether Regulation Best Interest's protections should apply to a 
broader or narrower set of ``retail customers.'' \45\
---------------------------------------------------------------------------

    \37\ See, e.g., Letter from David Certner, Legislative Counsel 
and Legislative Policy Director, AARP (Aug. 7, 2018) (``AARP August 
2018 Letter''); Letter from Christopher Gilkerson, Senior Vice 
President and General Counsel, and Tara Tune, Director and Corporate 
Counsel, Charles Schwab & Co., Inc. (Aug. 6, 2018) (``Schwab 
Letter''); Letter from Barbara Roper, Director of Investor 
Protection, and Micah Hauptman, Financial Services Counsel, Consumer 
Federation of America (``CFA'') (Aug. 7, 2018) (``CFA August 2018 
Letter''); Letter from Joseph Borg, President, North American 
Securities Administrators Association, Inc. (``NASAA'') (Aug. 23, 
2018) (``NASAA August 2018 Letter''); Letter from Kenneth E. 
Bentsen, Jr., President and Chief Executive Officer, SIFMA (Aug. 7, 
2018) (``SIFMA August 2018 Letter'').
    \38\ See, e.g., Letter from Jon Stein, Founder and CEO, Benjamin 
T. Alden, General Counsel, and Seth Rosenbloom, Associate General 
Counsel, Betterment (Aug. 7, 2018) (``Betterment Letter''); Letter 
from Kurt N. Schacht, Managing Director, James Allen, Head, Capital 
Markets Policy, and Linda L. Rittenhouse, Director, Capital Markets, 
CFA Institute (Aug. 7, 2018) (``CFA Institute Letter''); Letter from 
Jill I. Gross, Associate Dean for Academic Affairs, Professor of 
Law, Elisabeth Haub School of Law, Pace University (Mar. 11, 2019) 
(``Pace March 2019 Letter''); Letter from Sharon Cheever, Senior 
Vice President and General Counsel, Pacific Life Insurance Company 
(Aug. 3, 2018) (``Pacific Life August 2018 Letter''); Letter from 
Melanie Fein, Fein Law Offices (Jun. 6, 2018) (``Fein Letter''); 
Letter from Elizabeth Warren, U.S. Senator (Aug. 3, 2018) (``Warren 
Letter''); Letter from Dean P. McDermott, McDermott Investment 
Advisors (Jul. 7, 2018) (``McDermott Letter''); Letter from Brian 
Hamburger, President and CEO, MarketCounsel (Aug. 7, 2018) 
(``MarketCounsel Letter'').
    \39\ See, e.g., AARP August 2018 Letter; Letter from Americans 
for Financial Reform et al. (Aug. 7, 2018) (``Americans for 
Financial Reform Letter''); Letter from Robert J. Moore, Chief 
Executive Officer, Cetera Financial Group (``Cetera'') (Aug. 7, 
2018) (``Cetera August 2018 Letter''); Letter from L.A. Schnase, 
Individual Investor and Attorney at Law (Jul. 30, 2018) (``Schnase 
Letter''); Pacific Life August 2018 Letter; Pace March 2019 Letter; 
MarketCounsel Letter; Letter from Dennis M. Kelleher, President and 
CEO, Stephen Hall, Legal Director and Securities Specialist, Lev 
Bagramian, Senior Securities Policy Advisor, Better Markets (Aug. 7, 
2018) (``Better Markets August 2018 Letter''); Letter from Attorneys 
General of New York, California, Connecticut, Delaware, Hawaii, 
Illinois, Maine, Maryland, Massachusetts, Minnesota, New Mexico, 
Oregon, Pennsylvania, Rhode Island, Vermont, Washington, and the 
District of Columbia (Aug. 7, 2018) (``State Attorneys General 
Letter'').
    \40\ See, e.g., SIFMA August 2018 Letter; Letter from Mortimer 
J. Buckley, President and Chief Executive Officer, Vanguard (Aug. 7, 
2018) (``Vanguard Letter''); Letter from Chris Lewis, General 
Counsel, Edward Jones (Aug. 7, 2018) (``Edward Jones Letter''); 
Letter from Joseph E. Sweeney, President, Advice & Wealth Management 
Products and Service Delivery, Ameriprise Financial (Aug. 6, 2018) 
(``Ameriprise Letter''); Letter from Sheila Kearney Davidson, 
Executive Vice President, Chief Legal Officer & General Counsel, New 
York Life Insurance Company (``NY Life'') (Aug. 7, 2018) (``NY Life 
Letter''); Letter from Keith Gillies, NAIFA President, National 
Association of Insurance and Financial Advisors (``NAIFA'') (Aug. 2, 
2018) (``NAIFA Letter''); Letters from Tom Quaadman, Executive Vice 
President, Center for Capital Markets Competitiveness, U.S. Chamber 
of Commerce (``CCMC'') (Aug. 7, 2018) (supplemented by letter dated 
Sep. 5, 2018) (``CCMC Letters''); Letter from Dave Paulsen, 
Executive Vice President, Chief Distribution Officer, Transamerica 
(Aug. 7, 2018) (``Transamerica August 2018 Letter'').
    \41\ See, e.g., Letter from Seth A. Miller, General Counsel, 
Senior Vice President, Chief Risk Officer, Cambridge (Aug. 7, 2018) 
(``Cambridge Letter''); SIFMA August 2018 Letter; Vanguard Letter; 
Edward Jones Letter; Ameriprise Letter; NY Life Letter; NAIFA 
Letter; CCMC Letters; Letter from Aron Szapiro, Director of Policy 
Research, Morningstar (Aug. 7, 2018) (``Morningstar Letter''); 
Letter from David Kowach, Head of Wells Fargo Advisors, Wells Fargo 
(Aug. 7, 2018) (``Wells Fargo Letter'').
    \42\ See, e.g., CFA August 2018 Letter; Letter from Anthony 
Chereso, President & CEO, Institute for Portfolio Alternatives 
(``IPA'') (Aug. 7, 2018) (``IPA Letter''); Letter from Heather 
Slavkin Corzo, AFL-CIO et al. (Apr. 26, 2019) (``AFL-CIO April 2019 
Letter'').
    \43\ See, e.g., Letter from Jason Bortz, Senior Counsel, Capital 
Research and Management Company (Aug. 7, 2018) (``Capital Group 
Letter''); Letter from Andrew Stoltmann, President, Public Investors 
Arbitration Bar Association (``PIABA'') (Aug. 7, 2018) (``PIABA 
Letter''); SIFMA August 2018 Letter; NASAA Letter; Letter from 
Robert K. Shaw, President, Individual Markets, Great-West Financial 
(Aug. 7, 2018) (``Great-West Letter''); NAIFA Letter; Transamerica 
August 2018 Letter; Letter from Tim Rouse, Executive Director, The 
SPARK Institute (Aug. 7, 2018) (``SPARK Letter''); Letter from Robin 
C. Swope, Director, Global Product Governance & Support, Invesco 
(Aug. 7, 2018) (``Invesco Letter''); Letter from R. Keith Overly, 
President, National Association of Government Defined Contribution 
Administrators (``NAGDCA'') (Aug. 7, 2018) (``NAGDCA Letter''); 
Letter from Kevin R. Keller, Chief Executive Officer, CFP Board, et 
al., Financial Planning Coalition (``FPC'') (Aug. 7, 2018) (``FPC 
Letter''); Letter from Dennis Simmons, Executive Director, Committee 
on Investment of Employee Benefit Assets, Committee on Investment of 
Employee Benefit Assets (``CIEBA'') (Aug. 6, 2018) (``CIEBA 
Letter'').
    \44\ See, e.g., SIFMA August 2018 Letter; Letter from Lisa D. 
Crossley, Executive Director, National Society of Compliance 
Professionals (``NSCP'') (Aug. 7, 2018) (``NSCP Letter''); PIABA 
Letter; FPC Letter; Better Markets August 2018 Letter; Letter from 
Karen L. Barr, President and CEO, Investment Adviser Association 
(``IAA'') (Aug. 6, 2018) (``IAA August 2018 Letter'').
    We also received comments addressing when a broker-dealer's 
advisory services are ``solely incidental to the conduct of his 
business as a broker or dealer'' under the ``broker-dealer 
exclusion'' from the definition of investment adviser--and thus from 
the application of the Advisers Act--provided in Section 
202(a)(11)(C) of the Advisers Act. We have addressed these comments 
in the context of the Solely Incidental Interpretation.
    \45\ See, e.g., Letter from Carl B. Wilkerson, Vice President 
and Chief Counsel, American Council of Life Insurers (``ACLI'') 
(Aug. 3, 2018) (``ACLI Letter''); Letter from Brian H. Graff, 
Executive Director and CEO, Craig P. Hoffman, General Counsel, Dough 
Fisher, Director of Retirement Policy, and Joseph A. Caruso, 
Government Affairs Counsel, American Retirement Association 
(``ARA'') (Aug. 3, 2018) (``ARA August 2018 Letter''); Letter from 
Anne Tennant, Managing Director and General Counsel, Morgan Stanley 
(Aug. 7, 2018) (``Morgan Stanley Letter''); CCMC Letters; Letter 
from Thomas Roberts, Groom Law Group (Aug. 7, 2018) (``Groom 
Letter''); Letter from Catherine J. Weatherford, President and CEO, 
Insured Retirement Institute (``IRI'') (Aug. 7, 2018) (``IRI 
Letter''); NSCP Letter; Letter from Raymond J. Manista, Executive 
Vice President, Chief Legal Officer and Secretary, Northwestern 
Mutual (Aug. 7, 2018) (``Northwestern Mutual Letter''); State 
Attorneys General Letter; Letter from Mari-Anne Pisarri, Pickard 
Djinis and Pisarri LLP (Aug. 14, 2018) (``Pickard Letter''); SIFMA 
August 2018 Letter; Invesco Letter; Letter from Tom Clark, Managing 
Director, Sean Murphy, Vice President, Blackrock (Aug. 7, 2018) 
(``Blackrock Letter'').

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[[Page 33324]]

    In addition, most commenters from both industry and consumer 
advocate groups requested modifications to each of the Disclosure, 
Care, and Conflict of Interest Obligations, and also called for more 
specific examples of conduct that would--or would not--satisfy these 
obligations. With respect to the Disclosure Obligation, most commenters 
generally sought greater clarity or made suggestions regarding what 
material facts and material conflicts would need to be disclosed, the 
form and manner (e.g., written versus oral, individualized versus 
standardized, and the use of electronic and/or layered) and the timing 
and frequency of the disclosure (e.g., whether the disclosure should be 
prior to, at the time of, or could be after a recommendation), as well 
as whether the Disclosure Obligation could be satisfied by complying 
with other existing disclosure requirements.\46\ In particular, several 
commenters recommended that the Commission require broker-dealers 
provide ``full and fair'' disclosure.\47\
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    \46\ See, e.g., Ameriprise Letter; Great-West Letter; Letter 
from Ram Subramaniam, Head of Brokerage and Investment Solutions, 
David Forman, Chief Legal Officer, Fidelity Investments (Aug. 7, 
2018) (``Fidelity Letter''); Morgan Stanley Letter; CCMC Letters; 
Letter from Bret C. Hester, Senior Managing Director, Head of 
Regulatory Affairs, Teachers Insurance and Annuity Association of 
America (``TIAA'') (Aug. 7, 2018) (``TIAA Letter''); Letter from 
James Sonne, Assistant Vice President, Federal Government Relations, 
Mass Mutual (Feb. 19, 2019) (``Mass Mutual Letter''); Letter from 
Edmund F. Murphy III, President, Empower Retirement (Aug. 2, 2018) 
(``Empower Retirement Letter''); IRI Letter; Letter from Paul Schott 
Stevens, President and CEO, Investment Company Institute (``ICI'') 
(Aug. 7, 2018) (``ICI Letter''); SIFMA August 2018 Letter; Edward 
Jones Letter; Letter from Michelle Bryan Oroschakoff, Chief Legal 
Officer, LPL Financial (Aug. 7, 2018) (``LPL August 2018 Letter''); 
NASAA August 2018 Letter; AARP August 2018 Letter; PIABA Letter; 
Letter from Ann M. Kappler, Senior Vice President, Deputy General 
Counsel, Prudential Financial (Aug. 7, 2018) (``Prudential 
Letter''), CFA Institute Letter; State Attorneys General Letter; CFA 
August 2018 Letter; Letter from Jason Chandler, Group Managing 
Director, Co-Head Investment Platforms and Solutions, and Michael 
Crowl, Group Managing Director, General Counsel, UBS (Aug. 7, 2018) 
(``UBS Letter''), Letter from William F. Galvin, Secretary of the 
Commonwealth of Massachusetts (Aug. 7, 2018) (``Galvin Letter''); 
Letter from David T. Bellaire, Executive Vice President & General 
Counsel, Financial Services Institute (``FSI'') (Aug. 7, 2018) 
(``FSI August 2018 Letter''); Mass Mutual Letter; Schwab Letter; 
Letter from Michael F. Anderson, Senior Vice President and Chief 
Legal Officer, CUNA Mutual (Aug. 7, 2018) (``CUNA Letter''); 
Transamerica August 2018 Letter.
    \47\ See, e.g., CFA August 2018 Letter; Better Markets August 
2018 Letter; Pace Letter.
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    Regarding the Care Obligation, commenters from certain investor 
groups supported incorporating a ``prudence'' standard,\48\ while a 
number of industry commenters expressed concern about including this 
standard.\49\ Numerous commenters requested further clarity on what 
would be required to meet the Care Obligation, including what factors a 
broker-dealer should consider in developing a retail customer's 
investment profile and when making a recommendation, and in particular 
the role of cost and other relevant factors when making a 
recommendation, and also asked for more specific examples of how to 
weigh costs against other factors when making a recommendation.\50\ A 
majority of the IAC and other commenters requested clarification on how 
to consider ``reasonably available alternatives'' when making a 
recommendation and suggested clarifying the scope of the inquiry into 
potential reasonably available alternatives when a broker-dealer offers 
a limited product menu versus when the broker-dealer has an ``open 
architecture'' model.\51\ Several industry commenters made 
recommendations regarding the application of proposed Regulation Best 
Interest to recommendations of specific categories of securities, such 
as variable annuities or leveraged exchange-traded products.\52\
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    \48\ See, e.g., AARP August 2018 Letter; CFA August 2018 Letter; 
FPC Letter.
    \49\ See, e.g., Letter from Karen L. Sukin, Executive Vice 
President, Deputy General Counsel, Primerica (Aug. 7, 2018) 
(``Primerica Letter''); Transamerica August 2018 Letter; IPA Letter; 
Cetera August 2018 Letter.
    \50\ See, e.g., Letter from Felice R. Foundos, Partner, Chapman 
and Cutler (Aug. 6, 2018) (``Chapman Letter''); Vanguard Letter; ICI 
Letter; Morgan Stanley Letter; Wells Fargo Letter; Primerica Letter; 
Great-West Letter; NASAA August 2018 Letter; Cambridge Letter; 
Blackrock Letter.
    \51\ See, e.g., IAC 2018 Recommendation; Fidelity Letter; ICI 
Letter; SIFMA August 2018 Letter; Prudential Letter; LPL August 2018 
Letter; Morningstar Letter. See also AFL-CIO April 2019 Letter 
(stating that the rule ``must make clear that brokers are required 
to recommend the investments they reasonably believe are the best 
match for the investor from among the reasonably available 
investment options'').
    \52\ See, e.g., Letter from Brian Winikoff, Senior Executive 
Director and Head of U.S. Life, Retirement and Wealth Management, 
AXA (Aug. 7, 2018) (``AXA Letter''); Letter from Clifford Kirsch, 
Susan Krawczyk, Eversheds Sutherland, Committee of Annuity Insurers 
(Aug. 7, 2018) (``Committee of Annuity Insurers Letter''); Pacific 
Life August 2018 Letter; Letter from Angela Brickl, General Counsel, 
Rafferty Asset Management (``Direxion'') (Aug. 7, 2018) (``Direxion 
Letter''); Letter from Mark F. Halloran, VP Managing Director, 
Business Development, Transamerica (Nov. 9, 2018) (``Transamerica 
November 2018 Letter'').
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    With respect to the Conflict of Interest Obligation, many 
commenters questioned the distinction between financial incentives that 
would have to be mitigated and other conflicts that would only need to 
be disclosed, and recommended generally that the distinction be 
eliminated.\53\ In addition, some commenters suggested that the 
obligation to establish policies and procedures to mitigate conflicts 
should apply to material conflicts at the level of the natural person 
who is an associated person (as opposed to the firm).\54\ Commenters 
also asked for more clarity and examples of what conflicts must be 
mitigated versus eliminated and more guidance on appropriate mitigation 
methods.\55\ Some commenters also expressed the view that by requiring 
mitigation of financial incentives, proposed Regulation Best Interest 
would require more of broker-dealers than what is required of 
investment advisers under their fiduciary duty, which could create a 
competitive disadvantage for broker-dealers that could further 
encourage migration from the broker-dealer to investment adviser 
business model and result in a loss of retail investor access (in terms 
of choice and cost) to differing types of investment services and 
products.\56\
---------------------------------------------------------------------------

    \53\ See, e.g., CFA August 2018 Letter; SIFMA August 2018 
Letter; Primerica Letter; Letter from Jeff Hartney, Executive 
Director, Bank Insurance and Securities Association (``BISA'') (Aug. 
7, 2018) (``BISA Letter''); Committee of Annuity Insurers Letter; 
IPA Letter; CFA Institute Letter; Morgan Stanley Letter; CCMC 
Letters.
    \54\ See, e.g., Primerica Letter; TIAA Letter; ICI Letter; 
Letter from Craig D. Pfeiffer, President and CEO, Money Management 
Institute (Aug. 7, 2018) (``Money Management Institute Letter'').
    \55\ See, e.g., AALU Letter; CFA August 2018 Letter; Letter from 
Quinn Curtis, Professor of Law, University of Virginia School of Law 
(``UVA''), (Aug. 3, 2018) (``UVA Letter''); Primerica Letter; 
Committee of Annuity Insurers Letter; Cetera August 2018 Letter; 
Wells Fargo Letter; NASAA August 2018 Letter; Morningstar Letter.
    \56\ See, e.g., Letter from Craig S. Tyle, Executive Vice 
President and General Counsel, Franklin Templeton Investments, (Aug. 
6, 2018) (``Franklin Templeton Letter''); Primerica Letter; LPL 
August 2018 Letter; CCMC Letters; UBS Letter; ICI Letter; Letter 
from Christopher A. Iacovella, Chief Executive Officer, American 
Securities Association (``ASA'') (Aug. 7, 2018) (``ASA Letter''); 
Schwab Letter.
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    In addition, a number of commenters agreed with the Commission's 
statement that it was not intended to create a private right of action, 
but many requested that the Commission explicitly state in the final 
rule that Regulation Best Interest does not confer a private right of 
action.\57\ One

[[Page 33325]]

commenter requested that the Commission elaborate and make clear the 
remedies available to investors when broker-dealers violate Regulation 
Best Interest and emphasize that scienter is not required to establish 
a violation of Regulation Best Interest.\58\
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    \57\ See, e.g., Letter from Paul C. Reilly, Chairman and CEO, 
Raymond James Financial (Aug. 7, 2018) (``Raymond James Letter''); 
NAIFA Letter; ASA Letter; CCMC Letters; UBS Letter; LPL August 2018 
Letter; Cambridge Letter. Contra Letter from Elise Sanguinetti, 
President, American Association for Justice (Aug. 6, 2018) 
(``American Association for Justice Letter'').
    \58\ NASAA August 2018 Letter.
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    Finally, numerous commenters urged the Commission to coordinate 
with other regulators, in particular the DOL \59\ and state securities 
and insurance regulators,\60\ and several commenters opined that the 
Commission should preempt (or avoid preempting) state law.\61\
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    \59\ See, e.g., ICI Letter; Franklin Templeton Letter; 
Morningstar Letter; Wells Fargo Letter; Edward Jones Letter; IRI 
Letter; Letter from Cynthia Lo Bessette, Executive Vice President 
and General Counsel, Letter from Oppenheimer Funds (Aug. 7, 2018) 
(``Oppenheimer Letter''); Vanguard Letter.
    \60\ See, e.g., CCMC Letters; Letter from Robert Reynolds, 
President and CEO, Putnam Investments (Aug. 7, 2018) (``Putnam 
Letter''); Letter from Will H. Fuller, Executive Vice President, 
President, Annuity Solutions, Lincoln Financial Group (Nov. 13, 
2018) (``Lincoln Financial Letter''); Cetera August 2018 Letter; 
Great-West Letter; Letter from Marc Cadin, Chief Operating Officer, 
Association of Advanced Life Underwriting (``AALU'') (Aug. 7, 2018) 
(``AALU Letter''); IRI Letter; Pacific Life August 2018 Letter; 
Vanguard Letter; Fidelity Letter; Letter from Andrew J. Bowden, 
Senior Vice President and General Counsel, Jackson National Life 
Insurance Company (Aug. 7, 2018) (``Jackson National Letter''); 
Invesco Letter; Lincoln Letter; CUNA Mutual Letter; Great-West 
Letter.
    \61\ See, e.g., Cetera August 2018 Letter; ICI Letter; Franklin 
Templeton Letter; Putnam Investments Letter; but see NASAA August 
2018 Letter; PIABA Letter; Letter from Teresa J. Verges, Director, 
Investor Rights Clinic, University of Miami School of Law (Aug. 2, 
2018) (``U. of Miami Letter''); Letter from Kayla Martin, Legal 
Intern, Christine Lazaro, Director and Professor Clinical Legal 
Education, Securities Arbitration Clinic, St. John's University 
School of Law (Aug. 7, 2018) (``St. John's U. Letter''); Letter from 
Kevin M. Carroll, Managing Director & Associate General Counsel, 
SIFMA (Mar. 29, 2019) (``SIFMA March 2019 Letter''); Letter from 
Michael Pieciak, NASAA President and Commissioner, Vermont 
Department of Regulation, NASAA (Apr. 25, 2019); Letter from Tom 
Quaadman, Executive Vice President, CCMC (May 16, 2019) (``CCMC May 
2019 Letter''); AFL-CIO April 2019 Letter.
---------------------------------------------------------------------------

    After carefully reviewing the comments on the proposed rule, we 
have determined to retain its overall structure and scope. However, we 
have modified the proposed rule in a number of respects and are also 
providing additional interpretations and guidance to address and 
clarify issues raised by commenters. Summarized below are the key 
modifications from the proposal, as well as the interpretations and 
guidance provided.
     Retail Customer Definition: We are modifying the 
definition of ``retail customer'' to include any natural person who 
receives a recommendation from the broker-dealer for the natural 
person's own account (but not an account for a business that he or she 
works for), including individual plan participants.\62\ We are 
interpreting ``legal representative of such natural person'' to include 
the nonprofessional legal representatives of such a natural person 
(e.g., nonprofessional trustee who represents the assets of a natural 
person).
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    \62\ As discussed in Section II.B.3.a, Retail Customer, Focus on 
Natural Persons and Legal Representatives of Natural Persons, to the 
extent a plan representative who decides service arrangements for a 
workplace retirement plan is a sole proprietor or other self-
employed individual who will participate in the plan, the plan 
representative will be a retail customer to the extent that the sole 
proprietor or self-employed individual receives recommendations 
directly from a broker-dealer primarily for personal, family or 
household purposes.
---------------------------------------------------------------------------

     Implicit Hold Recommendations: While broker-dealers will 
not be required to monitor accounts, in instances where a broker-dealer 
agrees to provide the retail customer with specified account monitoring 
services, it is our view that such an agreement will result in buy, 
sell or hold recommendations subject to Regulation Best Interest, even 
when the recommendation to hold is implicit.\63\
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    \63\ See Section II.B.2.b, Interpretation of Any Securities 
Transaction or Investment Strategy Involving Securities.
---------------------------------------------------------------------------

     Recommendations of account types, including 
recommendations to roll over or transfer assets from one type of 
account to another: We are modifying Regulation Best Interest to 
expressly apply to account recommendations including, among others, 
recommendations to roll over or transfer assets in a workplace 
retirement plan account to an IRA, recommendations to open a particular 
securities account (such as brokerage or advisory), and recommendations 
to take a plan distribution for the purpose of opening a securities 
account.\64\ We are also providing guidance under the Care Obligation 
on what factors a broker-dealer generally should consider when making 
such recommendations.
---------------------------------------------------------------------------

    \64\ See id.
---------------------------------------------------------------------------

     Dual-Registrants: We are providing additional guidance on 
how dual-registrants can comply with Regulation Best Interest, and 
confirming that Regulation Best Interest does not apply to advice 
provided by a broker-dealer that is dually registered as an investment 
adviser (``dual-registrant'') when acting in the capacity of an 
investment adviser, and that a dual-registrant is an investment adviser 
solely with respect to accounts for which a dual-registrant provides 
advice and receives compensation that subjects it to the Advisers 
Act.\65\
---------------------------------------------------------------------------

    \65\ See Section II.B.3.d, Retail Customers, Treatment of Dual-
Registrants.
---------------------------------------------------------------------------

    We are also clarifying the relationship between the General 
Obligation and the specific component obligations, and in particular, 
what it means to ``act in the best interest'' of the retail customer. 
As is the case with the fiduciary duty applicable to investment 
advisers under the Advisers Act, we are not expressly defining in the 
rule text the term ``best interest,'' and instead are providing in 
Regulation Best Interest and through interpretations, what ``acting in 
the best interest'' means.\66\ Whether a broker-dealer has acted in the 
retail customer's best interest in compliance with Regulation Best 
Interest will turn on an objective assessment of the facts and 
circumstances of how the specific components of Regulation Best 
Interest--including its Disclosure, Care, Conflict of Interest, and 
Compliance Obligations--are satisfied at the time that the 
recommendation is made (and not in hindsight). In response to 
commenters, we are addressing, among other things, what the General 
Obligation does and does not require (for example, that it does not 
impose a continuing duty beyond a particular recommendation), providing 
specific examples of what would violate Regulation Best Interest, and 
its application to certain scenarios, particularly in the context of 
satisfying the Care Obligation.
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    \66\ In the investment adviser context, an investment adviser's 
fiduciary duty under the Advisers Act comprises a duty of care and a 
duty of loyalty. This combination of care and loyalty obligations 
has been characterized as requiring the investment adviser to act in 
the ``best interest'' of its client at all times. See Fiduciary 
Interpretation.
---------------------------------------------------------------------------

    We are also modifying and clarifying the component obligations that 
a broker-dealer would be required to satisfy in order to meet the 
General Obligation:
    Disclosure Obligation. We are refining the treatment of conflicts 
of interest by: (1) Defining in the rule text a ``conflict of 
interest'' for purposes of Regulation Best Interest (as opposed to 
interpreting the phrase ``material conflict of interest'' as in the 
Proposing Release) as an interest that might incline a broker-dealer--
consciously or unconsciously--to make a recommendation that is not 
disinterested; and (2) revising the Disclosure Obligation to require 
disclosure of ``material facts'' regarding conflicts of interest 
associated with the recommendation.\67\ Similar to the proposal, all 
such conflicts of interest will be covered by Regulation Best

[[Page 33326]]

Interest (e.g., subject to the Conflict of Interest Obligation), 
however, only ``material facts'' regarding these conflicts would be 
required to be disclosed under the Disclosure Obligation.
---------------------------------------------------------------------------

    \67\ See Section II.C.1.b, Disclosure Obligation, Material Facts 
Regarding Conflicts of Interest.
---------------------------------------------------------------------------

    Furthermore, we are modifying the Disclosure Obligation to 
explicitly require broker-dealers to provide ``full and fair'' 
disclosure of material facts, rather than requiring broker-dealers to 
``reasonably disclose'' such information. We are providing the 
Commission's view regarding what it means to provide ``full and fair'' 
disclosure to retail customers, including the level of specificity of 
disclosure required, and the form and manner and timing and frequency 
of such disclosure.\68\ We are explicitly requiring the disclosure of 
material facts relating to the scope and terms of the relationship that 
were specifically identified in the proposal (i.e., capacity, material 
fees and charges, and type and scope of services).\69\ In connection 
with disclosure requirements regarding the type and scope of services, 
we are also clarifying that at a minimum, a broker-dealer needs to 
disclose whether or not account monitoring services will be provided 
(and if so, the scope and frequency of those services), account 
minimums, and any material limitations on the securities or investment 
strategies involving securities that may be recommended to the retail 
customer.\70\ Also we conclude that the basis for a broker-dealer's 
recommendations as a general matter (i.e., what might commonly be 
described as the firm's investment approach, philosophy, or strategy) 
and the risks associated with a broker-dealer's recommendations in 
standardized (as opposed to individualized) terms are material facts 
relating to the scope and terms of the relationship that should be 
disclosed.\71\ Below, we outline a method to address oral disclosure 
and written disclosure provided after the fact.\72\
---------------------------------------------------------------------------

    \68\ See Section II.C.1.c, Disclosure Obligation, Full and Fair 
Disclosure.
    \69\ See Section II.C.1.a, Disclosure Obligation, Material Facts 
Regarding Scope and Terms of the Relationship.
    \70\ Id.
    \71\ Id.
    \72\ See Section II.C.1, Disclosure Obligation, Oral Disclosure 
or Disclosure After a Recommendation.
---------------------------------------------------------------------------

    Care Obligation. We are adopting the Care Obligation largely as 
proposed; however, we are expressly requiring that a broker-dealer 
understand and consider the potential costs associated with its 
recommendation, and have a reasonable basis to believe that the 
recommendation does not place the financial or other interest of the 
broker-dealer ahead of the interest of the retail customer.\73\ 
Nevertheless, we emphasize that while cost must be considered, it 
should never be the only consideration. Cost is only one of many 
important factors to be considered regarding the recommendation and 
that the standard does not necessarily require the ``lowest cost 
option.'' Relatedly, we are emphasizing the need to consider costs in 
light of other factors and the retail customer's investment profile.
---------------------------------------------------------------------------

    \73\ See generally Section II.C.2, Care Obligation.
---------------------------------------------------------------------------

    We are also providing additional guidance on what it means to make 
a recommendation in a retail customer's ``best interest.'' As in the 
Proposing Release, determining whether a broker-dealer's recommendation 
satisfies the Care Obligation will be an objective evaluation turning 
on the facts and circumstances of the particular recommendation and the 
particular retail customer. We recognize that a facts and circumstances 
evaluation of a recommendation makes it difficult to draw bright lines 
around whether a particular recommendation will meet the Care 
Obligation. Accordingly, we focus on how a broker-dealer could 
establish a reasonable basis to believe that a recommendation is in the 
best interest of its retail customer and does not place the broker-
dealer's interest ahead of the retail customer's interest, and the 
circumstances under which a broker-dealer could not establish such a 
reasonable belief.
    We are clarifying that an evaluation of reasonably available 
alternatives does not require an evaluation of every possible 
alternative (including those offered outside the firm) nor require 
broker-dealers to recommend one ``best'' product, and what this 
evaluation will require in certain contexts (such as a firm with open 
architecture). Furthermore, we clarify that, when a broker-dealer 
materially limits its product offerings to certain proprietary or other 
limited menus of products, it must still comply with the Care 
Obligation--even if it has disclosed and taken steps to prevent the 
limitation from placing the interests of the broker-dealer ahead of the 
retail customer, as required by the Disclosure and Conflict of Interest 
Obligation--and thus could not use its limited menu to justify 
recommending a product that does not satisfy the obligation to act in a 
retail customer's best interest.
    Conflict of Interest Obligation. We are revising the Conflict of 
Interest Obligation by: (1) Similar to the proposal, establishing an 
overarching obligation to establish written policies and procedures to 
identify and at a minimum disclose (pursuant to the Disclosure 
Obligation), or eliminate, all conflicts of interest associated with 
the recommendation; \74\ and (2) setting forth explicit requirements to 
establish written policies and procedures reasonably designed to 
mitigate or eliminate certain identified conflicts of interest, 
specifically:
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    \74\ This obligation achieves greater consistency with the 
treatment of conflicts under the Advisers Act. As discussed in the 
Fiduciary Interpretation, in seeking to meet its duty of loyalty, an 
adviser must make full and fair disclosure to its clients of all 
material facts relating to the advisory relationship. An adviser 
must eliminate or at least expose through full and fair disclosure 
all conflicts of interest which might incline an investment 
adviser--consciously or unconsciously--to render advice which was 
not disinterested. See Fiduciary Interpretation.
---------------------------------------------------------------------------

     Mitigation of Associated Person Conflicts of Interest. We 
are revising the proposal's mitigation requirement to: (1) Eliminate 
the distinction between financial incentives and all other conflicts of 
interest; and (2) focus on mitigating conflicts of interest associated 
with recommendations that create an incentive for the associated person 
of the broker-dealer to place the interest of the firm or the 
associated person ahead of the interest of the retail customer.\75\ We 
are providing further guidance regarding the types of incentives 
covered by this revised obligation, in particular focusing on 
compensation or employment related incentives and other incentives 
provided to the associated person (whether by the broker-dealer or 
third-parties). We are also confirming, clarifying and expanding on the 
proposal's guidance on potential mitigation methods to further promote 
compliance with this obligation.
---------------------------------------------------------------------------

    \75\ See generally Section II.C.3.e, Conflict of Interest 
Obligation, Mitigation of Certain Incentives to Associated Persons.
---------------------------------------------------------------------------

     Address Any Material Limitations on Recommendations to 
Retail Customers. To address the conflicts of interest presented when 
broker-dealers place any material limitations on the securities or 
investment strategies involving securities that may be recommended to a 
retail customer (i.e., only make recommendations of proprietary or 
other limited range of products), we are requiring broker-dealers to 
establish, maintain and enforce written policies and procedures 
reasonably designed to: (1) Identify and disclose any material 
limitations placed on the securities or investment strategies involving 
securities that may be recommended and any associated conflicts of 
interest; and (2) prevent the limitations and associated conflicts of

[[Page 33327]]

interest from causing the broker-dealer or their associated persons to 
make recommendations that place the interest of the broker-dealer or 
associated person ahead of the interest of the retail customer (for 
example, a broker-dealer could establish product review processes or 
establish procedures addressing which retail customers would qualify 
for the product menu).\76\
---------------------------------------------------------------------------

    \76\ See generally Section II.C.3.f, Conflict of Interest 
Obligation, Mitigation of Material Limitations on Recommendations to 
Retail Customers.
---------------------------------------------------------------------------

     Elimination of Certain Conflicts. We are requiring broker-
dealers to establish written policies and procedures reasonably 
designed to identify and eliminate any sales contests, sales quotas, 
bonuses, and non-cash compensation that are based on the sale of 
specific securities or the sale of specific types of securities within 
a limited period of time.\77\ By explicitly focusing on policies and 
procedures to eliminate these incentives, it does not mean that all 
other incentives are presumptively compliant with Regulation Best 
Interest. Rather, such other incentives and practices that are not 
explicitly prohibited are permitted provided that the broker-dealer 
establishes reasonably designed policies and procedures to disclose and 
mitigate the incentive created to the representative, and the broker-
dealer and its associated persons comply with the Care Obligation and 
the Disclosure Obligation.
---------------------------------------------------------------------------

    \77\ See generally Section II.C.3.g, Conflict of Interest 
Obligation, Elimination of Certain Conflicts of Interest.
---------------------------------------------------------------------------

    General Compliance Obligation. We are establishing a new, general 
``Compliance Obligation'' to require broker-dealers to establish 
policies and procedures to achieve compliance with Regulation Best 
Interest in its entirety.\78\
---------------------------------------------------------------------------

    \78\ See generally Section II.C.4, Compliance Obligation.
---------------------------------------------------------------------------

    Books and Records. In addition to adopting Regulation Best 
Interest, we are also adopting the record-making and recordkeeping 
requirements largely as proposed, with certain explanations and 
clarifications regarding the scope of these requirements and the extent 
to which new obligations have been created.\79\
---------------------------------------------------------------------------

    \79\ See generally Section II.D, Record-Making and 
Recordkeeping.
---------------------------------------------------------------------------

    Interaction with Other Standards, Waivers and Private Right of 
Action. Compliance with Regulation Best Interest will not alter a 
broker-dealer's obligations under the general antifraud provisions of 
the federal securities laws. Regulation Best Interest applies in 
addition to any obligations under the Exchange Act, along with any 
rules the Commission may adopt thereunder, and any other applicable 
provisions of the federal securities laws and related rules and 
regulations.\80\
---------------------------------------------------------------------------

    \80\ For example, any transaction or series of transactions, 
whether or not subject to the provisions of Regulation Best 
Interest, remain subject to the antifraud and anti-manipulation 
provisions of the securities laws, including, without limitation, 
Section 17(a) of the Securities Act of 1933 (``Securities Act'') [15 
U.S.C. 77q(a)] and Sections 9, 10(b), and 15(c) of the Exchange Act 
[15 U.S.C. 78i, 78j(b), and 78o(c)] and the rules thereunder.
---------------------------------------------------------------------------

    Scienter will not be required to establish a violation of 
Regulation Best Interest. We note that the preemptive effect of 
Regulation Best Interest on any state law governing the relationship 
between regulated entities and their customers would be determined in 
future judicial proceedings based on the specific language and effect 
of that state law. We believe that Regulation Best Interest, Form CRS, 
and the related rules, interpretations and guidance that the Commission 
is concurrently issuing will serve as focal points for promoting 
clarity, establishing greater consistency in the level of retail 
customer protections provided, and easing compliance across the 
regulatory landscape and the spectrum of investment professionals and 
products. In addition, under Section 29(a) of the Exchange Act, a 
broker-dealer will not be able to waive compliance with Regulation Best 
Interest, nor can a retail customer agree to waive her protections 
under Regulation Best Interest.
    Furthermore, we do not believe Regulation Best Interest creates any 
new private right of action or right of rescission, nor do we intend 
such a result.

D. Overview of Key Enhancements

    With these modifications and clarifications, Regulation Best 
Interest is designed to improve investor protection by:
     Requiring broker-dealers to have a reasonable basis to 
believe that recommendations are in the retail customer's best 
interest, which enhances existing suitability obligations by: Requiring 
compliance not only with the explicit Care Obligation, but also with 
Disclosure, Conflict of Interest, and Compliance Obligations; expressly 
requiring consideration of cost in evaluating a recommendation as part 
of the Care Obligation; expressing our views regarding the 
consideration of reasonably available alternatives when making a 
recommendation as part of the Care Obligation; applying Regulation Best 
Interest to recommendations of account types and rollovers and to any 
recommendations resulting from agreed-upon account monitoring services 
(including implicit hold recommendations); and, applying the Care 
Obligation to a series of recommended transactions (currently referred 
to as ``quantitative suitability'') irrespective of whether a broker-
dealer exercises actual or de facto control over a customer's account;
     requiring broker-dealers to establish, maintain, and 
enforce written policies and procedures reasonably designed to mitigate 
(and in some cases, eliminate) certain identified conflicts of interest 
that create incentives to make recommendations that are not in the 
retail customer's best interest; these new requirements are a 
significant and critical enhancement as existing requirements under the 
federal securities laws largely center upon conflict disclosure rather 
than conflict mitigation;
     requiring disclosure under the Disclosure Obligation of 
the material facts relating to the scope of terms of a broker-dealer's 
relationship with the retail customer and the conflicts of interest 
associated with a broker-dealer's recommendations, which will foster 
retail customers' understanding of their relationship with the broker-
dealer and help them to evaluate the recommendations received; and
     requiring broker-dealers to establish, maintain and 
enforce written policies and procedures reasonably designed to achieve 
compliance with Regulation as a whole, which will further promote 
broker-dealer compliance with Regulation Best Interest.
    Through these new requirements, we believe that Regulation Best 
Interest will improve investor protection by enhancing the quality of 
broker-dealer recommendations to retail customers and reducing the 
potential harm to retail customers that may be caused by conflicted 
brokerage recommendations. We also believe Regulation Best Interest 
achieves these enhancements in a manner that is workable for the 
transaction-based relationship offered by broker-dealers, thus 
preserving, to the extent possible, retail investor access (in terms of 
choice and cost) to different types of quality investment services and 
products. As discussed above, Regulation Best Interest will complement 
Form CRS and related rules, interpretations, and guidance that the 
Commission is concurrently issuing.

[[Page 33328]]

II. Discussion of Regulation Best Interest

A. General Obligation

    As in the Proposing Release, Regulation Best Interest is set forth 
in two subparagraphs: (1) An overarching provision setting forth a 
general best interest obligation (``General Obligation''); and (2) a 
second provision requiring compliance with specific obligations in 
order to satisfy the overarching standard (discussed below in Section 
II.C).\81\ Specifically, as in the Proposing Release, the General 
Obligation requires that a broker-dealer ``shall act in the best 
interest of the retail customer at the time the recommendation is made, 
without placing the financial or other interest of [the broker-dealer] 
. . . ahead of the interest of the retail customer.'' \82\
---------------------------------------------------------------------------

    \81\ See Proposing Release at 21585 et seq.
    \82\ See Paragraph (a)(1) of Regulation Best Interest.
---------------------------------------------------------------------------

    Most commenters, including a majority of the IAC, expressed 
opinions on this approach, and in particular on the General Obligation, 
including whether the obligation should be a ``fiduciary'' standard, 
whether it should be a uniform standard for broker-dealers and 
investment advisers,\83\ and whether the standard should be more 
principles-based or more prescriptive (in particular, whether to define 
``best interest'').\84\
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    \83\ See IAC 2018 Recommendation; Letter from Rob Foregger, Co-
Founder, NextCapital (Aug. 7, 2018) (``NextCapital Letter'') 
(recommending that the Commission adopt a uniform fiduciary standard 
of conduct applicable to both broker-dealers and investment 
advisers); Letter from Sharon Cheever, Senior Vice President and 
General Counsel, Pacific Life Insurance Company (May 28, 2019) 
(``Pacific Life May 2019 Letter'') (recommending that the Commission 
adopt a single `best interest' standard of care for all financial 
professionals).
     See also Letter from R. Scott Henderson, Bank of America (Aug. 
7, 2018) (``Bank of America Letter''); Letter from Christopher 
Jones, Chief Investment Officer, Financial Engines (Aug. 6, 2018) 
(``Financial Engines Letter''); State Attorneys General Letter; 
Letter from Jill I. Gross, Associate Dean, Academic Affairs, 
Elisabeth Haub School of Law, Pace University (Mar. 11, 2019) 
(``Gross Letter''). Relatedly, one commenter expressed concern that 
a court or arbitration panel would determine that Regulation Best 
Interest would control, rather than existing case law, which would 
apply a fiduciary duty in certain circumstances. See Gross Letter. 
See also AFL-CIO April 2019 Letter.
    \84\ See, e.g., Ameriprise Letter; Cambridge Letter; CCMC 
Letters; Edward Jones Letter; NAIFA Letter; Morningstar Letter; NY 
Life Letter; Letter from Kevin T. Reynolds, Senior Vice President, 
Penn Mutual Life Insurance Company (Aug. 1, 2018) (``Penn Mutual 
Letter''); SIFMA August 2018 Letter; Vanguard Letter; Letter from 
Kent. A Mason, Davis & Harman LLP (Jul. 20, 2018) (``Davis Harman 
Letter'').
---------------------------------------------------------------------------

    The views of commenters on the approach to an enhanced standard of 
conduct for broker-dealers varied widely. A number of commenters 
supported a broker-dealer specific standard of conduct.\85\ Several of 
these commenters supported the Commission's approach as proposed, with 
certain modifications to the specific component obligations discussed 
below.\86\ Some commenters urged the Commission to change the standard 
from what the commenters called ``suitability-plus'' to what the 
commenters called a ``true best interest standard,'' including the 
avoidance of certain conflicts,\87\ and urged the Commission to change 
the name of Regulation Best Interest unless it required firms to always 
be responsible for acting in the retail customer's best interest (as 
opposed to at the time of the recommendation).\88\ Other commenters 
advocated for the adoption of a broker-dealer standard modeled after 
FINRA suitability rules,\89\ and some suggested that the Commission 
create a safe harbor from liability for compliance with Regulation Best 
Interest.\90\
---------------------------------------------------------------------------

    \85\ See, e.g., SIFMA August 2018 Letter; Cetera August 2018 
Letter; Vanguard Letter; Edward Jones Letter; Ameriprise Letter; NY 
Life Letter; NAIFA Letter; CCMC Letters; Penn Mutual Letter; 
Cambridge Letter; PIABA Letter; Letter from Ronald J. Kruszewski, 
Chairman and Chief Executive Officer, Stifel Financial (Aug. 7, 
2018) (``Stifel Letter''); Financial Engines Letter.
    \86\ See, e.g., SIFMA August 2018 Letter; Vanguard Letter; 
Edward Jones Letter; Ameriprise Letter; NY Life Letter; NAIFA 
Letter; CCMC Letters; Penn Mutual Letter; Cambridge Letter; PIABA 
Letter.
    \87\ See, e.g., CFA Institute Letter.
    \88\ See, e.g., Letter from Jean-Luc Bourdon, CPA/PFS, Chair, 
Personal Financial Planning Legislative and Regulatory Task Force, 
and Charles R. Kowal, Chair, Personal Financial Planning Executive 
Committee, AICPA (Aug. 7, 2018) (``AICPA Letter''); Betterment 
August 2018 Letter; NASAA August 2018 Letter.
    \89\ See, e.g., National Society of Compliance Professionals 
Letter; Cetera August 2018 Letter.
    \90\ See Cambridge Letter; BISA Letter; IPA Letter.
---------------------------------------------------------------------------

    By contrast, other commenters recommended that the Commission adopt 
a uniform standard of conduct for investment advisers and broker-
dealers, in varying forms.\91\ Commenters expressed differing views on 
the form of such a uniform standard of conduct, including that the 
Commission should adopt: a fiduciary standard for broker-dealers 
similar to, or no less stringent than, the fiduciary duty under the 
Advisers Act; \92\ a uniform fiduciary standard as articulated in 
Section 913(g) of the Dodd-Frank Act \93\ and/or consistent with the 
recommendations of the staff's Section 913 Study; \94\ or a uniform 
standard similar to the DOL standard as reflected in the BIC Exemption; 
\95\ harmonized requirements and guidance for broker-dealers and 
investment advisers offering services to retail customers; \96\ or a 
new uniform best interest standard, with common core elements.\97\
---------------------------------------------------------------------------

    \91\ See, e.g., Betterment Letter; AARP August 2018 Letter; AFR 
Letter; Galvin Letter; State Attorneys General Letter.
    \92\ See, e.g., Betterment Letter; Warren Letter; Fein Letter; 
Letter from Joseph M. Torsella, Pennsylvania State Treasurer, et al. 
(Aug. 7, 2018) (``State Treasurers Letter''); AARP August 2018 
Letter.
    \93\ See, e.g., FPC Letter; Letter from Maxine Waters, Ranking 
Member, Committee on Financial Services, U.S. House of 
Representatives, et al. (Sep. 12, 2018) (``Waters Letter''); Fein 
Letter.
    \94\ See, e.g., ACLI Letter; Schwab Letter.
    \95\ See, e.g., Galvin Letter. See supra footnote 32.
    \96\ See, e.g., AARP August 2018 Letter.
    \97\ See, e.g., Pacific Life August 2018 Letter.
---------------------------------------------------------------------------

    In this vein, a number of commenters suggested specific revisions 
to the text of the General Obligation to clarify what the standard 
requires with respect to broker-dealer conflicts of interest, including 
that the Commission change the proposed ``without placing the financial 
or other interest [of the broker-dealer] ahead'' language to a standard 
that requires a recommendation be made ``without regard to'' a broker-
dealer's interest \98\ and/or requires the broker-dealer to ``place the 
customer's interest first'' or ahead of its own.\99\ These commenters 
stated that changing the proposed language to a ``without regard to'' 
and/or ``place the customer's interest first'' phrasing would result in 
a stronger standard, whereas the proposed phrasing would allow a 
broker-dealer to act in its own interests as long as the broker-dealer 
does not put its interests ahead of its customers' interest.\100\ These 
commenters stated that broker-dealers must put aside their own interest 
when determining what is best for the retail customer, that broker-
dealers must ensure that conflicts do not taint recommendations.\101\
---------------------------------------------------------------------------

    \98\ See, e.g., CFA August 2018 Letter; FPC Letter; PACE Letter; 
Better Markets August 2018 Letter.
    \99\ See, e.g., Invesco Letter; Schwab Letter; Better Markets 
August 2018 Letter; CFA Institute Letter.
    \100\ See, e.g., CFA August 2018 Letter; FPC Letter; Pace 
Letter.
    \101\ See, e.g., CFA August 2018 Letter.
---------------------------------------------------------------------------

    Some commenters challenged the Commission's concern that the 
``without regard to'' language ``could be inappropriately construed to 
require a broker-dealer to eliminate all of its conflicts,'' arguing 
that their position is supported by the plain meaning of the language 
and the context of 913(g) (which explicitly recognizes conflicts in 
certain areas), and the interpretations by others (such as the DOL) who 
have used it.\102\ Highlighting what commenters viewed as 
inconsistencies in the Proposing Release's interpretation of the 
proposed ``without placing . . . ahead'' phrasing, such as statements 
that the obligation would require broker-dealers to ``put aside their 
interests'' when

[[Page 33329]]

making a recommendation versus others suggesting that a broker-dealer's 
interests cannot ``predominantly motivate'' or be the ``sole basis'' 
for the recommendation, some commenters suggested we either adopt the 
``without regard to'' phrasing or state that the proposed phrasing 
requires a broker-dealer to put aside its interests.\103\ Some 
commenters further stated that the ``without regard to'' phrasing, 
which is used in Section 913(g) of the Dodd-Frank Act, is the stronger 
standard of conduct that Congress intended, and challenged the 
Commission's reliance on the authority provided in Section 913(f).\104\ 
In this vein, some commenters suggested that the Commission should 
adopt a uniform standard of conduct for broker-dealers and investment 
advisers that was authorized under Section 913(g), and recommended by 
the staff in the Section 913 Study.\105\
---------------------------------------------------------------------------

    \102\ See, e.g., CFA August 2018 Letter; Waters Letter.
    \103\ See, e.g., CFA August 2018 Letter. See also Waters Letter 
(stating that the proposal fails to adequately explain just what it 
would require of brokers that is different from the status quo, that 
the standard should clearly differ from the current ``suitability'' 
standard, and that any final rule must clearly explain the standard, 
what it requires and prohibits, and how it differs from the status 
quo).
    \104\ See, e.g., CFA August 2018 Letter; State Attorneys General 
Letter; Waters Letter; FPC Letter; Better Markets August 2018 
Letter.
    \105\ See, e.g., Waters Letter; FPC Letter.
---------------------------------------------------------------------------

    Other commenters, however, supported the proposal's ``without 
placing . . . ahead'' formulation.\106\ These commenters expressed 
concern that a ``without regard to'' standard would require ``conflict 
free'' recommendations, which would limit compensation structures and 
the offering of certain products.\107\ Instead, commenters stated that 
the appropriate role of a best interest standard is to require 
disclosure and management of conflicts of interest.\108\ Others 
generally supported, or did not object to, the Commission's decision 
not to proceed under its 913(g) authority in its current proposal.\109\
---------------------------------------------------------------------------

    \106\ See, e.g., AALU Letter; Cetera August 2018 Letter; NAIFA 
Letter; Pickard Letter.
    \107\ See, e.g., AALU Letter; Cetera August 2018 Letter; NAIFA 
Letter; Pickard Letter.
    \108\ See, e.g., AALU Letter; Cetera August 2018 Letter.
    \109\ See, e.g., Invesco Letter; IAC 2018 Recommendation 
(stating ``we recognize that the Commission has chosen not to 
proceed under its 913(g) authority in its current proposal, and it 
is not our intent to derail that proposal by advocating that the 
Commission change the legal basis for its rulemaking. Moreover, we 
believe the clarifications we have outlined above to the meaning of 
best interest, if implemented, have the potential to deliver 
immediate benefits to customers of broker-dealers and investment 
advisers alike. Should the Commission determine, however, that it 
cannot enforce the clarified best interest standard under the 
Advisers Act, a majority of the Committee believes the Commission 
should reconsider rulemaking under its 913(g) authority to close 
that regulatory gap.''). As noted above, Regulation Best Interest 
draws from key principles underlying fiduciary obligations, 
including those that apply to investment advisers under Advisers 
Act. Accordingly, as discussed below, the Commission has chosen to 
enhance existing obligations for broker-dealers when they make 
recommendations to a retail customer, while, in a separate 
interpretation, reaffirming and in some cases clarifying an 
investment adviser's fiduciary duty. See Fiduciary Interpretation.
---------------------------------------------------------------------------

    A common theme across many comments was the need for additional 
guidance on what ``best interest'' means, with some commenters 
recommending that the Commission codify its interpretation of ``best 
interest'' or provide a more specific definition of what it means to 
act in the ``best interest.'' \110\ Several commenters suggested that 
the ``best interest'' standard should require the ``best'' or most 
beneficial product available,\111\ while others (including a majority 
of the IAC) requested that the Commission clarify that there is no 
single ``best'' recommendation and that the obligation is to adhere to 
a professional standard of conduct when making a recommendation.\112\ 
Some commenters suggested defining ``best interest'' as including a 
duty of loyalty and care.\113\ Several also suggested that the 
Commission incorporate best execution and fair pricing and compensation 
as factors for determining compliance with the standard.\114\
---------------------------------------------------------------------------

    \110\ See, e.g., NASAA August 2018 Letter.
    \111\ See, e.g., Financial Engines Letter; CFA August 2018 
Letter.
    \112\ See, e.g., Wells Fargo Letter; see also IAC 2018 
Recommendation (``[T]he Commission should recognize there will often 
not be a single best option and that more than one of the available 
options may satisfy this standard.'').
    \113\ See, e.g., TIAA Letter; Morningstar Letter.
    \114\ See, e.g., CFA Institute Letter; Letter from Mark Heckert, 
Vice President, Pricing and Analytics, ICE Data Services, (Aug. 7, 
2018) (``ICE Letter''); FPC Letter.
---------------------------------------------------------------------------

    Several commenters recommended that the Commission adopt a 
definition of best interest that is consistent with the best interest 
obligation described by the DOL in the BIC Exemption's Impartial 
Conduct Standards,\115\ and supported a standard which would require a 
broker-dealer to act ``solely'' in the interest of the retail customer 
when making a recommendation.\116\ Conversely, other commenters 
recommended that the ``best interest'' standard could be satisfied even 
if the recommendations are in part influenced by ``self-promotion.'' 
\117\
---------------------------------------------------------------------------

    \115\ See, e.g., AARP August 2018 Letter; Wells Fargo Letter; 
Schwab Letter; NASAA August 2018 Letter.
    \116\ See, e.g., Galvin Letter.
    \117\ See, e.g., LPL August 2018 Letter.
---------------------------------------------------------------------------

    Finally, in lieu of a prescribed definition of ``best interest,'' a 
number of commenters advocated for a facts-and-circumstances or 
``totality of the circumstances approach'' for determining compliance 
with the ``best interest'' standard.\118\ A majority of the IAC 
recommended that the meaning of the best interest obligation should be 
clarified to require ``broker-dealers, investment advisers, and their 
associated persons to recommend the investments, investment strategies, 
accounts or services, from among those they have reasonably available 
to recommend, that they reasonably believe represent the best available 
options for the investor.'' \119\
---------------------------------------------------------------------------

    \118\ See, e.g., AAJ Letter; CFA August 2018 Letter.
    \119\ IAC 2018 Recommendation.
---------------------------------------------------------------------------

    After careful consideration of these comments, we continue to 
believe that our proposed approach for enhancing the standards of 
conduct that apply to broker-dealers' recommendations to retail 
customers is the appropriate approach, and therefore we are adopting as 
proposed the structure and scope of Regulation Best Interest, including 
the phrasing of the General Obligation, and are not expressly defining 
``best interest'' in the rule text.\120\ However, in consideration of 
these comments, we are providing our views on what the standard 
generally requires, what it is intended to achieve, and its alignment 
in many respects with fiduciary principles.
---------------------------------------------------------------------------

    \120\ Another commenter stated that any modification to the 
proposed rules and guidance that would make them ``more 
restrictive'' should be reproposed for additional public comment. 
See ACLI Letter. Because we have provided notice and the changes we 
are making are based on comments we received, reproposal is not 
necessary.
---------------------------------------------------------------------------

1. Commission's Approach
    After extensive consideration, and for the reasons discussed in the 
Proposing Release and further below, we are adopting a rule to enhance 
the existing broker-dealer conduct obligations when they make 
recommendations to a retail customer.\121\ At the same time, we seek to 
preserve retail investor access (in terms of choice and cost) to 
differing types of investment services and products.
---------------------------------------------------------------------------

    \121\ See Proposing Release at 21575. In particular, we 
considered the recommendations made by our staff in 2011 and the 
recommendations of the IAC. See Staff of the U.S. Securities and 
Exchange Commission, Study on Investment Advisers and Broker-Dealers 
As Required by Section 913 of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (Jan. 2011) (``913 Study''), at 9-10, 
available at www.sec.gov/news/studies/2011/913studyfinal.pdf; 
Recommendation of the Investor Advisory Committee: Broker-Dealer 
Fiduciary Duty (Nov. 2013) (``IAC 2013 Recommendation''), available 
at https://www.sec.gov/spotlight/investor-advisory-committee-2012/fiduciary-duty-recommendation-2013.pdf; IAC 2018 Recommendation.
---------------------------------------------------------------------------

    The Commission is adopting Regulation Best Interest pursuant to the

[[Page 33330]]

express and broad grant of rulemaking authority in Section 913(f) of 
the Dodd-Frank Act.\122\ As some commenters noted, Section 913(g) 
expressly authorizes the Commission to adopt rules that would hold 
broker-dealers to the same standard of conduct as investment advisers. 
However, the availability of overlapping, yet distinct, rulemaking 
power under Section 913(g) does not negate the grant of authority under 
Section 913(f). The plain text of Section 913(f) authorizes the 
Commission to promulgate this rule addressing the legal and regulatory 
standards of care for broker-dealers, and their associated persons.
---------------------------------------------------------------------------

    \122\ Section 913(f) of the Dodd-Frank Act provides the 
Commission discretionary authority to ``commence a rulemaking, as 
necessary or appropriate to the public interest and for the 
protection of retail customers (and such other customers as the 
Commission may by rule provide), to address the legal or regulatory 
standards of care for brokers, dealers . . . [and] persons 
associated with brokers or dealers . . . for providing personalized 
investment advice about securities to such retail customers.'' In 
addition to Section 913(f), the Commission is promulgating 
Regulation Best Interest pursuant to other provisions of the 
Exchange Act, including Section 15(c)(6) and Section 17.
---------------------------------------------------------------------------

    The Commission is utilizing its authority under 913(f) in order to 
adopt an enhanced investor-protection standard for broker-dealers that 
maintains the availability of both the broker-dealer model and the 
investment adviser model. The Commission has chosen not to apply the 
existing fiduciary standard under the Advisers Act to broker-dealers in 
part because of concerns that such a shift would result in fewer 
broker-dealers offering transaction-based services to retail customers, 
which would in turn reduce choice and may raise costs for certain 
retail customers.
    Moreover, the Commission has chosen not to create a new uniform 
standard applicable to both broker-dealers and investment advisers 
which, among other things, would discard decades of regulatory and 
judicial precedent and experience with the fiduciary duty for 
investment advisers that has generally worked well for retail clients 
and our markets. We believe that adopting a ``one size fits all'' 
approach would not appropriately reflect the fact that broker-dealers 
and investment advisers play distinct roles in providing 
recommendations or advice and services to investors, and may ultimately 
harm retail investors. Instead, the Commission has chosen to enhance 
existing obligations for broker-dealers when they make recommendations 
to a retail customer, while, in a separate interpretation, reaffirming 
and in some cases clarifying an investment adviser's fiduciary 
duty.\123\
---------------------------------------------------------------------------

    \123\ Although we are not adopting a uniform fiduciary standard 
of conduct, we note that our rules are designed to achieve many of 
the key goals advocated for by supporters of a uniform standard of 
conduct. For example, in advocating for a uniform standard of 
conduct former Commission Chair Elisse B. Walter (then a 
Commissioner) stated that (1) ``[t]o appreciate fully what a 
fiduciary standard means, and what it really means to act in the 
best interest of an investor, it is absolutely necessary to drill 
down and determine what duties and obligations flow from a fiduciary 
standard,'' (2) ``a fiduciary standard is not a substitute for 
business practice rules . . . [r]ather, the two are complementary . 
. . and can be used by the Commission] to prohibit certain 
conflicted behavior or to require mitigation or management of the 
conflict,'' (3) ``what a fiduciary duty requires depends on the 
scope of the engagement,'' and (4) ``[m]ost important, whatever 
gloss and guidance the Commission provides, it should not deviate 
from the basic principle that financial professionals should always 
act in the best interests of investors, both large and small.'' 
Commissioner Elisse B. Walter, Regulating Broker-Dealers and 
Investment Advisers: Demarcation or Harmonization? (May 5, 2009), 
available at https://www.sec.gov/news/speech/2009/spch050509ebw.htm.
    In our Fiduciary Interpretation and in this release, we are 
providing our views on the duties and obligations that flow from the 
fiduciary duty and Regulation Best Interest. In this release, we 
discuss the specific obligations of broker-dealers under the 
Disclosure, Care and Conflicts of Interest Obligations, which 
include requirements to establish policies and procedures that 
comply with the Conflict of Interest Obligation, specifically to 
disclose and mitigate (i.e., reasonably reduce), or eliminate, 
certain conflicts. As discussed below, these specific obligations 
are tailored to address particular concerns that arise as a result 
of the broker-dealer model. For that reason, as well as the other 
reasons set forth above, the Commission does not believe that it is 
necessary to adopt a uniform standard in order to ensure that these 
specific obligations also apply to investment advisers, as the IAC 
suggests. See IAC 2018 Recommendation. In our Fiduciary 
Interpretation, we state that ``the application of the investment 
adviser's fiduciary duty will vary with the scope of the 
relationship,'' and here we have noted that we are not expressly 
defining in the rule text the term ``best interest,'' and instead 
are providing in the rule and through interpretations what ``best 
interest'' means. Compliance with each of the specific component 
obligations will turn on an objective assessment of the facts and 
circumstances of how the specific components of Regulation Best 
Interest are satisfied at the time that the recommendation is made. 
Finally, regardless of whether a retail investor chooses a broker-
dealer or an investment adviser (or both), the retail investor will 
be entitled to a recommendation (from a broker-dealer) or advice 
(from an investment adviser) that is in the best interest of the 
retail investor and that does not place the interests of the firm or 
the financial professional ahead of the interests of the retail 
investor.
---------------------------------------------------------------------------

    Regulation Best Interest considers and incorporates (to the extent 
appropriate) obligations that apply to investment advice in other 
contexts, with the goal of fostering greater consistency and clarity in 
the level of protection provided to retail customers at the time that a 
recommendation is made. We are tailoring these principles to the 
structure and characteristics of the broker-dealer relationship with 
retail customers and building upon existing regulatory obligations. As 
a result, Regulation Best Interest protects investors who seek access 
to the services, products, and payment options offered by broker-
dealers.
    Although we are not applying the existing fiduciary standard under 
the Advisers Act to broker-dealers, key elements of the standard of 
conduct that applies to broker-dealers under Regulation Best Interest 
will be substantially similar to key elements of the standard of 
conduct that applies to investment advisers pursuant to their fiduciary 
duty under the Advisers Act \124\ at the time that a recommendation is 
made. Regulation Best Interest's regulatory structure is unique to 
broker-dealers--and is tailored to the broker-dealer business model--
but regardless of whether a retail investor chooses a broker-dealer or 
an investment adviser (or both), the retail investor will be entitled 
to a recommendation (from a broker-dealer) or advice (from an 
investment adviser) that is in the best interest of the retail investor 
and that does not place the interests of the firm or the financial 
professional ahead of the interests of the retail investor.
---------------------------------------------------------------------------

    \124\ Specifically, an investment adviser's fiduciary duty under 
the Advisers Act comprises a duty of care and a duty of loyalty. 
This combination of care and loyalty obligations has been 
characterized as requiring the investment adviser to act in the 
``best interest'' of its client at all times. See Fiduciary 
Interpretation.
---------------------------------------------------------------------------

    As discussed in the proposal, and in the discussion below, 
Regulation Best Interest, as adopted, incorporates Care and Conflict of 
Interest Obligations substantially similar to the fiduciary duties of 
care and loyalty under Section 206(1) and (2) of the Advisers Act, even 
if not in the same manner as the 913 Study recommendations or identical 
to the duties under the Advisers Act.\125\ We extensively considered 
the 913 Study as part of developing Regulation Best Interest, as 
discussed in the Proposing Release, and believe that the enhancements 
to the broker-dealer standard of conduct incorporate, and in many 
aspects (such as the concept of mitigation, and the detailed Care 
Obligation), build upon and go beyond the recommendations in the 913 
Study.
---------------------------------------------------------------------------

    \125\ See Proposing Release at 21590.
---------------------------------------------------------------------------

    Although key elements are substantially similar, the Commission 
notes that the obligations of a broker-dealer under Regulation Best 
Interest and the obligations of an investment adviser pursuant to its 
fiduciary duty under the Advisers Act differ in certain respects, 
taking into account the scope of the services and relationships 
typically offered by broker-dealers and

[[Page 33331]]

investment advisers. For example, an investment adviser's duty of care 
encompasses the duty to provide advice and monitoring at a frequency 
that is in the best interest of the client, taking into account the 
scope of the agreed relationship. This difference reflects the 
generally ongoing nature of the advisory relationship, and the 
Commission's view that, within the scope of the agreed adviser-client 
relationship, investment advisers' fiduciary duty generally applies to 
the entire relationship. In contrast, the provision of recommendations 
in a broker-dealer relationship is generally transactional and 
episodic, and therefore the final rule requires that broker-dealers act 
in the best interest of their retail customers at the time a 
recommendation is made and imposes no duty to monitor a customer's 
account following a recommendation.
    As noted above, Regulation Best Interest also generally imposes 
more specific obligations on broker-dealers under the Disclosure, Care 
and Conflict of Interest Obligations (each of which is discussed in 
detail below) than the principles-based requirements of investment 
advisers' fiduciary duty under the Advisers Act. This approach is 
intended to tailor the application of principles that have developed in 
the context of a different business model over the course of almost 80 
years. Moreover, this more specific and tailored approach drawing on 
key fiduciary principles (1) is consistent with the generally rules-
based regulatory regime that applies to broker-dealers, (2) 
acknowledges that certain relevant obligations may already be addressed 
by existing broker-dealer requirements (e.g., broker-dealers are 
already subject to a duty of best execution), (3) allows us to impose 
requirements that we are believe are more appropriately tailored to 
address the specific conflicts raised by the transaction-based nature 
of the broker-dealer model, and (4) recognizes that it would be 
inappropriate to apply to certain generally applicable obligations of 
investment advisers (e.g., duty to monitor) in the context of a 
transaction-based relationship.
    These specific obligations include express requirements relating to 
the Care Obligation, requiring that a broker-dealer exercise reasonable 
diligence, care, and skill to: (1) Understand the risks, rewards and 
costs of a recommendation; (2) have a reasonable basis to believe that 
the recommendation is in the best interest of a particular retail 
customer, based on the retail customer's investment profile, and that 
the recommendation does not place the broker-dealer's interest ahead of 
the retail customer's interest; and (3) have a reasonable basis to 
believe that a series of transactions is in the best interest of the 
retail customer and does not place the interest of the broker-dealer 
ahead of the retail customer's interests. Regulation Best Interest 
imposes a duty of care that enhances existing suitability obligations 
(as discussed further below). It also includes a requirement under the 
Care Obligation to specifically address the risk that a broker-dealer's 
transaction-based recommendations and compensation could result in a 
series of recommendations that are not in the best interest or a retail 
customer--a ``churning'' risk unique to the broker-dealer model of 
providing recommendations and resulting transaction-based compensation.
    Regulation Best Interest also includes a requirement under the 
Conflict of Interest Obligation for broker-dealers to establish, 
maintain, and enforce written policies and procedures reasonably 
designed to (1) mitigate conflicts of interest at the associated person 
level, (2) specifically address the conflicts of interest presented 
when broker-dealers place material limitations on the securities or 
products that may be recommended (i.e., only make recommendations of 
proprietary or other limited range of products), and (3) eliminate 
sales contests, bonuses, and non-cash compensation that are based on 
the sales of specific securities or specific types of securities within 
a limited period of time. The conflicts of interest associated with 
incentives at the associated person level and limitations on the 
securities or products that may be recommended to retail customers have 
raised particular concerns in the context of the broker-dealer, 
transaction-based relationship. Accordingly, the Commission believes 
specific disclosure and additional mitigation requirements are 
appropriate to address those conflicts. Sales contests, sales quotas, 
bonuses and non-cash compensation that are based on the sales of 
specific securities within a limited period of time create high-
pressure situations for associated persons to increase the sales of 
specific securities or specific types of securities within a limited 
period of time and thus compromise the best interests of their retail 
customers. The Commission does not believe such conflicts of interest 
can be reasonably mitigated and, accordingly, they must be eliminated.
Phrasing of Standard
    We are adopting the phrasing ``act in the best interest of the 
retail customer at the time the recommendation is made, without placing 
the financial or other interest of the [broker-dealer] ahead of the 
interest of the retail customer'' as it was proposed.\126\ In response 
to comments, we are clarifying our views on what this standard entails 
and how it compares to the ``without regard to'' language of Section 
913.
---------------------------------------------------------------------------

    \126\ See paragraph (a)(1) of Regulation Best Interest. As 
discussed in Section II.C.2, we are also adding the phrasing ``does 
not place the financial or other interest of the broker, dealer, or 
such natural person . . . ahead of the retail customer'' to certain 
provisions of the Care Obligation.
---------------------------------------------------------------------------

    By replacing the ``without regard to'' language of Section 913(g) 
and the 913 Study with the ``without placing the financial or other 
interest of the [broker-dealer] . . . ahead of the interest of the 
retail customer'' phrasing, we did not intend to create a ``lower'' or 
``weaker'' standard compared to the language of Section 913(g) and the 
913 Study. Rather, we are adopting a standard that reflects that a 
broker-dealer should not put its interests ahead of the retail 
customer's interest, and thereby aligns with (and in certain areas 
imposes more specific obligations than) the investment adviser 
fiduciary duty, at the time a broker-dealer makes a recommendation to a 
retail customer.
    As discussed in the Proposing Release, we do not intend for our 
standard to require a broker-dealer to provide conflict-free 
recommendations. For example, under Regulation Best Interest, a broker-
dealer could recommend a more expensive or more remunerative security 
or investment strategy if the broker-dealer has a reasonable basis to 
believe there are other factors about the security or investment 
strategy that make it in the best interest of the retail customer, 
based on that retail customer's investment profile.\127\
---------------------------------------------------------------------------

    \127\ See Section II.C.2, Care Obligation.
---------------------------------------------------------------------------

    We also agree with commenters that we do not believe that is the 
intent behind the ``without regard to'' phrase, as included in Section 
913 of the Dodd-Frank Act or recommended in the 913 Study, as is 
evident both from other provisions of Section 913 that acknowledge and 
permit the existence of financial interests under that standard, and 
how our staff articulated the recommended uniform fiduciary standard in 
the 913 Study.\128\

[[Page 33332]]

Nevertheless, we are concerned that there is a risk that the ``without 
regard to'' language would be inappropriately construed to require a 
broker-dealer to eliminate all of its conflicts when making a 
recommendation (i.e., require recommendations that are conflict free), 
which we believe could ultimately harm retail investors by reducing 
their access to differing types of investment services and products and 
by increasing their costs.
---------------------------------------------------------------------------

    \128\ See Proposing Release at 21590. As noted in the proposal, 
among other things, Dodd-Frank Act Section 913(g) expressly provides 
that the receipt of commission-based compensation, or other standard 
compensation, for the sale of securities shall not, in and of 
itself, violate any uniform fiduciary standard promulgated under 
that subsection's authority as applied to a broker-dealer. Moreover, 
Section 913(g) does not itself require the imposition of the 
principal trade provisions of Advisers Act Section 206(3) on broker-
dealers. In addition, Dodd-Frank Act Section 913 provides that 
offering only proprietary products by a broker-dealer shall not, in 
and of itself, violate such a uniform fiduciary standard, but may be 
subject to disclosure and consent requirements. See Exchange Act 
Section 15(k)(1) and Advisers Act Section 211(g)(1). See also 913 
Study at 113; Proposing Release at 21590.
---------------------------------------------------------------------------

    The potential for a range of different meanings to be given to the 
phrase ``without regard to'' was heightened by the DOL's use of this 
same language for purposes of the Impartial Conduct Standards set forth 
in the BIC Exemption. We recognize, as noted by some commenters, that 
the DOL interpretation of this phrase does not require ``conflict-
free'' recommendations. Nevertheless, because of the differences in the 
approach to the treatment of conflicts under ERISA and under the 
federal securities laws--ERISA starts by prohibiting conflicts and then 
through exemptions permits certain conflicts, whereas the federal 
securities laws generally start with disclosure and become more 
restrictive--we share commenters' concerns that DOL's use of the 
``without regard to'' language could alter the way in which conflicts 
are viewed and cause a substantial portion of conduct that is currently 
permitted, and reasonably accepted and desired by retail customers, to 
be limited or eliminated. Based on market participant experience with 
the implementation of--and reaction to the subsequent overturning of--
the DOL Fiduciary Rule, in particular the BIC Exemption,\129\ we 
continue to believe that it is better to use language that provides 
similar investor protections, but does not raise these legal 
ambiguities.
---------------------------------------------------------------------------

    \129\ See supra footnotes 33 and 34 (citing reduction in 
services and increase in costs following DOL).
---------------------------------------------------------------------------

    The ``without placing the financial or other interest . . . ahead 
of the interest of the retail customer'' phrasing recognizes that while 
a broker-dealer will inevitably have some financial interest in a 
recommendation--the nature and magnitude of which will vary--the 
broker-dealer's interests cannot be placed ahead of the retail 
customer's interest.\130\ Accordingly, we believe this phrasing 
establishes a standard that enhances investor protection by prohibiting 
a broker-dealer from placing its interests ahead of the retail 
customer's interests, and preserves investor access (in terms of both 
choice and cost) to differing types of investment services and 
products.
---------------------------------------------------------------------------

    \130\ In this vein, we believe that a broker-dealer's 
``financial interest'' is broad, and that a broker-dealer is 
unlikely to have an ``other interest'' that is not a ``financial 
interest.'' See, e.g., Proposing Release at 21618 (noting ``. . . 
our interpretation of the types of material conflicts of interest 
arising from financial incentives is broad. . .'').
---------------------------------------------------------------------------

    The phrasing also aligns with an investment adviser's fiduciary 
obligation. As discussed in the Fiduciary Interpretation, an investment 
adviser's fiduciary duty under the Advisers Act comprises a duty of 
care and a duty of loyalty.\131\ The fiduciary duty requires that an 
adviser ``adopt the principal's goals, objectives, or ends.'' \132\ 
This means the adviser must, at all times, serve the best interest of 
its clients and not subordinate its client's interest to its own. In 
other words, the investment adviser cannot place its own interests 
ahead of the interests of its client.\133\ This combination of care and 
loyalty obligations has been characterized as requiring the investment 
adviser to act in the ``best interest'' of its client at all 
times.\134\
---------------------------------------------------------------------------

    \131\ See, e.g., Proxy Voting by Investment Advisers, Advisers 
Act Release No. 2106 (Jan. 31, 2003) (``Investment Advisers Release 
No. 2106''). See also Fiduciary Interpretation.
    \132\ Arthur B. Laby, The Fiduciary Obligations as the Adoption 
of Ends, 56 Buffalo Law Review 99 (2008); see also Restatement 
(Third) of Agency, Sec.  2.02 Scope of Actual Authority (2006) 
(describing a fiduciary's authority in terms of the fiduciary's 
reasonable understanding of the principal's manifestations and 
objectives). See Fiduciary Interpretation.
    \133\ See Fiduciary Interpretation.
    \134\ Id. See also Amendments to Form ADV, Advisers Act Release 
No. 3060 (Jul. 28, 2010) (adopting amendments to Form ADV and 
stating that ``under the Advisers Act, an adviser is a fiduciary 
whose duty is to serve the best interests of its clients, which 
includes an obligation not to subrogate clients' interests to its 
own,'' citing Investment Advisers Act Release 2106). See SEC v. 
Tambone, 550 F.3d 106, 146 (1st Cir. 2008) (``Section 206 imposes a 
fiduciary duty on investment advisers to act at all times in the 
best interest of the fund. . .''); SEC v. Moran, 944 F. Supp. 286, 
297 (S.D.N.Y 1996) (``Investment advisers are entrusted with the 
responsibility and duty to act in the best interest of their 
clients.'').
---------------------------------------------------------------------------

    Language that would require a broker-dealer to put the retail 
customer's interest ``first'' arguably raises many of the same concerns 
as the ``without regard to'' language. Accordingly, we are adopting a 
formulation in Regulation Best Interest that is consistent with how we 
describe the duty of loyalty for investment advisers in the Fiduciary 
Interpretation--that is, a requirement not to place the adviser's 
interests ahead of the interests of its client.\135\
---------------------------------------------------------------------------

    \135\ See Fiduciary Interpretation at footnote 54 (stating that, 
in practice, referring to putting a client's interest first is a 
plain English formulation commonly used by investment advisers to 
explain their duty of loyalty in a way that may be more 
understandable to retail clients).
---------------------------------------------------------------------------

    While we are not revising this phrasing of the standard, we 
appreciate concerns raised by commenters about clarifying whether this 
standard permits broker-dealers to allow their conflicts to taint their 
recommendations or to allow broker-dealers to make recommendations that 
are motivated by their own interests or to put their interests first. 
We discuss below what it means to ``act in the best interests,'' 
particularly in the context of satisfying the Care and Conflict of 
Interest Obligations. Specifically, we clarify that the obligations set 
forth in Regulation Best Interest are intended to require broker-
dealers to take steps to reduce the effect of (and in some cases 
eliminate) conflicts that create an incentive to place a broker-
dealer's or an associated person's interest ahead of the retail 
customer's interest when making a recommendation, and to make 
recommendations in the best interest of the retail customer even where 
conflicts continue to exist. We believe that this approach will result 
in a standard of conduct that is consistent with what a reasonable 
retail customer would expect.\136\
---------------------------------------------------------------------------

    \136\ See, e.g., Brian Scholl, et al., SEC Office of the 
Investor Advocate and RAND Corporation, The Retail Market for 
Investment Advice (2018), available at https://www.sec.gov/comments/s7-07-18/s70718-4513005-176009.pdf (``OIAD/RAND''). OIAD/RAND 
summarized the results of focus groups, indicating that in the 
context of discussing expectations for standards of conduct, ``the 
groups typically expected that a financial professional who is 
acting in a client's best interest'' to, among other things, 
``disclose payments they receive that might influence their advice 
[and] avoid taking higher compensation for selling one product over 
a similar but less costly product.'' Further, OIAD/RAND summarized 
focus group comments on professionals' form of compensation, noting 
that ``although many participants prefer that a professional be 
compensated by the client alone, some might not rule out using a 
professional who is receiving other compensation, for example if the 
compensation is openly disclosed and they are comfortable with the 
professional.'' The SEC's Office of Investor Advocate and the RAND 
Corporation prepared this research report regarding the retail 
market of investment advice prior to, and separate from, our 
rulemaking proposals. This report was included in the comment file 
at https://www.sec.gov/comments/s7-07-18/s70718-4513005-176009.pdf. 
See also, e.g., Washington, DC Roundtable at 49 (``So it seems to me 
that there is a tight connection between the obligation that you 
have, and our obligations down below here to the conflicts of 
interest, that it's really important that advisers or brokers spell 
out what conflicts of interest they have, and what that means in 
real terms to the person before they make a choice, for example'').

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[[Page 33333]]

    Finally, although our standard draws from key fiduciary principles, 
for various reasons, including to emphasize that Regulation Best 
Interest is tailored to the broker-dealer relationship and distinct 
from the investment adviser fiduciary duty, we are not referring to 
Regulation Best Interest as a ``fiduciary'' standard, and we emphasize 
that Regulation Best Interest is separate from any common law analysis 
of whether a broker-dealer has fiduciary duties.\137\ As noted in the 
proposal, fiduciary standards vary, for example, for investment 
advisers, banks acting as trustees or fiduciaries, and fiduciaries to 
ERISA plans. As we have learned through our consideration of the 
Relationship Summary Proposal, and from various investor studies, using 
the term ``fiduciary'' to describe the standard may not sufficiently 
convey meaning regarding the specific substance of the standard.\138\ 
In addition, we appreciate commenters' concerns that using the term in 
the context of a different relationship may introduce further legal or 
compliance ambiguity.\139\
---------------------------------------------------------------------------

    \137\ In addition to the antifraud provisions of the federal 
securities laws, courts interpreting state common law have imposed 
fiduciary obligations on broker-dealers in certain circumstances. 
See Proposing Release at 21584. Generally, courts have found that 
broker-dealers that exercise discretion or control over customer 
assets, or have a relationship of trust and confidence with their 
customers, owe customers a fiduciary duty. Id. In developing 
proposed Regulation Best Interest, the Commission has drawn from 
principles that apply to investment advice under other regulatory 
regimes, including state common law fiduciary principles, among 
others. By doing so, we hope to establish greater consistency in the 
level of retail customer protections and to make it easier to comply 
with Regulation Best Interest where other legal regimes, such as 
state common law drawing upon comparable fiduciary principles, might 
also apply.
    \138\ See, e.g., RAND 2018 (``Some participants had never heard 
of the word, whereas others had heard it but did not know what it 
meant in this context. Others thought the word ``fiduciary implies 
acting in best interest . . .''). We have modified the standard of 
conduct disclosure required by Form CRS to eliminate technical 
words, such as ``fiduciary,'' and describe the standards of conduct 
of broker-dealers, investment advisers, or dual-registrants using 
similar terminology in a plain-English manner. In particular, Form 
CRS uses the term ``best interest'' to describe how broker-dealers, 
investment advisers, and dual-registrants must act regarding their 
retail customers or clients when providing recommendations as a 
broker-dealer or acting as an investment adviser. See Relationship 
Summary Adopting Release.
    \139\ See, e.g., Stifel Letter.
---------------------------------------------------------------------------

    As articulated in the Proposing Release, we appreciate the desire 
for clarity about the requirements imposed by Regulation Best Interest, 
and we have sought to provide such clarity by specifying by rule the 
specific components with which a broker-dealer is required to comply to 
satisfy its best interest obligation. The changes we are making from 
the Proposing Release to this final Regulation Best Interest and the 
additional interpretations and guidance we are providing are intended 
to further clarify how a broker-dealer could comply with these 
requirements.
    As noted above and discussed in the Fiduciary Interpretation, an 
investment adviser's fiduciary duty under the Advisers Act requires the 
adviser to act in the best interests of its clients. We have chosen to 
describe the standard by referring directly to what the standard 
requires at the time a recommendation is made.\140\ Furthermore, while 
key elements of the standard of conduct that applies to broker-dealers 
under Regulation Best Interest will be substantially similar to key 
elements of the standard of conduct that applies to investment advisers 
pursuant to their fiduciary duty under the Advisers Act at the time 
that a recommendation is made, we are concerned that using the term 
``fiduciary'' to describe a broker-dealer's obligations under 
Regulation Best Interest may create confusion by suggesting that the 
standards of conduct are identical in all respects, when there are key 
differences as noted above, including the scope of the of the duty 
(e.g., the application of the adviser's fiduciary duty to the entire 
relationship versus Regulation Best Interest's recommendation-specific 
application, and the application of an adviser's fiduciary duty to all 
clients as opposed to Regulation Best Interest's application to retail 
customers).\141\
---------------------------------------------------------------------------

    \140\ As discussed in the Relationship Summary Adopting Release, 
we are adopting a requirement in Form CRS for a description of a 
firm's applicable standard of conduct using prescribed wording.
    \141\ See Fiduciary Interpretation.
---------------------------------------------------------------------------

    Similarly, while we are not harmonizing the phrasing of the best 
interest standard with the DOL's definition of ``best interest'' as 
reflected in the BIC Exemption's Impartial Conduct Standards, as 
suggested by some commenters,\142\ or otherwise adopting some or all 
conditions of the BIC Exemption, we gave careful consideration to the 
DOL Fiduciary Rule in developing Regulation Best Interest.\143\ 
Regulation Best Interest takes into account both market participant 
experience with the implementation of--and reaction to the subsequent 
overturning of the DOL Fiduciary Rule, in particular the BIC Exemption. 
As discussed in the Proposing Release, we believe Regulation Best 
Interest is consistent with many of the key components of the DOL's 
Impartial Conduct Standards. Regulation Best Interest incorporates 
principles underlying the DOL Fiduciary Rule--such as the concept of 
conflict mitigation--that, based on our expertise in regulating the 
broker-dealer industry, we believe would further our goal of reducing 
the effect of conflicts on recommendations and would promote 
recommendations in the best interest of the retail customer even where 
conflicts continue to exist.
---------------------------------------------------------------------------

    \142\ See AARP August 2018 Letter; Wells Fargo Letter; Schwab 
Letter; NASAA August 2018 Letter.
    \143\ On March 15, 2018, the DOL Fiduciary Rule was vacated by 
the United States Court of Appeals for the Fifth Circuit. Chamber of 
Commerce v. U.S. Dep't of Labor, 885 F.3d 360 (5th Cir. 2018).
---------------------------------------------------------------------------

2. General Obligation To ``Act in Best Interest''
    We agree with commenters that further clarity should be provided on 
what it means to ``act in the best interest'' of a retail customer and 
particularly what it means to make a recommendation in a retail 
customer's ``best interest'' under the Care Obligation. In the guidance 
that follows and in the detailed discussion of each of the Disclosure, 
Care, Conflict of Interest, and Compliance Obligations in Section II.C 
below, we provide further clarity on how a broker-dealer acts in a 
retail customer's best interest when making a recommendation.
    First, in response to comments, we are clarifying the relationship 
between the General Obligation and the specific component obligations 
described in Section II.C. These specific component obligations 
expressly set forth what it means to ``act in the best interest'' of 
the retail customer in accordance with the General Obligation. As 
articulated in the proposal, and discussed in more detail in the 
relevant sections specifically addressing these obligations, these 
specific component obligations draw on principles underlying the 
fiduciary duties of care and loyalty interpreted under the Advisers Act 
and as recommended in the 913 Study. However, we believe that adopting 
specific regulatory obligations for broker-dealers appropriately 
reflects the structure and characteristics of broker-dealer 
relationships with retail customers and the extensive existing 
regulatory regime applicable to broker-dealers. Regulation Best 
Interest does not establish a ``safe harbor.'' The specific component 
obligations of Regulation Best Interest are mandatory, and failure to 
comply with any of the components would violate the General Obligation. 
By contrast, compliance with a safe harbor is optional, and failure to 
comply with the terms of the safe harbor does not necessarily violate 
the relevant legal requirement.
    Second, while we are declining to expressly define ``best 
interest'' in the

[[Page 33334]]

rule text as suggested by some commenters, we are providing 
interpretations and guidance regarding the application of the specific 
component obligations and in particular what it means to make a 
recommendation in the retail customer's ``best interest.'' Consistent 
with the proposal, compliance with each of the specific component 
obligations of Regulation Best Interest, including the ``best 
interest'' requirement in the Care Obligation, will be applied in a 
principles-based manner. This principles-based approach to determining 
what is in the ``best interest'' is similar to an investment adviser's 
fiduciary duty, which has worked well for advisers' retail clients and 
our markets. As proposed, whether a broker-dealer has acted in the 
retail customer's best interest will turn on an objective assessment of 
the facts and circumstances of how the specific components of 
Regulation Best Interest are satisfied at the time that the 
recommendation is made (and not in hindsight). In particular, whether a 
broker-dealer's recommendation satisfies the requirements of the Care 
Obligation is an objective evaluation that is not susceptible to a 
bright line test; rather it turns on the facts and circumstances of the 
particular recommendation and the particular retail customer, at the 
time the recommendation is made. This facts-and-circumstances approach 
recognizes that one size does not fit all, and what is in the best 
interest of one retail customer may not be in the best interest of 
another.
    We understand that markets evolve and we encourage broker-dealers 
to have an open dialogue with the Commission and Commission's staff as 
questions arise.
    As a general matter, however, in response to comments, we are 
changing guidance in the Proposing Release stating that under 
Regulation Best Interest, a broker-dealer's financial interests cannot 
be the ``predominant motivating factor behind'' a recommendation, and 
that a ``broker-dealer would violate proposed Regulation Best 
Interest's Care Obligation and Conflict of Interest Obligations, if any 
recommendation was predominantly motivated by the broker-dealer's self-
interest.'' \144\ Many commenters expressed concerns regarding and 
requested removal of the ``predominantly motivated'' language, stating 
that it contradicted statements that there was no scienter requirement 
under Regulation Best Interest by requiring a consideration of intent, 
creating ambiguity as to what extent a broker-dealer's interests could 
influence its recommendations or requiring a weighing of the broker-
dealer's interests against the retail customer's interests.\145\ Some 
commenters, however, indicated support for the ``predominantly 
motivated language'' in the context of agreeing with the Commission's 
proposed ``without placing the financial or other interest . . . 
ahead'' phrasing of the best interest standard.\146\
---------------------------------------------------------------------------

    \144\ See Proposing Release at 21588.
    \145\ See CFA August 2018 Letter; Better Markets August 2018 
Letter; Wells Fargo Letter.
    \146\ See AXA Letter; FSI August 2018 Letter.
---------------------------------------------------------------------------

    In consideration of these comments, we are modifying these 
statements to remove this language and to clarify our intent. 
Specifically, Regulation Best Interest recognizes that while a broker-
dealer will inevitably have some financial interest in a 
recommendation--the nature and magnitude of which will vary--the 
broker-dealer's interests cannot be placed ahead of the retail 
customer's interest.\147\ Accordingly, Regulation Best Interest will 
not per se prohibit a broker-dealer from making recommendations where 
conflicts of interest are present.\148\ Instead, Regulation Best 
Interest includes specific requirements for broker-dealers to address 
their conflicts of interest.\149\ These specific requirements are 
designed to promote recommendations that are in the best interest of 
the retail customer despite the existence of these conflicts of 
interest. In other words, recommendations involving conflicts of 
interest between the broker-dealer and the retail customer will be 
permissible under Regulation Best Interest only to the extent that the 
broker-dealer satisfies the specific requirements of Regulation Best 
Interest.
---------------------------------------------------------------------------

    \147\ See id. See infra Section II.C.2.
    \148\ Such conflicts of interest may include: Charging 
commissions or other transaction-based fees; receiving or providing 
differential compensation based on the product sold; receiving 
third-party compensation; recommending proprietary products, 
products of affiliates or a limited range of products; recommending 
a security underwritten by the broker-dealer or a broker-dealer 
affiliate, including initial public offerings (``IPOs''); 
recommending a transaction to be executed in a principal capacity; 
allocating trades and research, including allocating investment 
opportunities (e.g., IPO allocations or proprietary research or 
advice) among different types of customers and between retail 
customers and the broker-dealer's own account; considering cost to 
the broker-dealer of effecting the transaction or strategy on behalf 
of the customer (for example, the effort or cost of buying or 
selling a complex or an illiquid security); or accepting a retail 
customer's order that is contrary to the broker-dealer's 
recommendations. While these practices will not be per se prohibited 
by Regulation Best Interest, we are also not saying that these 
practices are per se consistent with Regulation Best Interest or 
other obligations under the federal securities laws. See also 
Proposing Release at 21587.
    \149\ Id at 21588.
---------------------------------------------------------------------------

    Further, for the reasons discussed in the proposal, we confirm that 
Regulation Best Interest is not intended to limit or eliminate 
recommendations that encourage diversity in a retail customer's 
portfolio through investment in a wide range of products, including, 
when appropriate, products that may involve higher risks or cost to the 
retail customer, as these products may be in the best interest of 
certain retail customers at certain times or in certain 
circumstances.\150\ Regulation Best Interest will not necessarily 
obligate a broker-dealer to recommend the ``least expensive'' or the 
``least remunerative'' security or investment strategy, provided the 
broker-dealer complies with the specific component obligations.\151\ In 
other words, Regulation Best Interest will allow a broker-dealer to 
recommend products that entail higher costs or risks for the retail 
customer, or that result in greater compensation to the broker-dealer, 
or that are more expensive, than other products, provided that the 
broker-dealer complies with the specific component obligations detailed 
below,\152\ including the requirement to make these recommendations 
exercising reasonable diligence, care, and skill to have a reasonable 
basis to believe that the recommendation is in the retail customer's 
best interest and does not place the broker-dealer's interest ahead of 
the retail customer's interest.
---------------------------------------------------------------------------

    \150\ Id.
    \151\ See id.
    \152\ See id.
---------------------------------------------------------------------------

    Finally, some commenters sought additional clarity whether 
Regulation Best Interest would extend beyond a particular 
recommendation, impose a duty to monitor the retail customer's account, 
or apply to unsolicited orders.\153\ We confirm that, consistent with 
the Proposing Release and as discussed further below, Regulation Best 
Interest would not: (1) Extend beyond a particular recommendation \154\ 
or generally require a broker-dealer to have a continuous duty to a 
retail customer or impose a duty to monitor; \155\ (2) require the 
broker-dealer

[[Page 33335]]

to refuse to accept a customer's order that is contrary to the broker-
dealer's recommendation; or (3) apply to self-directed or otherwise 
unsolicited transactions by a retail customer, whether or not she also 
receives separate recommendations from the broker-dealer.
---------------------------------------------------------------------------

    \153\ See, e.g., SIFMA August 2018 Letter; Transamerica August 
2018 Letter; see also generally CFA August 2018 Letter; Better 
Markets August 2018 Letter.
    \154\ However, paragraph (a)(2)(iii)(C) of Regulation Best 
Interest addresses a series of recommended transactions. See Section 
II.C.2.d.
    \155\ However, as discussed below, it is our position that when 
a broker-dealer agrees with a retail customer to provide account 
monitoring services: (1) The broker-dealer would be required to 
disclose the material facts (including scope and frequency) of those 
services pursuant to the Disclosure Obligation, and (2) such agreed-
upon account monitoring services involve an implicit recommendation 
to hold (i.e., an implicit recommendation not to buy, sell, or 
exchange assets pursuant to that securities account review) at the 
time agreed-upon monitoring occurs, which is a recommendation ``of 
any securities transaction or investment strategy involving 
securities'' covered by Regulation Best Interest.
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B. Key Terms and Scope of Best Interest Obligation

1. Natural Person Who Is an Associated Person
    In the Proposing Release, we stated that a ``natural person who is 
an associated person'' is a natural person who is an associated person 
as defined in Section 3(a)(18) of the Exchange Act: ``any partner, 
officer, or director or branch manager of such broker or dealer (or any 
person occupying a similar status or performing similar functions); any 
person directly or indirectly controlling, controlled by, or under 
common control with such broker or dealer; or any employee of such 
broker or dealer, except that any person associated with a broker or 
dealer whose functions are solely clerical or ministerial shall not be 
included in the meaning of such term for purposes of Section 15(b) of 
this title (other than paragraph 6 thereof).'' \156\ In limiting the 
term to only a ``natural person who is an associated person,'' we 
sought to exclude affiliated entities of the broker-dealer that are not 
themselves broker-dealers, as they are not the intended focus of 
Regulation Best Interest.\157\
---------------------------------------------------------------------------

    \156\ Proposing Release at 21592-21593.
    \157\ Id.
---------------------------------------------------------------------------

    We solicited comment on whether the application of the definition 
was appropriate, alternative definitions should be considered, or the 
scope should be broadened or narrowed. We received no comments and, for 
the reasons discussed in the Proposing Release, are using the term 
``natural person who is an associated person,'' consistent with the 
definition in Section 3(a)(18) of the Exchange Act.\158\
---------------------------------------------------------------------------

    \158\ Id.
---------------------------------------------------------------------------

2. Recommendation of Any Securities Transaction or Investment Strategy 
Involving Securities
    We proposed to apply Regulation Best Interest to broker-dealer 
recommendations of any securities transaction or investment strategy 
involving securities to a retail customer. We believed that by applying 
Regulation Best Interest to a ``recommendation,'' as that term is 
currently interpreted under broker-dealer regulation, we would make 
clear when the obligation applied and would maintain efficiencies for 
broker-dealers that have already established infrastructures to comply 
with suitability obligations, which are recommendation-based.\159\ 
Moreover, we believed that focusing on each recommendation would 
appropriately capture and reflect the various types of recommendations 
that broker-dealers make to retail customers, whether on an episodic, 
periodic, or more frequent basis and would help ensure that retail 
customers receive the protections that Regulation Best Interest is 
intended to provide. We received numerous comments supporting our 
general proposed approach to what is a ``recommendation,'' while 
several commenters suggested modifications regarding the scope of a 
recommendation or sought additional clarity regarding particular 
scenarios.\160\
---------------------------------------------------------------------------

    \159\ Id.
    \160\ See generally SIFMA August 2018 Letter; Financial Engines 
Letter; IPA Letter; Putnam Letter; Cambridge Letter (recommending 
the Commission adopt FINRA's approach to determining whether a 
communication is a ``recommendation''). But see NASAA August 2018 
Letter; BlackRock Letter; FSI August 2018 Letter (recommending 
modifications or clarifications to ``recommendation'').
---------------------------------------------------------------------------

    As we indicated in the Proposing Release, in our view, the 
determination of whether a broker-dealer has made a recommendation that 
triggers application of Regulation Best Interest should turn on the 
facts and circumstances of the particular situation and therefore, 
whether a recommendation has taken place is not susceptible to a bright 
line definition. Factors considered in determining whether a 
recommendation has taken place include whether the communication 
``reasonably could be viewed as a `call to action''' and ``reasonably 
would influence an investor to trade a particular security or group of 
securities.'' \161\ The more individually tailored the communication to 
a specific customer or a targeted group of customers about a security 
or group of securities, the greater the likelihood that the 
communication may be viewed as a ``recommendation.'' We continue to 
believe this general framework regarding what is a recommendation is 
appropriate, and for the reasons discussed in the Proposing Release, 
are taking this approach.\162\
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    \161\ See Proposing Release at 21592-21593; see also NASD Notice 
to Members 01-23, Online Suitability--Suitability Rules and Online 
Communications (Apr. 2001); Notice of Filing Proposed Rule Change to 
Adopt FINRA Rule 2090 (Know Your Customer) and FINRA Rule 2111 
(Suitability) in the Consolidated FINRA Rulebook, Exchange Act 
Release No. 62718 (Aug. 13, 2010), 75 FR 51310 (Aug. 19, 2010), as 
amended, Exchange Act Release No. 67218A (Aug. 20, 2010), 75 FR 
52562 (Aug. 26, 2010) (discussing what it means to make a 
``recommendation'').
    \162\ See Proposing Release at 21592-21593.
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    While certain commenters recommended formally defining the term 
``recommendation,'' including what does not come within that term,\163\ 
other commenters maintained there is no need to define 
``recommendation'' and expressed support for harmonizing the term in 
accordance with existing broker-dealer guidance and case law.\164\ We 
agree with commenters that clarity is important, and we continue to 
believe that the current principles-based approach underlying existing 
Commission precedent and guidance will provide effective clarity. Being 
more prescriptive could result in a definition that is over inclusive, 
under inclusive, or both.\165\ We believe that what constitutes a 
recommendation is highly fact-specific and not conducive to an express 
definition in the rule text. Furthermore, we believe that the existing 
framework has worked well, that broker-dealers generally are familiar 
with the existing framework, and therefore, that this approach should 
continue. Accordingly, we are taking the approach as set forth in the 
Proposing Release, which we believe provides a workable framework and 
clarity for broker-dealers regarding the contours of a recommendation. 
To provide further clarity, in response to comments, we describe below 
the types of communications that we generally view

[[Page 33336]]

as falling outside of the scope of a recommendation.
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    \163\ See, e.g., Prudential Letter (recommending an express 
definition of ``recommendation'' that would codify guidance).
    \164\ See, e.g., SIFMA August 2018 Letter (``Similarly, the SEC 
refers to the FINRA concept of `recommendation' rather than 
prescribing a specific definition. We believe this is appropriate, 
and we believe that a carve-out for educational materials would be 
consistent with that approach.''); Edward Jones Letter (``We do not 
believe it is necessary for the SEC to define the phrase `at the 
time the recommendation is made,' because its meaning is plain.''); 
Cambridge Letter (``FINRA Rule 2111 sets forth an explicit standard 
for what constitutes a recommendation and recognizes `call to 
action' as the hallmark. Cambridge believes this definition is fully 
understood and in use by the industry.'' Cambridge also states that 
harmonizing the final rule with existing FINRA rules and guidance 
will provide clarity to firms, financial professionals, and 
investors).
    \165\ See id.; Proposing Release at 21592-21593. Similarly, 
FINRA has stated that ``defining the term `recommendation' is 
unnecessary and would raise many complex issues in the absence of 
specific facts of a particular case.'' Exchange Act Release No. 
37588, 1996 SEC LEXIS 2285, at *29 (Aug. 20, 1996), 61 FR 44100, 
44107 (Aug. 27, 1996).
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    We are also generally confirming our interpretation in the 
Proposing Release of the phrase ``any securities transaction or 
investment strategy involving securities.'' However, in response to 
comments regarding the coverage of certain securities or investment 
strategies, we are providing further clarity regarding our 
interpretation of this phrase, and in certain instances, refining our 
interpretation. For example, as discussed more fully below, we are 
confirming our interpretation that recommendations of ``any securities 
transaction'' (purchase, sale, or exchange) and any ``investment 
strategy'' involving securities (including an explicit hold 
recommendation) are recommendations ``of any securities transaction or 
investment strategy involving securities.''
    In addition, we are generally confirming our interpretation that a 
broker-dealer may agree with a retail customer to take on additional 
obligations beyond those imposed by Regulation Best Interest, for 
example, by agreeing with a retail customer to provide monitoring of 
the retail customer's investments on a periodic basis for purposes of 
recommending changes in investments.\166\ In response to comments, it 
is our position that when a broker-dealer agrees \167\ with a retail 
customer to monitor that customer's account: (1) The broker-dealer is 
required to disclose the terms of such account monitoring services 
(including the scope and frequency of those services) pursuant to the 
Disclosure Obligation \168\ and (2) such agreed-upon monitoring 
involves an implicit recommendation to hold (i.e., recommendation not 
to buy, sell, or exchange assets pursuant to that securities account 
review) at the time the agreed-upon monitoring occurs, which is a 
recommendation ``of any securities transaction or investment strategy 
involving securities'' covered by Regulation Best Interest.\169\ As 
discussed further below, in our view, a recommendation of ``an 
investment strategy'' includes implicit hold recommendations in this 
context, where the broker-dealer has agreed to monitor a retail 
customer's account.\170\ We are interpreting the phrase ``any security 
transaction or investment strategy'' to include instances where there 
is an agreement to monitor because in this context there is an implicit 
recommendation to hold at the time the agreed-upon monitoring occurs 
when the broker-dealer does not provide an express recommendation to 
buy, sell, or hold.\171\
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    \166\ Proposing Release at 21594-21595. The Proposing Release 
referred to ``ongoing'' monitoring of the retail customer's 
investments for purposes of recommending changes in investments. Id. 
In the discussion that follows and the Solely Incidental 
Interpretation, we are clarifying our views regarding broker-dealer 
account monitoring services, and the application of Regulation Best 
Interest to such services. As discussed in the Solely Incidental 
Interpretation, a broker-dealer that agrees to monitor a retail 
customer's account on a periodic basis for purposes of providing 
buy, sell, or hold recommendations may still be considered to 
provide advice in connection with and reasonably related to 
effecting securities transactions. Broker-dealers may choose to 
adopt policies and procedures that, if followed, would help 
demonstrate that any agreed-upon monitoring is in connection with 
and reasonably related to the broker-dealer's primary business of 
effecting securities transactions. See Solely Incidental 
Interpretation.
    \167\ An agreement to provide account monitoring services to a 
retail customer is not required to be in writing (although whether 
or not the broker-dealer is providing account monitoring services, 
and, if so, the scope and frequency of such monitoring services, 
must be disclosed in writing pursuant to the Disclosure Obligation). 
For example, a broker-dealer's oral undertaking that the broker-
dealer will monitor the retail customer's account on a periodic 
basis would create an agreement to monitor the account on the terms 
specified orally. Whether an agreement with the retail customer has 
been established in the absence of a written agreement or express 
oral undertaking will depend on an objective inquiry of the 
particular facts and circumstances, including reasonable retail 
customer expectations arising from the broker-dealer's course of 
conduct. In cases where a broker-dealer does not intend to create an 
implied agreement to monitor the retail customer's account through 
course of conduct or otherwise, and to avoid ambiguity over whether 
an implied agreement has been formed, broker-dealers should take 
steps to ensure that all communications with the retail customer are 
consistent with its disclosures required under the Disclosure 
Obligation, which in this case would require the broker-dealer to 
clearly disclose that the broker-dealer does not monitor the retail 
customer's account.
    \168\ To avoid ambiguity over whether or when an implicit hold 
recommendation has been made, this disclosure should identify with 
specificity when the agreed upon monitoring will occur. See also 
FINRA Regulatory Notice 12-25 at Q14.
    \169\ See IAC 2018 Recommendation; NAIFA Letter; AFL-CIO April 
2019 Letter; see also FINRA Regulatory Notice 12-25, Suitability--
Additional Guidance on FINRA's New Suitability Rule (May 2012) at Q3 
and accompanying footnotes.
    \170\ See FINRA Rule 2111.03; FINRA Regulatory Notice 12-25. The 
Commission recognizes that its position with respect to Regulation 
Best Interest differs from that provided in FINRA guidance regarding 
whether implicit hold recommendations are subject to the suitability 
rule. This interpretation applies in the context of the protections 
of Regulation Best Interest, and does not change the scope of the 
application of the FINRA suitability rule. Further, while for 
purposes of Regulation Best Interest implicit hold recommendations 
are generally recommendations of ``any securities transaction or 
investment strategy regarding securities'' where a broker-dealer 
agrees to provide account monitoring services, we are not otherwise 
addressing the treatment of implicit hold recommendations in other 
contexts. In other words, except where a broker-dealer agrees to 
provide account monitoring services as described, consistent with 
existing FINRA guidance, Regulation Best Interest will only apply to 
explicit hold recommendations. See FINRA Regulatory Notice 12-25 at 
Q3 and accompanying footnotes.
    \171\ Our interpretation is generally consistent with 
commenters' views regarding the application of Regulation Best 
Interest to implicit hold recommendations in the context of agreed-
upon account monitoring services. See IAC 2018 Recommendation (``we 
believe the best interest standard should be applied to the broker-
dealer's monitoring of the customer account, where brokers provide 
ongoing services to the account. In essence, this would apply the 
best interest standard to the implicit ``no recommendation'' 
recommendation that a broker makes when reviewing the account and 
recommending no change.''); NAIFA Letter (asserting broker-dealers 
should be free to agree to, and define the nature of, any ongoing 
relationship via contract, such as including monitoring services). 
See also AFL-CIO April 2019 Letter (``adopt a principles-based 
obligation to monitor the account, where the nature and extent of 
the monitoring follows the contours of the relationship''). See also 
supra footnote 166 (encouraging broker-dealers to adopt policies and 
procedures that, if followed, would help demonstrate that any 
agreed-upon monitoring is in connection with and reasonably related 
to the broker-dealer's primary business of effecting securities 
transactions in accordance with the Solely Incidental 
Interpretation).
---------------------------------------------------------------------------

    We recognize that a broker-dealer may voluntarily, and without any 
agreement with the customer, review the holdings in a retail customer's 
account for the purposes of determining whether to provide a 
recommendation to the customer. We do not consider this voluntary 
review to be ``account monitoring,'' nor would it in itself create an 
implied agreement with the retail customer to monitor the customer's 
account. Any explicit recommendation made to the retail customer as a 
result of any such voluntary review would be subject to Regulation Best 
Interest.
    Finally, in response to comments received, we have modified the 
rule text to provide that an ``investment strategy involving 
securities'' includes ``account recommendations.'' We interpret 
``account recommendations'' to include recommendations of securities 
account types generally, as well as recommendations to roll over or 
transfer assets from one type of account to another (e.g., workplace 
retirement plan to an IRA). As discussed in more detail below, we 
believe that recommendations of securities account types are consistent 
with the types of recommendations that have been treated as investment 
strategies,\172\ because the

[[Page 33337]]

type of securities account recommended is an investment strategy that 
has the potential to greatly affect retail customers' costs and 
investment returns.\173\ For example, different types of securities 
accounts can offer different features, products, or services, some of 
which may--or may not--be in the best interest of certain retail 
customers.\174\ Our interpretation is consistent with a majority of the 
IAC and other commenters that stated that such important 
recommendations relating to securities are ``investment strategies 
involving securities'' and thus within the scope of Regulation Best 
Interest.\175\ We note that, although we are specifically identifying 
``account recommendations'' as an investment strategy involving 
securities in the rule text, an account recommendation is just one 
example of an investment strategy.
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    \172\ Although FINRA has stated that a recommendation concerning 
the type of workplace retirement plan account in which a customer 
should hold his retirement investments typically involves a 
recommended securities transaction, and thus is subject to 
suitability requirements, FINRA did not address whether such a 
recommendation would be an investment strategy in the absence of 
such a recommended securities transaction. FINRA Regulatory Notice 
13-45, Rollovers to Individual Retirement Accounts--FINRA Reminds 
Firms of Their Responsibilities Concerning IRA Rollovers (Dec. 
2013). Taking this approach is consistent with Commission precedent 
finding a recommendation of a margin strategy to be unsuitable under 
the NASD suitability rule, in light of the associated transactions 
costs and the impact the strategy could have on customer returns. 
See F.J. Kaufman & Co., 50 SEC. 164 (1989) (Commission Opinion) 
(stating that a broker-dealer recommending the purchase of 
securities using a margin strategy ``at a minimum . . . had an 
obligation to understand that, in light of the applicable 
transaction costs, the two components of his recommended strategy, 
when combined, always would have produced returns inferior to those 
that could have been obtained from one of those components 
alone.'').
    \173\ See SEC Office of Investor Education and Advocacy, Updated 
Investor Bulletin: How Fees and Expenses Affect Your Investment 
Portfolio (Sep. 2016).
    \174\ In addition to brokerage versus investment advisory 
accounts, there are also many options or account types within 
brokerage accounts. For example, brokerage accounts can include: 
Education accounts (e.g., 529 Plans and tax-free Coverdell 
accounts); retirement accounts (e.g., IRA, Roth IRA, or SEP-IRA 
accounts); and specialty accounts (e.g., cash or margin accounts, 
and accounts with access to Forex or options trading). Different 
brokerage accounts can also offer different levels of services, such 
as access to online trading, or can offer different products, for 
example, in higher dollar amount accounts (e.g., access to products 
with break-points).
    \175\ See, e.g., IAC 2018 Recommendation (``Decisions about 
which type of account to open have the potential to greatly affect 
their costs. Moreover, both rollover and account type 
recommendations are recommendations of an `investment strategy 
involving securities' that can have substantial potential long-term 
impacts on investors. Both types of recommendations inherently 
involve potential conflicts of interest, making it critical that 
advisers and brokers put their clients' interests ahead of their own 
in making such recommendations.''); Capital Group Letter (``Choosing 
between a brokerage and an advisory account is an incredibly 
impactful decision for investors. It is very important that these 
recommendations be made in the best interest of the retail 
[customer].'').
---------------------------------------------------------------------------

a. Recommendation
    We interpret whether a ``recommendation'' has been made to a retail 
customer that triggers the best interest obligation consistent with 
precedent under the anti-fraud provisions of the federal securities 
laws as applied to broker-dealers, and with how the term has been 
applied under the rules of self-regulatory organizations 
(``SROs'').\176\ Several commenters supported this approach, and 
specifically agreed with following the existing facts and circumstances 
approach as understood under federal securities laws and SRO 
rules.\177\
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    \176\ See Proposing Release at 21592-21595. In this regard, 
Regulation Best Interest does not extend beyond a particular 
recommendation, for example, by imposing a general broker-dealer 
duty to monitor a customer's account or by applying the duty to 
unsolicited orders.
    \177\ See, e.g., AXA Letter; SIFMA August 2018 Letter; IPA 
Letter; Putnam Letter; FSI August 2018 Letter; Cetera August 2018 
Letter.
---------------------------------------------------------------------------

    Commenters sought additional clarity regarding the scope of a 
recommendation and in particular whether certain activities or 
communications would constitute recommendations, and requested that the 
Commission incorporate or specifically identify exceptions or 
exclusions such as the exceptions recognized in FINRA Rule 2111.03 
(Suitability) or acknowledged by the DOL.\178\ Some commenters also 
sought an explicit carve out or confirmation that certain 
communications, such as general education materials, general retirement 
planning materials, or general retirement communications, including 
``pure distribution recommendations,'' are not ``recommendations'' 
subject to Regulation Best Interest.\179\
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    \178\ See, e.g., Prudential Letter; Transamerica August 2018 
Letter; SPARK Letter; see also FINRA Rule 2111.03 (excluding the 
following communications from the coverage of Rule 2111 as long as 
they do not include (standing alone or in combination with other 
communications) a recommendation of a particular security or 
securities: (a) General financial and investment information, 
including: (i) Basic investment concepts, such as risk and return, 
diversification, dollar cost averaging, compounded return, and tax 
deferred investment, (ii) historic differences in the return of 
asset classes (e.g., equities, bonds, or cash) based on standard 
market indices, (iii) effects of inflation, (iv) estimates of future 
retirement income needs, and (v) assessment of a customer's 
investment profile; (b) Descriptive information about an employer-
sponsored retirement or benefit plan, participation in the plan, the 
benefits of plan participation, and the investment options available 
under the plan; (c) Asset allocation models that are: (i) Based on 
generally accepted investment theory, (ii) accompanied by 
disclosures of all material facts and assumptions that may affect a 
reasonable investor's assessment of the asset allocation model or 
any report generated by such model, and (iii) in compliance with 
Rule 2214 (Requirements for the Use of Investment Analysis Tools) if 
the asset allocation model is an ``investment analysis tool'' 
covered by Rule 2214; and (d) Interactive investment materials that 
incorporate the above).
     The DOL took a similar approach, excluding from the term 
``recommendation,'' among other things, general communications and 
investment education (including plan information, general financial, 
investment and retirement information, asset allocation models and 
interactive investment materials). See DOL Interpretative Bulletin 
96-1; Participant Investment Education, 29 CFR 2509.96-1, 61 FR 
29588 (Jun. 11, 1996) (IB 96-1). See also DOL, Definition of the 
Term ``Fiduciary''; Conflict of Interest Rule--Retirement Investment 
Advice, 81 FR 20945, 20975 (Apr. 8, 2016) (noting that the now 
vacated DOL Fiduciary Rule would have carved out investment 
education from the definition of investment advice, incorporating 
much of IB 96-1).
    \179\ See SPARK Letter; NAGDCA Letter. Similarly, communications 
regarding participation in a plan and communications to make or 
increase plan contributions, without more, would generally not come 
within ``recommendation.''
---------------------------------------------------------------------------

    The treatment of certain communications as ``education'' rather 
than ``recommendations'' is well understood by broker-dealers. We 
generally view the following types of communications as not being 
recommendations of any securities transaction or investment strategy 
involving securities as long as they do not include, standing alone or 
in combination with other communications, a recommendation of a 
particular security or securities or particular investment strategy 
involving securities: \180\
---------------------------------------------------------------------------

    \180\ This concept also applies to investment strategies. See 
FINRA Regulatory Notice 11-25, Know Your Customer and Suitability--
New Implementation Date for and Additional Guidance on the 
Consolidated FINRA Rules Governing Know-Your-Customer and 
Suitability Obligations (May 2011) at FAQ 9 (``It is important to 
note, however, that the suitability rule would not apply to a firm's 
explanation of a strategy falling outside the safe-harbor provision 
if a reasonable person would not view the communication as a 
recommendation. Accordingly, the suitability rule would cover a 
firm's recommendation that a customer purchase securities using 
margin, whereas the rule generally would not cover a firm's brochure 
that simply explains the risks and benefits of margin without 
suggesting that the customer take action.'').
---------------------------------------------------------------------------

     General financial and investment information, including:
    [cir] Basic investment concepts, such as risk and return, 
diversification, dollar cost averaging, compounded return, and tax 
deferred investment,
    [cir] historic differences in the return of asset classes (e.g., 
equities, bonds, or cash) based on standard market indices,
    [cir] effects of inflation,
    [cir] estimates of future retirement income needs, and
    [cir] assessment of a customer's investment profile;
     Descriptive information about an employer-sponsored 
retirement or benefit plan, participation in the plan, the benefits of 
plan participation, and the investment options available under the 
plan; \181\
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    \181\ While this descriptive information would be treated as 
``education'' rather than a ``recommendation,'' we caution broker-
dealers to ensure that communications by their associated persons 
intended as ``education'' do not cross the line into 
``recommendations.'' See FINRA Regulatory Notice 13-45.

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[[Page 33338]]

     Asset allocation models that are:
    [cir] Based on generally accepted investment theory,
    [cir] accompanied by disclosures of all material facts and 
assumptions that may affect a reasonable investor's assessment of the 
asset allocation model or any report generated by such model, and
    [cir] in compliance with FINRA Rule 2214 (Requirements for the Use 
of Investment Analysis Tools) if the asset allocation model is an 
``investment analysis tool'' covered by FINRA Rule 2214; \182\ and
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    \182\ In this regard, as an allocation recommendation becomes 
narrower or more specific, the recommendation gets closer to 
becoming a recommendation of particular securities and, thus, 
subject to the suitability rule. See FINRA Regulatory Notice 12-25 
at FAQ 8.
---------------------------------------------------------------------------

     Interactive investment materials that incorporate the 
above.
    Thus, for example, a general conversation about retirement 
planning, such as providing a company's retirement plan options to a 
retail customer, would not, by itself, rise to the level of a 
recommendation. Similarly, where a broker-dealer informs a retail 
customer that he or she needs to take a required minimum distribution 
under the Internal Revenue Code, we would not interpret such 
communication, by itself, to rise to the level of a recommendation. 
Such a communication would be considered investment education or 
descriptive information, provided it does not involve, for example, a 
recommendation regarding specific securities to be sold or a 
recommendation regarding specific securities to be purchased with the 
proceeds of any sale.\183\ We agree with commenters that Regulation 
Best Interest should not stifle investment education as a means to 
encourage financial wellness, or otherwise restrict broker-dealers from 
disseminating information about, for example, retirement plans, and the 
approach we are taking to what is or is not considered a 
``recommendation'' achieves this goal.\184\
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    \183\ See, e.g., SPARK Letter (asking for confirmation that 
``pure `distribution recommendations' involving retirement accounts, 
such as those required under Internal Revenue Code section 
401(a)(9), are not a `recommendation of any securities transaction 
or investment strategy involving securities.' ''). However, 
informing a retail customer about a required minimum distribution 
may become a recommendation where a broker-dealer includes (standing 
alone or in combination with other communications) a recommendation 
of, or regarding, a particular security or securities or an 
investment strategy involving securities. See FINRA Rule 2111 
(Suitability) FAQ.
    \184\ See SPARK Letter (suggesting expressly excluding 
beneficial conversations about retirement savings and ``ensuring 
that Regulation Best Interest does not discourage broker-dealers in 
any way from having these important conversations with retirement 
investors''); see also Transamerica August 2018 Letter (suggesting 
the exclusion of various conversations designed to facilitate 
retirement savings).
---------------------------------------------------------------------------

b. Interpretation of Any Securities Transaction or Investment Strategy 
Involving Securities
    As proposed, Regulation Best Interest would apply to 
recommendations of ``any securities transaction'' (purchase, sale, and 
exchange) and any ``investment strategy'' involving securities 
(including explicit recommendations to hold a security or regarding the 
manner in which it is to be purchased or sold). In addition, the 
Proposing Release stated that securities transactions or investment 
strategies involving securities might also include recommendations to 
roll over or transfer assets from one type of account to another, such 
as recommendations to roll over or transfer assets from a retirement 
plan.\185\ Finally, although we did not propose to cover account type 
recommendations generally, we noted that evaluating the appropriateness 
of the type of account is an issue that relates to both broker-dealers 
and investment advisers, and requested comment on whether and how we 
should address this type of recommendation.
---------------------------------------------------------------------------

    \185\ See Proposing Release at 21595.
---------------------------------------------------------------------------

    In response to the Proposing Release, several commenters supported 
the Commission's approach; however, several commenters also requested 
modifications or clarifications regarding products or strategies 
covered under Regulation Best Interest. For example, a majority of the 
IAC and numerous commenters highlighted the conflicts of interest 
associated with account type recommendations, and urged the Commission 
to apply Regulation Best Interest to account type recommendations 
generally, and to IRA rollovers.\186\ Relatedly, several commenters 
sought clarity regarding whether and when a rollover or account type 
recommendation would be a ``recommendation'' under Regulation Best 
Interest.\187\
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    \186\ See, e.g., IAC 2018 Recommendation (supporting the 
``expan[sion] of the best interest obligation to cover rollover 
recommendations and recommendations by dual registrant firms 
regarding account types''); see also NASAA August 2018 Letter; SPARK 
Letter; Financial Engines Letter; Cetera August 2018 Letter; AFL-CIO 
April 2019 Letter. But see SIFMA August 2018 Letter (viewing 
recommendations of an account type as not involving a recommendation 
of a securities transaction or investment strategy involving 
securities).
    \187\ See, e.g., NAGDCA Letter; FPC Letter.
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    After careful consideration of comments and feedback, the 
Commission has modified the rule text to state that an ``investment 
strategy involving securities'' includes ``account recommendations.'' 
We interpret ``account recommendations'' to include recommendations by 
broker-dealers of securities account types generally,\188\ as well as 
recommendations to roll over or transfer assets from one type of 
account to another (e.g., workplace retirement plan account to an 
IRA).\189\ In addition, the Commission is stating its view that ``any 
securities transaction or investment strategy involving securities'' 
not only includes explicit hold recommendations, but also includes 
implicit hold recommendations that are the result of agreed-upon 
account monitoring between the broker-dealer and retail customer.\190\
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    \188\ In the discussion of the Care Obligation in Section 
II.C.2, we are also setting forth additional positions regarding the 
application of the Care Obligation to account type recommendations, 
as well as recommendations to roll over or transfer assets from one 
account to another. See also Fiduciary Interpretation (explaining 
that ``[a]dvice about account type includes advice about whether to 
open or invest through a certain type of account (e.g., a 
commission-based brokerage account or a fee-based advisory account) 
and advice about whether to roll over assets from one account (e.g., 
a retirement account) into a new or existing account that the 
adviser or an affiliate of the adviser manages'').
    \189\ A majority of the IAC and numerous commenters expressed 
the importance of account rollovers and the need for rollovers to be 
covered under Regulation Best Interest. See, e.g., IAC 2018 
Recommendation; Financial Engines Letter.
    \190\ Several commenters stated that broker-dealers should be 
able to contract with retail customers to provide additional 
services, such as account monitoring, and that such agreed upon 
services should be subject to Regulation Best Interest. See, e.g., 
NAIFA Letter; IAA August 2018 Letter; AFL-CIO April 2019 Letter.
---------------------------------------------------------------------------

Account Recommendations
    The Proposing Release indicated that securities transactions or 
investment strategies involving securities could include 
recommendations to roll over or transfer assets from one type of 
account to another, such as recommendations to roll over or transfer 
assets in a workplace retirement plan account to an IRA, and requested 
comment on whether and how to address account type recommendations.
    Several commenters suggested expanding Regulation Best Interest to 
explicitly cover rollover recommendations and recommendations by firms 
regarding account types. For example, a majority of the IAC explained 
that rollover recommendations ``are frequently provided at a critical 
juncture in an investor's life--retirement--and are often irrevocable 
decisions,'' and further noted that ``[d]ecisions about which type of 
account to open have the

[[Page 33339]]

potential to greatly affect [retail customers'] costs'' and that both 
rollovers and account type recommendations can ``have substantial 
potential long-term impacts on investors.'' \191\ Another commenter 
noted that ``[r]etirees have no practical ability to recoup lost 
spending power by returning to work and setting aside additional 
retirement savings, so they are particularly vulnerable to the adverse 
consequences of poor advice and high expenses.'' \192\ Finally, a 
majority of the IAC and several commenters noted that broker-dealers 
and investment advisers alike have a strong economic incentive to 
recommend investors roll over plan assets into an IRA or otherwise 
transfer assets to open an account with the broker-dealer or investment 
adviser.\193\
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    \191\ IAC 2018 Recommendation. See also Letter from Brian H. 
Graff, Executive Director and CEO, Craig P. Hoffman, General 
Counsel, Doug Fisher, Director of Retirement Policy, American 
Retirement Association (``ARA'') (Dec. 13, 2018) (``ARA December 
2018 Letter''); Transamerica August 2018 Letter.
    \192\ Fiduciary Benchmarks Letter.
    \193\ See, e.g., IAC 2018 Recommendation; NASAA August 2018 
Letter; Fiduciary Benchmarks Letter.
---------------------------------------------------------------------------

    After consideration of comments received, including concerns 
expressed about the conflicts associated with recommendations of 
account types, IRA rollovers and retirement advice more broadly, it is 
our view that Regulation Best Interest should apply broadly to 
recommendations of securities transactions and investment strategies 
involving securities. Accordingly, the Commission is including in the 
rule text account recommendations as recommendations that will be 
covered by Regulation Best. ``Account recommendations'' include 
recommendations of securities account types generally (e.g., to open an 
IRA or other brokerage account), as well as recommendations to roll 
over or transfer assets from one type of account to another (e.g., a 
workplace retirement plan account to an IRA).
    Although account recommendations, including recommendations of a 
securities account type generally, as well as recommendations to roll 
over assets from a workplace retirement plan account to an IRA or to 
open an IRA held at the broker-dealer, will almost always involve a 
``securities transaction'' (such as a securities purchase, sale, or 
exchange), and thus would generally be subject to Regulation Best 
Interest, we are modifying the rule text to provide that such 
recommendations are ``investment strategies involving securities'' for 
purposes of Regulation Best Interest, regardless of whether they are 
tied to a specific securities transaction.\194\ Existing broker-dealer 
regulation and guidance stresses that the term ``investment strategy'' 
is to be interpreted broadly, and would include, among others, 
recommendations generally to use a bond ladder, day trading, 
``liquefied home equity,'' or margin strategy involving securities, 
irrespective of whether the recommendations mention particular 
securities.\195\ This approach appropriately recognizes that customers 
may rely on firms' and associated persons' investment expertise and 
knowledge, and therefore the broker-dealer should be responsible for 
such recommendations, regardless of whether those recommendations 
result in transactions or generate transaction-based compensation.\196\
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    \194\ A recommendation that a retail customer roll over or 
transfer assets to an IRA held at the broker-dealer, or open an IRA 
or another securities account with a broker-dealer, presumes that 
the recommendation would involve transactions in securities, even if 
the rollover or account recommendation does not result in 
transactions or transaction-based compensation.
    \195\ See FINRA Rule 2111.03; FINRA Regulatory Notice 12-25 at 
Q7.
    \196\ See FINRA Regulatory Notice 11-02, Know Your Customer and 
Suitability--SEC Approves Consolidated FINRA Rules Governing Know-
Your-Customer and Suitability Obligations (Jan. 2011).
---------------------------------------------------------------------------

    Account recommendations, including recommendations of securities 
account types generally (e.g., to open an IRA or other brokerage 
account), and recommendations to roll over or transfer assets into an 
IRA or another securities account, are consistent with the types of 
recommendations that have been treated as investment strategies under 
existing suitability rules.\197\ Specifically, like other investment 
strategies, account recommendations are recommendations of an approach 
or method (i.e., a ``strategy'') for how a retail customer should 
engage in transactions in securities, involve conflicts of interest, 
and can have long-term effects on investors' costs and returns from 
their investments.\198\ In addition, we believe retail customers rely 
on broker-dealers' and associated persons' investment expertise and 
knowledge with respect to such recommendations. As a result, such 
recommendations must be made consistent with the retail customer's 
objectives and needs (i.e., investment profile), irrespective of 
whether those recommendations are tied to a specific securities 
transaction. Consistent with a majority of the IAC's and other 
commenters' suggestions, we are modifying the rule text to state that 
the term ``investment strategy involving securities'' includes 
``account recommendations,'' which we interpret to include 
recommendations of securities account types generally, as well as 
recommendations to roll over or transfer assets.\199\
---------------------------------------------------------------------------

    \197\ See supra footnotes 172 and 173.
    \198\ See Capital Group Letter; see also IAC 2018 
Recommendation; NASAA August 2018 Letter.
    \199\ See, e.g., IAC 2018 Recommendation; Capital Group Letter 
(``Choosing between a brokerage and an advisory account is an 
incredibly impactful decision for investors. It is very important 
that these recommendations be made in the best interest of the 
retail [customer].'').
---------------------------------------------------------------------------

    Thus, such account recommendations will be subject to Regulation 
Best Interest even if there is not a recommendation of a securities 
transaction. Although we proposed only covering account type 
recommendations that are tied to securities transactions, and not 
account type recommendations generally, we agree with commenters and a 
majority of the IAC that consistent with other investment strategies 
involving securities, securities account type recommendations should be 
covered under Regulation Best Interest regardless of whether those 
recommendations result in transactions or generate transaction-based 
compensation.\200\ In addition, as discussed in the Fiduciary 
Interpretation, investment advisers' fiduciary duty applies to advice 
to clients about account types, which satisfies the concerns about 
parity set forth in the Proposing Release and protects retail customers 
of broker-dealers and retail clients of investment advisers alike.\201\
---------------------------------------------------------------------------

    \200\ See, e.g., IAC 2018 Recommendation; NASAA August 2018 
Letter.
    \201\ See Fiduciary Interpretation.
---------------------------------------------------------------------------

    Where a financial professional who is dually registered (i.e., an 
associated person of a broker-dealer and a supervised person of an 
investment adviser (regardless of whether the professional works for a 
dual-registrant, affiliated firm, or unaffiliated firm)) is making an 
account recommendation to a retail customer,\202\ whether Regulation 
Best Interest or the Advisers Act will apply will depend on the 
capacity in which the financial professional making

[[Page 33340]]

the recommendation is acting.\203\ As discussed further in the Care 
Obligation, if the individual is acting as a broker-dealer or 
associated person thereof, he or she must comply with Regulation Best 
Interest and will need to take into consideration all types of accounts 
offered by the financial professional (i.e., both brokerage and 
advisory accounts) when making the recommendation of an account that is 
in the retail customer's best interest.
---------------------------------------------------------------------------

    \202\ As discussed in more detail below in Section II.B.3.b, 
Regulation Best Interest applies to a retail customer who receives a 
recommendation and uses the recommendation. Among other things, we 
interpret a retail customer to use a recommendation when: (1) The 
retail customer opens a brokerage account with the broker-dealer, 
regardless of whether the broker-dealer receives compensation; (2) 
the retail customer has an existing account with the broker-dealer 
and receives a recommendation from the broker-dealer, regardless of 
whether the broker-dealer receives or will receive compensation, 
directly or indirectly, as a result of that recommendation; or (3) 
the broker-dealer receives or will receive compensation, directly or 
indirectly as a result of that recommendation, even if that retail 
customer does not have an account at the firm.
    \203\ See Section II.B.3.d, below for discussion of factors the 
Commission will consider in determining capacity. See also Fiduciary 
Interpretation at footnotes 42-44 and accompanying text. As 
discussed in the Fiduciary Interpretation, while advice to 
prospective clients about these matters is subject to the antifraud 
provisions under section 206 of the Advisers Act, the adviser must 
also satisfy its fiduciary duty with respect to any such advice 
(e.g., regarding account type) once a prospective client becomes a 
client. Thus, at the point in time at which the prospective client 
becomes a client of the investment adviser (e.g., at account 
opening), the fiduciary duty applies. Id.
---------------------------------------------------------------------------

    In the case of an account recommendation by a financial 
professional who is only registered as an associated person of broker-
dealer (regardless of whether that broker-dealer entity is a dual-
registrant or affiliated with an investment adviser), Regulation Best 
Interest will apply to the recommendation. Further, the associated 
person can only recommend a brokerage account that the broker-dealer 
offers when the associated person has a reasonable basis to believe 
that the recommended brokerage account is in the best interest of the 
retail customer and the broker-dealer otherwise complies with 
Regulation Best Interest.
    Regulation Best Interest would apply to account recommendations by 
the dual-registrant firm, and consistent with the Conflict of Interest 
Obligation, the firm would need to, among other things, establish, 
maintain and enforce policies and procedures to identify, disclose, and 
mitigate, any incentives for an associated person of the broker-dealer 
to place the interest of the firm or the associated person ahead of the 
interests of the retail customer.
    In the discussion of the Care Obligation below, we discuss how a 
broker-dealer and associated persons of a broker-dealer can make 
recommendations of securities account types, including recommendations 
to open an IRA or to roll over assets into an IRA, in the best interest 
of the retail customer.
Hold Recommendations
    The Proposing Release stated that Regulation Best Interest would 
apply to any securities transaction or investment strategy involving 
securities, including explicit recommendations to hold a security or 
regarding the manner in which it is to be purchased or sold to retail 
customers.\204\ The Proposing Release also recognized that broker-
dealers may agree with a retail customer by contract to take on 
additional obligations beyond those imposed by Regulation Best 
Interest, for example, by agreeing with a retail customer to provide 
periodic or ongoing services, such as ongoing monitoring of the retail 
customer's investments for purposes of recommending changes in 
investments.\205\ To the extent that a broker-dealer takes on such 
additional obligations, the Proposing Release indicated that Regulation 
Best Interest would apply to any recommendations about securities or 
investment strategies involving securities made to retail customers 
resulting from such services.
---------------------------------------------------------------------------

    \204\ Proposing Release at 21593-21595.
    \205\ Id. We also asked whether broker-dealers who provide 
ongoing monitoring should be considered investment advisers. Id. at 
21592.
---------------------------------------------------------------------------

    Several commenters agreed that broker-dealers should be able to 
contract with retail customers for additional services and be able to 
expand the relationship on their own terms, while other commenters 
recommended that a duty to monitor apply to broker-dealers depending on 
the facts and circumstances.\206\ Other commenters suggested that the 
Commission not impose a duty to monitor brokerage accounts.\207\
---------------------------------------------------------------------------

    \206\ See, e.g., NAIFA Letter (``Additionally, while the best 
interest standard applies to each recommendation and may not be 
waived or modified by contract as it applies to those 
recommendations, it should not be interpreted to create obligations 
with respect to other, expanded services (e.g., ongoing research and 
monitoring services, regular in-person meetings, etc.). Again, 
however, advisors and consumers may agree to expand the relationship 
in these ways on their own terms.''); see also CFA August 2018 
Letter; Better Markets August 2018 Letter (recommending the 
Commission establish a duty to monitor depending on the facts and 
circumstances); AFL-CIO April 2019 Letter.
    We note that additional commenters maintained that if broker-
dealers agree with retail customers to provide ongoing monitoring 
for purposes of recommending changes in investments, they should be 
considered investment advisers. See NASAA August 2018 Letter; FPC 
Letter. We have addressed these comments in the context of the 
Solely Incidental Interpretation. See Solely Incidental 
Interpretation.
    \207\ See IAA August 2018 Letter.
---------------------------------------------------------------------------

    We are confirming that, consistent with existing broker-dealer 
regulation, Regulation Best Interest will apply to explicit 
recommendations to hold a security or securities.\208\ We are also 
confirming that Regulation Best Interest does not impose a duty to 
monitor a retail customer's account. We agree, however, with commenters 
that Regulation Best Interest should apply to any recommendations that 
result from the account monitoring services that a broker-dealer agrees 
to provide.\209\ We believe that any monitoring service agreed to by 
the broker-dealer, the scope and frequency of which would be required 
to be disclosed pursuant to the Disclosure Obligation, would be covered 
by Regulation Best Interest, as these activities will result in a 
recommendation to purchase, sell, or hold a security, or the manner in 
which to purchase, sell, or hold a security, at each time the agreed-
upon monitoring occurs.\210\ Thus, by agreeing to perform account 
monitoring services, the broker-dealer is taking on an obligation to 
review and make recommendations with respect to that account (e.g., to 
buy, sell or hold) on that specified, periodic basis.\211\ For example, 
if a broker-dealer agrees to monitor the retail customer's account on a 
quarterly basis, the quarterly review and each resulting recommendation 
to purchase, sell, or hold, will be a recommendation subject to 
Regulation Best Interest. This is the case even in instances where the 
broker-dealer does not communicate any recommendation to the retail 
customer. We believe that such an ``implicit'' recommendation to hold 
in this context should be covered under Regulation Best Interest in 
addition to ``explicit'' recommendations to hold.\212\
---------------------------------------------------------------------------

    \208\ See FINRA Regulatory Notice 12-25.
    \209\ See NAIFA Letter; IAA August 2018 Letter.
    \210\ In agreeing to provide any account monitoring services, 
broker-dealers need to consider whether the monitoring services fit 
within the broker-dealer exclusion from the Advisers Act. See Solely 
Incidental Interpretation.
    \211\ The broker-dealer would also be required to disclose the 
existence, scope, and frequency of such account monitoring services 
pursuant to the Disclosure Obligation. To avoid ambiguity over 
whether or when an implicit hold recommendation has been made, this 
disclosure should identify with specificity when the agreed upon 
monitoring will occur.
    \212\ See FINRA Rule 2111.03 (noting ``[t]he phrase `investment 
strategy involving a security or securities' used in this Rule is to 
be interpreted broadly and would include, among other things, an 
explicit recommendation to hold a security or securities.''); see 
also NASAA August 2018 Letter.
---------------------------------------------------------------------------

    This position differs from FINRA guidance, which generally states 
that the FINRA suitability rule does not cover an implicit 
recommendation to hold.\213\ We believe that ``implicit'' hold

[[Page 33341]]

recommendations in this context, where the broker-dealer agrees to 
provide specified account monitoring services, are similar to explicit 
hold recommendations that are considered ``investment strategies'' 
because they would constitute the type of recommendations that retail 
customers would be expected to rely upon and would be a ``call to 
action'' in the sense of a recommendation that the customer stay the 
course.\214\ We believe that, in this context, silence is tantamount to 
an explicit recommendation to hold, and should be viewed as a 
recommendation to hold the securities for purposes of Regulation Best 
Interest.\215\ Our interpretation that the term ``investment strategy 
involving securities'' includes implicit recommendations to hold that 
result from an agreement to monitor, at the time the agreed-upon 
monitoring occurs, is generally consistent with the treatment of 
similar broker-dealer communications as ``investment strategies,'' and 
applies the Regulation Best Interest protections to retail customers 
relying on a broker-dealer's agreement to monitor the customer's 
account.\216\
---------------------------------------------------------------------------

    \213\ FINRA Regulatory Notice 11-25 at Q7 (``The rule, for 
instance, would not apply where an associated person remains silent 
regarding, or refrains from recommending the sale of, securities 
held in an account. That is true regardless of whether the 
associated person previously recommended the purchase of the 
securities, the customer purchased them without a recommendation, or 
the customer transferred them into the account from another firm 
where the same or a different associated person had handled the 
account.''). See also id. at footnote 21 (``To the extent that a 
customer account at a broker-dealer can be discretionary under 
applicable federal securities laws, the suitability rule generally 
would not apply where a firm refrains from selling a security. The 
rule states that it applies to explicit recommendations to hold. 
Unless the facts indicate that an associated person's failure to 
sell securities in a discretionary account was intended as or 
tantamount to an explicit recommendation to hold, FINRA would not 
view the associated person's inaction or silence in such 
circumstances as a recommendation to hold the securities for 
purposes of the suitability rule.'').
    \214\ See FINRA Regulatory Notice 11-25 at Q7 (``The rule would 
apply, for example, when an associated person meets with a customer 
during a quarterly or annual investment review and explicitly 
advises the customer not to sell any securities in or make any 
changes to the account or portfolio.''). While the FINRA guidance 
goes on to state that the rule generally would not cover an implicit 
recommendation to hold, it does not address the particular scenario 
in which a broker-dealer agrees to monitor an account (such as a 
quarterly review) and discloses the terms of that monitoring, and 
then during that review is silent on whether the customer should 
make any changes. Id.; see also FINRA Regulatory Notice 12-25 at Q3 
and accompanying footnotes.
    \215\ See FINRA Regulatory Notice 11-25 at footnote 21.
    \216\ Our interpretation is generally consistent with a majority 
of the IAC's and other commenters' views regarding application of 
Regulation Best Interest to implicit hold recommendations in the 
context of agreed-upon account monitoring services. See IAC 2018 
Recommendation (``We believe the best interest standard should be 
applied to the broker-dealer's monitoring of the customer account, 
where brokers provide ongoing services to the account. In essence, 
this would apply the best interest standard to the implicit ``no 
recommendation'' recommendation that a broker makes when reviewing 
the account and recommends no change.''); NAIFA Letter (asserting 
broker-dealers should be free to agree to, and define the nature of, 
any ongoing relationship via contract, such as including monitoring 
services); AFL-CIO April 2019 Letter.
---------------------------------------------------------------------------

    Although for purposes of Regulation Best Interest, implicit hold 
recommendations will be considered a recommendation of ``any securities 
transaction or investment strategy regarding securities'' where a 
broker-dealer has agreed to provide account monitoring services, we are 
not otherwise changing the treatment of implicit hold recommendations 
in other contexts. In other words, unless the broker-dealer has agreed 
to provide account monitoring services as described, Regulation Best 
Interest would only apply to explicit--and not to implicit--hold 
recommendations regarding security positions in an account.\217\ This 
is consistent with the fact that Regulation Best Interest would not 
impose a duty to monitor customer accounts.\218\
---------------------------------------------------------------------------

    \217\ FINRA Notice to Members 11-25 at Q7.
    \218\ Our approach does not require broker-dealers to undertake 
account monitoring, unless they choose to do so. See Solely 
Incidental Interpretation.
---------------------------------------------------------------------------

    Finally, although certain commenters stated that account monitoring 
services should only be performed by investment advisers,\219\ we 
reiterate that Regulation Best Interest does not change the scope of 
account monitoring that broker-dealers may agree to provide, nor does 
it change the scope of activities that would come within the ``solely 
incidental'' prong of the broker-dealer exclusion to the definition of 
``investment adviser'' in the Advisers Act. We recognize that a broker-
dealer may voluntarily, and without any agreement with the customer, 
review the holdings in a retail customer's account for the purpose of 
determining whether to provide a recommendation to the customer. We 
view this voluntary review--and any subsequent recommendation to the 
customer--as in connection with and reasonably related to the broker-
dealer's primary business of effecting securities transactions.\220\
---------------------------------------------------------------------------

    \219\ See, e.g., NASAA August 2018 Letter; FPC Letter.
    \220\ See Solely Incidental Interpretation. Absent an agreement 
with the customer (which would be required to be disclosed pursuant 
to the Disclosure Obligation), we do not consider this voluntary 
review to be ``account monitoring'' nor would it in itself create an 
obligation under Regulation Best Interest, provided of course that 
any recommendation made to the customer as a result of any such 
voluntary review would be subject to Regulation Best Interest.
---------------------------------------------------------------------------

Recommendations Involving Retirement Accounts
    Furthermore, based on comments, our position is that 
recommendations to retail customers regarding retirement accounts would 
also be subject to Regulation Best Interest where they involve 
securities transactions or investment strategies involving securities. 
We agree with commenters that recommendations to retail customers to 
take distributions from proceeds of specific securities or to take in-
service loans from an employer-sponsored plan are recommendations of a 
securities transaction, as they would involve a recommendation to sell 
a security.\221\ However, while such recommendations to take plan 
distributions are ``recommendations'' and thereby subject to Regulation 
Best Interest, we reiterate that general communications by broker-
dealers relating to distributions in the context of a required minimum 
distribution or education regarding a plan's options would not, by 
themselves, constitute recommendations that would be subject to 
Regulation Best Interest.\222\
---------------------------------------------------------------------------

    \221\ See supra footnotes 185-189 and accompanying text. See, 
e.g., NASAA August 2018 Letter; Fiduciary Benchmarks Letter; IAC 
2018 Recommendation.
    \222\ For example, where a broker-dealer informs a retail 
customer that based on age and other relevant factors, he or she 
needs to take a required minimum distribution, but does not 
otherwise recommend specifics, such as what securities to sell, or 
where to place the proceeds, the communication would generally not 
be a ``recommendation'' subject to Regulation Best Interest. As with 
other communications subject to broker-dealer regulation, an inquiry 
of whether a ``recommendation'' was made would depend on the facts 
and circumstances relating to the communication, as discussed more 
fully above. See supra Section II.B.2.a.
---------------------------------------------------------------------------

3. Retail Customer
    We proposed to define retail customer as: ``a person, or the legal 
representative of such person, who: (1) Receives a recommendation of 
any securities transaction or investment strategy involving securities 
from a broker, dealer, or a natural person who is an associated person 
of a broker or dealer, and (2) uses the recommendation primarily for 
personal, family or household purposes.'' \223\ The definition was 
generally intended to track the definition of ``retail customer'' under 
Section 913(a) of the Dodd-Frank Act with some differences, as 
described in the Proposing Release.\224\
---------------------------------------------------------------------------

    \223\ As we stated in the Proposing Release, we believe that 
broker-dealers would generally be required to obtain sufficient 
facts about a customer to determine an account's primary purpose for 
purposes of Regulation Best Interest. See Proposing Release at 
21595.
    \224\ See Proposing Release at Section II.C.4. Section 913(a) 
defines ``retail customer'' as a natural person, or the legal 
representative of such natural person who: (1) Receives personalized 
investment advice about securities from a broker or dealer or 
investment adviser; and (2) uses such advice primarily for personal, 
family, or household purposes.
---------------------------------------------------------------------------

    In proposing the definition, we intended to exclude recommendations

[[Page 33342]]

related to commercial or business purposes but for the definition to 
remain sufficiently broad to capture recommendations related to the 
various reasons retail customers may invest, such as saving for 
retirement, education expenses and other savings purposes. As such, the 
proposed definition applied to any persons who receive a recommendation 
from a broker or dealer or a natural person who is an associated person 
of a broker or dealer, provided that the recommendation is primarily 
for personal, family or household purposes. In the case of dual-
registrants, the proposed definition was intended to apply only to 
recommendations made by broker-dealers in their brokerage capacity, 
based on a facts and circumstances analysis and consistent with 
existing guidance.\225\ The proposed definition differed from the 
definition of ``retail investor'' in the Relationship Summary Proposal 
as the Relationship Summary was intended for a broader range of 
investors.\226\
---------------------------------------------------------------------------

    \225\ Id.
    \226\ Id.
---------------------------------------------------------------------------

    The Commission requested comment on the scope and definition of 
retail customer and received a range of comments requesting: 
modification of the definition to focus on natural persons; 
clarification of the ``personal, family or household purposes'' 
qualification; harmonization with the definition in Form CRS; and 
further guidance surrounding the treatment of dual-registrants. In 
consideration of the comments received, the Commission is modifying the 
definition of ``retail customer'' to mean a natural person, or the 
legal representative of such natural person, who: (A) Receives a 
recommendation of any securities transaction or investment strategy 
involving securities from a broker, dealer, or a natural person who is 
an associated person of a broker or dealer; and (B) uses the 
recommendation primarily for personal, family, or household purposes.
    The revised definition shifts the focus to natural persons, as 
opposed to any persons, but otherwise it is adopted largely as 
proposed. However, as discussed below, the Commission is providing 
additional interpretations, guidance and clarification regarding: The 
interpretation of the ``personal, family, or household purposes'' 
qualifier; the interaction of this definition with the definition of 
``retail investor'' in Form CRS; what it means for a retail customer to 
``use'' the recommendation; and the status of dual-registrants. 
Furthermore, we are providing guidance on who would be considered to be 
the legal representative of a natural person for purposes of this 
definition.
a. Focus on Natural Persons and Legal Representatives of Natural 
Persons
    The Commission proposed to extend the definition of ``retail 
customer'' in Regulation Best Interest beyond natural persons to any 
persons to cover non-natural persons (e.g., trusts that represent the 
assets of a natural person), which the Commission stated it believed 
would benefit from the protections of Regulation Best Interest.
    Commenters generally suggested that the definition of retail 
customer be modified to focus on natural persons.\227\ To that end, a 
number of commenters suggested eliminating the ``personal, family or 
household purposes'' qualifier from the definition under Dodd-Frank 
Section 913.\228\ Many commenters suggested excluding institutional 
investors and professional advisers or fiduciaries, including 
retirement plan representatives \229\ and family offices,\230\ while a 
few stated that non-professional plan fiduciaries should have the same 
protections as retail customers.\231\ Many commenters suggested 
harmonizing the definition with FINRA's definition,\232\ in particular, 
by excluding: (1) Institutional accounts that would be exempted from 
certain suitability protections under FINRA Rule 2111 (Suitability) 
\233\ or (2) institutional investors as defined in Rule 2210 
(Communications with the Public),\234\ which is broader \235\ and would 
include, among others, certain workplace retirement plans. Conversely, 
a few commenters believed that Regulation Best Interest should apply to 
both retail and institutional customers.\236\
---------------------------------------------------------------------------

    \227\ See, e.g., Cetera August 2018 Letter; Invesco Letter.
    \228\ See FPC Letter; SIFMA August 2018 Letter; BlackRock 
Letter. Contra ACLI Letter (supporting the provision in Section 913 
and positing that Regulation Best Interest appropriately implements 
this foundational threshold).
    \229\ See, e.g., SIFMA August 2018 Letter; Vanguard Letter; 
Prudential Letter; ICI Letter; Fidelity Letter.
    \230\ See, e.g., TIAA Letter; SIFMA August 2018 Letter; Letter 
from Stuart J. Kaswell, Executive Vice President and Managing 
Director, Managed Funds Association, and Jiri Krol, Deputy CEO, 
Global Head of Government Affairs, Alternative Investment Management 
Association (Aug. 7, 2018) (``Managed Funds Association Letter'').
    \231\ ARA August 2018 Letter; CFA August 2018 Letter.
    \232\ See, e.g., UBS Letter; Bank of America Letter; Raymond 
James Letter; TIAA Letter; Letter from Joseph Giovanniello, 
Ladenburg Thalmann Financial Services Inc. (Jul. 30, 2018) 
(``Ladenburg Letter'').
    \233\ FINRA Rule 2111(b). Institutional accounts include banks, 
savings and loan associations, insurance companies, registered 
investment companies, state and Federal Registered investment 
advisers, and other persons with total assets of at least $50 
million.
    \234\ FINRA Rule 2210(a)(4). Institutional investors include, in 
addition to persons with institutional accounts, government entities 
and their subdivisions, employee benefit plans, qualified plans as 
defined in Exchange Act Section 3(a)(12)(C), broker-dealers and 
registered representatives, and persons acting solely on behalf of 
such institutional investors.
    \235\ See, e.g., SIFMA August 2018 Letter; TIAA Letter; IPA 
Letter.
    \236\ NASAA August 2018 Letter, Better Markets August 2018 
Letter; FPC Letter. But see Managed Funds Association Letter 
(suggesting that sophisticated investors should not be treated as 
retail customers).
---------------------------------------------------------------------------

    In response to comments, we are modifying the definition to focus 
on natural persons and their legal representatives, and are clarifying 
that we interpret ``legal representatives'' to mean non-professional 
legal representatives of a natural person, as we discuss below. We 
believe this change and clarification provides more certainty that 
institutions and certain professional fiduciaries are not covered for 
purposes of Regulation Best Interest. It would also retain, however, 
coverage of certain legal entities (i.e., trusts that represent the 
assets of a natural person) specifically identified in the Proposing 
Release as ``retail customers'' within the scope of Regulation Best 
Interest, but would not exclude certain high-net-worth natural persons, 
as was suggested by some commenters \237\ to match the current FINRA 
exclusion of such natural persons from customer-specific suitability 
requirements.\238\
---------------------------------------------------------------------------

    \237\ See, e.g., Morgan Stanley Letter; FSI August 2018 Letter.
    \238\ See FINRA Rule 4512(c), which includes within the 
definition of ``institutional account'' any person (whether a 
natural person, corporation, partnership, trust or otherwise) with 
total assets of at least $50 million. Currently, under FINRA rules, 
broker-dealers are exempt from the customer-specific suitability 
obligations with respect to these ``institutional accounts'' if 
certain conditions are met. FINRA Rule 2111(b).
---------------------------------------------------------------------------

    While the Commission recognizes commenters' concerns regarding 
compliance costs and burdens if the definition of retail customer does 
not align with FINRA's exclusion of certain institutional accounts and 
institutional investors, we have decided not to align our definition 
with FINRA's exclusion because we believe conflicted recommendations 
can also result in harm to high net-worth individuals.\239\

[[Page 33343]]

We believe the benefits of Regulation Best Interest justify compliance 
costs as these individuals could benefit from the protections included 
in Regulation Best Interest regardless of their net worth, which may 
not necessarily correlate to a particular level of financial 
sophistication.\240\
---------------------------------------------------------------------------

    \239\ The Commission has brought numerous enforcement actions 
against financial professionals engaged in schemes to defraud 
certain high net-worth individuals, in particular, professional 
athletes. See, e.g. SEC v. Charles A. Banks, IV, Civil Action No. 
16-CV-3399-TWT (N.D. Ga. Nov. 2, 2018) (former investment adviser 
who fraudulently induced a former professional athlete to invest 
$7.5 million in a sports team and apparel merchandise company based 
on a series of misrepresentations); SEC v. Ash Narayan, The Ticket 
Reserve Inc. a/k/a Forward Market Media, Inc., Richard M. Harmon, 
and John A. Kaptrosky, Civil Action No. 16-CV-1417-M (N.D. Tex. May 
24, 2016) (investment adviser who misappropriated millions of 
dollars from accounts he managed for professional athletes and 
invested them in online sports and entertainment ticket business on 
whose board he served).
    In addition, reports indicate deficiencies in financial literary 
among the general population of retail investors. See Federal 
Research Division, Library of Congress, Financial Literacy Among 
Retail Investors in the United States (Dec. 30, 2011) at 25, 
available at https://www.sec.gov/news/studies/2012/917-financial-literacy-study-part2.pdf (``Library of Congress Report'').
    \240\ See Primerica Letter (noting challenges in using wealth 
and education as proxies for investment sophistication).
    In addition, the definition of ``retail customer'' under Section 
913(a) of the Dodd-Frank Act did not make a distinction based on net 
worth.
---------------------------------------------------------------------------

    In addition, we view a ``legal representative'' of a natural person 
to only cover non-professional legal representatives (e.g., a non-
professional trustee that represents the assets of a natural person and 
similar representatives such as executors, conservators, and persons 
holding a power of attorney for a natural person),\241\ thereby 
excluding certain institutions from Regulation Best Interest's 
coverage. In capturing non-professional legal representatives within 
the definition of retail customer, we are providing the protections of 
Regulation Best Interest to non-professional persons who are acting on 
behalf of natural persons but who are not regulated financial services 
industry professionals retained by natural persons to exercise 
independent professional judgment, such as registered investment 
advisers and broker-dealers, corporate fiduciaries (e.g., banks, trust 
companies and similar financial institutions) and insurance companies, 
and the employees or other regulated representatives of such advisers, 
broker-dealers, corporate fiduciaries and insurance companies.\242\ Our 
definition is intended to capture natural persons and their legal 
representatives who rely directly on the broker-dealer for the 
recommendation. Accordingly, such non-professional legal 
representatives would not include regulated financial industry 
professionals. We believe this responds to commenters who stated that 
it should not be necessary to provide the protections of Regulation 
Best Interest to regulated professionals.\243\ Importantly, however, 
this will not relieve firms or financial professionals retained to 
represent the assets of natural persons from their own obligations to 
retail customers.\244\
---------------------------------------------------------------------------

    \241\ A non-professional legal representative is covered 
pursuant to this rule even if another person is a trustee or 
managing agent of the trust.
    \242\ See also Relationship Summary Adopting Release.
    \243\ See, e.g., Bank of America Letter; Invesco Letter; Letter 
from Bob Grohowski, Senior Legal Counsel, and Jon Siegel, Senior 
Legal Counsel, T. Rowe Price (Aug. 10, 2018) (``T. Rowe Letter''); 
Oppenheimer Letter; ICI Letter.
    \244\ See also Relationship Summary Adopting Release.
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    We retained the ``personal, family, or household purposes'' 
qualifier,\245\ but are providing additional guidance and clarification 
on our interpretation of this phrase to address comments received. In 
particular, we interpret ``personal, family or household purposes'' to 
mean that any recommendation to a natural person for his or her account 
would be subject to Regulation Best Interest, other than 
recommendations to natural persons seeking these services for 
commercial or business purposes. Accordingly, under this 
interpretation, ``personal, family or household purposes'' would not 
include, for example, an employee seeking services for an employer or 
an individual who is seeking services for a small business or on behalf 
of another non-natural person entity such as a charitable trust.\246\ 
As discussed above \247\ and pursuant to the Care Obligation,\248\ we 
believe broker-dealers are able to obtain sufficient facts to determine 
the purpose for which a recommendation will be used.
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    \245\ Regulation Best Interest relies in part on the statutory 
authority provided in Section 913 of the Dodd-Frank Act which 
includes the statutory definition of ``retail customer.'' See 
Section 913(a) of the Dodd-Frank Act.
    \246\ As discussed below, to the extent a plan representative 
who decides service arrangements for a workplace retirement plan is 
a sole proprietor or other self-employed individual who will 
participate in the plan, the plan representative will be a retail 
customer to the extent that the sole proprietor or self-employed 
individual receives recommendations directly from a broker-dealer 
primarily for personal, family or household purposes.
    \247\ See supra footnote 223 and accompanying text.
    \248\ Pursuant to the Care Obligation, a broker-dealer is 
required to ascertain the customer's investment profile which 
considers, among other things, financial situation and needs and 
investment objectives, in evaluating a recommendation and whether it 
is in a retail customer's best interest.
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    We also confirm that ``personal, family or household purposes'' 
would cover retirement accounts, as retirement savings is a personal, 
household or family purpose. Accordingly, the definition of retail 
customer will include a natural person receiving recommendations \249\ 
for his or her own retirement account, including but not limited to 
IRAs and individual accounts in workplace retirement plans, such as 
401(k) plans and other tax-favored retirement plans.\250\ For example, 
plan participants receiving recommendations about whether to take a 
distribution from a 401(k) plan or other workplace retirement plan and 
how to invest that distribution would be covered as retail customers. 
Similarly, a plan participant receiving recommendations for the 
participant's individual account held in a 401(k) plan or other 
workplace retirement plan would be a retail customer for purposes of 
Regulation Best Interest.\251\
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    \249\ See Section II.C.2 (describing what constitutes a 
``recommendation'' for purposes of Regulation Best Interest).
    \250\ Such IRAs include, for example, individual retirement 
accounts and individual retirement annuities described by Internal 
Revenue Code section 408(a) and (b), ``simplified employee 
pensions'' (SEPs) described by Code section 408(k), and simple 
retirement accounts described by Code section 408(p) (SIMPLE IRAs). 
In response to commenters, we also clarify that workplace retirement 
plans include any arrangement available at a workplace that provides 
retirement benefits or allows saving for retirement, including, for 
example, any 401(k) plans or other plan that meet requirements for 
qualification under Code section 401(a), deferred compensation plans 
of state and local governments and tax-exempt organizations 
described by Code section 457, and annuity contracts and custodial 
accounts described by Code section 403(b). Likewise, the definition 
of retail investor includes natural persons seeking brokerage or 
advisory services for other tax-favored savings arrangements such as 
an Archer Medical Savings Account described by Code section 220(d), 
a Health Savings Accounts described by Code section 223(d) and any 
similar tax-favored health plan saving arrangement, a Coverdell 
education savings account described by Code section 530 and a 
qualified tuition program or ``529 plan'' established pursuant to 
Code section 529.
    \251\ For example, we understand that, although not common, some 
401(k) plans and other individual account plans provide participants 
total discretion to choose a broker-dealer to provide services for 
their individual plan account. See, e.g., 29 CFR 2550. 404c-1(f), 
Example 9.
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    The Commission acknowledges concerns from some commenters that 
workplace retirement plans and their representatives (e.g., plan 
sponsors, trustees, other fiduciaries) and service providers should be 
included in the definition of retail customer.\252\ However, we 
understand that plan representatives of workplace retirement plans 
typically are not receiving recommendations for their own account for 
personal, family or household purposes when they engage a broker-dealer 
to provide services to a retirement plan established, maintained,

[[Page 33344]]

and operated by an employer to provide pension or retirement savings 
benefits to employees; and further, as a legal representative of a plan 
participant, must comply with DOL rules.\253\ As such, the Commission 
does not believe that workplace retirement plans or their 
representatives and service providers generally fall within the 
definition of retail customer for purposes of Regulation Best Interest 
because the workplace retirement plan is not a natural person, and 
therefore the workplace retirement plan representatives are not a non-
professional representative of a natural person that is receiving a 
recommendation directly from a broker-dealer for ``personal, family, or 
household purposes.'' \254\
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    \252\ See, e.g., ARA December 2018 Letter; FPC Letter. But see 
Empower Letter (``It would be helpful if the SEC could confirm that 
the definition of `retail customer' under RBI does not include 
advice to managers of retirement plans or to their fiduciaries or 
representatives.'').
    \253\ It is our understanding that the investment 
responsibilities of plan representatives typically include, among 
other things, selecting and monitoring a menu of plan investment 
options and designating and monitoring ``default'' investments for 
investing account balances of participants who do not make their own 
investment elections, and that plan representatives typically make 
these investment selections for a workforce with diverse investment 
profiles. See ARA December 2018 Letter (describing obligations of 
plan fiduciaries selecting an investment menu and qualified default 
investment alternatives); Empower Letter (describing plan fiduciary 
obligations to select investment menus). We also understand that 
plan representatives may receive brokerage and advice services for 
plans together with or complimentary with, other services supporting 
the plan's establishment, maintenance and operation, such as plan 
design, recordkeeping and other administrative services. See, e.g., 
Groom Letter (describing business models of firms offering brokerage 
and advice services together with other services); SPARK Letter 
(same). In this context, a plan representative would not be 
receiving recommendations from a broker-dealer for his or her own 
account and considerations material to the plan representative's 
investment decisions differ from a situation in which a retail 
customer receives a recommendation from a broker-dealer for his or 
her own account.
    Further, we note that DOL has rules currently in place (not 
affected by the Fifth Circuit's decision vacating the DOL Fiduciary 
Rule) that address how plan representatives operate participant-
directed plans and select investment menus for such plans, see 29 
CFR 2550.404c-1, what actions, including disclosures, plan 
representatives must take to be able to raise a defense or claim for 
investment losses by a participant or beneficiaries, see 29 CFR 
2550.404c-5, and also generally require broker-dealers making 
investment alternatives available for a participant-directed plan to 
disclose in writing (among other things) all direct and indirect 
compensation received in connection with providing plan services. 
See 29 CFR 2550.408b-2(c). See also Form 5500, Schedule C, requiring 
after-the-fact reporting by certain plans of information regarding 
direct and indirect compensation received by, among others, broker-
dealers and investment advisers, in connection with services 
rendered or their position with the plan.
    Accordingly, we agree with those commenters who recommended that 
plan representatives should not be included in the definition of 
retail customer. See Empower Letter; Groom Letter; Letter from Nora 
M. Everett, President, Retirement and Income Solutions, Principal 
Financial Group (Aug. 7, 2018) (``Principal Letter''); SPARK Letter; 
T. Rowe Price Letter; Transamerica August 2018 Letter.
    \254\ Although workplace retirement plans are not generally 
covered by the definition of retail customer in by Regulation Best 
Interest, based on preliminary discussions with DOL staff, we 
understand that the DOL is considering regulatory options in light 
of the Fifth Circuit's decision vacating the DOL Fiduciary Rule, 
including the types of protections available to such workplace 
retirement plans and their representatives. Department of Labor 
Regulatory Agenda, Fiduciary Rule and Prohibited Transaction 
Exemptions, Fall 2018, available at https://www.reginfo.gov/public/do/eAgendaViewRule?pubId=201810&RIN=1210-AB82.
---------------------------------------------------------------------------

    We note, however, that some plan representatives may participate 
under their employer's workplace plan, for example, in the case of a 
workplace IRA or other workplace retirement plan that is established 
and maintained by a sole proprietor or other self-employed individual 
that includes one or more employees in addition to the plan 
representative. To the extent that a plan representative who decides 
service arrangements for a workplace retirement plan is a sole 
proprietor or other self-employed individual who will participate in 
the plan, the plan representative would be a retail customer for 
purposes of Regulation Best Interest to the extent the sole proprietor 
or self-employed individual receives recommendations directly from a 
broker-dealer primarily for personal, family or household purposes.
b. Retail Customer Use of the Recommendation
    In the Proposing Release, the Commission did not specifically 
address whether recommendations subject to Regulation Best Interest 
needed to be for compensation, but did state that the proposed 
definition of retail customer would only apply to a person who 
``received a recommendation . . . from a broker or dealer or a natural 
person who is an associated person of a broker or dealer, and used the 
recommendation primarily for personal, family, or household purposes.'' 
We stated that this approach was appropriate because it builds upon the 
guidance provided for FINRA's suitability rule.\255\ In response, a few 
commenters recommended that the Commission limit the application of 
Regulation Best Interest to recommendations made to retail customers 
for compensation.\256\
---------------------------------------------------------------------------

    \255\ See Proposing Release at 21596, footnote 160.
    \256\ See Morgan Stanley Letter; CCMC Letters.
---------------------------------------------------------------------------

    Regulation Best Interest applies to a retail customer that both 
receives a recommendation of any securities transaction or investment 
strategy involving securities by a broker-dealer and that uses that 
recommendation primarily for personal, family, or household purposes, 
and not simply those recommendations for which a broker-dealer receives 
compensation.\257\ In response to commenters, we interpret that a 
retail customer ``uses'' a recommendation of a securities transaction 
or investment strategy involving securities when, as a result of the 
recommendation: (1) The retail customer opens a brokerage account with 
the broker-dealer, regardless of whether the broker-dealer receives 
compensation,\258\ (2) the retail customer has an existing account with 
the broker-dealer and receives a recommendation from the broker-dealer, 
regardless of whether the broker-dealer receives or will receive 
compensation, directly or indirectly, as a result of that 
recommendation, or (3) the broker-dealer receives or will receive 
compensation, directly or indirectly as a result of that 
recommendation, even if that retail customer does not have an account 
at the firm.\259\
---------------------------------------------------------------------------

    \257\ See paragraph (b)(1) of Regulation Best Interest.
    \258\ As discussed in Section II.B.2.b below, account 
recommendations, including recommendations of a securities account 
type generally, and recommendations to open an IRA or to roll over 
or transfer assets into an IRA, are covered by Regulation Best 
Interest regardless of whether those recommendations result in 
transactions or generate transaction-based compensation.
    \259\ See Proposing Release at 21596, footnote 160 and 
accompanying text. See also FINRA Regulatory Notice 12-55, 
Suitability--Guidance on FINRA's Suitability Rule (Dec. 2012) at 
Q6(b) (``The suitability rule would apply when a broker-dealer or 
registered representative makes a recommendation to a potential 
investor who then becomes a customer. Where, for example, a 
registered representative makes a recommendation to purchase a 
security to a potential investor, the suitability rule would apply 
to the recommendation if that individual executes the transaction 
through the broker-dealer with which the registered representative 
is associated or the broker-dealer receives or will receive, 
directly or indirectly, compensation as a result of the recommended 
transaction.''); NASD Notice to Members 04-72, Transfers of Mutual 
Funds and Variable Annuities--Impermissible Use of Negative Response 
Letters for the Transfer of Mutual Funds and Variable Annuities 
(Changes in Broker-Dealer of Record) (Oct. 2004).
---------------------------------------------------------------------------

    When a retail customer opens or has an existing account with a 
broker-dealer the retail customer has a relationship with the broker-
dealer and is therefore in a position to ``use'' (i.e., accept or 
reject) the broker-dealer's recommendation. In this context, tying 
``use'' solely to a broker-dealer's receipt of compensation would 
inappropriately result in Regulation Best Interest not applying to the 
broker-dealer's recommendations to hold securities positions or to 
maintain an investment strategy (such as account type), recommendations 
to open an account, or recommendations that may

[[Page 33345]]

ultimately be rejected by the retail customer.
    Whether the recommendation complies with Regulation Best Interest 
will be evaluated based on the circumstances that existed at the time 
the recommendation was made to the retail customer. Accordingly, 
broker-dealers should carefully consider the extent to which associated 
persons can make recommendations to prospective retail customers (i.e., 
that have received, but not yet ``used'' the recommendation as noted 
above) in compliance with Regulation Best Interest, including having 
gathered sufficient information that would enable them to comply with 
Regulation Best Interest at the time the recommendation is made, should 
the prospective retail customer use the recommendation.\260\
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    \260\ See FINRA Regulatory Notice 12-55 at Q6(b).
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c. Conformity With Form CRS
    The proposed definition of ``retail customer'' differed from the 
definition of ``retail investor'' proposed in the Relationship Summary 
Proposal, which was a prospective or existing client or customer who is 
a natural person (an individual), regardless of the individual's net 
worth, including a trust or other similar entity that represents 
natural persons.\261\ The proposed definition was different from the 
definition of ``retail investor'' because the Relationship Summary was 
intended for an earlier state of the relationship between an investor 
and a financial professional, was intended to be required regardless of 
whether the investor would receive investment advice primarily for 
personal, family, or household purposes, and was designed to be 
delivered by investment advisers as well as broker-dealers.\262\ Many 
commenters recommended that we use the same definition to facilitate 
compliance for firms and avoid investor confusion.\263\
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    \261\ See Relationship Summary Proposal.
    \262\ See Relationship Summary Proposal, Section II, footnote 
29.
    \263\ See, e.g., Invesco Letter; BlackRock Letter; ICI Letter; 
Committee of Annuity Insurers Letter; Bank of America Letter; CFA 
August 2018 Letter; Cetera August 2018 Letter; Fidelity Letter; 
Morgan Stanley Letter; Oppenheimer Letter; Raymond James Letter; 
SIFMA August 2018 Letter; TIAA Letter; Transamerica August 2018 
Letter.
---------------------------------------------------------------------------

    The Commission agrees with commenters that using a similar 
definition would provide consistency in the protections, and ease the 
compliance burden, of the package of rulemakings. Therefore, the 
definitions in Form CRS and Regulation Best Interest have been revised 
to generally conform to each other, consistent with our respective 
goals in each of these rulemakings.\264\ As discussed above, the 
definition of ``retail customer'' for purposes of Regulation Best 
Interest has been revised to apply only to natural persons, not all 
persons, in line with the definition of ``retail investor'' for 
purposes of Form CRS. In addition, the definition in Form CRS as 
adopted now includes the ``personal, family or household purposes'' 
qualifier.
---------------------------------------------------------------------------

    \264\ See Relationship Summary Adopting Release.
---------------------------------------------------------------------------

    While the definitions have generally been harmonized across the 
package of rulemakings,\265\ they differ to reflect differences between 
the Relationship Summary delivery requirement and the obligations of 
broker-dealers under Regulation Best Interest, including that the 
Relationship Summary is required whether or not there is a 
recommendation and covers any prospective and existing clients and 
customers (i.e., a person who ``seeks to receive or receives 
services'') of investment advisers as well as broker-dealers.\266\ For 
the reasons discussed in the Proposing Release and in response to 
commenters who requested clarification on whether Regulation Best 
Interest applies to prospective customers,\267\ we would like to 
clarify that the definition of ``retail customer'' does not apply to 
prospective customers who do not receive and use recommendations from a 
broker-dealer,\268\ as discussed above. This distinction reflects 
differences between the point in time the Relationship Summary is 
delivered to an investor and when the obligations of broker-dealers 
pursuant to Regulation Best Interest attach.
---------------------------------------------------------------------------

    \265\ Id.
    \266\ Id.
    \267\ See, e.g., SIFMA August 2018 Letter; Prudential Letter; 
Money Management Institute Letter.
    \268\ See Section II.B.3.b.
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d. Treatment of Dual-Registrants
    In the Proposing Release, the Commission stated that Regulation 
Best Interest applies only in the context of a brokerage relationship 
with a brokerage customer, and specifically, when a broker-dealer is 
making a recommendation in the capacity of a broker-dealer. In 
particular, for dual-registrants (for purposes of this section, a 
broker-dealer that is dually registered as an investment adviser with 
the Commission), the obligations associated with Regulation Best 
Interest were intended to apply only when they are acting in the 
capacity as a broker-dealer.\269\ The Commission recognized the issues 
surrounding the determination of whether a dual-registrant is acting in 
the capacity of a broker-dealer or an investment adviser, and asserted 
that such a determination requires a facts and circumstances analysis, 
with no one factor being determinative.\270\
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    \269\ Although this discussion focuses on the treatment of 
broker-dealers that are dually registered with the Commission as 
investment advisers, a broker-dealer should perform the same 
analysis when it is engaged in other financial services (such as, as 
a bank, a commodity trading advisor or a future commission 
merchant).
    \270\ Proposing Release at 21596.
---------------------------------------------------------------------------

    Many commenters requested that the Commission clarify the treatment 
of dual-registrants and what is expected when offering products in both 
types of accounts.\271\ Some commenters asserted that dually registered 
financial professionals should be held to a fiduciary standard.\272\ A 
few commenters requested clarification on how Regulation Best Interest 
applies to particular scenarios, some of which involved dual-
registrants.\273\
---------------------------------------------------------------------------

    \271\ See, e.g., SIFMA August 2018 Letter; CCMC Letters; NASAA 
August 2018 Letter.
    \272\ See PIABA Letter; AICPA Letter.
    \273\ See SIFMA August 2018 Letter; Letter from Michael Pieciak, 
NASAA President, Commissioner Vermont Department of Financial 
Regulation, NASAA (Feb. 19, 2019) (``NASAA February 2019 Letter'').
---------------------------------------------------------------------------

    In response, the Commission is reaffirming the guidance provided in 
the proposal and providing further clarification on when and how 
Regulation Best Interest would apply to dual-registrants. As stated in 
the proposal, Regulation Best Interest would not apply to investment 
advice provided to a retail customer by a dual-registrant when acting 
in the capacity of an investment adviser, even if the retail customer 
has a brokerage relationship with the dual-registrant or the dual-
registrant executes the transaction in its brokerage capacity.\274\ 
Similarly, as proposed, we are confirming that a dual-registrant is an 
investment adviser solely with respect to those accounts for which a 
dual-registrant provides investment advice or receives compensation 
that subjects it to the Advisers Act.\275\
---------------------------------------------------------------------------

    \274\ This analysis would apply even if the dual-registrant 
receives transaction-based compensation for executing the 
transaction because the dual-registrant did not provide a 
recommendation in its capacity as a broker-dealer. While Regulation 
Best Interest would not apply in this situation, other provisions of 
the federal securities laws and SRO rules would apply to the actions 
taken or services provided by the broker-dealer.
    \275\ See Proposing Release at 21596; see also Certain Broker-
Dealers Deemed Not To Be Investment Advisers, Exchange Act Release 
No. 51523 (Apr. 12, 2005) at 8 (``Release 51523''); Interpretive 
Rule Under the Advisers Act Affecting Broker-Dealers, Advisers Act 
Release No. 2652 (Sep. 24, 2007). See also Fiduciary Interpretation.
---------------------------------------------------------------------------

    While we acknowledge that some commenters believe all dual-
registrants

[[Page 33346]]

should be held to a fiduciary standard, for the reasons discussed in 
Section II.A, the Commission believes that Regulation Best Interest 
enhances the obligations that apply when a broker-dealer makes a 
recommendation to a retail customer by drawing from key principles 
underlying the fiduciary obligation that applies to investment advisers 
under the Advisers Act, while being tailored to the broker-dealer 
model.\276\
---------------------------------------------------------------------------

    \276\ See Section I.
---------------------------------------------------------------------------

    As stated in the proposal, determining the capacity in which a 
dual-registrant is making a recommendation is a facts and circumstances 
test, with no one factor being determinative, but the Commission 
considers, among other factors, the type of account, how the account is 
described, the type of compensation and the extent to which the dual-
registrant made clear to the customer or client the capacity in which 
it was acting.\277\
---------------------------------------------------------------------------

    \277\ Proposing Release at 21596.
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    In addition and in response to a commenter's presentation \278\ of 
particular scenarios in its comment letter,\279\ we would like to 
confirm or correct the commenter's understanding of Regulation Best 
Interest in practice to provide further guidance to firms as it relates 
to their examples of dual-registrants.\280\ For example, in the 
commenter's explanation of a scenario related to a recommendation to 
open a fee-based account, we agree that Regulation Best Interest would 
not apply when a dually registered financial professional of a dually 
registered broker-dealer and investment adviser, who is acting in the 
capacity of an investment adviser, recommends a fee-based account. We 
note, however, that the dually registered financial professional would 
need to comply with the Advisers Act as well as the requirements with 
respect to Form CRS for the firm.\281\ In response to another scenario 
in which a financial professional who is dually registered provides a 
holistic review of the overall performance of a family's accounts, 
which are both brokerage and advisory, whether Regulation Best Interest 
applies depends on a facts and circumstances analysis. Regulation Best 
Interest would apply if the financial professional in her brokerage 
capacity (disclosed pursuant to the Disclosure Obligation), provides a 
recommendation of a securities transaction or investment strategy 
involving securities to the family in the course of the holistic 
review.\282\
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    \278\ See SIFMA August 2018 Letter. For purposes of the 
presented scenarios, SIFMA has assumed that the customer is a 
``retail customer.''
    \279\ Id.
    \280\ For purposes of this section, we have only addressed the 
scenarios applicable to dual-registrants and have not confirmed or 
rejected the commenter's analysis of the other scenarios.
    \281\ See Fiduciary Interpretation at Section II.B.1. In 
providing advice about account type, the adviser should consider 
both types of accounts (i.e., brokerage and advisory accounts) when 
determining whether the advice is in the client's best interest. See 
also NASAA February 2019 Letter (stating that Regulation Best 
Interest would not apply but instead that the fiduciary duty under 
the Advisers Act would apply).
    \282\ But see NASAA February 2019 Letter (stating that ``a full 
fiduciary duty'' should be imposed on the financial adviser as to 
all accounts in this case as the family has probably entrusted their 
entire financial well-being to one financial professional).
---------------------------------------------------------------------------

C. Component Obligations

    As proposed Regulation Best Interest's obligation to ``act in the 
best interest of the retail customer . . . without placing the 
financial or other interest of the [broker-dealer] ahead of the retail 
customer'' would have been satisfied by complying with four specified 
obligations: A Disclosure Obligation, a Care Obligation, and two 
Conflict of Interest Obligations.\283\ Failure to comply with any of 
these proposed requirements would have violated Regulation Best 
Interest.\284\
---------------------------------------------------------------------------

    \283\ Proposing Release at 21598.
    \284\ Id.
---------------------------------------------------------------------------

    As discussed above, we have determined to retain the overall 
structure and scope of the proposed rule, but are modifying and 
clarifying the component obligations that a broker-dealer must satisfy 
in order to meet the General Obligation. As adopted, the General 
Obligation is satisfied only if the broker-dealer complies with four 
specified component obligations: (1) The Disclosure Obligation; (2) the 
Care Obligation; (3) the Conflict of Interest Obligation; and (4) the 
Compliance Obligation. Each of these component obligations is discussed 
below. Whether a broker-dealer has acted in the retail customer's best 
interest under the General Obligation will turn on an objective 
assessment of the facts and circumstances of how these specific 
components of Regulation Best Interest are satisfied at the time that 
the recommendation is made (and not in hindsight). The specific 
component obligations of Regulation Best Interest are mandatory, and 
failure to comply with any of the components would violate Regulation 
Best Interest.
1. Disclosure Obligation
    We proposed a Disclosure Obligation that would require a broker-
dealer ``to, prior to or at the time of [a] recommendation, reasonably 
disclose to the retail customer, in writing, the material facts 
relating to the scope and terms of the relationship with the retail 
customer and all material conflicts of interest associated with the 
recommendation.'' The Proposing Release states that, for purposes of 
the Disclosure Obligation, we would consider the following to be 
examples of material facts relating to the scope and terms of the 
relationship with the retail customer: (1) That the broker-dealer was 
acting in a broker-dealer capacity with respect to the recommendation; 
(2) fees and charges that would apply to the retail customer's 
transactions, holdings, and accounts; and (3) type and scope of 
services provided by the broker-dealer, including, for example, 
monitoring the performance of the retail customer's account.
    As stated in the Proposing Release, we understand that broker-
dealers typically provide information about their services and 
accounts, which may include disclosures concerning the broker-dealer's 
capacity, fees, services, and conflicts, on their firm websites and in 
their account opening agreements.\285\ Furthermore, while broker-
dealers are subject to a number of specific disclosure obligations when 
they effect certain customer transactions, and are subject to the 
antifraud provisions of the federal securities laws, broker-dealers are 
not currently subject to an explicit and broad disclosure requirement 
under the Exchange Act regarding the scope and terms of the broker-
dealer relationship.\286\ To promote broker-dealer recommendations that 
are in the best interest of retail customers, we determined it was 
necessary to impose a more explicit and broader disclosure obligation 
on broker-dealers than that which currently exists under the federal 
securities laws and SRO rules.\287\
---------------------------------------------------------------------------

    \285\ Proposing Release at 21599.
    \286\ Proposing Release at 21599-21600.
    \287\ Proposing Release at 21600.
---------------------------------------------------------------------------

    We solicited comment on the Disclosure Obligation and commenters 
addressed several aspects of this proposed obligation, including the 
interpretation of each required element, as discussed in the relevant 
sections below.\288\ In consideration of these comments, we are 
revising the Disclosure Obligation to require a broker-dealer, prior to 
or at the time of the recommendation, to provide to the retail 
customer, in writing, full and fair disclosure \289\ of all material 
facts related to the scope and terms of the

[[Page 33347]]

relationship with the retail customer and all material facts relating 
to conflicts of interest that are associated with the 
recommendation.\290\ We are explicitly requiring in the rule text the 
disclosure of examples in the Proposing Release of the ``material facts 
relating to the scope and terms of the relationship with the retail 
customer:'' (1) That the broker, dealer or such natural person is 
acting as a broker, dealer or an associated person of a broker-dealer 
with respect to the recommendation; (2) the material fees and costs 
that apply to the retail customer's transactions, holdings, and 
accounts; and (3) the type and scope of services provided to the retail 
customer, including: any material limitations on the securities or 
investment strategies involving securities that may be recommended to 
the retail customer.
---------------------------------------------------------------------------

    \288\ See, e.g., Better Markets August 2018 Letter; CCMC 
Letters; LPL August 2018 Letter; Schwab Letter; Morgan Stanley 
Letter; CFA August 2018 Letter; IPA Letter; NASAA Letter; SIFMA 
August 2018 Letter.
    \289\ See Section II.C.1.c, Disclosure Obligation, Full and Fair 
Disclosure.
    \290\ As discussed in more detail below, aspects of the 
Disclosure Obligation may be satisfied by other regulatory 
requirements.
---------------------------------------------------------------------------

    The Disclosure Obligation requires the disclosure of all material 
facts related to the scope and terms of the relationship with the 
retail customer. The material facts identified in Regulation Best 
Interest are the minimum of what must be disclosed. Similar to what was 
proposed, broker-dealers will need to disclose in writing prior to or 
at the time of a recommendation any material facts that relate to the 
``scope and terms of the relationship.'' As to what constitutes a 
``material'' fact related to the ``scope and terms of the 
relationship,'' the standard for materiality for purposes of the 
Disclosure Obligation is consistent with the one the Supreme Court 
articulated in Basic v. Levinson.\291\ Specifically, a fact is material 
if there is ``a substantial likelihood that a reasonable shareholder 
would consider it important.'' In the context of Regulation Best 
Interest, the standard is the retail customer, as defined in the rule.
---------------------------------------------------------------------------

    \291\ Basic, Inc. v. Levinson, 485 U.S. 224 (1988).
---------------------------------------------------------------------------

    In response to comments, we are also refining and clarifying the 
treatment of conflicts of interest under Regulation Best Interest by: 
(1) Generally consistent with the fiduciary duty under the Advisers 
Act, adopting for purposes of Regulation Best Interest, the definition 
of ``conflict of interest'' associated with a recommendation as ``an 
interest that might incline a broker, dealer, or a natural person who 
is an associated person of a broker or dealer--consciously or 
unconsciously--to make a recommendation that is not disinterested''; 
\292\ and (2) revising the Disclosure Obligation to require disclosure 
of ``material facts'' relating to such conflicts of interest that are 
associated with the recommendation. Under this approach, all conflicts 
of interest as so defined will be covered by Regulation Best Interest 
(and thus, will be subject to the Conflict of Interest Obligation 
described below). However, only ``material facts'' regarding these 
conflicts of interest are required to be disclosed under the Disclosure 
Obligation.\293\
---------------------------------------------------------------------------

    \292\ This is the same as the definition of ``material conflict 
of interest'' discussed in the Proposing Release but eliminates 
``material'' and ``a reasonable person would expect'' for the 
reasons discussed below.
    \293\ The Conflict of Interest Obligation requires, among other 
things, that a broker-dealer establish written policies and 
procedures reasonably designed to identify and disclose all 
conflicts of interest associated with a recommendation. Such 
disclosure is required to be provided in accordance with the 
Disclosure Obligation. See Section II.C.3.d.
---------------------------------------------------------------------------

    As discussed above, we are adopting a new set of disclosure 
requirements designed to reduce retail investor confusion in the 
marketplace for brokerage and advisory services and to assist retail 
investors with the process of deciding whether to engage a particular 
firm or financial professional and whether to establish an investment 
advisory or brokerage relationship.\294\ Specifically, we are requiring 
broker-dealers and investment advisers to deliver to retail investors a 
Relationship Summary.\295\ The Relationship Summary will provide 
succinct information about the relationships and services the firm 
offers to retail investors, fees and costs that retail investors will 
pay, specified conflicts of interest and standards of conduct, and 
disciplinary history, among other things.\296\ The Relationship Summary 
has a distinct purpose: It is intended to summarize information about a 
particular broker-dealer or investment adviser in a format that allows 
for comparability among the enumerated items, encourages investors to 
ask questions, and highlights additional sources of information.
---------------------------------------------------------------------------

    \294\ See Relationship Summary Adopting Release.
    \295\ See Relationship Summary Adopting Release.
    \296\ See Relationship Summary Adopting Release at Section I. 
For purposes of Form CRS, ``retail investor'' is defined as ``a 
natural person, or the legal representative of such natural person, 
who seeks to receive or receives services primarily for personal, 
family, or household purposes.''
---------------------------------------------------------------------------

    As a general matter, the Relationship Summary reflects an initial 
layer of disclosure, with the Disclosure Obligation reflecting more 
specific and additional, detailed layers of disclosure.\297\ We believe 
the Relationship Summary and the Disclosure Obligation, while separate 
obligations with significant individual value, will complement each 
other and, consistent with our layered approach to disclosure, are 
designed to build upon each other to provide different levels of key 
information and may be required to be delivered at different times. In 
addition, we believe the Relationship Summary and Disclosure Obligation 
will improve the quality and consistency of disclosures and thus: (1) 
Reduce the information asymmetry that may exist between a retail 
customer and their broker-dealer, and (2) facilitate customer 
comparisons of different broker-dealers which we expect will, in turn, 
increase competition among broker-dealers, including with respect to 
fees and costs.\298\
---------------------------------------------------------------------------

    \297\ Nevertheless, as discussed below where relevant, in some 
instances disclosures made pursuant to Form CRS may be sufficient to 
satisfy some aspects of the Disclosure Obligation.
    \298\ See infra footnote 1192 and accompanying text.
---------------------------------------------------------------------------

    As discussed below, we have identified those items of information 
that we consider to be ``material facts'' under the Disclosure 
Obligation. Though there are disclosures in the Relationship Summary 
that could satisfy the Disclosure Obligation, in most instances the 
Relationship Summary will not be sufficient.\299\ Moreover, as 
discussed below, we believe the Disclosure Obligation can be satisfied 
to varying degrees with existing documents provided to retail 
customers, such as account opening documents, with a standalone 
document, or by some combination. However, we encourage broker-dealers, 
in deciding whether to rely on such an existing disclosure document or 
whether to include or repeat information from existing disclosures, to 
consider the usefulness and ease of understanding for retail customers 
of any existing disclosure document.
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    \299\ For example, as noted below, a standalone broker-dealer 
will be able to satisfy the Disclosure Obligation's requirement to 
disclose the broker-dealer's capacity by delivering the Relationship 
Summary to the retail customer.
---------------------------------------------------------------------------

Oral Disclosure or Disclosure After a Recommendation
    As discussed in more detail below, a number of commenters 
highlighted practical difficulties associated with delivering 
disclosure either in writing, or prior to or at the time of a 
recommendation in some instances. Although Regulation Best Interest 
requires that the Disclosure Obligation be made ``in writing,'' we 
recognize the challenges associated with providing written disclosure 
in each instance that disclosure may be required. For example, a 
broker-dealer may need to supplement, clarify or update written 
disclosure it has previously made before

[[Page 33348]]

or at the time it provides a customer with a recommendation. As we 
stated in the Proposing Release, we recognized that broker-dealers may 
provide recommendations by telephone and may need to offer clarifying 
disclosure orally in some instances subject to certain conditions, such 
as a dual-registrant informing a retail customer of the capacity in 
which the dual-registrant is acting in conjunction with a 
recommendation. We stated that a broker-dealer could orally clarify the 
capacity in which it is acting at the time of the recommendation if it 
had previously provided written disclosure to the retail customer 
beforehand disclosing its capacity as well as the method it planned to 
use to clarify its capacity at the time of the recommendation.
    Similarly, although Regulation Best Interest requires a broker-
dealer to disclose, prior to or at the time of a recommendation, all 
material facts relating to the scope and terms of the relationship with 
the retail customer and relating to conflicts of interest that are 
associated with the recommendation, we recognize that in some instances 
a broker-dealer may not have all the material facts at the time of the 
recommendation, or that such disclosure is provided to the retail 
customer pursuant to an existing regulatory obligation, such as the 
delivery of a product prospectus or a trade confirmation, after the 
execution of the trade.\300\ In the Proposing Release we stated that in 
circumstances where a broker-dealer determines to provide an initial, 
more general disclosure (such as a relationship guide) followed by 
specific information in a subsequent disclosure that is provided after 
the recommendation (e.g., a trade confirmation) the initial disclosure 
should address when and how a broker-dealer would provide more specific 
information regarding the material fact or conflict in a subsequent 
disclosure (e.g., after the trade in the trade confirmation). We noted 
also that whether there is sufficient disclosure in both the initial 
disclosure and any subsequent disclosure would depend on the facts and 
circumstances.
---------------------------------------------------------------------------

    \300\ See infra footnote 525.
---------------------------------------------------------------------------

    We continue to believe that some flexibility with respect to the 
provision by broker-dealers of written and oral disclosure, as well as 
with respect to the timing that disclosure is made, is appropriate in 
certain circumstances, such as when a broker-dealer updates its written 
disclosures orally in order to reflect facts not reasonably known at 
the time the written disclosure is provided. In such circumstances, a 
broker-dealer may satisfy its Disclosure Obligation by making 
supplemental oral disclosure not later than the time of the 
recommendation, provided that the broker-dealer maintains a record of 
the fact that oral disclosure was provided to the retail customer.\301\ 
In addition, in the limited instances where existing regulations permit 
disclosure after the recommendation is made (e.g., trade confirmation, 
prospectus delivery), a broker dealer may satisfy its Disclosure 
Obligation regarding the information contained in the applicable 
disclosure document by providing such document to the retail customer 
after the recommendation is made. Before supplementing, clarifying or 
updating written disclosures in the limited circumstances described 
above, broker-dealers must provide an initial disclosure in writing 
that identifies the material fact and describes the process through 
which such fact may be supplemented, clarified or updated.
---------------------------------------------------------------------------

    \301\ See Section II.D, Record-Making and Recordkeeping.
---------------------------------------------------------------------------

    For example, with regard to product-level fees, a broker-dealer 
could provide an initial standardized disclosure of product-level fees 
generally (e.g., reasonable dollar or percentage ranges), noting that 
further specifics for particular products appear in the product 
prospectus, which will be delivered after a transaction in accordance 
with the delivery method the retail customer has selected, such as by 
mail or electronically.\302\ Similarly, with regard to the disclosure 
of a broker-dealer's capacity, a dual-registrant could disclose that 
recommendations will be made in a broker-dealer capacity unless 
otherwise expressly stated at the time of the recommendation, and that 
any such statement will be made orally. Or, a broker-dealer could 
disclose that its associated persons may have conflicts of interest 
beyond than those disclosed by the broker-dealer, and that associated 
persons will disclose, where appropriate, any additional material 
conflicts of interest not later than the time of a recommendation, and 
that any such disclosure will be made orally.
---------------------------------------------------------------------------

    \302\ While using a percentage or dollar range to describe a fee 
can be appropriate, that range should be designed to reasonably 
reflect the actual fees to be charged. For example, if the firm 
offers in almost all instances funds with up-front sales charges of 
between 5% and 5.5%, but the disclosure states that mutual fund up-
front sales charges may ``range from 0.0% to 5.5%,'' then the 
broker-dealer would need to evaluate whether the disclosure should 
be revised to more accurately describe the sales charge. See 
discussion in Section II.C.1.a, Disclosure Obligation, Material 
Facts Regarding Scope and Terms of the Relationship, Fees and Costs, 
Particularly of Fees and Costs Disclosed.
---------------------------------------------------------------------------

    We believe it is in the public interest and consistent with the 
protection of investors to permit such flexibility in the delivery of 
information pursuant to the Disclosure Obligation. Providing retail 
customers written summary information about material facts relating to 
a recommendation and indicating that additional information will be 
forthcoming, the point at which the additional information will be 
delivered, and the method by which it will be conveyed, highlights for 
retail customers a useful summary of information while allowing for the 
practical realities of the process by which securities recommendations 
are made and transactions are executed and leaving longstanding 
existing disclosure regimes, particularly those relating to product 
issuer disclosure, undisturbed.
Other Liabilities Under the Federal Securities Laws
    Further, the requirements under Regulation Best Interest that 
particular information be disclosed is not determinative of a broker-
dealer or associated person's other potential liabilities under the 
general antifraud provisions of the federal securities laws for failure 
to disclose material information to a customer at the time of a 
recommendation.\303\ In addition, we

[[Page 33349]]

remind broker-dealers that even full and fair disclosure of the 
information required by the Disclosure Obligation is not sufficient, 
standing alone, to satisfy the Care Obligation, and that even 
sufficient disclosure cannot cure a violation of the Care Obligation.
---------------------------------------------------------------------------

    \303\ Broker-dealers are liable under the antifraud provisions 
for failure to disclose material information to their customers when 
they have a duty to make such disclosure. See Basic v. Levinson, 485 
U.S. 224, 239 footnote 17 (1988) (``Silence, absent a duty to 
disclose, is not misleading under Rule 10b-5.''); Chiarella v. U.S., 
445 U.S. 222, 228 (1980) (explaining that a failure to disclose 
material information is only fraudulent if there is a duty to make 
such disclosure arising out of ``a fiduciary or other similar 
relation of trust and confidence''); SEC v. Monarch Funding Corp., 
192 F.3d 295, 308 (2d Cir. 1999) (explaining that defendant is 
liable under Section 10(b) and Rule 10b-5 for material omissions 
``as to which he had a duty to speak''). Generally, under the 
antifraud provisions, a broker-dealer's duty to disclose material 
information to its customer is based upon the scope of the 
relationship with the customer, which is fact intensive. See, e.g., 
Conway v. Icahn & Co., Inc., 16 F.3d 504, 510 (2d Cir. 1994) (``A 
broker, as agent, has a duty to use reasonable efforts to give its 
principal information relevant to the affairs that have been 
entrusted to it.''). For example, where a broker-dealer processes 
its customers' orders, but does not recommend securities or solicit 
customers, then the material information that the broker-dealer is 
required to disclose is generally narrow, encompassing only the 
information related to the consummation of the transaction. See, 
e.g., Press v. Chemical Inv. Servs. Corp., 166 F.3d 529, 536 (2d 
Cir. 1999). However, courts have found that a broker-dealer's duty 
to disclose material information under the antifraud provisions is 
broader when the broker-dealer is making a recommendation to its 
customer. See, e.g., Hanly, 415 F.2d 589, 597 (2d Cir. 1969). When 
recommending a security, broker-dealers generally are liable under 
the antifraud provisions if they do not give ``honest and complete 
information'' or disclose any material adverse facts or material 
conflicts of interest, including any economic self-interest. See, 
e.g., De Kwiatkowski v. Bear, Stearns & Co., 306 F.3d 1293, 130 (2d 
Cir. 2002); Chasins v. Smith, Barney & Co., 438 F.2d 1167, 1172 (2d 
Cir. 1970). See Proposing Release at 21599 footnote 176.
---------------------------------------------------------------------------

Disclosures by Natural Persons Associated With a Broker-Dealer
    The Disclosure Obligation applies to a broker, dealer, or natural 
person who is an associated person of a broker or dealer.\304\ As 
stated in the Proposing Release, we are requiring not only the broker-
dealer entity, but also individuals who are associated persons of a 
broker-dealer (e.g., registered representatives) to comply with 
specified components of Regulation Best Interest when making 
recommendations to retail customers.\305\ One commenter requested 
guidance on how an associated person should comply with the Disclosure 
Obligation.\306\ In response, we believe that a natural person who is 
an associated person of a broker-dealer may in many instances rely on 
the disclosures provided by the broker-dealer with which he or she is 
associated to satisfy the Disclosure Obligation. However, when an 
associated person knows or should have known that the broker-dealer's 
disclosure is insufficient to describe ``all material facts,'' the 
associated person must supplement that disclosure. For example, if an 
associated person of a broker-dealer that offers a full range of 
securities products is licensed solely as a Series 6 Registered 
Representative,\307\ and can sell only mutual funds, variable annuities 
and other enumerated products, that limitation on the scope of services 
provided by the particular associated person must be sufficiently clear 
in the broker-dealer's disclosures; otherwise additional clarifying 
disclosure by the associated person would be necessary.
---------------------------------------------------------------------------

    \304\ Rule 15l-1(a)(2)(i).
    \305\ Proposing Release at 21592.
    \306\ See NASAA August 2018 Letter (recommending that the 
Commission provide specific instructions on how associated persons 
should disclose capacity in which they are acting).
    \307\ A candidate who passes the Series 6 exam is qualified for 
the solicitation, purchase and/or sale of the following securities 
products: Mutual funds (closed-end funds on the initial offering 
only), Variable annuities, Variable life insurance, Unit investment 
trusts (UITs), Municipal fund securities (e.g., 529 savings plans, 
local government investment pools (LGIPs)). FINRA, Series 6--
Investment Company and Variable Contracts Products Representative 
Exam, Permitted Activities, available at: https://www.finra.org/industry/series6#permitted-activities.
---------------------------------------------------------------------------

a. Material Facts Regarding Scope and Terms of the Relationship
    As discussed above, the proposed Disclosure Obligation would 
require a broker-dealer to, among other things, ``prior to or at the 
time of such recommendation, reasonably disclose to the retail 
customer, in writing, the material facts relating to the scope and 
terms of the relationship with the retail customer.'' We proposed to 
consider the following to be examples of material facts relating to the 
scope and terms of the relationship with the retail customer: (i) That 
the broker-dealer was acting in a broker-dealer capacity with respect 
to the recommendation; (ii) fees and charges that would apply to the 
retail customer's transactions, holdings, and accounts; and (iii) the 
type and scope of services provided by the broker-dealer, including, 
for example, monitoring the performance of the retail customer's 
account.
    Commenters requested that we clarify which facts a broker-dealer 
would be required to disclose about the scope and terms of the 
relationship it has with a customer under Regulation Best 
Interest.\308\ In particular, several commenters recommended that the 
Commission clarify how a dual-registrant should disclose its capacity 
regarding its recommendations.\309\ Other commenters recommended that 
the Commission define the scope of fees a broker-dealer must disclose 
\310\ and the form that disclosure should take.\311\ In addition, some 
commenters requested clarity on the types of services that a broker-
dealer would be required to disclose, including limitations on 
securities offered \312\ and account monitoring services.\313\
---------------------------------------------------------------------------

    \308\ See, e.g., SIFMA August 2018 Letter; Edward Jones Letter; 
NASAA August 2018 Letter; AARP August 2018 Letter; PIABA Letter; 
Prudential Letter.
    \309\ See, e.g., SIFMA August 2018 Letter; Edward Jones Letter.
    \310\ See, e.g., Bank of America Letter (recommending that the 
Commission apply a ``materiality'' threshold to determine which fees 
should be disclosed).
    \311\ See, e.g., SIFMA August 2018 Letter (stating that a 
broker-dealer's disclosure of a range of customer costs per product 
should be sufficient); CFA August 2018 Letter (stating a broker-
dealer's disclosure of percentages or ranges of cost information 
would do little to enlighten investors about the true costs of 
brokers' advice services).
    \312\ See, e.g., NY Life Letter (stating that an insurer may 
appropriately focus its career agents on the distribution of 
variable insurance products that the insurer manufactures, so long 
as limitations on the universe of available products are disclosed 
to consumers and supervisory procedures are in place to ensure that 
a variable insurance product is in the client's best interest); CFA 
Institute Letter (stating that the Disclosure Obligation should 
complement the information presented in Form CRS and provide greater 
specificity about, among other things, the type and scope of 
services offered by the broker-dealer).
    \313\ See, e.g., IAA August 2018 Letter (recommending that the 
Commission clarify that Regulation Best Interest would apply to all 
advisory activities that broker-dealers agree to provide (e.g., 
ongoing monitoring for purposes of recommending changes in 
investments)).
---------------------------------------------------------------------------

    As discussed below, in response to comments, we have revised the 
Disclosure Obligation to require disclosure of ``all material facts 
relating to the scope and terms of the relationship with the retail 
customer, including: (i) That the broker, dealer or such natural person 
is acting as a broker, dealer or an associated person of a broker-
dealer with respect to the recommendation; (ii) the material fees and 
costs that apply to the retail customer's transactions, holdings, and 
accounts; and (iii) the type and scope of services provided to the 
retail customer, including any material limitations on the securities 
or investment strategies involving securities that may be recommended 
to the retail customer.'' \314\ In addition, we are clarifying the 
scope of the obligation.
---------------------------------------------------------------------------

    \314\ Rule 15l-1(a)(2)(i)(A).
---------------------------------------------------------------------------

    As we did in the Proposing Release, we emphasize that although we 
have explicitly identified the capacity in which the broker-dealer is 
acting, material fees and costs, and the type and scope of services, as 
what would at a minimum be required to be disclosed as ``material facts 
relating to the scope and terms of the relationship with the retail 
customer,'' the Disclosure Obligation requires broker-dealers and 
associated persons to disclose ``all material facts relating to the 
scope of the terms of the relationship,'' (emphasis added) and broker-
dealers and such associated persons thus will need to consider, based 
on the facts and circumstances, whether there are other material facts 
relating to the scope and terms of the relationship with the retail 
customer that need to be disclosed. This analysis generally should 
include consideration of whether information in the Relationship 
Summary constitutes a ``material fact'' that could appropriately be 
expanded upon in satisfying the Disclosure Obligation. It would be 
possible, but would be unlikely for most

[[Page 33350]]

broker-dealers, for the abbreviated format of the Relationship Summary 
to sufficiently disclose ``all material facts'' regarding the scope and 
terms of the relationship such that no further information would be 
required to satisfy the Disclosure Obligation.
Capacity In Which the Broker-Dealer Is Acting
    In the Proposing Release, the Commission identified that the 
capacity in which a broker-dealer is acting is a material fact relating 
to the scope and terms of a customer relationship subject to the 
Disclosure Obligation.\315\ In so identifying this critical element of 
information, we hoped to promote greater awareness among retail 
customers of the capacity in which their financial professional or firm 
acts with respect to recommendations.
---------------------------------------------------------------------------

    \315\ Proposing Release at 21601.
---------------------------------------------------------------------------

    Several commenters requested additional guidance on how dual-
registrants and their associated persons could comply with the proposed 
Disclosure Obligation in this respect.\316\ Some commenters stated that 
repeated disclosures of capacity would distract customers from more 
important disclosures related to a recommendation and could lead to 
confusion.\317\ While we received comments expressing concerns that our 
proposed approach might lead to investor confusion,\318\ many of these 
commenters were seeking clarity regarding this requirement and not its 
elimination.\319\
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    \316\ See, e.g., NASAA August 2018 Letter (requesting that the 
Commission provide guidance to associated persons of dual-
registrants explaining how they should disclose the capacity in 
which they are acting and whether they are providing a 
recommendation or advice); Better Markets August 2018 Letter; CFA 
August 2018 Letter; Fidelity Letter; IPA Letter; SIFMA August 2018 
Letter; Edward Jones Letter; CCMC Letters.
    \317\ See, e.g., Edward Jones Letter (recommending that the 
Commission not require repeated capacity disclosures to customers 
because it would be redundant and potentially confuse customers); 
SIFMA August 2018 Letter (stating that disclosure of capacity should 
not be required at the time of the recommendation as it would cause 
unnecessary delay and distract customers from more important 
disclosures regarding account features and recommendations); Better 
Markets August 2018 Letter (stating that one-time written disclosure 
about a dual-registrant's advisory capacity, followed by future oral 
disclosures when they change roles when making recommendations would 
be confusing).
    \318\ See, e.g., Better Markets August 2018 Letter; CFA August 
2018 Letter (stating that flexibility in disclosure will result in 
disclosures that do not effectively convey key information 
especially for dual-registrants as customers will not understand the 
capacity the dual-registrant is acting in at the particular time or 
its significance).
    \319\ See, e.g., SIFMA August 2018 Letter (requesting that the 
Commission clarify the application of the Disclosure Obligation to 
dually registered firms and personnel, including what, and how 
frequently, disclosure is required to put customer on notice of 
their capacity); Edward Jones Letter; IPA Letter; CCMC Letters.
---------------------------------------------------------------------------

    In response to commenters, we are revising Regulation Best Interest 
to explicitly require disclosure of capacity, which the Proposing 
Release addressed in guidance. Therefore, Rule 15l-1(a)(2)(i)(A) 
requires that the broker, dealer, or natural person who is an 
associated person of a broker or dealer, prior to or at the time of the 
recommendation, provide the retail customer, in writing, full and fair 
disclosure of all material facts relating to the scope and terms of the 
relationship with the retail customer, including that the broker-dealer 
or such natural person is acting as a broker-dealer or an associated 
person of a broker-dealer with respect to the recommendation.
    This disclosure is designed to improve awareness among retail 
customers of the capacity in which their financial professional or 
broker-dealer acts when it makes recommendations so that the retail 
customer can more easily identify and understand their relationship, a 
goal shared with the Relationship Summary.\320\ Form CRS requires a 
firm to state the name of the broker-dealer or investment adviser and 
whether the firm is registered with the Commission as a broker-dealer, 
investment adviser, or both.\321\ A standalone broker-dealer (i.e., a 
broker-dealer not also registered as an investment adviser) will 
generally be able to satisfy the Disclosure Obligation's requirement to 
disclose the broker-dealer's capacity by delivering the Relationship 
Summary to the retail customer.
---------------------------------------------------------------------------

    \320\ See Relationship Summary Proposal at 21420.
    \321\ See Relationship Summary Adopting Release at Section II.C.
---------------------------------------------------------------------------

    For broker-dealers who are dually registered, and for associated 
persons who are either dually registered or, who are not dually 
registered but only offer broker-dealer services through a firm that is 
dually registered, the information contained in the Relationship 
Summary will not be sufficient to disclose their capacity in making a 
recommendation. Although some commenters expressed concerns about 
potential investor confusion caused by ``additional'' disclosure 
regarding a dual-registrant's capacity, we believe that the Disclosure 
Obligation will not duplicate or confuse, but instead will provide 
clarifying detail on capacity to supplement the information contained 
in the Relationship Summary. Accordingly, we are clarifying that dually 
registered associated persons and associated persons who are not dually 
registered but only offer broker-dealer services through a firm that is 
dually registered as an investment adviser with the Commission or with 
a state, must disclose whether they are acting (or, in the case of the 
latter, that they are only acting) as an associated person of a broker-
dealer to satisfy the Disclosure Obligation.\322\ An associated person 
of a dual-registrant who does not offer investment advisory services 
must disclose that fact as a material limitation in order to satisfy 
the Disclosure Obligation.
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    \322\ Financial professionals with registrations to offer 
services as a representative of a broker-dealer and investment 
adviser may offer services through a dual-registrant, affiliated 
firms, or unaffiliated firms, or only offer one type of service 
notwithstanding their dual licensing. Financial professionals who 
are not dually registered may offer one type of service through a 
firm that is dually registered. See Relationship Summary Adopting 
Release at Section II.B.4.
---------------------------------------------------------------------------

    Furthermore, as discussed in greater detail below, we would presume 
the use of the terms ``adviser'' and ``advisor'' by (1) a broker-dealer 
that is not also registered as an investment adviser or (2) a financial 
professional that is not also a supervised person of an investment 
adviser to be a violation of the Disclosure Obligation under Regulation 
Best Interest. Disclosure of capacity may, in part, be made orally 
under the circumstances outlined in Section II.C.1, Oral Disclosure or 
Disclosure After a Recommendation. For example, a broker-dealer may 
disclose that: ``All recommendations will be made in a broker-dealer 
capacity unless otherwise expressly stated at the time of the 
recommendation; any such statement will be made orally.'' In this case, 
no further oral or written disclosure would be required until a 
recommendation is made in a capacity other than as a broker-dealer. 
Similarly, a broker-dealer may disclose that: ``All recommendations 
regarding your brokerage account will be made in a broker-dealer 
capacity, and all recommendations regarding your advisory account will 
be in an advisory capacity. When we make a recommendation to you, we 
will expressly tell you orally which account we are discussing''). In 
this instance, no further disclosure of capacity is necessary.
Capacity in the Context of Names, Titles, and Marketing Practices
    The Relationship Summary Proposal included a proposed rule that 
would have restricted broker-dealers and their associated persons 
(unless they were registered as, or supervised persons of, an 
investment adviser), when communicating with a retail investor,

[[Page 33351]]

from using the term ``adviser'' or ``advisor'' as part of a name or 
title (``Titling Restrictions'').\323\ After further consideration of 
our policy goals and the comments we received, and in light of the 
disclosure requirements under Regulation Best Interest, we do not 
believe that adopting a separate rule restricting these terms is 
necessary, because we presume that the use of the term ``adviser'' and 
``advisor'' in a name or title by (1) a broker-dealer that is not also 
registered as an investment adviser or (2) an associated person that is 
not also a supervised person of an investment adviser, to be a 
violation of the capacity disclosure requirement under the Disclosure 
Obligation as discussed further below.\324\
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    \323\ See Relationship Summary Proposal, supra footnote 12, at 
21461-63. We also requested comment on whether we should explicitly 
restrict other terms, including ``wealth manager'' and ``financial 
consultant.'' Additionally, we requested comment on whether we 
should restrict terms that are synonymous with ``adviser'' or 
``advisor.''
    \324\ We recognize that, in adopting the fee-based brokerage 
rule in 2005, we declined to place any limitations on how a broker-
dealer may hold itself out or the titles it may employ. Certain 
Broker-Dealers Deemed Not to Be Investment Advisers, Advisers Act 
Release No. 2376 (Apr. 12, 2005). However, as we noted in the 
Relationship Summary Proposal, comments we received in response to 
Chairman Clayton's request for comment and our experience prompted 
us to revisit our approach from 2005. In addition, given that the 
new disclosure requirements under Regulation Best Interest and Form 
CRS will and should necessitate a reassessment of a broker-dealer's 
names, titles, and communications with its customers, we believe it 
is necessary to re-evaluate the appropriateness of these practices 
in light of these new obligations. See also generally Relationship 
Summary Proposal, supra footnote 12, at 21459-61 (citing commenters 
and studies by the Siegel and Gale Consulting Group and the RAND 
Corporation that document investor confusion in the marketplace, all 
of which were conducted subsequent to the 2005 fee-based brokerage 
rule); Public Comments from Retail Investors and Other Interested 
Parties on Standards of Conduct for Investment Advisers and Broker-
Dealers, Chairman Jay Clayton (Jun. 1, 2017), available at https://www.sec.gov/news/public-statement/statement-chairman-clayton-2017-05-31. We also proposed rules (the ``Affirmative Disclosures'') that 
would have required a broker-dealer and an investment adviser to 
prominently disclose that it is registered as a broker-dealer or 
investment adviser, as applicable, with the Commission in print or 
electronic retail investor communications. As we discuss in a 
concurrent rulemaking, we are not adopting the Affirmative 
Disclosures. See Relationship Summary Adopting Release, supra 
footnote 12, at Section III.
---------------------------------------------------------------------------

    We received several comments on the proposed Titling Restrictions, 
which we have also considered when determining to presume use of such 
names and titles to be a violation of the capacity disclosure.\325\ 
Some commenters supported a restriction on the terms ``adviser'' and 
``advisor,'' noting, for example, that these particular terms are often 
associated with the statutory term ``investment adviser,'' \326\ or 
that investors ``typically associate'' these terms with registered 
investment advisers.\327\ A few commenters generally noted that the 
title ``financial advisor'' prevents investors from understanding 
whether they are engaging a financial professional who provides 
advisory services or who sells brokerage services.\328\ Moreover, other 
commenters generally stated that names and titles containing 
``adviser'' or ``advisor'' create investor confusion and/or could 
mislead investors about the differences between broker-dealers and 
investment advisers including the applicable standard of care \329\ and 
the services to be provided.\330\
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    \325\ See, e.g., CFA August 2018 Letter; IAA August 2018 Letter; 
LPL August 2018 Letter; Letter from Dennis M. Kelleher, President 
and CEO, et al., Better Markets (Aug. 7, 2018) (``Better Markets CRS 
Letter'').
    \326\ See Letter from Lexie Pankratz, Owner, Trailhead 
Consulting, LLC (Aug. 7, 2018) (``Trailhead Letter'').
    \327\ See, e.g., Letter from Kurt N. Schacht, Managing Director, 
et al., CFA Institute (Aug. 7, 2018) (``CFA Institute CRS Letter''); 
Pickard Letter.
    \328\ See, e.g., Letter from Gerald Lopatin (Jul. 30, 2018) 
(``Lopatin Letter''); Letter from Paula Hogan (Aug. 6, 2018) 
(``Hogan Letter''); Letter from Arlene Moss (Jul. 31, 2018) (``Moss 
Letter''); Letter from Daniel Wrenne (Jul. 31, 2018) (``Wrenne 
Letter'').
    \329\ See, e.g., FSI August 2018 Letter; Schwab Letter; CFA 
Institute CRS Letter; Betterment Letter.
    \330\ See, e.g., NASAA August 2018 Letter (stating that ``[t]his 
rule change will help forestall retail investors' confusion about 
the different roles and duties owed by broker-dealers/agents and 
investment advisers/investment adviser Representatives''); CFA 
Institute CRS Letter (stating that ``[i]nvestor confusion about the 
roles and duties of different financial services providers who use 
``adviser/advisor'' in their titles has become problematic from both 
an investor protection and trust standpoint. Use of the proposed 
CRS, alone, will not allay the substantial investor confusion in the 
marketplace about the differences between broker-dealers and 
investment advisers.'')
---------------------------------------------------------------------------

    Other commenters did not support the proposed Titling Restrictions, 
believing that the terms ``adviser'' and ``advisor'' are more 
generically used and understood, and refer to financial professionals 
who provide advice and financial services more generally.\331\ Several 
of these commenters stated that the restriction adds little additional 
investor protection when taken together with Regulation Best Interest 
and Form CRS (i.e., it is duplicative).\332\ Additionally, some 
commenters stated that Form CRS alone provides similar investor 
protections that alleviate the need for the restriction.\333\ Along 
similar lines, one commenter stated that certain fraud-based securities 
laws and FINRA rules provide the same protections that the proposed 
restriction seeks to add, making it unnecessary.\334\
---------------------------------------------------------------------------

    \331\ See LPL August 2018 Letter (stating that ``restricting use 
of `advisor' and `adviser' is contrary to the plain English meaning 
the average investor associates with those terms . . . regardless of 
the legal contours of the service relationship.''); NAIFA Letter 
(stating that ``[m]any financial professionals are recognized as 
and/or refer to themselves as `advisors/advisers' or `financial 
advisors/advisers.' These words are (aptly) used by professionals 
who offer advice on any number of financial topics.''); Letter from 
Investments & Wealth Institute (``IWI'') (Aug. 6, 2018) (``IWI 
August 2018 Letter'') (stating that an outright ban on the use of 
the terms ``adviser'' and ``advisor'' by broker-dealers would raise 
First Amendment concerns).
    \332\ See, e.g., Letter from Robert D. Oros, Chief Executive 
Officer, HD Vest Financial Services (Aug. 7, 2018) (``HD Vest 
Letter''); LPL August 2018 Letter; SIFMA August 2018 Letter. But see 
Pickard Letter (supporting the restriction and our proposed 
alternative holding out approach by noting that ``[w]e do not think 
that Reg BI or Form CRS as currently proposed is sufficient.'')
    \333\ See, e.g., LPL August 2018 Letter; Morgan Stanley Letter; 
Raymond James Letter.
    \334\ See Cambridge Letter.
---------------------------------------------------------------------------

    We also received several comments on the following alternative 
approaches to the Titling Restrictions on which we sought comment: (i) 
A broker-dealer that used the terms ``adviser'' or ``advisor'' as part 
of a name or title would not be considered to provide investment advice 
solely incidental to the conduct of its business as a broker-dealer, 
and (ii) a broker-dealer would not be providing investment advice 
solely incidental to its brokerage business if it ``held itself out'' 
as an investment adviser to retail investors.\335\ This second 
alternative approach would have resulted in a restriction generally 
broader in scope than the Titling Restrictions, as it would also have 
encompassed communications and sales practices in addition to the use 
of names and titles.
---------------------------------------------------------------------------

    \335\ See Relationship Summary Proposal, supra footnote 12, at 
21463-64. We are not adopting the proposed alternative approach that 
would have restricted a broker-dealer from availing itself of the 
solely incidental exclusion if it ``held itself out'' as an 
investment adviser. Use of the terms ``adviser'' or ``advisor,'' 
however, could support a conclusion depending on other facts and 
circumstances, that the primary business of the firm is advisory in 
nature, in which case the advice provided by the broker-dealer would 
not be solely incidental to the conduct of its brokerage business. 
See Solely Incidental Interpretation, supra footnote 12, at Section 
II.B (providing the Commission's interpretation of the solely 
incidental prong of the broker-dealer exclusion from the Advisers 
Act).
---------------------------------------------------------------------------

    In response to these alternatives, several commenters stated that 
the Titling Restrictions were too narrow in meeting the Commission's 
intended objective of mitigating the risk that investors could be 
misled by the use of certain names and titles because the Titling 
Restrictions did not address other confusing names or titles,\336\ and,

[[Page 33352]]

more specifically, because the Titling Restrictions did not address the 
broker-dealers who ``hold themselves out'' as investment advisers.\337\ 
Several of these commenters instead advocated for precluding reliance 
on the solely incidental prong by any broker-dealer that holds itself 
out as an investment adviser.\338\ Some commenters stated that certain 
marketing practices indicate that advice is the main function of the 
broker-dealer's service.\339\ Additionally, one commenter stated that 
``the potential for investor confusion is at its greatest when dealing 
with broker-dealers and dual-registrants that routinely market their 
services as advisory in nature. . . .'' \340\
---------------------------------------------------------------------------

    \336\ See e.g., Letter from Barbara Roper, Director of Investor 
Protection, and Micah Hauptman, Financial Services Counsel, (Dec. 7, 
2018) (``CFA December 2018 Letter''); State Treasurers Letter; 
Waters Letter (noting that the Titling Restrictions are too narrow 
of a fix for investor confusion because they fail ``to address the 
numerous other titles professionals use. . . . As a result, most 
retail investors cannot easily distinguish between financial 
advisers who are mere salespeople and those that are investment 
advisers that must provide advice that is in the best interests of 
the investor.''). See also NAIFA Letter (noting that restricting 
these terms for broker-dealers and their financial professionals 
only ``and not for numerous other professionals using those words 
and delivering advice on a wide variety of financial topics creates 
more consumer confusion and does not enhance consumers' 
understanding of the specific obligations and standards that apply 
to their advisor(s).'')
     Additionally, several of the commenters who supported the 
restriction recommended modifications such as broadening the 
restriction to include other terms, including ``wealth manager'' and 
``financial consultant.'' See, e.g., Financial Engines Letter; 
Comment Letter of Altruist Financial Advisors LLC (Aug. 7, 2018) 
(``Altruist Letter''); Letter from David John Marotta (April 22, 
2018) (``Marotta Letter''); Galvin Letter; Letter from Pamela Banks, 
Senior Policy Counsel, Consumers Union (Oct. 19, 2018) (``Consumers 
Union Letter'').
    \337\ See, e.g., CFA August 2018 Letter; FPC Letter; IAA August 
2018 Letter; Letter from Michael Kitces (Aug. 2, 2018) (``Kitces 
Letter''); LPL August 2018 Letter; MarketCounsel Letter; Waters 
Letter.
    \338\ See, e.g., IAA August 2018 Letter (noting that ``[w]hile 
names or titles are contributing factors to investor confusion and 
the potential for investors to be misled, we believe that other 
factors should be considered as well. In particular, previous 
studies noted the confusion arising from `we do it all' 
advertisements and `marketing efforts which depicted an ongoing 
relationship between the broker-dealer and the investor.' ''); 
Betterment Letter; CFA August 2018 Letter; LPL August 2018 Letter.
    \339\ See CFA August 2018 Letter (citing to Micah Hauptman and 
Barbara Roper, Financial Advisor or Investment Salesperson? Brokers 
and Insurers Want to Have it Both Ways, January 18, 2017). See also 
Better Markets CRS Letter (stating that titles present a 
professional as not ``only an expert in financial matters but also 
someone who will offer advice and recommendations''); Letter from 
Michael Palumbo (Aug. 7, 2018) (``Palumbo Letter''); Kitces Letter.
    \340\ See CFA August 2018 Letter. See also CFA Institute CRS 
Letter (stating that the proposal should address ``those who may not 
expressly refer to themselves as `adviser/[advis]or' but through 
their actions convey that meaning to investors. . . .'').
---------------------------------------------------------------------------

Use of Terms ``Adviser'' or ``Advisor''
    Financial firms and their professionals, including broker-dealers 
and investment advisers, seek to acquire new customers and to retain 
existing customers by marketing their services, including through the 
use of particular terms in names and titles. Firms often spend time and 
money to market, brand, and create intellectual property by using these 
terms in an effort to shape investor expectations.\341\ A name or title 
is generally used, and is designed to have significance, on its own 
without any additional context as to what it means. Given that the 
titles ``adviser'' and ``advisor'' are closely related to the statutory 
term ``investment adviser,'' their use by broker-dealers can have the 
effect of erroneously conveying to investors that they are regulated as 
investment advisers, and have the business model, including the 
services and fee structures, of an investment adviser.\342\ Such 
potential effect undermines the objective of the capacity disclosure 
requirement under Regulation Best Interest to enable a retail customer 
to more easily identify and understand their relationship.
---------------------------------------------------------------------------

    \341\ See, e.g., Letter from Barbara Roper, Director of Investor 
Protection, and Micah Hauptman, Financial Services Counsel, CFA 
(Sep. 14, 2017) (``CFA September 2017 Letter'') (``[O]ur study 
documents how everything from the titles brokers use to the way they 
describe their services is designed to send the message that they 
are in the business of `providing expert investment advice, 
comprehensive financial planning, and retirement planning that is 
based on their clients' needs and goals and that is designed to 
serve their best interests.' '')
    \342\ See Relationship Summary Proposal, supra footnote 12, at 
21461.
---------------------------------------------------------------------------

    As discussed above, the Disclosure Obligation requires broker-
dealers to make full and fair disclosure of all material facts relating 
to the scope and terms of the relationship with a retail customer, 
including the capacity in which they are acting with respect to a 
recommendation. The capacity disclosure requirement is designed to 
improve awareness among retail customers of the capacity in which their 
firm and/or financial professional acts when it makes recommendations 
so that a retail customer can more easily identify and understand their 
relationship.\343\ We believe that in most cases broker-dealers and 
their financial professionals cannot comply with the capacity 
disclosure requirement by disclosing that they are a broker-dealer 
while calling themselves an ``adviser'' or ``advisor.'' Under the 
Disclosure Obligation, a broker-dealer, or an associated person, must, 
prior to or at the time of the recommendation, disclose that the 
broker-dealer or that associated person is acting as a broker or dealer 
with respect to the recommendation.\344\ When a broker-dealer or an 
associated person uses the name or title ``adviser'' or ``advisor'' 
there are few circumstances \345\ in which that broker-dealer or 
associated person would not violate the capacity disclosure requirement 
because the name or title directly conflicts with the information that 
the firm or professional would be acting in a broker-dealer 
capacity.\346\ Therefore, use of the titles ``adviser'' and ``advisor'' 
by broker-dealers and their financial professionals would undermine the 
objectives of the capacity disclosure requirement by potentially 
confusing a retail customer as to type of firm and/or professional they 
are engaging, particularly since ``investment adviser'' is defined by 
statute separately from ``broker'' or ``dealer.''
---------------------------------------------------------------------------

    \343\ Similarly, Form CRS is designed to reduce retail investor 
confusion in the marketplace for brokerage and investment advisory 
services and to assist retail investors with the process of deciding 
whether to engage, or to continue to engage, a particular firm or 
financial professional and whether to establish, or to continue to 
maintain, an investment advisory or brokerage relationship. A 
broker-dealer firm or financial professional's use of ``adviser'' or 
``advisor'' in its name or title would inhibit a customer's full 
understanding of the contours of his or her relationship with the 
firm and financial professional, undermining Form CRS.
    \344\ See Rule 15l-1(a)(2)(i)(A)(i).
    \345\ See infra footnotes 349-351 and accompanying text.
    \346\ In the Relationship Summary Proposal, we stated that our 
proposed restriction on the terms ``adviser'' and ``advisor'' would 
not have applied to broker-dealers when communicating with 
institutions. See Relationship Summary Proposal, supra footnote 12, 
at 21462. Given that Regulation Best Interest and the Relationship 
Summary apply only to retail customers and retail investors, 
respectively, our presumption would only apply to the use of 
``adviser'' and ``advisor'' in such contexts. Therefore, we do not 
believe that further clarification of communications by non-retail 
focused broker-dealers is necessary.
---------------------------------------------------------------------------

    As a result,\347\ we presume that the use of the terms ``adviser'' 
and ``advisor'' in a name or title by (i) a broker-dealer that is not 
also registered as an investment adviser or (ii) an associated person 
that is not also a supervised person of an investment adviser to be a 
violation of the capacity disclosure requirement under Regulation Best 
Interest.\348\
---------------------------------------------------------------------------

    \347\ Specifically, in the Proposing Release we stated that a 
standalone broker-dealer would satisfy the capacity disclosure by 
complying with the proposed Relationship Summary and Affirmative 
Disclosure requirements. We provided this proposed guidance in the 
context of concurrently proposing the Titling Restrictions. For the 
reasons discussed herein, we believe a presumption against the use 
of these titles by standalone broker-dealers is more appropriate 
than a restriction.
    \348\ If a financial professional is a registered representative 
of a broker-dealer that is a dual-registrant but the professional is 
not also a supervised person of an investment adviser, this 
professional would similarly be presumptively in violation of the 
capacity disclosure requirement if the financial professional uses 
the title ``adviser'' or ``advisor.'' However, this financial 
professional may continue to use either the dual-registrant's 
materials or may use the firm's name in the financial professional's 
communications even if the firm's name includes the title 
``adviser'' or ``advisor'' because such firm is dually registered as 
an investment adviser and broker-dealer and is not presumptively 
violating the capacity disclosure requirement under Regulation Best 
Interest. Moreover, we believe it would be consistent for dual-
registrants and dually registered financial professionals to use 
these terms as they would be accurately describing their 
registration status as an investment adviser.

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[[Page 33353]]

    Although using these names or titles creates a presumption of a 
violation of the Disclosure Obligation in Regulation Best Interest, we 
are not expressly prohibiting the use of these names and titles by 
broker-dealers because we recognize that some broker-dealers use them 
to reflect a business of providing advice other than investment advice 
to retail clients. A clear example is a broker-dealer (or associated 
person) that acts on behalf of a municipal advisor \349\ or commodity 
trading adviser,\350\ or as an advisor to a special entity,\351\ as 
these are distinct advisory roles specifically defined by federal 
statute that do not entail providing investment advisory services. We 
also recognize that a broker-dealer may provide advice in other 
capacities outside the context of investment advice to a retail 
customer that would present a similarly compelling claim to the use of 
these terms. In these circumstances, firms and their financial 
professionals may in their discretion use the terms ``adviser'' or 
``advisor.'' \352\ In most instances, however, when a broker-dealer 
uses these terms in its name or title in the context of providing 
investment advice to a retail customer, they will generally violate the 
capacity disclosure requirement under Regulation Best Interest.
---------------------------------------------------------------------------

    \349\ 15 U.S.C. 78o-4(e)(4).
    \350\ 15 U.S.C. 80b-2(a)(29).
    \351\ 15 U.S.C. 78o-8(h)(2)(A).
    \352\ Some commenters raised concerns that the proposed 
restriction would not permit financial professionals to indicate 
that they maintain particular certifications that include in the 
name or title ``adviser'' or ``advisor.'' See, e.g., IWI August 2018 
Letter; Letter from IWI (Oct. 9, 2018) (``IWI October 2018 
Letter''). Cf. Letter from John Robinson (Aug. 6, 2018) (``Robinson 
Letter'') (suggesting that the Commission limit the use of the term 
``financial planner'' to investment adviser representatives); FPC 
Letter (suggesting that the Commission clarify which certifications 
or professional designations may be used for financial planners). We 
recognize that these designations are intended to convey adherence 
to particular standards that financial professionals have met. 
However, these designations are not rooted in any statutory 
construct (as are the titles ``commodity trading advisor'' and 
``municipal advisor'') and given that the terms ``adviser'' and 
``advisor'' are still associated with the statutory term 
``investment adviser,'' even if used in a designation, a broker-
dealer or associated person that uses these designations would 
similarly be in presumptive violation of the capacity disclosure 
requirement in Regulation Best Interest.
---------------------------------------------------------------------------

Marketing Communications
    As discussed above, several commenters on the Titling Restrictions 
raised concerns that restricting the use of names and titles would be 
insufficient to address what they viewed as the larger issue of broker-
dealer marketing communications where a broker-dealer and/or its 
financial professional appears to be holding itself out as an 
investment adviser. Marketing communications provide additional context 
to investors and are designed to persuade potential customers to obtain 
and pay for the firm's services and products.\353\ They communicate to 
customers what services firms understand themselves to be providing--
including, for broker-dealers, recommendations in connection with and 
reasonably related to effecting securities transactions.
---------------------------------------------------------------------------

    \353\ Affiliated firms may market advisory and brokerage 
services in a single set of communications. A dually registered firm 
also may seek to market the primary services provided by its 
advisory and brokerage business lines in a single set of 
communications. We believe this combined approach to providing 
customers with information about investment services enhances 
customer choice, and we understand that many such firms market in 
this way in an effort to provide a comprehensive picture of the 
firm's services.
     See also Instructions to Form CRS, General Instruction 5. 
(Encouraging dual-registrants to prepare one relationship summary 
discussing both its brokerage and investment advisory services, but 
stating that they may prepare two separate relationship summaries 
for brokerage services and investment advisory services. Whether the 
firm prepares one relationship summary or two, the firm must present 
the brokerage and investment advisory information with equal 
prominence and in a manner that clearly distinguishes and 
facilitates comparison of the two types of services.).
---------------------------------------------------------------------------

    The way in which a broker-dealer markets itself may have regulatory 
consequences. As noted above, Form CRS requires, among other items, 
broker-dealers (and investment advisers) to state clearly key facts 
about their relationship, including their registration status and the 
services they provide.\354\ Broker-dealers (and investment advisers) 
will also be required through Form CRS to provide information to assist 
retail investors in deciding whether to engage in an investment 
advisory or brokerage relationship.\355\ Additionally and as discussed 
above, we are adopting the capacity disclosure requirement under 
Regulation Best Interest, which requires broker-dealers and their 
financial professionals to affirmatively disclose the capacity (e.g., 
brokerage) in which they are acting with respect to their 
recommendations.\356\ These obligations are designed to improve 
awareness among retail customers of the capacity in which their firm or 
financial professional acts when it makes recommendations so that the 
retail customer can more easily identify and understand their 
relationship.
---------------------------------------------------------------------------

    \354\ See Relationship Summary Adopting Release, supra footnote 
12.
    \355\ Id.
    \356\ See Rule 15l-1(a)(2)(i)(A)(i).
---------------------------------------------------------------------------

    As noted above, we are not adopting the Commission's proposed 
alternative holding out approach that would have addressed broker-
dealer marketing communications through the lens of the solely 
incidental exclusion.\357\ However, under our interpretation of the 
solely incidental prong of the broker-dealer exclusion from the 
definition of investment adviser, a broker-dealer's investment advisory 
services do not fall within that prong if the broker-dealer's primary 
business is giving investment advice or if its investment advisory 
services are not offered in connection with and are not reasonably 
related to the broker-dealer's business of effecting securities 
transactions.\358\ By more clearly delineating when a broker-dealer's 
performance of advisory activities renders it an investment adviser, 
this interpretation provides guidance that may be informative to 
broker-dealers when designing marketing communications that accurately 
reflect their activities.
---------------------------------------------------------------------------

    \357\ See supra footnote 335 and accompanying text.
    \358\ See Solely Incidental Interpretation, supra footnote 12, 
Section II.B (providing the Commission's interpretation of the 
solely incidental prong of the broker-dealer exclusion from the 
Advisers Act.)
---------------------------------------------------------------------------

    Broker-dealers, dual-registrants, and affiliated broker-dealers of 
investment advisers that market their services together should consider 
whether modifications are needed in their marketing communications in 
light of these new obligations. As we noted in the Relationship Summary 
Proposal, broker-dealers can, and do, provide investment advice so long 
as such advice comports with the broker-dealer exclusion under Advisers 
Act section 202(a)(11)(C). While broker-dealers and their financial 
professionals may state that they provide ``advice'' in their marketing 
communications, those and other statements should not be made in a 
manner that contradicts the disclosures made pursuant to Regulation 
Best Interest and Form CRS, and should be reviewed in light of the 
Solely Incidental Interpretation.\359\ We believe that the combination 
of new disclosure obligations and requirements and firms' 
implementation of these new obligations will appropriately address 
commenters' concerns regarding broker-dealers that hold themselves out 
as

[[Page 33354]]

investment advisers, particularly those who can change capacities when 
serving retail investors in a dual capacity.\360\
---------------------------------------------------------------------------

    \359\ See Relationship Summary Proposal, supra footnote 12, at 
21461.
    \360\ See, e.g., IAA August 2018 Letter; FPC Letter; Better 
Markets CRS Letter.
---------------------------------------------------------------------------

    In addition to these new obligations, FINRA Rule 2210 (regarding 
its members' communications with the public) is designed to ensure that 
broker-dealer communications with the public are fair, balanced, and 
not misleading.\361\ This rule includes general standards, such as a 
requirement to not make any false or misleading statements, and 
specific content standards, such as requirements on how to disclose the 
broker-dealer's name in marketing communications.\362\ Accordingly, we 
anticipate that FINRA will be reviewing the application of these rules 
in light of these new disclosure obligations. The Commission staff also 
will evaluate broker-dealer marketing communications to consider 
whether additional measures may be necessary.
---------------------------------------------------------------------------

    \361\ See FINRA Rule 2210.
    Additionally, broker-dealers and their financial professionals 
should keep in mind the applicability of the antifraud provisions of 
the federal securities laws, including section 17(a) of the 
Securities Act, and Exchange Act Section 10(b) and Rule 10b-5 
thereunder, to their marketing practices.
    \362\ See, e.g., FINRA Rule 2210(d)(1) and (d)(3).
---------------------------------------------------------------------------

Fees and Costs
    In the Proposing Release, we stated that fees and charges 
applicable to the retail customer's transactions, holdings, and 
accounts would also be examples of ``material facts relating to the 
terms and scope of the relationship'' \363\ As such, these fees and 
charges would generally have needed to be disclosed in writing prior 
to, or at the time of, the recommendation. While we did not propose to 
mandate the form, specific content, or method for delivering fee 
disclosure, we stated that we would generally expect that, to meet the 
Disclosure Obligation, broker-dealers would build upon the proposed 
Relationship Summary by disclosing, among other things, additional 
detail regarding the types of fees and charges described in the 
proposed Relationship Summary.\364\
---------------------------------------------------------------------------

    \363\ See Proposing Release at 21601.
    \364\ See Proposing Release at 21600.
---------------------------------------------------------------------------

    We received a number of comments on the proposed Disclosure 
Obligation relating to fees and charges. As discussed in more detail in 
the relevant sections below, these comments generally sought clarity on 
the scope of fees and charges to be disclosed, including the 
particularity of the fees and charges to be disclosed (i.e., whether 
standardized or individualized disclosure would be required). In 
consideration of the comments received, and in light of the obligations 
being imposed by the Relationship Summary, we are revising Regulation 
Best Interest to explicitly require the disclosure of fees and costs, 
and are providing additional clarifying guidance. In addition, we are 
revising the Regulation Best Interest rule text to refer to ``fees and 
costs'' instead of ``fees and charges,'' consistent with the approach 
taken in the Relationship Summary. Specifically, we are revising the 
Disclosure Obligation to require disclosure of ``all material facts 
relating to the scope and terms of the relationship with the retail 
customer, including [. . .] the material fees and costs that apply to 
the retail customer's transactions, holdings and accounts.'' \365\
---------------------------------------------------------------------------

    \365\ Rule 15l-1(a)(2)(i)(A)(ii).
---------------------------------------------------------------------------

    We are also providing additional guidance addressing the scope of 
fees and costs to be disclosed. Namely, the Disclosure Obligation 
requires disclosure of material fees and costs relating to the retail 
customer's transactions, holdings and accounts. This obligation would 
not require individualized disclosure for each retail customer. Rather, 
the use of standardized numerical and other non-individualized 
disclosure (e.g., reasonable dollar or percentages ranges) is 
permissible, as discussed below.\366\
---------------------------------------------------------------------------

    \366\ See Section II.C.1.a, Disclosure Obligation, Fees and 
Costs, Particularity of Fees and Costs Disclosed; Individualized 
Disclosure.
---------------------------------------------------------------------------

Scope of Fees and Costs To Be Disclosed
    Several commenters asked for clarification about whether all fees 
and charges must be disclosed, or only those that are ``material.'' 
\367\ In response, we are revising Regulation Best Interest to make 
explicit that a material fact regarding the scope and terms of the 
relationship includes material fees and costs that apply to the retail 
customer's transactions, holdings and accounts. As noted above, the 
standard for materiality for purposes of the Disclosure Obligation is 
consistent with the one the Supreme Court articulated in Basic v. 
Levinson; fees and costs are material and must be disclosed, if there 
is ``a substantial likelihood that a reasonable shareholder would 
consider it important.'' \368\ As noted above, in the context of this 
Regulation Best Interest, the standard of materiality is based on the 
retail customer, as defined in the rule.
---------------------------------------------------------------------------

    \367\ See, e.g., Bank of America Letter (recommending that the 
Commission: (i) Provide greater specificity regarding the fees to be 
disclosed under Regulation Best Interest, and (ii) apply a 
``materiality'' threshold to those fees).
    \368\ Basic, Inc. v. Levinson, 485 U.S. 224, 224 (1988).
---------------------------------------------------------------------------

    We would generally expect that, to satisfy the Disclosure 
Obligation, broker-dealers would build upon the material fees and costs 
identified in the Relationship Summary, providing additional detail as 
appropriate. These descriptions could include, for example, an 
explanation of how and when the fees are deducted from the customer's 
account (e.g., such as on a per-transaction basis or quarterly). 
Although the fees and costs identified in the Relationship Summary may 
provide a useful starting point for the identification of the material 
fees and costs that may be disclosed pursuant to the Disclosure 
Obligation, there may be other categories of fees and costs that are 
material under the facts and circumstances of a broker-dealer's 
business model that must be disclosed pursuant to the Disclosure 
Obligation.
Particularity of Fees and Costs Disclosed; Individualized Disclosure
    Several commenters recommended that the Commission not require that 
broker-dealers provide individualized fee disclosures to retail 
customers. Specifically, they recommended that the Commission clarify 
that broker-dealers could meet the Disclosure Obligation if they 
provide a range of fees and costs or use standardized and hypothetical 
amounts rather than requiring disclosure of actual dollar amounts based 
on proposed amounts to be invested (i.e., individualized fees).\369\ 
These commenters cited concerns about cost and practicality associated 
with generating individualized disclosures.\370\ With regard to 
product-level fees in particular, several commenters expressed concern 
that

[[Page 33355]]

broker-dealers could not easily calculate individualized fees and 
charges associated with the securities about which they provide 
recommendations and that doing so might lead to inadvertently providing 
inconsistent or inaccurate fee estimates to their retail 
customers.\371\ In this vein, several commenters recommended that 
broker-dealers should be able to satisfy the Disclosure Obligation 
regarding product-level fees by providing retail customers with or 
referring them to an issuer's offering materials, such as a 
prospectus.\372\ Other commenters, on the other hand, stated that the 
Commission should not allow the use of percentages or ranges because 
such a presentation does not adequately inform investors of the fees 
and charges they will incur.\373\
---------------------------------------------------------------------------

    \369\ See, e.g., Vanguard Letter (recommending that the 
Disclosure Obligation could be satisfied by relaying the types and 
ranges of costs associated with a recommendation, or by using 
standardized and hypothetical investments, rather than requiring 
computation of actual dollar amounts based on proposed amounts to be 
invested); Capital Group Letter (stating that customized mutual fund 
fee and expense disclosures for investors at the time of the 
recommendation would be impractical); SIFMA August 2018 
(recommending the Commission permit disclosure of a range of 
customer costs per product); NASAA August 2018 Letter (suggesting 
that the Commission mandate its Model Fee Table along with 
disclosure of other fees paid for services and any other third party 
remuneration).
    \370\ See, e.g., TIAA Letter (stating that broker-dealers would 
need to expend significant resources to build new systems and new 
compliance programs in order to provide individualized fee 
disclosure); ICI Letter (recommending that the Commission confirm 
that the Disclosure Obligation would not require a broker-dealer to 
separately calculate fund fees and expenses); Capital Group Letter 
(stating that individualized disclosures raise significant 
operational burdens and compliance issues in exchange for, at best, 
inconsistent utility).
    \371\ See, e.g., TIAA Letter (stating that calculating 
individualized fee information for any retail customer would be 
difficult and might lead to inadvertently providing inconsistent or 
inaccurate fee estimate); Capital Group Letter.
    \372\ See TIAA Letter (stating that broker-dealers should not be 
obligated to provide fund-level fee disclosure outside of a fund 
prospectus or to provide individualized fee disclosure to retail 
customers); ICI Letter (stating that when making a recommendation of 
a fund, a broker-dealer should be permitted to direct customers to 
the fund's prospectus as the source of information about fund fees 
and expenses); Oppenheimer Letter (stating that the fund, not the 
broker-dealer, is in a better position to provide these disclosures, 
in a manner that is accurate, consistent and complete).
    \373\ See, e.g., CFA August 2018 Letter (stating that the 
Commission should not allow for percentages or ranges because it 
would do little to inform investors); PIABA Letter (stating that 
broker-dealers should disclose the specific charges that their 
customers will incur as a result of the particular recommendation); 
UMiami Letter (stating that customers should be provided with clear 
and concise information that fully and fairly discloses the specific 
charges the customer will incur as a result of a particular 
recommendation).
---------------------------------------------------------------------------

    As adopted, the Disclosure Obligation does not mandate 
individualized fee disclosure particular to each retail customer. 
Instead, broker-dealers may disclose ``material facts'' about material 
fees and costs in terms of more standardized numerical and narrative 
disclosures, such as standardized or hypothetical amounts, dollar or 
percentage ranges, and explanatory text where appropriate. The 
disclosure should accurately convey why a fee is being imposed and when 
the fee is to be charged. Further, as discussed below,\374\ a broker-
dealer will need to supplement this standardized disclosure with more 
particularized information if the broker-dealer concludes that such 
information is necessary to fully and fairly disclose the material 
facts associated with the fee or charge. For example, a broker-dealer 
might initially disclose a range of product fees, and later supplement 
that information with more particularized information by delivering the 
product prospectus.\375\
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    \374\ See Section II.C.1.c, Disclosure Obligation, Full and Fair 
Disclosure, Layered Disclosure.
    \375\ See supra footnote 302.
---------------------------------------------------------------------------

    Consistent with this approach, and also in response to comments, we 
are further clarifying that a broker-dealer recommending a securities 
transaction or an investment strategy involving securities can meet the 
Disclosure Obligation regarding fees and costs assessed at the product 
level by describing those fees and costs in initial, standardized terms 
and providing subsequent particularized disclosure as necessary. To the 
extent that such subsequent information regarding product-level fees 
and costs appears in a currently mandated disclosure document, such as 
a trade confirmation or a prospectus, delivery of that information in 
accordance with existing regulatory obligations will be deemed to 
satisfy the Disclosure Obligation, even if delivery occurs after the 
recommendation is made, under the circumstances outlined in Section 
II.C.1. Although it is not required by Regulation Best Interest, 
broker-dealers may refer the customer to any issuer disclosure of the 
security being recommended, such as a prospectus, private placement 
memorandum, or offering circular, where more particular information may 
be found.
    We acknowledge that the desire for greater fee transparency was a 
consistent theme of our investor engagement and we believe that the 
Disclosure Obligation, in conjunction with the Relationship Summary, 
significantly advances that goal. Individualized fee disclosure may be 
helpful to some retail customers, but it can also be costly, prone to 
errors, and cause delays in trade execution. In addition, in some cases 
the precise amount of the fee may be based on the dollar value of the 
transaction, and would not be known prior to or at the time of the 
recommendation, meaning that it could only be expressed in more general 
terms, such as a percentage value or range, as an initial matter. We 
believe that adopting the Disclosure Obligation that allows for the use 
of standardized disclosure furthers our goal of informing investors 
about fees and costs by the time of a recommendation in a workable 
manner. Nothing in Regulation Best Interest prevents a broker-dealer 
from providing such individualized disclosure to its customers should 
it wish to do so, and we encourage firms to assist retail customers in 
understanding the specific fees and costs that apply, and to provide 
more individualized disclosure where appropriate, or in response to a 
retail customer's request. As a best practice, firms may also consider 
reviewing with their retail customers the effect of fees and costs on 
the retail customer's account(s) on a periodic basis.\376\ The costs, 
errors, delays, and other practical obstacles to individualized fee 
disclosure are likely to fall over time. We will continue to consider 
whether to require more personalized fee disclosure, particularly as 
technology evolves to address operational and technological costs.
---------------------------------------------------------------------------

    \376\ Although we encourage firms to have this conversation with 
their retail customers, we are not suggesting that engaging in such 
a best practice would, by itself, create any implied or explicit 
obligation to monitor such fees and costs.
---------------------------------------------------------------------------

    With regard to the disclosure of product-level fees in particular, 
while we support the goal of bringing greater transparency to all fees 
incurred, we are seeking to supplement, not supplant, the existing 
regulatory regime currently applicable to product-level fees with the 
adoption of Regulation Best Interest. We acknowledge that if a broker-
dealer highlights such fees with particularity, it may raise a 
customer's awareness of them, and we encourage as a best practice that 
broker-dealers do so.\377\ We acknowledge also that the nature and 
extent of product-level disclosures may vary. However, we do not 
believe that requiring broker-dealers to deliver product disclosures 
earlier than is currently required, to generate fee disclosure not 
currently required of issuers, or to recalculate or highlight specific 
product-level fees already disclosed in an issuer's offering materials 
will meaningfully improve fee disclosure and it may, in fact, be unduly 
burdensome and raise the possibility of errors if broker-dealers were 
to be obligated to project or calculate product fees based on product 
issuer information. Accordingly, we believe that allowing broker-
dealers to meet the Disclosure Obligation with regard to product-level 
fees by describing those fees in standardized terms with further 
detailed, particularized information related to the recommendation 
provided either prior to or at the time of the recommendation or 
afterwards under the circumstances outlined in Section II.C.1, Oral 
Disclosure or Disclosure After a Recommendation, strikes an

[[Page 33356]]

appropriate balance between costs to firms and benefits to retail 
customers.\378\
---------------------------------------------------------------------------

    \377\ With regard to product-level fees, in particular, broker-
dealers may wish to highlight certain categories of fees such as 
distribution fees, platform fees, shareholder servicing fees and 
sub-transfer agency fees, in order to enhance retail customers' 
understanding of these fees to the extent applicable to the 
customer's transactions, holdings, and accounts.
    \378\ See Section II.C.1, Disclosure Obligation, Oral Disclosure 
or Disclosure After a Recommendation.
---------------------------------------------------------------------------

    We believe this approach is bolstered by the existence of 
complementary obligations protective of retail customers that are 
imposed by Regulation Best Interest. For example, to the extent fees 
and costs incurred related to these products create conflicts of 
interest associated with a recommendation, we believe they are 
appropriately highlighted and addressed in the context of the conflicts 
and incentives they create to make a recommendation, and must be 
addressed as part of the obligation to disclose material facts about 
conflicts of interest associated with a recommendation, as discussed 
below.\379\
---------------------------------------------------------------------------

    \379\ See Section II.C.1.b, Disclosure Obligation, Material 
Facts Regarding Conflicts of Interest.
---------------------------------------------------------------------------

    Moreover, under the Care Obligation, a broker-dealer recommending a 
securities transaction or investment strategy involving securities to a 
retail customer must consider costs associated with that recommendation 
when determining whether it is in the best interest of that retail 
customer. As a result, disclosure of product-level fees and costs to 
satisfy the Disclosure Obligation will be supplemented by other aspects 
of Regulation Best Interest.
    While the Disclosure Obligation provides broker-dealers with 
flexibility in describing the material fees and costs that apply, the 
disclosure should accurately convey why the fee or charge is being 
imposed and when the fee or charge is to be assessed. For example, 
describing a commission or markup as a fee for ``handling services'' 
could inappropriately disguise the fee's true nature. Furthermore, 
while using a percentage or dollar range to describe a fee can be 
appropriate, that range should be designed to reasonably reflect the 
actual fee to be charged. For example, a statement that a charge may be 
``between 5 and 100 basis points'' would not be accurate if the fee is 
in almost all instances between 85 and 100 basis points. However, in 
this case, a broker-dealer could accurately describe the fee, for 
example, as ``generally being between 85 and 100 basis points, 
sometimes lower, but never above.'' In some cases, actual dollar values 
based on a hypothetical transaction may facilitate customer 
understanding.
    A material fact about fees and costs could also include informing a 
retail customer of a fee's triggering event, such as a fee imposed 
because an account minimum falls below a threshold and whether fees are 
negotiable or waivable.
Type and Scope of Services Provided
    In the Proposing Release, we provided guidance that the type and 
scope of services a broker-dealer provides its retail customers would 
also be an example of what typically would be ``material facts relating 
to the terms and scope of the relationship,'' that would require 
disclosure pursuant to the Disclosure Obligation.\380\ Specifically, we 
stated that broker-dealers should build upon their disclosure in the 
Relationship Summary, and provide additional information regarding the 
types of services that will be provided as part of the relationship 
with the retail customer and the scope of those services.\381\
---------------------------------------------------------------------------

    \380\ See Proposing Release at 21602.
    \381\ Id.
---------------------------------------------------------------------------

    In particular, we noted that under proposed Form CRS broker-dealers 
would provide high-level disclosures concerning services offered to 
retail investors, including, for example, recommendations of 
securities, assistance with developing or executing an investment 
strategy, monitoring the performance of the retail investor's account, 
regular communications, and limitations on selections of products.\382\ 
We recognized that a broker-dealer that offers different account types, 
or offers varying additional services to the retail customer may not be 
able, within the content and space constraints of the Relationship 
Summary, to provide ``all material facts relating to the scope and 
terms of the relationship'' with the retail customer.\383\ Thus, we 
stated that pursuant to the proposed Disclosure Obligation, we would 
have generally expected broker-dealers to disclose these types of 
material facts concerning the actual services offered as part of the 
relationship with the retail customer separately from the Relationship 
Summary.
---------------------------------------------------------------------------

    \382\ See Relationship Summary Proposing Release at 31426.
    \383\ See Section II.C.1.a, Disclosure Obligation, Standard of 
Conduct.
---------------------------------------------------------------------------

    Commenters generally agreed that it was important for broker-
dealers to disclose to their customers material facts about the type 
and scope of services they provide to their customers.\384\ However, 
commenters sought clarity regarding the application of this proposed 
guidance, and raised questions about whether firms would be 
specifically required to disclose certain services (e.g., monitoring 
account performance and providing financial education) pursuant to 
Regulation Best Interest,\385\ as discussed below, and the level of 
disclosure required under Regulation Best Interest.\386\
---------------------------------------------------------------------------

    \384\ See, e.g., Pacific Life August 2018 Letter; Cetera August 
2018 Letter.
    \385\ See, e.g., Betterment Letter (recommending that the 
Commission ensure that dual-registrants communicate which of their 
services are advisory in nature); Northwestern Mutual Letter.
    \386\ See, e.g., Cetera August 2018 Letter (stating that a best 
interest standard should include a requirement to deliver a summary 
description of the relationship between the firm and customer, 
including the scope of services); Committee of Annuity Insurers 
Letter (recommending the Commission clarify that a broker-dealer 
could satisfy the Disclosure Obligation by disclosing the products 
and services available to its retail customers and does not need to 
disclose information particularized to a recommendation).
---------------------------------------------------------------------------

    Consistent with our approach in the Proposing Release, we continue 
to believe that the type and scope of services a broker-dealer provides 
to its retail customers are ``material facts relating to the scope and 
terms of the relationship.'' Accordingly, we are revising the rule text 
to explicitly require the disclosure of the ``type and scope of 
services provided to the retail customer, including any material 
limitations on the securities or investment strategies involving 
securities that may be recommended to the retail customer,'' as part of 
the ``material facts relating to the scope and terms of the 
relationship'' that must be disclosed pursuant to the Disclosure 
Obligation.\387\
---------------------------------------------------------------------------

    \387\ Rule 15l-1(a)(2)(i)(A)(iii).
---------------------------------------------------------------------------

    We are interpreting the Disclosure Obligation to only require 
disclosure of material facts relating to the type of services provided 
(e.g., the fact that the broker-dealer monitors securities transactions 
and investment strategies) and the scope of services (e.g., information 
about the frequency and duration of the services). In response to 
comments, we are also specifically addressing the disclosure of 
information regarding whether or not the broker-dealer provides account 
monitoring services and whether the broker-dealer has account minimums 
or similar requirements.
    In addition, in response to comments, we are clarifying that 
pursuant to the Disclosure Obligation, broker-dealers need to disclose 
only material information relating to the ``type and scope of services 
provided.'' As discussed in the context of the disclosure of fees and 
costs above, the standard for materiality of the type and scope of 
services to be disclosed is consistent with the standard articulated in 
Basic v. Levinson: Information related to the type and scope of 
services provided is material, and must be disclosed, if there is ``a 
substantial likelihood that a reasonable shareholder

[[Page 33357]]

would consider it important.'' \388\ As noted above, in the context of 
Regulation Best Interest, this standard would apply in the context of 
retail customers, as defined.
---------------------------------------------------------------------------

    \388\ Basic, Inc. v. Levinson, 485 U.S. 224, 224 (1988).
---------------------------------------------------------------------------

    We believe the information included in the Relationship Summary may 
provide a useful starting point for the identification of the type and 
scope of services that must be disclosed pursuant to the Disclosure 
Obligation. For example, in the Relationship Summary a broker-dealer 
must describe its principal brokerage services offered, including 
buying and selling securities, and whether or not it offers 
recommendations to retail investors.\389\ Additionally, in the 
Relationship Summary, if applicable, the broker-dealer must address 
whether or not the firm offers monitoring of investments.
---------------------------------------------------------------------------

    \389\ See Form CRS, Item 2.B. (Description of Services).
---------------------------------------------------------------------------

    We believe that broker-dealers will generally need to build upon 
the disclosures made in the Relationship Summary as appropriate, and to 
provide additional information regarding the types of services that 
will be provided as part of the relationship with the retail customer 
and the scope of those services (e.g., the frequency and duration of 
the services), as necessary, in order to meet the Disclosure 
Obligation's requirement to disclose ``all material facts'' regarding 
the type and scope of services provided. Broker-dealers may be able to 
satisfy this aspect of the Disclosure Obligation by relying on their 
existing disclosures about the type and scope of their services, 
typically reflected in their account opening agreement or other account 
opening related documentation, so long as the disclosure as a whole 
addresses the material facts relating to the type and scope of services 
offered to the retail customer.
Disclosure of Material Limitations on Securities and Investment 
Strategies
    In the Proposing Release, we included any limitations on the 
products and services offered as an example of a material fact relating 
to the terms and scope of the relationship that would need to be 
disclosed pursuant to the Disclosure Obligation. We agree with 
commenters who advocated for helping investors to understand whether a 
broker-dealer limits its product offerings, and to what extent, before 
entering into a relationship with a broker-dealer.\390\ We continue to 
believe that broker-dealers that place material limitations on the 
securities or investment strategies involving securities that may be 
recommended to retail customers--such as recommending only proprietary 
products or a specific asset class--need to describe the material facts 
relating to those limitations.\391\
---------------------------------------------------------------------------

    \390\ See CFA Institute Letter (stating that if a broker-dealer 
only offers proprietary products, it should clearly call attention 
to the higher product cost and the potential cost to the investor of 
such a limited offering); SIFMA August 2018 Letter (stating that a 
firm should be able to limit its offerings to a particular subset of 
its customers to proprietary product or revenue sharing products as 
long as: (1) The broker-dealer discloses that it is limiting its 
recommendation to a specific set of securities and (2) the specific 
set of securities contains appropriate securities to meet the 
customer's needs); SPARK Letter (recommending that the Commission 
permit broker-dealers that only offers proprietary products or a 
limited menu of investments to satisfy the conflict mitigation 
requirements by: (1) Disclosing any material limitations on the 
investment products being offered and (2) reasonably concluding that 
the limitations will not violate the Care Obligation).
    \391\ See Form CRS, Item 2.B.(iii).
---------------------------------------------------------------------------

    Therefore, in response to comments, we are revising Regulation Best 
Interest to explicitly require that, as part of the disclosure of the 
type and scope of services provided to the retail customer, a broker-
dealer must include ``any material limitations on the securities or 
investment strategies involving securities that may be recommended to 
the retail customer.'' \392\ For purposes of this requirement, a 
``material limitation'' placed on the securities or investment 
strategies involving securities could include, for example, 
recommending only proprietary products (e.g., any product that is 
managed, issued, or sponsored by the broker-dealer or any of its 
affiliates), a specific asset class, or products with third-party 
arrangements (e.g., revenue sharing, mutual fund service fees).\393\ 
Similarly, the fact that the broker-dealer recommends only products 
from a select group of issuers, or makes IPOs available only to certain 
clients, could also be considered a material limitation. To cite 
another example, if an associated person of a dually registered broker-
dealer only offers brokerage services, and is not able to offer 
advisory services, the fact that the associated person's services are 
materially narrower than those offered by the broker-dealer would 
constitute a material limitation.
---------------------------------------------------------------------------

    \392\ Rule 15l-1(a)(2)(A). See also Section II.C.1 for a 
discussion of the materiality standard under Basic, Inc. v. 
Levinson, 485 U.S. 224 (1988).
    \393\ This is consistent with the approach we are taking in the 
Relationship Summary Adopting Release.
---------------------------------------------------------------------------

    We recognize that, as a practical matter, all broker-dealers limit 
their offerings of securities and investment strategies to a greater or 
lesser degree. We do not believe that disclosing the fact that a 
broker-dealer does not offer the entire possible range of securities 
and investment strategies would convey useful information to a retail 
customer, and therefore we would not consider this fact, standing 
alone, to constitute a material limitation.\394\
---------------------------------------------------------------------------

    \394\ See Basic, Inc. v. Levinson, 485 U.S. 224, 224 (1988).
---------------------------------------------------------------------------

    In addition, we believe that there are a number of reasonable 
practices by which appropriate limitations are determined, including 
processes for the selection of a ``menu'' of products that will be 
available for recommendations to retail customers. We further recognize 
that these limitations can be beneficial, such as by helping ensure 
that a broker-dealer and its associated persons understand the 
securities they are recommending, as required by paragraph 
(a)(2)(ii)(A) of the Care Obligation. We have also explicitly stated 
that Regulation Best Interest would not prohibit a broker-dealer from 
recommending, for example, a limited range of products, or only 
proprietary products, provided the broker-dealer satisfies the 
component obligations of Regulation Best Interest. Nonetheless, because 
these firm-wide threshold decisions have such a significant effect on 
the subsequent recommendations ultimately made to a retail customer, we 
are requiring disclosure of the material limitations on the securities 
or investment strategies involving securities that may be recommended--
by the broker-dealer and its associated persons--as well as any 
associated conflicts of interest.
    Explicitly requiring disclosure of these limitations is also 
consistent with our approach in the Care and Conflict of Interest 
Obligations. As discussed below, despite the potential beneficial 
aspects of some limitations, we are concerned that such limitations and 
any associated conflicts of interest can negatively affect the 
securities or investment strategies recommended to a retail 
customer.\395\ In recognition of this concern, we have revised the 
Conflict of Interest Obligation to specifically require the 
establishment of policies and procedures to identify, disclose, and 
address that risk.\396\ Furthermore, we reiterate that even if a 
broker-dealer discloses and addresses any material limitations on the 
securities or investment strategies involving securities recommended to 
a retail customer, and any associated conflicts of interest, as 
required by the Disclosure

[[Page 33358]]

and Conflict of Interest Obligations, it would nevertheless need to 
satisfy the Care Obligation in recommending such products.\397\
---------------------------------------------------------------------------

    \395\ See Section II.C.3, Conflicts of Interest. See Proposing 
Release at 21608 (asking commenters to comment on whether, and, if 
so why, the Commission should require specific disclosure on product 
limitations).
    \396\ See Section II.C.4.
    \397\ See Section II.C.2.
---------------------------------------------------------------------------

Account Monitoring Services
    In the Proposing Release, we identified as a material fact relating 
to the scope and terms of the relationship with the retail customer the 
type and scope of services provided by the broker-dealer, including, 
for example, monitoring the performance of the retail customer's 
account.\398\ Additionally, the Proposing Release stated that to the 
extent that the broker-dealer agrees with a retail customer by contract 
to provide periodic or ongoing monitoring of the retail customer's 
investments for purposes of recommending changes in investments, 
Regulation Best Interest would apply to, and a broker-dealer would be 
liable for not complying with the proposed rule with respect to, any 
recommendations about securities or investment strategies made to 
retail customers resulting from such services.\399\
---------------------------------------------------------------------------

    \398\ Proposing Release at 21600.
    \399\ Id. at 21594.
---------------------------------------------------------------------------

    Commenters suggested that broker-dealers should be required to 
clearly define the nature of account monitoring services offered, with 
some commenters pointing to retail customer confusion on this 
topic.\400\ One commenter stated that disclosure will not help a retail 
customer of a dual-registrant who has both brokerage and advisory 
accounts, who is unlikely to remember which accounts his or her 
financial advisor is responsible for monitoring, and for which accounts 
the customer bears that responsibility. Accordingly, the commenter 
recommends that we require broker-dealers to monitor all retail 
customers' accounts.\401\
---------------------------------------------------------------------------

    \400\ See, e.g., NAIFA Letter (asserting broker-dealers should 
be free to agree to, and define the nature of, any ongoing 
relationship via contract, such as including monitoring services); 
see also RAND 2018 (stating that participants demonstrated a lack of 
clarity on how a financial professional would monitor an account); 
OIAD/RAND (stating that some participants perceived that continuous 
monitoring of a client's account is consistent with acting in the 
client's best interest).
    \401\ AFL-CIO April 2019 Letter.
---------------------------------------------------------------------------

    As discussed in the Solely Incidental Interpretation, we disagree 
with commenters who suggested that any monitoring of customer accounts 
would require a broker-dealer to register as an investment adviser and 
we believe that it is important for retail customers to understand: (1) 
The types of account monitoring services (if any) a particular broker-
dealer provides, and (2) whether or not the broker-dealer will be 
providing monitoring services for the particular retail customer's 
account. Accordingly, we believe that whether or not the broker-dealer 
will monitor the retail customer's account and the scope and frequency 
of any account monitoring services that a broker-dealer agrees to 
provide are material facts relating to the type and scope of services 
provided to the retail customer and must be disclosed pursuant to the 
Disclosure Obligation. This disclosure could indicate, for example, 
that the broker-dealer will monitor the account or investments at a 
stated frequency in light of the retail customer's investment 
objectives for the purpose of recommending an asset reallocation where 
appropriate, or that the broker-dealer will monitor the account 
periodically to determine whether a brokerage account continues to be 
in the retail customer's best interest. Or, broker-dealers that offer 
no account monitoring services could disclose that they will not 
monitor the account or consider whether any recommendations may be 
appropriate unless the retail customer specifically requests that they 
do so.\402\
---------------------------------------------------------------------------

    \402\ As discussed in footnote 167, we recognize that a broker-
dealer may voluntarily, and without any agreement with the customer, 
review the holdings in a retail customer's account for the purposes 
of determining whether to provide a recommendation to the customer. 
We do not consider this voluntary review to be ``account 
monitoring,'' nor would it in and of itself on its own to create an 
implied agreement with the retail customer to monitor the customer's 
account. Any explicit recommendation made to the retail customer as 
a result of any such voluntary review would be subject to Regulation 
Best Interest.
---------------------------------------------------------------------------

    The Relationship Summary requires broker-dealers to explain whether 
or not they monitor retail investors' investments, including the 
frequency and any material limitations.\403\ However, as noted above, 
because the Relationship Summary provides high-level disclosure, in 
most cases it generally would not be sufficiently specific to inform 
investors about the scope and frequency of any account monitoring 
services applicable to the particular retail customer's account. The 
Disclosure Obligation is designed to provide investors with an expanded 
description of the material information relating to such services. 
Furthermore, as discussed in Section 2.B.2.b., Regulation Best Interest 
applies to recommendations resulting from agreed-upon account 
monitoring services (including implicit hold recommendations). 
Requiring disclosure of whether or not the broker-dealer will monitor 
the retail customer's account, and the scope and frequency of such 
monitoring, will help retail customers understand the terms applicable 
to the particular retail customer's account. While retail customers 
with multiple accounts will have to keep track of the accounts for 
which their broker-dealer has agreed to monitor, we believe that 
requiring disclosure of this service will provide those retail 
customers with sufficient clarity about the monitoring services they 
may expect. Requiring all broker-dealers to monitor all retail customer 
accounts, as one commenter suggested, would diminish the options 
available to retail customers, who may wish to have their accounts 
monitored to a greater or lesser degree (including not at all).
---------------------------------------------------------------------------

    \403\ See Form CRS, Item 2.B.(i).
---------------------------------------------------------------------------

Account Balance Requirements
    The Proposing Release did not address whether a broker-dealer 
offering brokerage accounts subject to account balance requirements is 
a ``material fact relating to the scope and terms of the 
relationship.'' However, several commenters to the Form CRS proposal 
suggested that the Commission require firms to disclose any account 
balance requirements in the Relationship Summary.\404\ We believe that 
account balance requirements are a material fact relating to the terms 
and scope of the relationship. Consequently, we are interpreting the 
Disclosure Obligation to include disclosure of whether a broker-dealer 
has any requirements for retail customers to open or maintain an 
account or establish a relationship, such as a minimum account size. We 
believe that if a broker-dealer will only open a brokerage account for 
a retail customer with a specific account minimum, such a basic 
operational aspect of the account is a material fact relating to the 
type and scope of services provided. If dollar thresholds or other 
requirements apply to a retail customer's ability to maintain an 
existing account, or to avoid additional fees when the threshold is 
crossed (for example, a ``low account balance'' fee), such requirements 
also would likely be of importance to a retail customer.\405\ We 
further believe retail customers can use facts about different account 
size requirements for both current and future planning and decision-
making purposes. Accordingly,

[[Page 33359]]

the Commission believes this information constitutes a ``material 
fact'' that must be disclosed pursuant to the Disclosure Obligation.
---------------------------------------------------------------------------

    \404\ See, e.g., NASAA Letter (stating that ``Form CRS should 
specify minimum account size and include information on 
miscellaneous fees different categories of investors can expect to 
pay.''); Cetera August 2018 Letter (stating that Form CRS should 
include ``[w]hether or not the firm has established standards for 
the minimum or maximum dollar amount of various account types;'' and 
submitting mock-up form that include disclosures of account 
minimums); Primerica Letter. See Relationship Summary Adopting 
Release.
    \405\ See Relationship Summary Adopting Release.
---------------------------------------------------------------------------

Other Material Facts Related to the Scope and Terms of the Relationship
    In the Proposing Release, although we identified the broker-
dealer's capacity, fees and charges, and type and scope of services 
provided as examples of what would generally be considered ``material 
facts relating to the scope and terms of the relationship with the 
retail customer,'' we noted that the Disclosure Obligation would also 
require broker-dealers and their associated persons to determine, based 
on the facts and circumstances, whether there are other material facts 
relating to the scope and terms of the relationship that would need to 
be disclosed.\406\ We also asked for comment on whether examples of 
other information relating to scope and terms of the relationship 
should be highlighted by the Commission as likely to be considered a 
material fact relating to the scope and terms of the relationship that 
would need to be disclosed.\407\
---------------------------------------------------------------------------

    \406\ See Proposing Release at 21600-21601.
    \407\ See Proposing Release at 21607.
---------------------------------------------------------------------------

    A number of commenters provided suggestions of additional examples 
of such material facts that the Commission should highlight or 
explicitly require to be disclosed as a ``material fact relating to the 
scope and terms of the relationship.'' Specifically, commenters raised 
whether a broker-dealer's basis for,\408\ and risks associated 
with,\409\ a recommendation, or the standard of conduct applicable to a 
broker-dealer making a recommendation,\410\ should be material facts 
relating to the scope and terms of the relationship.
---------------------------------------------------------------------------

    \408\ See infra footnote 411.
    \409\ See infra footnote 412.
    \410\ See infra footnote 417.
---------------------------------------------------------------------------

Basis for and Risks Associated With the Recommendation
    The Proposing Release did not address whether a broker-dealer's 
basis for a recommendation is a ``material fact relating to the scope 
and terms of the relationship.'' However, several commenters requested 
that the Commission treat a broker-dealer's basis for a recommendation 
as a ``material fact relating to the scope and terms of the 
relationship'' that would likely need to be disclosed prior to, or at 
the time of the recommendation, pursuant to the Disclosure 
Obligation.\411\ Similarly, several commenters suggested that the 
Commission should treat risks associated with a broker-dealer's 
recommendation as ``material facts relating to the scope and terms of 
the relationship'' that would likely need to be disclosed prior to, or 
at the time of the recommendation.\412\ Other commenters opposed 
requiring particularized disclosure of the basis of individual 
recommendations, stating that it is sufficient to disclose that 
different products are available with different features rather than 
require firms specify why the broker-dealer recommended one product 
over another.\413\
---------------------------------------------------------------------------

    \411\ See, e.g., PIABA Letter (recommending that broker-dealers 
be required to provide a clear and understandable explanation as to 
the other lower cost investments which are available, and why the 
higher cost investment is being recommended); Morningstar Letter 
(recommending that the Commission require a firm to disclose its 
analysis of the reasons it is recommending a rollover from an ERISA-
covered retirement plan to an IRA and why it is in the participant's 
best interest).
    \412\ See, e.g., PIABA Letter (recommending that the Commission 
extend the Disclosure Obligation to include the risks, benefits, and 
ramifications of a recommendation).
    \413\ See, e.g., LPL August 2018 Letter (stating that a broker-
dealer could satisfy the Care Obligation if it recommends a more 
expensive investment product so long as it discloses that the 
recommended product is not the least expensive among the 
alternatives and is otherwise in the investor's best interest); 
Committee of Annuity Insurers Letter (recommending that the 
Commission clarify that a broker-dealer could satisfy the Disclosure 
Obligation through the use of a disclosure describing the products 
and services available to its retail customers and related conflicts 
of interest, and that a broker-dealer or associated person need not 
provide a disclosure particularized to a recommendation). See also 
CCMC Letters (requesting that the SEC confirm that it is sufficient 
to disclose that different products are available with different 
features rather than require firms to also document why the firm 
recommended one product over another); IPA Letter (requesting 
additional guidance regarding specificity of disclosure needed to 
demonstrate why a broker-dealer recommended one of multiple 
different products (with different terms, cost structures and 
conditions) that each meet the customer's investment objective).
---------------------------------------------------------------------------

    Our view is that the general basis for a broker-dealer's or an 
associated person's recommendations (i.e., what might commonly be 
described as the firm's or associated person's investment approach, 
philosophy, or strategy) is a material fact relating to the scope and 
terms of the relationship with the broker-dealer that must be disclosed 
pursuant to the Disclosure Obligation. The process by which a broker-
dealer and an associated person develop their recommendations to retail 
customers is of fundamental importance to the retail customer's 
understanding of what services are being provided, and whether those 
services are appropriate to the retail customer's needs and goals. We 
believe that such a description can be made in standardized or summary 
form; however the disclosure should also address circumstances of when 
the standardized disclosure does not apply and how the broker-dealer 
will notify the customer when that is the case. For example, if an 
associated person has a distinct investment approach, as may be the 
case with persons associated with an independent contractor broker-
dealer, the broker-dealer's standardized disclosure should indicate how 
its associated persons will notify retail customers of their own 
investment approach.
    While the general basis for the recommendation is a material fact 
for purposes of the Disclosure Obligation, we decline to require 
disclosure of the basis for each recommendation, an approach that could 
involve significant costs and in many cases may simply repeat the more 
standardized disclosure that we are already requiring. With regard to 
how conflicts of interest may affect the basis for a particular 
recommendation, we note that the Disclosure Obligation requires 
disclosure of the material facts relating to the conflicts of interest 
associated with the recommendation, which will help retail customers 
evaluate the incentives a broker-dealer or associated person may have 
in making a recommendation; and the Conflict of Interest Obligation 
requires a broker-dealer to have policies and procedures to mitigate, 
and in certain instances, eliminate, specified conflicts of interest. 
Accordingly, to the extent the basis for any recommendation is subject 
to any conflicts of interest, the Commission believes that the Care 
Obligation's substantive requirement to have a reasonable basis for the 
recommendation, combined with the Disclosure, Conflict of Interest and 
Compliance Obligations, provides sufficient protections to broker-
dealers' retail customers.
    Similarly, we are interpreting disclosure of the risks associated 
with a broker-dealer's or associated person's recommendations in 
standardized terms as a material fact related to the scope and terms of 
the relationship that needs to be disclosed. For example, a broker-
dealer could disclose: ``While we will take reasonable care in 
developing and making recommendations to you, securities involve risk, 
and you may lose money. There is no guarantee that you will meet your 
investment goals, or that our recommended investment strategy will 
perform as anticipated. Please consult any available offering documents 
for any security we recommend for a discussion of risks associated with 
the product. We can provide those documents to you, or help you to find 
them.'' This example is purely illustrative. Whether any

[[Page 33360]]

particular disclosure by a broker-dealer is sufficient to meet the 
Disclosure Obligation will depend on the facts and circumstances.
    The risks associated with a particular recommendation would be 
relevant to a retail customer. However, we believe that broker-dealers 
may rely on the existing disclosure regime governing securities issuers 
to disclose the risks associated with any issuer, security or 
offering,\414\ and it is not our intent to require the broker-dealer to 
duplicate or expand on those disclosures. Consistent with our approach, 
discussed above, to disclosure of product-level fees and costs, we 
believe that describing product-level risks in standardized terms, with 
additional information in any available issuer disclosure documents 
delivered in accordance with existing regulatory requirements would 
satisfy the Disclosure Obligation. As noted above, we are not seeking 
to supplant the developed regulatory regime currently applicable to 
offering disclosure with the adoption of Regulation Best Interest.
---------------------------------------------------------------------------

    \414\ See, e.g., Item 503(c) of Reg. S-K (requiring disclosure 
of the ``most significant'' factors that make an offering 
``speculative or risky,'' as well as an explanation of how each risk 
``affects the issuer or the securities being offered.'' See also 
Form 10-K (requiring a description of the 503(c) risk factors that 
are ``applicable to the registrant''). In some cases, SRO Rules 
applicable to recommendations of particular securities may also 
require disclosure of risks. See, e.g., FINRA Rule 2330 (requiring a 
FINRA member or its associated persons recommending deferred 
variable annuity to have a reasonable belief that the customer has 
been informed of, among other things, market risk). See also FINRA 
Rule 2210(d), requiring, among other things, that statements in 
member communications ``are clear and not misleading within the 
context in which they are made, and that they provide balanced 
treatment of risks and potential benefits.''
---------------------------------------------------------------------------

    While we believe that a standardized discussion of risks is a 
material fact that must be disclosed to satisfy the Disclosure 
Obligation, we decline to impose a disclosure requirement specific to 
each recommendation. As with regard to the disclosure of the 
individualized basis for each recommendation, we believe that such 
specific disclosure could involve significant costs and in many cases 
simply repeat the more standardized disclosure that we are requiring, 
which we believe will sufficiently inform retail customers, in broad 
terms, of the nature of the risks associated with a recommendation.
    In addition, under the Care Obligation, a broker-dealer making a 
recommendation of a securities transaction or investment strategy 
involving securities to a retail customer must consider the risks when 
determining whether it has a reasonable basis for believing that the 
recommended transaction or investment strategy could be in the best 
interest of at least some retail customers, and is in the best interest 
of a particular retail customer. Moreover, under paragraph (a)(2)(B) of 
Regulation Best Interest, discussed below, broker-dealers need to 
disclose ``all material facts relating to conflicts of interest that 
are associated with the recommendation,'' which will require disclosure 
of what we believe to be a significant risk associated with a broker-
dealer's recommendations--the broker-dealer's conflicts of interest. 
For these reasons, we believe that standardized written disclosure of 
this information in general terms is sufficient.
    Consistent with the Compliance Obligation, broker-dealers should 
consider developing policies and procedures that address the 
circumstances under which the basis for a particular recommendation 
would be disclosed to a retail customer. As a best practice, firms also 
should encourage their associated persons to discuss the basis for any 
particular recommendation with their retail customers, including the 
associated risks, particularly where the recommendation is significant 
to the retail customer. For example, the decision to roll over a 401(k) 
into an IRA may be one of the most significant financial decisions a 
retail investor could make. Thus, a broker-dealer should discuss the 
basis of such recommendations with the retail customer. Similarly, we 
encourage broker-dealers to record the basis for their recommendations, 
especially for more complex, risky or expensive products and 
significant investment decisions, such as rollovers and choice of 
accounts, as a potential way a broker-dealer could demonstrate 
compliance with the Care Obligation.
Standard of Conduct \415\
---------------------------------------------------------------------------

    \415\ See Section II.C.1.a, Disclosure Obligation, Capacity in 
Which the Broker-Dealer is Acting.
---------------------------------------------------------------------------

    As stated in the Proposing Release, the Commission intended the 
Relationship Summary to touch on issues that are also contemplated 
under the Disclosure Obligation, such as facilitating greater awareness 
of key aspects of a relationship with a firm or financial professional, 
such as the applicable standard of conduct.\416\ Several commenters on 
Regulation Best Interest also requested that the Commission treat the 
standard of conduct applicable to a broker-dealer making the 
recommendation to its retail customer as a ``material fact relating to 
the scope and terms of the relationship'' that would likely need to be 
disclosed prior to, or at the time of the recommendation under the 
Disclosure Obligation.\417\ Specifically, these commenters requested 
that the Commission require a firm to disclose whether it is providing 
a recommendation subject to Regulation Best Interest or advice subject 
to a fiduciary duty.\418\
---------------------------------------------------------------------------

    \416\ See Proposing Release at 21600.
    \417\ See, e.g., NASAA 2018 Letter (recommending that the 
Commission provide specific instructions on how associated persons 
of dually registered firms should disclose capacity in which they 
are acting and whether the information they are providing is a 
recommendation subject to ``best interest'' or advice subject to a 
fiduciary duty). See also Betterment Letter (recommending that the 
Commission require broker-dealers to disclose that they are 
``salespeople who are providing sales recommendations and not 
advice'' in lieu of the adoption of a fiduciary duty on broker-
dealers).
    \418\ Id.
---------------------------------------------------------------------------

    The Commission also carefully considered numerous comments 
concerning the standard of conduct disclosure in proposed Form CRS, 
along with the results of investor testing and the Commission's 
Feedback Form.\419\ As discussed more fully in the Relationship Summary 
Adopting Release, we are adopting a requirement in Form CRS for a 
description of a firm's applicable standard of conduct using prescribed 
wording.\420\ This ``standard of conduct'' disclosure (as modified from 
proposed Form CRS) both eliminates technical words, such as 
``fiduciary,'' and describes the legal obligations of broker-dealers, 
investment advisers, or dual-registrants using similar terminology in 
plain English. The prescribed wording

[[Page 33361]]

also highlights when a firm must satisfy its legal obligation--
specifically, in the case of a broker-dealer, when making a 
recommendation.
---------------------------------------------------------------------------

    \419\ Most commenters did not object to the proposal's 
requirement that broker-dealers and investment advisers provide 
disclosure regarding their standards of conduct or that such 
disclosure be standardized. See, e.g., CFA Institute Letter (urging 
the Commission to require disclosure of the standard of conduct 
under which broker-dealers operate); IAA August 2018 Letter. In 
addition, results of investor studies and surveys indicate that 
retail investors view this information as helpful. See RAND 2018 
(almost one third of survey respondents selected this section as one 
of the two most useful; Letter from Mark Quinn, Director of 
Regulatory Affairs, Cetera (Nov. 19, 2018) (``Cetera November 2018 
Letter'') (88% of survey respondents somewhat or strongly agreed 
``the firm's obligations to you'' is an important topic''). See also 
Schwab Letter I (Hotspex) (``obligations the firm and its 
representatives owe me'' ranked third where survey participants were 
asked to identify four topics as most important for a firm to 
communicate''). Similarly, commenters on Feedback Forms found this 
information to be useful. See Feedback Forms Comment Summary (38% of 
commenters on Feedback Forms graded the ``Our Obligations to You'' 
section of the relationship summary as ``very useful'' and 46% 
graded this section as ``useful'').
    \420\ Form CRS, Item 3.B.(i).a (stating that ``If you are a 
broker-dealer that provides recommendations subject to Regulation 
Best Interest, include: `When we provide you with a recommendation, 
we have to act in your best interest and not put our interest ahead 
of yours' '').
---------------------------------------------------------------------------

    We believe the standard of conduct owed to a retail customer under 
Regulation Best Interest is a material fact relating to the scope and 
terms of the relationship. However, given that Form CRS requires firms 
to disclose in prescribed language the applicable standard of conduct 
and, as discussed above, the Disclosure Obligation requires broker-
dealers to disclose the capacity (i.e., brokerage) in which they are 
acting with respect to a recommendation, we believe this disclosure to 
be sufficient and thus requiring any additional disclosure would be 
duplicative.
b. Material Facts Regarding Conflicts of Interest
    As noted above, in addition to requiring disclosure of the 
``material facts relating to the scope and terms of the relationship,'' 
the proposed Disclosure Obligation would have required a broker-dealer 
to disclose ``all material conflicts of interest associated with the 
recommendation.'' We proposed to interpret a ``material conflict of 
interest'' as a conflict of interest that a reasonable person would 
expect might incline a broker-dealer--consciously or unconsciously--to 
make a recommendation that is not disinterested.'' \421\ We generally 
modeled this proposed interpretation on the Advisers Act approach to 
identifying conflicts of interest for which investment advisers may 
face antifraud liability in the absence of full and fair 
disclosure.\422\ We expressed our preliminary belief that a material 
conflict of interest that generally should be disclosed would include 
material conflicts associated with recommending: Proprietary products, 
products of affiliates, or a limited range of products, or one share 
class versus another share class of a mutual fund; securities 
underwritten by the broker-dealer or an affiliate; the rollover or 
transfer of assets from one type of account to another (such as a 
recommendation to roll over or transfer assets in an ERISA account to 
an IRA); and allocation of investment opportunities among retail 
customers (e.g., IPO allocation).\423\
---------------------------------------------------------------------------

    \421\ Proposing Release at 21602.
    \422\ See id. (citing Capital Gains (stating that as part of its 
fiduciary duty, an adviser must fully and fairly disclose to its 
clients all material information in accordance with Congress's 
intent ``to eliminate, or at least expose, all conflicts of interest 
which might incline an investment adviser--consciously or 
unconsciously--to render advice which was not disinterested'')).
    \423\ See Proposing Release at 21603.
---------------------------------------------------------------------------

    While commenters supported the disclosure of conflicts of interest, 
some sought clarity on the standard for determining which conflicts 
should be disclosed,\424\ and others requested clarity on whether 
conflicts involving certain actions (e.g., rollovers) \425\ and 
products (e.g., proprietary products) \426\ should be disclosed.\427\
---------------------------------------------------------------------------

    \424\ See, e.g., SIFMA August 2018 Letter, Edward Jones Letter 
(requesting clarity on the definition of materiality with regards to 
conflicts); Ameriprise Letter (stating that the definition of 
``material conflicts of interest'' should follow well known and 
understood principles); Fidelity Letter (stating that the Commission 
should not distinguish between conflicts of interest based on 
financial incentives and all other conflicts of interest); Morgan 
Stanley Letter; CCMC Letters; TIAA Letter; Mass Mutual Letter; 
Empower Letter. See also IRI Letter (stating that requiring a 
registered representative to predict what a hypothetical reasonable 
person might think is confusing); ICI Letter (stating that rather 
than focusing on what a ``reasonable person would expect . . .'' the 
standard should focus on that nature of the incentive and its effect 
on a broker-dealer's conduct).
    \425\ See, e.g., CFA Institute Letter.
    \426\ See, e.g., SIFMA August 2018 Letter; State Attorneys 
General Letter; CFA Institute Letter.
    \427\ See, e.g., Ameriprise Letter; State Attorneys General 
Letter; CFA August 2018 Letter.
---------------------------------------------------------------------------

    Several commenters urged the Commission to define ``conflicts of 
interest'' without a reference to the terms ``consciously or 
unconsciously.'' \428\ These commenters claim that discerning a 
broker's conscious or unconscious state of mind is ``confusing and 
inherently unknowable.'' \429\ Similarly, one commenter stated that a 
broker-dealer would be unable to draft adequate policies and procedures 
that address an individual's mindset, noting that it would be 
impossible for a broker-dealer to anticipate an individual's 
unconscious conflicts.\430\ Instead, these commenters suggested revised 
language that eliminates the notion of conscious or unconscious 
inclination.\431\ Similarly, several commenters opposed the 
Commission's use of the term ``not disinterested.'' \432\ These 
commenters believe that the term is not clear and could, among other 
things, suggest the elimination of all conflicts.\433\ One of these 
commenters recommended that the Commission eliminate the term ``not 
disinterested'' \434\ while another suggested that the Commission 
clarify whether ``material'' and ``not disinterested'' are intended to 
be identical or different standards for brokers and advisers.\435\ 
Other commenters opposed the proposed standard, arguing that it was not 
as broad as the disclosure obligation applicable to investment 
advisers. In particular, some commenters urged the Commission to apply 
the standard for disclosure applicable to investment advisers as 
articulated by the Supreme Court in SEC. v. Capital Gains Research 
Bureau.\436\ Specifically, commenters requested that the Commission 
require disclosure of not only material conflicts but also the material 
facts related to a recommendation.\437\
---------------------------------------------------------------------------

    \428\ See, e.g., Edward Jones Letter (urging the Commission to 
articulate a definition of materiality that does not refer to a 
person's unconscious activity); Empower Letter; Ameriprise Letter.
    \429\ Id.
    \430\ See Great-West Letter.
    \431\ See, e.g., Edward Jones Letter (suggesting that the 
Commission define ``material conflict'' as an activity that: (i) 
Affects financial compensation of a person making a recommendation; 
and (ii) a reasonable investor would likely view as important to the 
total mix of information available when considering that 
recommendation); Ameriprise Letter (suggesting that the Commission 
define ``material conflict of interest'' as a conflict of interest 
that a reasonable person might conclude has the potential to 
influence the recommendation); Pacific Life August 2018 Letter 
(suggesting the Commission define ``material conflict of interest'' 
as a financial interest of the financial professional making a 
recommendation that a reasonable person would expect to affect the 
impartiality of such recommendation).
    \432\ See, e.g., IPA Letter (stating that the use of the term 
``not disinterested'' may require unnecessary legal interpretation); 
Empower Letter.
    \433\ See, e.g., Empower Letter.
    \434\ See id.
    \435\ See IPA Letter.
    \436\ 375 U.S. 180 (1963). See, e.g., CFA August 2018 Letter; 
Schnase Letter.
    \437\ See, e.g., CFA August 2018 Letter.
---------------------------------------------------------------------------

    We are adopting the obligation to disclose conflicts of interest, 
with several modifications and clarifications to the Proposing Release. 
Specifically, Paragraph (a)(2)(i)(B) of Regulation Best Interest 
requires that broker-dealers disclose ``material facts relating to 
conflicts of interest that are associated with the recommendation.'' 
\438\
---------------------------------------------------------------------------

    \438\ This supplements the disclosure required in the 
Relationship Summary regarding ways in which the broker-dealer and 
its affiliates make money from brokerage or investment advisory 
services they provide to retail investors, and about the related 
material conflicts of interest. The Relationship Summary requires 
firms to disclose, if applicable, conflicts related to compensation 
it could receive from proprietary products, third-party payments, 
revenue sharing, or principal trading. If firms do not have any of 
these conflicts, the firm must disclose at least one other material 
conflict of interest that affects retail investors. As described in 
the Relationship Summary Adopting Release, we declined to make a 
change pursuant to comments that suggested that Regulation Best 
Interest's and Form CRS's conflicts disclosures be coordinated, and 
that any conflict disclosure obligations under Regulation Best 
Interest should be satisfied upon delivery of the Relationship 
Summary. We recognize that broker-dealers may need to disclose 
additional conflicts at a point in time other than at the beginning 
of the relationship with a retail investor. Broker-dealers also may 
need to include additional information about conflicts of interest 
summarized in the Relationship Summary. The Relationship Summary 
will provide a high-level summary for retail investors so that they 
can engage in a conversation with their financial professional about 
investment advisory or brokerage services, and so that the retail 
investors can choose the type of service that best meets their 
needs, but will not necessarily include all material facts related 
to a particular conflict of interest. We believe many firms may not 
be able to capture all of the necessary disclosures about their 
conflicts in this short standardized disclosure.

---------------------------------------------------------------------------

[[Page 33362]]

    However, as discussed in more detail below, in response to comments 
and in the light of the Relationship Summary, we are: (1) Adopting for 
purposes of Regulation Best Interest a definition of ``conflict of 
interest'' associated with a recommendation ``as an interest that might 
incline a broker, dealer, or a natural person who is an associated 
person of a broker or dealer--consciously or unconsciously--to make a 
recommendation that is not disinterested;'' and (2) revising the 
Disclosure Obligation to require disclosure of ``material facts'' 
regarding such conflicts of interest. Under this approach, all 
conflicts of interest as interpreted under the Proposing Release will 
be covered by Regulation Best Interest.
    We believe distinguishing between ``conflicts of interest'' and 
``material facts'' regarding such conflicts that would be disclosed 
would make the Disclosure Obligation more consistent with the 
proposal's intent. In the Proposing Release, the Commission discussed 
limiting the disclosure of conflicts under the Disclosure Obligation 
``consistent with case law under the antifraud provisions, which limit 
disclosure obligations to ``material facts.''
    After considering the comments, we have determined to retain the 
proposed approach to conflicts of interest as described in Capital 
Gains. In particular, we acknowledge commenter concerns about 
discerning a broker's conscious or unconscious state of mind. However, 
the description of conflicts of interest in Capital Gains is well 
established, familiar to many in the industry, particularly dual-
registrants, and guidance already exists regarding what constitutes a 
conflict of interest under this standard. To provide clarity that this 
interpretation is limited to Regulation Best Interest, however, we are 
revising Regulation Best Interest to explicitly provide that a 
``conflict of interest'' ``means an interest that might incline a, 
broker, dealer, or natural person who is an associated person of a 
broker-dealer--consciously or unconsciously--to make a recommendation 
that is not disinterested,'' \439\ consistent with the scope of the 
meaning of ``conflict of interest'' for investment advisers under 
Capital Gains.\440\
---------------------------------------------------------------------------

    \439\ Rule 15l-1(b)(3).
    \440\ For the same reasons, we have eliminated the phrase ``a 
reasonable person would expect'' that was included in the definition 
of ``material conflict of interest'' discussed in the Proposing 
Release at 21602.
---------------------------------------------------------------------------

    Several commenters also made suggestions regarding the Commission's 
interpretation of the term ``material'' as used in the proposed 
Disclosure Obligation (i.e., the proposed requirement to disclose ``all 
material conflicts of interest that are associated with the 
recommendation'').\441\ Many commenters agreed with the Commission's 
decision to use a ``materiality'' standard to determine those facts 
about conflicts of interest that must be disclosed.\442\ However, 
several other commenters asked the Commission to clarify the meaning of 
``material.'' \443\ These latter commenters stated, among other things, 
that the term ``material'' in proposed Regulation Best Interest was not 
clearly defined and would be subjectively interpreted.\444\ 
Accordingly, many of these commenters recommended that the Commission 
adopt a materiality standard based on the standard articulated in Basic 
v. Levinson.\445\
---------------------------------------------------------------------------

    \441\ See, e.g., Transamerica August 2018 Letter; Fidelity 
Letter; SIFMA August 2018 Letter; Morgan Stanley Letter; IPA Letter; 
Great-West Letter.
    \442\ See, e.g., Morgan Stanley Letter; Great-West Letter.
    \443\ See, e.g., FSI August 2018 Letter (recommending the 
Commission publish examples of when a conflict is material); Wells 
Fargo Letter; Cetera August 2018 Letter; IPA Letter.
    \444\ See, e.g., Great-West Letter (stating that the Commission 
appears to have created a very subjective standard to determine 
materiality).
    \445\ See, e.g., Mass Mutual Letter; SIFMA August 2018 Letter; 
Bank of America Letter; CCMC Letters; TIAA Letter; Cetera August 
2018 Letter; Fidelity Letter.
---------------------------------------------------------------------------

    The Supreme Court in Basic articulated a standard for materiality, 
stating that information is material if there is ``a substantial 
likelihood that a reasonable shareholder would consider it important.'' 
\446\ This definition of ``material'' is well established and thus 
limiting disclosure to material facts in the Disclosure Obligation will 
eliminate confusion and reduce the compliance burden on broker-dealers 
in fulfilling the Disclosure Obligation. It will also help focus the 
information made available to retail customers.\447\ Accordingly, we 
interpret ``material facts'' consistent with the Basic standard. 
Moreover, while the Regulation Best Interest definition of ``conflict 
of interest'' is modeled on the regulatory regime applicable to 
investment advisers, and is not by its terms explicitly limited to 
``material'' conflicts of interest, it would be difficult to envision a 
``material fact'' that must be disclosed pursuant to the Disclosure 
Obligation that is not related to a conflict of interest that is also 
material under the Basic standard.\448\
---------------------------------------------------------------------------

    \446\ Basic v. Levinson.
    \447\ As stated in the Proposing Release, we are sensitive to 
the potential that broker-dealers could adopt an approach that 
results in lengthy disclosures that undermine the Commission's goal 
of facilitating meaningful disclosure to assist retail customers in 
making informed investment decisions. Proposing Release at 21604.
    \448\ See Fiduciary Interpretation.
---------------------------------------------------------------------------

Interpretation of Disclosure of Material Facts Relating to Conflicts of 
Interest
    In response to comments, we are providing our view regarding what 
we would consider ``material facts relating to conflicts of interest 
that are associated with a recommendation'' that would need to be 
disclosed under the Disclosure Obligation. We believe the conflicts of 
interest identified in the Relationship Summary may provide a useful 
starting point for the identification of material facts that need to be 
disclosed pursuant to the Disclosure Obligation.\449\ In addition, we 
also view how a broker-dealer's investment professionals are 
compensated, and the conflicts associated with those arrangements, as 
material facts relating to conflicts of interest that are associated 
with a recommendation.\450\ While these conflicts of interest must be 
summarized in the Relationship Summary to the extent they are 
applicable, we believe that additional details regarding many of these 
conflicts need to be disclosed under the Disclosure Obligation as 
``material facts'' relating to conflicts of interest associated with a 
recommendation.
---------------------------------------------------------------------------

    \449\ See, e.g., Form CRS, Item 3 (Fees, Costs, Conflicts, and 
Standard of Conduct).
    \450\ See Form CRS, Item 3.C.(i) (``Description of How Financial 
Professionals Make Money: Summarize how your financial professionals 
are compensated, including cash and non-cash compensation, and the 
conflicts of interest those payments create.'').
---------------------------------------------------------------------------

Disclosure of Compensation
    Broker-dealers receive compensation that typically varies depending 
on what securities transaction or investment strategy involving 
securities is being recommended. The source of the compensation may 
also vary, for example being paid directly by the investor, or by a 
product sponsor, or a combination of both. A broker-dealer may also pay 
its associated persons different rates of compensation depending on the 
type of security they sell.\451\ Similarly, broker-dealers can receive 
different payments from

[[Page 33363]]

different product providers (e.g., mutual funds) for a variety of 
reasons, such as payments for inclusion on a broker-dealer's menu of 
products offered (sometimes referred to as shelf space). These 
compensation arrangements create a variety of conflicts of interest 
that must be addressed under both Form CRS and the Disclosure 
Obligation.
---------------------------------------------------------------------------

    \451\ See NASD NTM 03-54.
---------------------------------------------------------------------------

    We believe that compensation associated with recommendations to 
retail customers and related conflicts of interest--whether at the 
broker-dealer or the associated person level--is a conflict of interest 
about which material facts must be disclosed as part of the Disclosure 
Obligation. This disclosure should summarize how the broker-dealer and 
its financial professionals are compensated for their recommendations 
and, as importantly, the conflicts of interest that such compensation 
creates. This summary should include the sources and types of 
compensation received, and may include the fact that fees and costs 
disclosed pursuant to Paragraph (a)(2)(i)(A) of Regulation Best 
Interest that a retail customer may pay directly or indirectly are a 
source of compensation, if that is the case. For example, if a broker-
dealer receives compensation derived from the sale of securities or 
other investment products held by retail customers of the firm, 
including asset-based sales charges or service fees on mutual funds, 
that fact and the conflicts associated with the receipt of such 
compensation should be fully and fairly described.
    Broker-dealers could meet the Disclosure Obligation by making 
certain required disclosures of information regarding conflicts of 
interest to their customers at the beginning of a relationship, and 
this form of disclosure may be standardized. However, if standardized 
disclosure, provided at such time, does not sufficiently identify the 
material facts relating to conflicts of interest associated with any 
particular recommendation, the disclosure would need to be supplemented 
so that such disclosure is tailored to the particular recommendation. 
For example, with regard to mutual fund transactions and holdings, a 
broker-dealer might disclose broadly that it is compensated by funds 
out of product fees or by the funds' sponsors, and that such 
compensation gives it an incentive to recommend certain products over 
other products for which the broker-dealer receives less compensation; 
later, when a broker-dealer recommends a particular fund, it could 
provide more specific detail about compensation arrangements, for 
example revenue sharing associated with the fund family. In the 
alternative, so long as the ``material facts'' regarding the conflicts 
associated with a recommendation of a mutual fund were disclosed at the 
outset of the relationship, no further disclosure need be made at the 
time of recommendation; we are not requiring that information regarding 
conflicts be disclosed on a recommendation-by-recommendation basis.
    The Disclosure Obligation also does not require specific written 
disclosure of the amounts of compensation received by the broker-dealer 
or the financial representative. For example, we are not requiring 
broker-dealers to disclose the amount, if any, they compensate their 
financial professionals per transaction, or for year-end bonuses. We 
believe that disclosure of the material facts regarding conflicts of 
interest associated with a recommendation need not entail such 
individualized numerical disclosure, and that in any event such a level 
of detail may be difficult and costly to calculate with accuracy, and 
also confusing to investors in many instances. Instead, disclosure 
regarding conflicts must reasonably inform investors so that the 
investor may use the information to evaluate the recommendation, and 
that can be done without specific disclosure of the amount of the 
compensation. Although disclosure of specific compensation amounts is 
not required, depending on facts and circumstances, full and fair 
disclosure may require disclosure of the general magnitude of the 
compensation.\452\
---------------------------------------------------------------------------

    \452\ See, e.g., Advantage Investment Management, Advisers Act 
Release No. 4455 (Jul. 18, 2016) (settled order) (the Commission 
brought an enforcement action against an adviser for failing to 
disclose the existence, nature and magnitude of a forgivable loan 
from a broker-dealer that the adviser had engaged to provide 
services to the adviser's clients); Taberna Capital Management LLC, 
Advisers Act Release No. 4186 (Sep. 2, 2015) (settled order) (the 
Commission brought an enforcement action against an adviser for 
failing to disclose the existence, nature, and extent of a conflict 
of interest raised by the adviser's receipt of certain fees from 
issuers); BISYS Fund Services, Inc., Advisers Act Release No. 2554 
(Sep. 26, 2006) (settled order) (the Commission brought an 
enforcement action against a mutual fund administrator for failure 
to disclose information concerning the existence or magnitude of the 
conflicts of interest created by a marketing arrangement that called 
for BISYS to rebate a portion of its administrative fees to 27 
mutual fund advisers so that the fund advisers would continue to 
recommend BISYS as an administrator).
---------------------------------------------------------------------------

    We are also clarifying that while product fees and costs can be a 
significant source of compensation received by broker-dealers and 
associated persons, no disclosure regarding the particular amounts of 
these fees and costs is required under Regulation Best Interest with 
regard to conflicts of interest. Instead, what must be disclosed under 
Paragraph (a)(2)(i)(B) of Regulation Best Interest are the ``material 
facts relating to conflicts of interest'' created by compensation 
sourced from product fees and costs, rather than the fees and costs 
themselves.
Differences in Compensation and Proprietary Products
    Several commenters recommended that required conflict disclosure 
address recommendations where a less expensive alternative is 
available, or condition the ability to recommend a more expensive 
product on the adequacy of a broker-dealer's conflict disclosures.\453\ 
Similarly, several commenters expressed differing views on how payment 
of varying compensation should be handled under the ``best interest'' 
standard of Regulation Best Interest and how related conflicts should 
be disclosed.\454\ For example, one commenter identified compensation 
differences within product lines as an example of a conflict that 
should be disclosed.\455\ Several commenters also recommended that the 
Commission require disclosure of conflicts of interest related to use 
of proprietary products, and whether the broker-dealer offers 
alternatives to proprietary products.\456\ Similarly, several 
commenters requested that the Commission clarify that broker-dealers 
can limit their offerings to proprietary products or products that make 
revenue sharing payments if, among other

[[Page 33364]]

things, appropriate disclosure is made.\457\
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    \453\ See PIABA Letter (stating that where less expensive 
alternatives are available, disclosure should include an explanation 
of why the recommendation is nevertheless in the best interest given 
other factors associated with the recommendation); LPL August 2018 
Letter (recommending that the Commission clarify that a broker-
dealer can recommend a product involving costs and charges that are 
within a range of reasonableness that has been disclosed to the 
investor in advance provided the recommendation is otherwise in the 
investor's best interest); UMiami Letter; SIFMA August 2018 Letter.
    \454\ See, e.g., CFA August 2018 Letter (recommending that the 
Commission include compensation differences within product lines as 
an example of a conflict that should be disclosed); Ameriprise 
(stating that differential compensation for diverse products aligns 
with Regulation Best Interest provided the firm mitigates the 
potential related conflicts); Pacific Life August 2018 Letter 
(stating that the definition of ``material conflicts of interest'' 
must encompass, among other things, the types of compensation 
received by the person making the recommendation).
    \455\ See CFA August 2018 Letter.
    \456\ See, e.g., Money Management Institute Letter (recommending 
the SEC allow firms to meet the Conflict of Interest Obligation with 
respect to their preference for proprietary products through 
disclosure); CFA Institute Letter; IRI Letter; SIFMA August 2018 
Letter.
    \457\ See, e.g., SIFMA August 2018 Letter (stating that a firm 
should be allowed to limit its offerings to proprietary products or 
revenue sharing products, as long as: (a) The broker-dealer 
discloses to its customer that it is limiting the recommendation to 
a specific set of securities, and (b) the specific set of securities 
contains appropriate securities to meet the customer's needs); CFA 
Institute Letter (stating that when a firm only offers proprietary 
products it should disclose not only the higher product cost, but 
the potential cost to the investor of such a limited offering).
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    As discussed above, we agree with commenters who stated that it may 
be compatible with the Care Obligation to recommend a more expensive 
product that is otherwise in a retail customer's best interest when 
there are less expensive alternatives available, to receive 
compensation that varies among products, and to recommend proprietary 
products.\458\ However, we also believe that the conflicts of interest 
associated with such practices constitute ``material facts'' relating 
to conflicts of interest that must be disclosed under the Disclosure 
Obligation.
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    \458\ See generally Section II.A.1, Commission's Approach.
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    The receipt of higher compensation for recommending some products 
rather than others, whether received by the broker-dealer, the 
associated person, or both, is a fundamental and powerful incentive to 
favor one product over another.\459\ While we are requiring firms to 
establish policies and procedures reasonably designed to mitigate the 
conflicts of interest that create an incentive for financial 
professionals to place the interest of the professional or broker-
dealer ahead of the interest of the retail customer, we believe also 
that full and fair disclosure of the material facts concerning 
conflicts raised by variable compensation schemes is of particularly 
critical importance for an investor seeking to evaluate a 
recommendation under such circumstances, a concern further underscored 
by our approach under the Conflict of Interest Obligation of requiring 
policies and procedures to mitigate or eliminate certain 
conflicts.\460\
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    \459\ See Proposing Release at 21578 (referencing the 
Commission's long-held concerns about the incentives that 
commission-based compensation provides to churn accounts, recommend 
unsuitable securities, and engage in aggressive marketing of 
brokerage services); FINRA Report on Conflicts of Interest (Oct. 
2013), available at https://www.finra.org/sites/default/files/Industry/p359971.pdf (``FINRA Conflicts Report'') at p. 4.
    \460\ See generally Section II.C.3.
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    The benefits that accrue to a broker-dealer and its financial 
professionals from recommending proprietary products also raise 
conflicts of interest that must be disclosed. Material facts relating 
to the conflicts of interest associated with recommending proprietary 
products could include, as relevant, that the broker-dealer owns the 
product, and that in addition to any commission associated with 
purchasing the product, the broker-dealer or an affiliate may receive 
additional fees and compensation \461\ related to that product.\462\
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    \461\ For example, a broker-dealer's sale of proprietary 
products potentially generates a compensation stream for the broker-
dealer, in addition to commissions, which may need to be disclosed 
under paragraph (a)(2)(i)(A).
    \462\ As discussed further in Section II.C.3, in addition to 
disclosure of such conflicts, broker-dealers are also required under 
the Conflict of Interest Obligation to establish, maintain, and 
enforce written policies and procedures reasonably designed to 
mitigate or address the conflicts presented.
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c. Full and Fair Disclosure
    As proposed, the Disclosure Obligation would have required broker-
dealers to ``reasonably disclose'' material facts relating to the scope 
and terms of the relationship with the retail customer, including all 
material conflicts of interest associated with the recommendation. The 
Commission used this formulation in order to give flexibility to 
broker-dealers in determining the most appropriate way to meet the 
proposed Disclosure Obligation depending on their individual business 
practices. The Commission also provided preliminary guidance on what it 
believed would be to ``reasonably disclose'' in accordance with the 
Disclosure Obligation by setting forth the aspects of effective 
disclosure, including the form and manner of disclosure and the timing 
and frequency of disclosure.
    In this regard, the Commission requested comment on whether broker-
dealers should be required to ``reasonably disclose'' and whether 
additional guidance as to how broker-dealers could meet this standard 
should be provided. The Commission also requested comment on whether 
disclosure should explicitly be required to be ``full and fair.'' In 
response, some commenters raised questions about using the term 
``reasonably disclose'' \463\ and whether broker-dealers should be 
subject to less rigorous disclosure obligations for recommendations 
made to retail customers than investment advisers.\464\ These 
commenters recommended that the Commission explicitly require broker-
dealers to provide full and fair disclosure of material facts.\465\ One 
commenter reasoned that the Commission should not make Regulation Best 
Interest any more stringent than in the Proposing Release, stating that 
``full and fair'' is both inapplicable and unnecessary given the 
proposed standard under the Disclosure Obligation.\466\
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    \463\ See, e.g., CFA August 2018 Letter (stating that a 
``reasonable'' disclosure standard gives firms too much discretion 
to determine how the disclosures will be presented); Galvin (arguing 
that the proposed standard would give broker-dealers more 
opportunities to argue that they acted ``reasonably'' under the 
rules).
    \464\ See, e.g., CFA August 2018 Letter (stating that ``[t]he 
Commission offers no explanation for why broker-dealers should be 
subject to less rigorous disclosure obligations than investment 
advisers'').
    \465\ See, e.g., Pace Investor Rights Clinic August 2018 Letter 
(urging the Commission to require broker-dealers to provide full and 
fair disclosure of any conflicts that are not eliminated or 
mitigated); Better Markets August 2018 Letter (urging the Commission 
to further enhance the Disclosure Obligations by requiring broker-
dealers to make full and fair disclosure of all information required 
to be disclosed); State Attorneys General Letter; NASAA August 2018 
Letter.
    \466\ See SIFMA August 2018 Letter.
---------------------------------------------------------------------------

    After careful consideration of the comments received, the 
Commission is adopting the Disclosure Obligation with revisions to 
require ``full and fair disclosure'' of all material facts relating to 
the scope and terms of the relationship with the retail customer and 
all material facts relating to conflicts of interest associated with 
the recommendation for the reasons described below.
    While we do not believe that adopting a ``full and fair 
disclosure'' standard is significantly different from the proposed 
requirement to ``reasonably disclose,'' we believe that the Regulation 
Best Interest serves the Commission's goal of facilitating disclosure 
to assist retail customers in making informed investment 
decisions.\467\ In addition,

[[Page 33365]]

Regulation Best Interest will more closely align the Disclosure 
Obligation with existing requirements for investment advisers \468\ and 
is consistent with disclosure standards in other contexts under the 
federal securities laws.\469\
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    \467\ This approach is consistent with the rationale articulated 
in the Fiduciary Interpretation. See Fiduciary Interpretation at 
Section II.C (stating, ``In order for disclosure to be full and 
fair, it should be sufficiently specific so that a client is able to 
understand the material fact or conflict of interest and make an 
informed decision whether to provide consent. For example, it would 
be inadequate to disclose that the adviser has `other clients' 
without describing how the adviser will manage conflicts between 
clients if and when they arise, or to disclose that the adviser has 
`conflicts' without further description. Similarly, disclosure that 
an adviser `may' have a particular conflict, without more, is not 
adequate when the conflict actually exists.'' [However,] ``[t]he 
word `may' could be appropriately used to disclose to a client a 
potential conflict that does not currently exist but might 
reasonably present itself in the future.''). See also In the Matter 
of The Robare Group, Ltd., et al., Advisers Act Release No. 4566 
(Nov. 7, 2016) (Commission Opinion) (finding, among other things, 
that adviser's disclosure that it may receive a certain type of 
compensation was inadequate because it did not reveal that the 
adviser actually had an arrangement pursuant to which it received 
fees that presented a potential conflict of interest); aff'd in part 
and rev'd in part on other grounds Robare Group, Ltd., et al. v. 
SEC, 922 F.3d 468 (D.C. Cir. 2019); SEC v. Blavin, 760 F.2d 706, 711 
(6th Cir. 1985) (disclosure that investment adviser ``may'' trade in 
recommended securities for its own account was false and misleading 
where the adviser actually invested in 10%-25% of the publicly 
available stock of the companies it recommended); ICI Letter 
(commenting on the Fiduciary Interpretation proposing release).
    \468\ See Fiduciary Interpretation at Section II.A (stating that 
``[t]he [investment adviser's] fiduciary duty follows the contours 
of the relationship between the adviser and its client, and the 
adviser and its client may shape that relationship by agreement 
provided that there is full and fair disclosure and informed 
consent'' (emphasis added)).
    \469\ For instance, the Municipal Securities Rulemaking Board 
requires that municipal advisors provide full and fair disclosure of 
material conflicts of interest and material legal or disciplinary 
events. See MSRB Rule G-42. In addition, the registration and 
disclosure requirements of the Securities Act of 1933 (``Securities 
Act'') are based on the concept that investors in a public offering 
should be provided with full and fair disclosure of material 
information needed for an informed investment decision. See 
Securities Act Concepts and Their Effects on Capital Formation, 
Securities Act Release No. 7314 (Jul. 25, 1996); 61 FR 40044 (Jul. 
31, 1996) at text accompanying footnote 13; see also SEC v. Ralston 
Purina Co., 346 U.S. 119, 124 (1953). Finally, Regulation FD under 
the Securities Act was ``designed [in part] to promote the full and 
fair disclosure of information by issuers.'' See Selective 
Disclosure and Insider Trading, Securities Act Release No. 7881 
(Aug. 15, 2000), 65 FR 51715 (Aug. 24, 2000).
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    The full and fair disclosure standard that the Commission is 
adopting for broker-dealers under the Disclosure Obligation is 
generally similar to the disclosure standard applicable to investment 
advisers under the Advisers Act.\470\ Similar to the Proposing 
Release's interpretation of the phrase ``reasonably disclose,'' broker-
dealers' obligation to provide full and fair disclosure should give 
sufficient information to enable a retail investor to make an informed 
decision with regard to the recommendation.\471\
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    \470\ See supra footnote 468. See also Fiduciary Interpretation, 
stating that the disclosure ``should be sufficiently specific so 
that a client is able to understand the material fact or conflict of 
interest and make an informed decision whether to provide consent.''
    \471\ See Proposing Release at 21604, footnote 208.
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    We disagree with commenters who believe the ``full and fair'' 
standard is too stringent. While the general standard for broker-
dealers under the Disclosure Obligation will be generally similar to 
the disclosure requirements applicable to investment advisers, the 
scope of the required disclosure is not as broad. For example, the 
Disclosure Obligation only requires disclosure of material facts 
relating to the scope and terms of the relationship with the broker-
dealer, and material facts relating to conflicts of interest associated 
with a broker-dealer's recommendations, and not of all material facts 
relating to the relationship. In addition, the Disclosure Obligation 
only applies to retail customers. In contrast, the disclosure 
requirements imposed by the fiduciary duty under the Advisers Act 
generally and Form ADV in particular are broader (e.g., Form ADV 
requires disclosure of the adviser's principal owner(s) and certain 
financial industry activities and affiliations, which are not 
explicitly required under the Disclosure Obligation; Form ADV and the 
fiduciary duty also go to disclosure of the entire relationship while 
the Disclosure Obligation is tailored to the recommendation and also 
given at relevant points in time). We designed our approach to avoid 
having retail customers receive overwhelming amounts of 
information.\472\
---------------------------------------------------------------------------

    \472\ Commenters pointed out that requiring too much information 
regarding conflicts of interest would go beyond the standard of 
materiality set forth under Basic. See, e.g., SIFMA August 2018 
Letter; Cetera August 2018 Letter (citing Basic at 231, noting that 
``an avalanche of trivial information'' would not be ``conducive to 
informed decision making.''). See also Letter from David Schwartz, 
President and CEA, Florida International Bankers Association 
(``FIBA'') (Feb. 8, 2019) FIBA (``February 2019 Letter'') (stating 
that ``the amount of required disclosure may overwhelm rather than 
educate'').
---------------------------------------------------------------------------

    Some commenters suggested that disclosure and informed consent 
should be required in order to comply with the obligations under 
Regulation Best Interest, similar to the approach taken under the 
fiduciary duty under the Advisers Act.\473\ We have carefully 
considered these comments. As noted above, under the Disclosure 
Obligation, broker-dealers are required to provide full and fair 
disclosure such that a retail customer can make an informed decision 
with regard to the recommendation (i.e., whether to accept (or reject) 
that recommendation). In making such an informed decision after being 
provided with full and fair disclosure, we believe that the retail 
customer has provided ``informed consent'' in a manner that is 
analogous to the informed consent required to be provided by a client 
in the context of an investment adviser-client relationship.\474\ An 
investment advisory client must provide informed consent to the 
adviser's conflicts of interest in the context of the entire 
relationship, which can be broader than the informed consent provided 
by a retail customer when making an informed decision to accept or 
reject a particular recommendation by a broker-dealer. We believe this 
is appropriate because the investment-adviser client relationship is 
generally broader and can include, for example, unlimited investment 
discretion by the investment adviser to conduct securities transactions 
on behalf of the client. The broker-dealer customer relationship on the 
other hand is generally transaction-based and the retail customer must 
accept (or reject) each recommendation by a broker-dealer after the 
broker-dealer has provided full and fair disclosure as required under 
the Disclosure Obligation. Thus, in this regard, Regulation Best 
Interest will more closely align the Disclosure Obligation with the 
existing requirements for investment advisers, as noted above, but is 
tailored to the broker-dealer relationship.\475\ The Commission 
believes that the final Disclosure Obligation along with the 
protections provided by the requirements of Regulation Best Interest, 
including the Care Obligation and Conflict of Interest Obligation, will 
further serve to enhance the protections available to retail customers.
---------------------------------------------------------------------------

    \473\ See, e.g., ASA Letter (stating that the Commission should 
reaffirm that broker-dealers can address conflicts of interest by 
disclosing them and obtaining informed consent); Primerica Letter 
(suggesting that the Commission clarify that broker-dealers can 
effectively address all material conflicts by providing full and 
fair disclosure and obtaining customer consent); Morgan Stanley 
Letter.
    \474\ As discussed in the Fiduciary Interpretation, a client's 
informed consent can be either explicit or, depending on the facts 
and circumstances, implicit. See Fiduciary Interpretation at Section 
II.C. Under Regulation Best Interest, however, assuming the retail 
customer has been provided with full and fair disclosure, the retail 
customer will be considered to have provided informed consent by 
affirmatively accepting a recommendation.
    \475\ See Fiduciary Interpretation (describing an investment 
adviser's obligation to provide disclosure designed to put a 
reasonable client in a position to be able to understand and provide 
informed consent).
---------------------------------------------------------------------------

    One commenter recommended that the Commission clarify what a 
broker-dealer is required to deliver to a retail customer in order to 
permit the retail customer to make an ``informed decision,'' and asked 
the Commission to confirm that it does not require a case-by-case 
analysis of what is reasonable to permit the retail customer to make an 
informed decision.\476\ In addition, other commenters underscored the 
importance of providing retail customers with sufficient time to review 
and comprehend the disclosed information prior to making an informed 
decision about a recommendation.\477\ Other commenters

[[Page 33366]]

questioned whether providing ``sufficient information'' to enable a 
retail customer to make an informed decision broadens the Disclosure 
Obligation beyond ``material facts'' and ``material conflicts.'' \478\
---------------------------------------------------------------------------

    \476\ See, e.g., CCMC Letters.
    \477\ See, e.g., Financial Planning Coalition Letter (stating 
that disclosures should be made prior to the recommendation so a 
retail customer has sufficient time to review and understand them, 
as well as to ask questions); CFA August 2018 Letter (stating that 
if the Commission wants to give investors time to consider the 
information and make an informed choice disclosure should be 
provided as soon as reasonably feasible and, when possible, no later 
than the point of recommendation).
    \478\ See, e.g., IPA Letter (requesting clarification on whether 
providing sufficient information to enable a retail investor to make 
an informed decision broadens the disclosure obligation beyond 
material facts); CCMC Letters.
---------------------------------------------------------------------------

    We have considered the issues raised by the commenters and in the 
sections that follow are providing guidance on what we believe 
constitutes ``full and fair disclosure'' for purposes of the Disclosure 
Obligation, including the form and manner, and the timing and 
frequency, of the disclosure. Similar to the proposal, in lieu of 
setting explicit requirements by rule for what constitutes full and 
fair disclosure of all material facts, we are providing broker-dealers 
flexibility in determining the most appropriate way to meet the 
Disclosure Obligation depending on each broker-dealer's specific 
business practices.
    As we noted in the Proposing Release, while we are providing 
flexibility to broker-dealers to meet the Disclosure Obligation, we 
continue to be sensitive to the potential that broker-dealers could opt 
to disclose all facts, including those that do not meet the materiality 
threshold.\479\ We are cognizant of the likelihood that some broker-
dealers could provide lengthy disclosures that do not meaningfully 
convey the material facts regarding the scope and terms of the 
relationship and material facts regarding conflicts of interest, an 
outcome that could undermine the Commission's goal of facilitating 
disclosure to assist retail customers in making an informed investment 
decision. To this end, broker-dealers will only be required to disclose 
material facts about the scope and terms of the relationship or 
conflicts of interest.
---------------------------------------------------------------------------

    \479\ Id.
---------------------------------------------------------------------------

    Although we are adopting the requirement with revisions to require 
full and fair disclosure of all material facts, we still believe it is 
important to clarify that broker-dealers' compliance with the 
Disclosure Obligation will be measured against a negligence standard, 
not against a standard of strict liability, consistent with the 
Proposing Release. The Commission has taken this position in other 
contexts where full and fair disclosure is required, including under 
the fiduciary duty under the Advisers Act.\480\
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    \480\ While establishing scienter is a requirement to establish 
violations of Section 206(1) of the Advisers Act, it is not required 
to establish a violation of Section 206(2); a showing of negligence 
is adequate. See SEC v. Capital Gains Research Bureau, Inc., 375 
U.S. 180, 195 (1963); see also SEC v. Steadman, 967 F.2d at 643 and 
footnote 5; Steadman v. SEC, 603 F.2d 1126, 1132-34 (5th Cir. 1979), 
aff'd on other grounds, 450 U.S. 91 (1981). See also Prohibition of 
Fraud by Advisers to Certain Pooled Investment Vehicles, Advisers 
Act Release No. 2628 (Aug. 3, 2007). In its adoption of Rule 206(4)-
8 under the Advisers Act, the Commission stated that it would not 
need to demonstrate that an adviser violating the rule acted with 
scienter.
---------------------------------------------------------------------------

Form and Manner
    In the Proposing Release, the Commission noted that it was not 
proposing to specify by rule the form (e.g., narrative v. graphical/
tabular) or manner (e.g., relationship guide or other written 
communications) of disclosure required under the Disclosure Obligation. 
The Commission stated that disclosure should be concise, clear and 
understandable to promote effective communication between a broker-
dealer and a retail customer.\481\ We also stated that broker-dealers 
would be able to deliver disclosure required pursuant to Regulation 
Best Interest consistent with the Commission's guidance regarding 
electronic delivery of documents.\482\ Although we preliminarily 
believed that broker-dealers should have the flexibility to make 
disclosures by any means, as opposed to requiring a standard written 
document at the outset of the relationship, we stated our belief that 
any such disclosure should be provided in writing.\483\
---------------------------------------------------------------------------

    \481\ See Proposing Release at 21604, footnote 211.
    \482\ Id. at 21604 and footnote 214.
    \483\ Id. at 21604 and footnote 213.
---------------------------------------------------------------------------

    Commenters sought further guidance in a number of areas relating to 
disclosure, including the extent to which the Relationship Summary or 
other disclosures may satisfy the Disclosure Obligation,\484\ the 
circumstances under which standardized disclosure could be sufficient, 
as well as how, and the extent to which, disclosures made pursuant to 
the Disclosure Obligation should be made in writing.\485\ In response 
to comments we are providing additional guidance. We are also 
reaffirming guidance that we provided in the Proposing Release.
---------------------------------------------------------------------------

    \484\ See, e.g., Cambridge Letter (arguing that the Relationship 
Summary and Disclosure Obligation are duplicative requirements); 
CUNA Mutual Letter (seeking greater clarification regarding the 
extent to which information provided in other documents could 
satisfy the Disclosure Obligation); Financial Services Institute 
August 2018 Letter (arguing that providing the Relationship Summary 
should be deemed to satisfy the requirements of the broker-dealer's 
Disclosure Obligation); Morningstar Letter (arguing that due to the 
brevity of the Relationship Summary, additional broker-dealer 
disclosures would be necessary); Wells Fargo Letter (recommending 
that the requirements of the Disclosure Obligation be incorporated 
into Form CRS).
    \485\ See, e.g., Schwab Letter (arguing that because most 
recommendations occur over the phone and through various digital 
means, the Commission should remove the ``in writing'' requirement 
and allow firms to determine the best method for disclosure 
depending on the situation); SIFMA August 2018 Letter (seeking 
clarification that oral disclosure at the time of the recommendation 
may be sufficient to satisfy the Disclosure Obligation in certain 
circumstances). But see AARP August 2018 Letter (stating that oral 
disclosures should never be permitted).
---------------------------------------------------------------------------

Prescribed Form of Disclosure
    As noted in the Proposing Release, we believe it is important to 
provide broker-dealers with flexibility in determining the most 
appropriate and effective way to meet the Disclosure Obligation to 
reflect the structure and characteristics of their relationships with 
retail customers.\486\ Many commenters agreed with this reasoning, 
arguing that there was a need to preserve flexibility for broker-
dealers to comply with the Disclosure Obligation as proposed.\487\ 
Other commenters believed, however, that the proposed Disclosure 
Obligation gave broker-dealers too much discretion.\488\
---------------------------------------------------------------------------

    \486\ See Proposing Release at 21604.
    \487\ See, e.g., Prudential Letter; SIFMA August 2018 Letter; 
TIAA Letter; UBS Letter.
    \488\ See, e.g., Better Markets August 2018 Letter (arguing that 
proving broker-dealer discretion in this area will virtually assure 
a failure to communicate helpfully with investors); CFA August 2018 
Letter (arguing that the flexibility the Commission provides will 
result in disclosure that does not effectively convey key 
information). See also Morningstar Letter (supporting the expansion 
of disclosures, but arguing that ``publicly available disclosures 
with a standard taxonomy work best because they empower third 
parties such as ``fintech'' and ``reg-tech'' firms to analyze and 
contextualize critical information and amplify a call to action for 
ordinary investors'').
---------------------------------------------------------------------------

    After careful consideration of these comments, the Commission has 
decided not to require any standard written disclosures (other than the 
Relationship Summary) at this time. Although we recognize the potential 
value to retail customers of standardizing the disclosures required 
pursuant to the Disclosure Obligation, we believe that retail customers 
can derive value from disclosures that accommodate the structure and 
characteristics of the particular broker-dealer. On balance, we 
recognize the wide variety of business models and practices and we 
continue to believe it is important to provide broker-dealers with 
flexibility to enable them to better tailor disclosure and information 
that their retail customers can understand and may be more likely to 
read at relevant points in time, rather

[[Page 33367]]

than, for example, mandating a standardized all-inclusive (and likely 
lengthy) disclosure.\489\
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    \489\ With respect to the length of disclosure documents, 
investor testing of proposed Form CRS examined retail investors' 
likelihood of reading only longer documents (such as Form ADV Part 
II or an account opening agreement), only a short document (Form 
CRS), both, or neither when choosing a financial professional, 
account type or firm. Although the context was specific to Form CRS 
and the retail investor's initial determination regarding a 
financial professional, account type or firm, the survey suggests 
that retail investors may be more likely to read either both longer 
and shorter disclosures or just shorter disclosures. See RAND 2018 
(``Whereas Figure 2.20 shows that half of all investors reported 
having reviewed neither a Form ADV nor an account opening agreement 
in the past and another 20 percent reported not knowing whether they 
had ever done so, Figure 2.21 shows that about 70 percent of all 
respondents and of all investors reported that they would be likely 
to read either both types of documents or only the Relationship 
Summary when choosing a financial professional in the future. Just 2 
percent of investors and 1 percent of noninvestors reported being 
likely to read only the longer documents, whereas 29 percent of 
investors and 13 percent of noninvestors were likely to read only 
the Relationship Summary.'' More specifically, Figure 2.21 shows 
that over 40% of all respondents indicated they would read both and 
under 30% indicated that they would read only the Relationship 
Summary.)
---------------------------------------------------------------------------

    We disagree that flexibility will prevent investors from obtaining 
information necessary to make an informed investment decision and do 
not believe that requiring a standard written disclosure beyond the 
Relationship Summary is necessary at this time. We emphasize, however, 
that the adequacy of the disclosure will depend on the facts and 
circumstances. We intend to evaluate broker-dealer disclosure practices 
in response to Regulation Best Interest over time to determine whether 
additional disclosure initiatives may be appropriate.
Relying on Other Disclosures and Standardized Documents
    In the Proposing Release, we described how the Disclosure 
Obligation builds upon the requirements of Form CRS and the disclosures 
in the Relationship Summary.\490\ We also stated that we anticipated 
that broker-dealers may elect to use other documents to satisfy 
elements of the Disclosure Obligation, such as an account agreement, a 
relationship guide, or a fee schedule.\491\
---------------------------------------------------------------------------

    \490\ See Proposing Release at 21600.
    \491\ See id. at 21605.
---------------------------------------------------------------------------

    Several commenters requested guidance on their ability to use other 
documents to meet the requirements of the Disclosure Obligation. For 
example, some commenters recommended that the Commission harmonize the 
Disclosure Obligation with the broad, firm-level disclosure obligations 
of Form CRS so that firms can use the Relationship Summary to help 
satisfy the Disclosure Obligation.\492\ Commenters also recommended 
that broker-dealers should be permitted to satisfy the Disclosure 
Obligation by using standardized language generally to describe the 
broker-dealer's products and services available to their retail 
customers and related conflicts of interest, including the ranges of 
remuneration payable to a broker-dealer in connection with its 
recommendation of different products.\493\ Several commenters also 
suggested that the Commission should clarify that the Disclosure 
Obligation should not apply where an existing disclosure regime already 
exists.\494\ Similarly, other commenters recommended that the 
Commission clarify whether broker-dealers could meet the Disclosure 
Obligation by referencing information required to be disclosed pursuant 
to other regulatory requirements such as FINRA disclosure rules.\495\
---------------------------------------------------------------------------

    \492\ See, e.g., Cambridge Letter (recommending that providing 
the Form CRS should fulfill the broker-dealer's Disclosure 
Obligation under Regulation Best Interest); ACLI Letter (noting that 
a single disclosure fulfilling Regulation Best Interest and Form CRS 
would reduce the disclosure burdens and increase the likelihood 
consumers will read the required information); FSI August 2018 
Letter; Mutual of America Letter; Northwestern Mutual Letter; IPA 
Letter; Transamerica August 2018 Letter; NAIFA Letter.
    \493\ See, e.g., LPL August 2018 Letter (recommending that all 
investors be provided with general disclosures setting forth the 
ranges of remuneration payable to broker-dealers in connection with 
its recommendations of different products); Committee of Annuity 
Insurers (urging the Commission to clarify that a broker-dealer can 
satisfy the Disclosure Obligation through disclosure describing 
products and services available to its retail customers and need not 
provide a disclosure particularized to a recommendation).
    \494\ See, e.g., SIFMA August 2018 Letter (asking the Commission 
to clarify that the Disclosure Obligation does not apply in contexts 
where there is an existing regime, such as for equity and debt 
research); Transamerica August 2018 Letter (recommending that the 
Commission recognize that existing disclosure regimes suffice to 
meet certain disclosure requirements).
    \495\ See, e.g., Transamerica August 2018 Letter (stating that 
the disclosure obligation should expressly take into consideration 
existing disclosures).
---------------------------------------------------------------------------

    After careful consideration of the comments, the Commission is 
providing guidance to permit a broker-dealer to utilize existing 
disclosures and standardized documents, such as a product prospectus, 
relationship guide, account agreement, or fee schedule to help satisfy 
the Disclosure Obligation. The Commission recognizes that broker-
dealers are subject to disclosure requirements other than the 
Disclosure Obligation and Form CRS, and believes utilizing such 
existing disclosures where appropriate is a reasonable and cost-
effective way to satisfy the requirements of the Disclosure Obligation, 
and can also help avoid duplicative or voluminous disclosure by not 
requiring the creation of new disclosure documents.\496\ We recognize 
also that in many instances, information necessary to satisfy the 
Disclosure Obligation may be broadly applicable to a broker-dealer's 
retail customers, and therefore the use of standardized disclosure may 
be appropriate.
---------------------------------------------------------------------------

    \496\ See Proposing Release at 21599, footnotes 175 and 176. For 
example, broker-dealers must disclose information about a 
transaction on trade confirmations pursuant to Exchange Act Rule 
10b-10. 17 CFR 240.10b-10. See also Morgan Stanley Letter (noting 
that the securities laws and FINRA rules already require firms to 
provide significant disclosures to clients at natural touchpoints in 
the client relationship).
---------------------------------------------------------------------------

    However, while broker-dealers may choose to standardize certain 
forms of their disclosure, whether such materials would be sufficient 
to satisfy the Disclosure Obligation will depend on the facts and 
circumstances.\497\ For example, disclosures may need to be tailored to 
a particular recommendation if the standardized disclosure does not 
sufficiently identify the material facts about a conflict of interest 
presented by a particular recommendation. Accordingly, a broker-dealer 
remains responsible for disclosing all material facts relating to the 
scope and terms of the relationship with the retail customer (as 
discussed above), as well as all material facts relating to conflicts 
of interest that are associated with a recommendation whether or not 
the firm relies on other materials to fulfill that obligation.
---------------------------------------------------------------------------

    \497\ Similarly, we also note that a number of broker-dealers 
are modeling their disclosure of fees other than transaction-based 
fees on the NASAA Schedule of Miscellaneous Account and Service 
Fees. See NASAA August 2018 Letter. A broker-dealer may use this 
schedule to comply in part with its obligation to disclose fees and 
costs pursuant to the Disclosure Obligation. We note, however, that 
the NASAA Schedule may recommend the disclosure of certain fees that 
may not be required under the Disclosure Obligation depending on the 
facts and circumstances, for example those that are not ``material 
facts'' for purposes of Regulation Best Interest.
---------------------------------------------------------------------------

    With regard to commenters' request that the Relationship Summary be 
considered sufficient to satisfy the Disclosure Obligation, we note 
that the Relationship Summary will provide succinct information and is 
designed to assist retail investors with the process of deciding 
whether to engage, or to continue to engage, a particular firm or 
financial professional, deciding whether to establish or continue to 
maintain a brokerage or investment advisory relationship, and asking 
questions and easily finding additional information.

[[Page 33368]]

We recognize that additional details regarding many of the topics 
(e.g., services, fees and conflicts of interest) would in many cases be 
necessary to satisfy the Disclosure Obligation. Thus, although a 
broker-dealer could use a Relationship Summary and other standardized 
disclosures about its products and services to help satisfy the 
Disclosure Obligation, these disclosures may not be sufficient to 
satisfy the Disclosure Obligation. Whether the Relationship Summary 
standing alone, or any additional or existing disclosures, satisfy any 
of these required disclosures in full would depend on the facts and 
circumstances. In most instances, broker-dealers will need to provide 
additional information beyond that contained in the Relationship 
Summary in order to satisfy the Disclosure Obligation.
In Writing
    We proposed requiring that disclosures be provided in writing.\498\ 
We also stated that requiring written disclosures would help facilitate 
investor review of the disclosure, promote compliance by firms, 
facilitate effective supervision, and facilitate more effective 
regulatory oversight to help ensure and evaluate whether the disclosure 
complies with the requirements of Regulation Best Interest.\499\ We 
also stated that the ``in writing'' requirement could be satisfied 
either through paper or electronic means consistent with existing 
Commission guidance on electronic delivery of documents. We also 
provided guidance on how broker-dealers could comply with the ``in 
writing'' requirement when recommendations are given over the 
telephone.\500\
---------------------------------------------------------------------------

    \498\ See Proposing Release at 21604.
    \499\ Id.
    \500\ Id.
---------------------------------------------------------------------------

    A number of commenters supported the ``in writing'' 
requirement.\501\ Other commenters, however, recommend that the 
Commission also permit the use of oral disclosure.\502\ For example, 
several commenters recommend that the Commission permit broker-dealers 
to orally disclose information to their customers provided they later 
follow-up in writing.\503\ Other commenters highlighted concerns 
associated with such oral disclosure.\504\
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    \501\ See, e.g., Vanguard Letter (recommending that the 
Commission require a consolidated written disclosure of all material 
conflicts); CFA August 2018 Letter.
    \502\ See Schwab Letter (recommending that the Commission 
eliminate the ``in writing'' requirement and allow firms to design 
and document the best method depending on the situation); SIFMA 
August 2018 Letter; TIAA Letter. But see AARP August 2018 Letter 
(stating that oral disclosures should never be permitted).
    \503\ See PIABA Letter (recommending that the Commission allow 
broker-dealers to discharge their disclosure obligations by: (i) 
Orally explaining the relationship, any conflicts, how the broker-
dealer is paid, and the features, benefits and risks of the 
recommendation; and (ii) confirming the discussion by letter or 
email, which is signed or confirmed as being accurate by the 
customer, and retained in customer's file); SIFMA August 2018 Letter 
(recommending that the Commission clarify that oral disclosure at 
the time of the recommendation may satisfy the Disclosure Obligation 
if: (1) The associated person documents that the oral disclosure was 
made, or (2) the firm provides written disclosure after the trade); 
USAA Letter (suggesting that the Commission could allow oral 
product-level disclosures, while providing the client the choice to 
request confirming disclosure in writing at her option).
    \504\ See Edward Jones Letter (expressing concern that the 
Commission is implying that a dual-registrant would need to provide 
an oral point of sale disclosure regarding the capacity in which it 
is acting when it makes a recommendation, and that such oral 
disclosure would be difficult to supervise and of little value); 
CCMC Letters (stating that a dual-registrant should not have to make 
an oral disclosure of the capacity for each and every conversation 
it has with retail customers).
---------------------------------------------------------------------------

    After carefully considering the comments, we are adopting the ``in 
writing'' requirement as proposed, subject to discussion in Section 
II.C.1, Oral Disclosure or Disclosure After a Recommendation. As stated 
above, we believe that retail customers would benefit from receiving a 
written disclosure to assist their investment decisions and form the 
basis of an informed investment decision.\505\ However, we also believe 
that broker-dealers require flexibility to make proper written 
disclosures to their customers. Accordingly, the Commission is not 
requiring a specific form or method of written disclosure.
---------------------------------------------------------------------------

    \505\ One commenter stated that certain foreign laws do not 
permit firms to provide their customers with written materials prior 
to entering into a contractual relationship. See FIBA February 2019 
Letter. In response, we note that the Disclosure Obligation requires 
disclosure to be provided prior to or at the time of the 
recommendation and is not tied to a contractual relationship. In 
addition, the staff will continue to evaluate the application of the 
Disclosure Obligation in circumstances such as the one raised by 
this commenter. Interested parties are invited to provide further 
feedback on issues involving non-U.S.- resident retail customers.
---------------------------------------------------------------------------

    Although we are requiring that disclosure be made ``in writing,'' 
we recognize that a broker-dealer may need to supplement, clarify or 
update written disclosure it has previously made before it provides a 
retail customer with a recommendation. For instance, as we stated in 
the Proposing Release, we recognized that broker-dealers may provide 
recommendations by telephone and offer clarifying disclosure orally in 
some instances subject to certain conditions,\506\ such as a dual-
registrant informing a retail customer of the capacity in which the 
dual-registrant is acting in conjunction with a recommendation.\507\ In 
such instances, we believe that it may be necessary as a practical 
matter to provide oral disclosure of a material fact to supplement, 
clarify, or update written disclosure made previously.\508\ Therefore, 
firms may make oral disclosures under the circumstances outlined in 
Section II.C.1, Oral Disclosure or Disclosure After a 
Recommendation.\509\
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    \506\ See Proposing Release at 21604, footnote 213.
    \507\ See id. at 21605, footnote 216. We stated that a broker-
dealer could orally clarify the capacity in which it is acting at 
the time of the recommendation if it had previously provided written 
disclosure to the retail customer beforehand disclosing its capacity 
as well as the method it planned to use to clarify its capacity at 
the time of the recommendation.
    \508\ For more discussion on guidance relating to updating 
disclosures, see Section II.C.1.d, Disclosure Obligation, Updating 
Disclosure.
    \509\ See Section II.C.1, Disclosure Obligation, Oral Disclosure 
or Disclosure After a Recommendation.
---------------------------------------------------------------------------

    When making such an oral disclosure, firms must maintain a record 
of the fact that oral disclosure was provided to the retail 
customer.\510\ We are not explicitly requiring broker-dealers to create 
a record documenting the substance of the oral disclosure itself, but 
rather a record of the fact that such oral disclosure was made.\511\ 
This record should include documentation sufficient to demonstrate that 
disclosure was made to the retail customer, which could include, for 
example, recordings of telephone conversations or contemporaneous 
written notations. Nonetheless, although it is not required by 
Regulation Best Interest, as a best practice we encourage broker-
dealers that make oral disclosures to subsequently provide to their 
retail customers in a timely manner written disclosure summarizing the 
information conveyed orally.
---------------------------------------------------------------------------

    \510\ See Section II.D.
    \511\ See Section II.C.1, Disclosure Obligation, Oral Disclosure 
or Disclosure After a Recommendation.
---------------------------------------------------------------------------

Plain English
    In the Proposing Release, we stated that broker-dealers should 
apply plain English principles to written disclosures including, among 
other things, the use of short sentences and active voice, and 
avoidance of legal jargon, highly technical business terms, or multiple 
negatives.\512\ Similarly, several commenters recommended that whatever 
format broker-dealers use for their disclosure, they should be written 
in plain English and easy to understand.\513\ Accordingly, although it

[[Page 33369]]

is not required, the Commission encourages broker-dealers to use plain 
English in preparing any disclosures they make in satisfaction of the 
Disclosure Obligation.
---------------------------------------------------------------------------

    \512\ Proposing Release at 21604, footnote 213.
    \513\ See State Attorneys General Letter (stating that all 
disclosures must be in plain language and easily understood by 
investors); CFA Institute (recommending that the Commission require 
a clear English listing of all conflicts of interest in which a 
broker-dealer engages). One commenter requested that the Commission 
consider clarifying that the Plain English standard in the 
Disclosure Obligation is not an English-only requirement to address 
the needs of certain non-U.S. customers. See FIBA February 2019 
Letter. In response, we note that any disclosure should be made 
consistent with Plain English principles.
---------------------------------------------------------------------------

Electronic Delivery
    In the Proposing Release, we took the position that broker-dealers 
could deliver written disclosures required by Regulation Best Interest 
in accordance with the Commission's existing guidance regarding 
electronic delivery of documents.\514\ This framework consists of the 
following elements: (1) Notice to the investor that information is 
available electronically; (2) access to information comparable to that 
which would have been provided in paper form and that is not so 
burdensome that the intended recipients cannot effectively access it; 
and (3) evidence to show delivery (i.e., reason to believe that 
electronically delivered information will result in the satisfaction of 
the delivery requirements under the federal securities laws).\515\ We 
have furthermore clarified that one method to satisfy the evidence of 
delivery element is to obtain informed consent from investors.\516\
---------------------------------------------------------------------------

    \514\ See Proposing Release at 21604. We cited to a number of 
prior Commission releases on electronic delivery in the Proposing 
Release, including Use of Electronic Media by Broker-Dealers, 
Transfer Agents, and Investment Advisers for Delivery of 
Information, Exchange Act Release No. 37182 (May 9, 1996), 61 FR 
24644 (May 15, 1996) (``1996 Release'') (providing Commission views 
on electronic delivery of required information by broker-dealers, 
transfer agents and investment advisers) and Use of Electronic 
Media, Exchange Act Release No. 42728 (Apr. 28, 2000), 65 FR 25843 
(May 4, 2000) (``2000 Release'') (providing updated interpretive 
guidance on the use of electronic media to deliver documents on 
matters such as telephonic and global consent; issuer liability for 
website content; and legal principles that should be considered in 
conducting online offerings).
    \515\ See 1996 Release at 24646-47; see also Relationship 
Summary Proposing Release at 21454.
    \516\ See 2000 Release at 25845-46 (clarifying how market 
intermediaries and other market participants can obtain consent for 
electronic delivery).
---------------------------------------------------------------------------

    Several commenters agreed with this approach.\517\ These commenters 
typically supported the use of electronic disclosure and recommended 
various methods (e.g., hyperlinks to web-based documents) but 
recommended paper delivery as the default option.\518\ Other commenters 
recommended permitting electronic delivery for required 
disclosures.\519\ While investor testing on the proposed Relationship 
Summary indicated that some retail investors generally support some 
form of electronic copies, most participants in the study ``generally 
liked having a paper version of the Relationship Summary.'' \520\ 
Similarly, as stated in the Form CRS adopting release, the IAC has 
cited one study indicating that nearly half of investors (49%) still 
prefer to receive paper disclosures through the mail, compared with 
only 33% who prefer to receive disclosures electronically, either 
through email (27%) or accessing them online (6%).\521\
---------------------------------------------------------------------------

    \517\ See, e.g., CFA August 2018 Letter (stating that giving 
firms discretion to choose the delivery mechanism would all but 
ensure that many investors would never see the disclosures); AARP 
August 2018 Letter (recommending that the Commission prohibit firms 
from solely providing electronic access to disclosures and require 
delivery of paper copies).
    \518\ Id. See also LPL August 2018 Letter (noting that modern 
communication practices underscore the need for the Commission to 
provide more flexibility to broker-dealers to satisfy their document 
delivery obligations; and requesting that the Commission confirm 
that broker-dealers can deliver disclosures in compliance with 
existing guidance regarding electronic delivery of documents (which 
requires paper delivery as a default)).
    \519\ See, e.g., IPA Letter (urging the Commission to confirm 
that all required disclosures may be delivered electronically); see 
also AXA Letter (urging the Commission to encourage the use of 
appropriate electronic disclosures, which can make information 
available to consumers more quickly and in a more digestible 
format); Prudential Letter (recommending that electronic delivery be 
deemed to comply with the Disclosure Obligation).
    \520\ See RAND 2018.
    \521\ Relationship Summary Adopting Release at Section II.D.3.a 
(citing Investor Advisory Committee, Recommendation of the Investor 
as Purchaser Subcommittee: Promotion of Electronic Delivery and 
Development of a Summary Disclosure Document for Delivery of 
Investment Company Shareholder Reports (Dec. 7, 2017), available at 
https://www.sec.gov/spotlight/investor-advisory-committee-2012/recommendation-promotion-of-electronic-delivery-and-development.pdf 
(citing FINRA Investor Education Foundation, ``Investors in the 
United States 2016,'' December 2016, available at https://bit.ly/2hMrppX).
---------------------------------------------------------------------------

    After considering investor testing results and commenters' concerns 
and recommendations, the Commission reaffirms the application of 
existing Commission guidance relating to paper and electronic delivery 
of disclosure documents to broker-dealers in meeting the Disclosure 
Obligation. Specifically, we believe that broker-dealers should be able 
to satisfy the Disclosure Obligation by using electronic delivery.\522\ 
However, if a broker-dealer is providing its customers with electronic 
delivery (upon their consent) it cannot solely offer electronic 
delivery and must make paper delivery available, upon request. Both 
Regulation Best Interest and Form CRS require firms to provide 
electronic delivery of documents within the framework of the 
Commission's existing guidance regarding electronic delivery.\523\
---------------------------------------------------------------------------

    \522\ See 1996 Release (stating that ``the Commission believes 
that broker-dealers . . . similarly should have reason to believe 
that electronically delivered information will result in the 
satisfaction of the delivery requirements under the federal 
securities laws. Thus, whether using paper or electronic media, 
broker-dealers . . . should consider the need to establish 
procedures to ensure that applicable delivery obligations are 
met''); see also 2000 Release.
    \523\ See Relationship Summary Adopting Release, Section II.C.3.
---------------------------------------------------------------------------

d. Timing and Frequency
    We proposed requiring broker-dealers to provide the disclosures 
required by the Disclosure Obligation ``prior to or at the time of'' 
the recommendation. We noted the importance of determining the 
appropriate timing and frequency of disclosure that may be effectively 
provided ``prior to or at the time of'' the recommendation.\524\ In 
cases where a broker-dealer determines that disclosure may be more 
effectively be provided in an initial, more general disclosure (such as 
a relationship guide) followed by specific information in a subsequent 
disclosure that is provided at a later time, the initial disclosure 
would address when and how a broker-dealer would provide more specific 
information regarding the material fact or conflict in a subsequent 
disclosure. We stated also that in circumstances where a broker-dealer 
determines to provide an initial, more general disclosure (such as a 
relationship guide) followed by specific information in a subsequent 
disclosure that is provided after the recommendation (such as a trade 
confirmation), the initial disclosure must address when and how a 
broker-dealer would provide more specific information regarding the 
material fact or conflict in a subsequent disclosure (e.g., after the 
trade in the trade confirmation).\525\ We also stated

[[Page 33370]]

that disclosure after the recommendation, such as in a trade 
confirmation for a particular recommended transaction would not, by 
itself, satisfy the Disclosure Obligation, because the disclosure would 
not be ``prior to, or at the time of the recommendation.'' We noted 
also that whether there is sufficient disclosure in both the initial 
disclosure and any subsequent disclosure would depend on the facts and 
circumstances.\526\
---------------------------------------------------------------------------

    \524\ See Proposing Release at 21605.
    \525\ The Commission has granted exemptions to certain dual-
registrants, subject to a number of conditions, from the written 
disclosure and consent requirements of Advisers Act Section 206(3) 
(which makes it unlawful for an adviser to engage in a principal 
trade with an advisory client, unless it discloses to the client in 
writing before completion of the transaction the capacity in which 
the adviser is acting and obtains the consent of the client to the 
transaction). The exemptions are subject to several conditions, 
including conditions to provide disclosures at multiple points in 
the relationship, including disclosure that the entity may be acting 
in a principal capacity in a written confirmation at or before 
completion of a transaction. See, e.g., In the matter of Merrill 
Lynch Pierce Fenner & Smith, Incorporated, Investment Advisers Act 
Release No. 4595; (Dec. 28, 2016); In the matter of Robert W. Baird 
& Co., Incorporated, Advisers Act Release No. 4596 (Dec. 28, 2016); 
In the matter of UBS Financial Services, Inc., Advisers Act Release 
No. 4597 (Dec. 28, 2016); In the matter of Wells Fargo Advisors, 
LLC, Wells Fargo Advisors Financial Network, LLC, Advisers Act 
Release No. 4598 (Dec. 28, 2016).
    \526\ See Proposing Release at 21605.
---------------------------------------------------------------------------

    Several commenters supported the Commission's proposal to require 
broker-dealers to make disclosure prior to or at the time of the 
recommendation, but disagreed about the precise timing with which 
disclosure should be provided.\527\ For example, some commenters 
recommended that the Commission require or allow broker-dealers to meet 
the Disclosure Obligation prior to or at account opening.\528\ 
Similarly, several commenters recommended that the Commission require 
broker-dealers to provide disclosure prior to a recommendation or 
investment decision.\529\ Specifically, commenters recommended that the 
Commission require disclosures to be made with enough time prior to a 
recommendation that a retail customer has sufficient time to review and 
understand them, as well as ask questions.\530\
---------------------------------------------------------------------------

    \527\ See, e.g., CFA August 2018 Letter (stating that any 
information that can be provided before the transaction is entered 
into should be provided to give investor time to consider it); AARP 
August 2018 Letter (stating that all key disclosures should be made 
significantly in advance of an investment decision; disclosure made 
at the time of or immediately prior to investing is not adequate); 
Bank of America Letter (stating that disclosure of material 
conflicts of interest can be satisfied in advance of a particular 
recommendation on a one-time basis); Pacific Life August 2018 Letter 
(stating that disclosure of material conflicts of interest must be 
disclosed at or prior to the point of sale or at the time the 
recommendation is made); FPC Letter.
    \528\ See, e.g., TIAA Letter (recommending that the Commission 
require firms to meet their Regulation Best Interest and CRS 
disclosure obligations at or before the point the investor: (i) 
Opens a brokerage account; or (ii) engages the broker-dealer to 
provide advice services (including for recommendations provided by 
phone)).
    \529\ See, e.g., Better Markets August 2018 Letter (stating that 
disclosure should be provided in a timely fashion so investors have 
a meaningful opportunity to read, digest, understand, and discuss 
them); FPC Letter; AARP August 2018 Letter.
    \530\ See, e.g., NAIFA Letter (recommending that disclosure be 
provided at or before the time of a recommendation because it helps 
consumers better understand and evaluate the recommendations they 
receive and preserves flexibility for professionals who may be 
interacting with clients of various levels of financial 
sophistication, duration of relationship, and investment history); 
CFA August 2018 Letter (recommending that transaction-specific 
information should be provided, whenever possible, at the point of 
recommendation rather than at the point of sale); Groom Letter 
(recommending that the Commission require disclosure of material 
conflicts of interest related to investing plan distribution 
proceeds at the inception of any discussions of the matter); PIABA 
Letter (recommending that the Commission require firms to provide 
specific charges prior to or at the time the recommendation is 
made); FPC Letter (stating that disclosures should be made prior to 
the recommendation so the retail customer has sufficient time to 
review and understand them, as well as to ask questions); Better 
Markets August 2018 Letter; AARP August 2018 Letter; Bank of America 
Letter.
---------------------------------------------------------------------------

    Several other commenters, however, recommended that the Commission 
clarify whether broker-dealers could meet the Disclosure Obligation at 
the point of sale \531\ or after a recommendation is made.\532\ 
Conversely, several commenters recommended that the Commission clarify 
that it will not require point of sale or point of recommendation 
disclosure obligations.\533\
---------------------------------------------------------------------------

    \531\ See Pacific Life August 2018 Letter (stating that material 
conflicts of interest must be disclosed at or prior to the point-of-
sale or at the time the recommendation is made).
    \532\ See, e.g., LPL August 2018 Letter (suggesting that the 
Commission permit a broker-dealer to satisfy the Disclosure 
Obligation by directing an investor in writing to review the 
recommended product's offering documents, along with hyperlinks to 
those documents, prior to the recommendation or shortly thereafter 
via a trade confirmation); SIFMA August 2018 Letter (recommending 
that the Commission confirm that firms would be permitted to provide 
disclosures on a website or on a post-trade basis, provided 
customers have been informed in advance of the timing of those 
disclosures).
    \533\ See, e.g., SIFMA August 2018 Letter (requesting the 
Commission clarify that there is no requirement for a point of sale 
or point of recommendation disclosure, as such a requirement would 
be unworkable for the industry); Morgan Stanley Letter (noting that 
point-of-sale disclosures pose operational issues and may not afford 
clients sufficient time to adequately consider and understand them); 
HD Vest Letter (recommending that the Commission not mandate written 
point of recommendation or point of sale disclosure); Prudential 
Letter (requesting that the Commission clarify that it is not 
mandating a point of sale or point of recommendation disclosure 
obligation). But see NASAA August 2018 Letter (stating that only a 
transaction-by-transaction disclosure obligation will ensure that 
broker-dealers are meeting their ``best interest'' duties and 
provide investors the level of protection they deserve); AARP August 
2018 Letter (recommending that the Commission require firms to 
disclose their fees any time a recommendation is made).
---------------------------------------------------------------------------

    After carefully considering the comments received, we are providing 
our view on what it means for broker-dealers to provide the required 
disclosures in writing ``prior to or at the time of'' the 
recommendation. As with the ``form and manner'' of making disclosures, 
the Commission continues to believe that broker-dealers should have 
flexibility with respect to the ``timing and frequency'' of providing 
disclosure to determine the most appropriate and effective way to meet 
the Disclosure Obligation. Accordingly, the Commission has decided not 
to provide any prescriptive requirements for the timing and frequency 
of written disclosures, other than requiring disclosure prior to or at 
the time of the recommendation.
    In order to make an informed decision about a securities 
recommendation, retail customers must have appropriate information at 
the time or before a recommendation is made. Being in possession of 
relevant information gives investors the tools with which to judge the 
merits of acting on a particular recommendation. As stated in the 
Proposing Release, the Commission believes that broker-dealers should 
provide retail customers information early enough in the process to 
give them adequate time to consider the information and promote the 
investor's understanding in order to make informed investment 
decisions.\534\ Similarly, the Commission believes that broker-dealers 
should not provide information so early that the disclosure fails to 
provide meaningful information (e.g., does not sufficiently identify 
material conflicts presented by a particular recommendation, or 
overwhelms the retail customer with disclosures related to a number of 
potential options that the retail customer may not be qualified to 
pursue).\535\ Nevertheless, in order to provide broker-dealers the 
flexibility to determine how and when to make relevant disclosures 
pursuant to the Disclosure Obligation, we are not mandating a 
requirement that disclosures be made within a certain timeframe 
preceding a recommendation. However, we continue to encourage broker-
dealers to consider whether it would be helpful to repeat or highlight 
disclosures already made pursuant to the Disclosure Obligation at the 
time of the recommendation.
---------------------------------------------------------------------------

    \534\ Proposing Release at 21605.
    \535\ Id.
---------------------------------------------------------------------------

    We are also clarifying the ability of a broker-dealer to 
supplement, clarify, or update information after making a 
recommendation.\536\ In particular, if a broker-dealer determines to 
disclose information, in part, after the recommendation, such as in a 
prospectus or trade confirmation, that disclosure may be used to 
supplement, clarify, or update the initial, general disclosure. For 
example, any necessary

[[Page 33371]]

information in a product offering document, such as information about 
product risks or fees, may be provided in accordance with existing 
disclosure mechanisms that occur after a transaction, such as the 
delivery of a trade confirmation or a prospectus, private placement 
memorandum, or offering circular.\537\ However, the broker-dealer must 
comply with the circumstances outlined in Section II.C.1, Oral 
Disclosure or Disclosure After a Recommendation, in order to make any 
such disclosure after the recommendation.
---------------------------------------------------------------------------

    \536\ See id. In the proposal, we noted that there may be 
material information that the broker-dealer may not be in a position 
to disclose at or prior to the recommendation that may be revealed 
following the transaction, such as the final transaction information 
contained in a trade confirmation.
    \537\ In instances where a recommended transaction is not acted 
upon by the retail customer, and therefore there is no subsequent 
delivery of disclosure otherwise required by the transaction, the 
fact that such information is not provided would not be a violation 
of the Disclosure Obligation.
---------------------------------------------------------------------------

Layered Disclosure
    We proposed to require broker-dealers to provide disclosure prior 
to or at the time of the recommendation but gave guidance on a number 
of approaches they could take to achieve this requirement, including 
providing layered disclosure, in which more general information is 
supplemented by more detailed information provided either at the same 
time or subsequently.\538\ We received a number of comments supporting 
our proposed guidance concerning a layered approach to the Disclosure 
Obligation.\539\ In addition, investor testing illustrates that many 
retail investors support a layered approach as well.\540\
---------------------------------------------------------------------------

    \538\ See Proposing Release at 21605 (suggesting the Disclosure 
Obligation could be satisfied, for example, at multiple points in 
the relationship or through a layered approach to disclosure, such 
as an initial disclosure conveying more general information 
regarding the material fact or conflict followed by more specific 
information in a subsequent disclosure).
    \539\ See, e.g., Commonwealth Letter (supporting a layered 
disclosure approach that includes (i) the Relationship Summary at 
the inception of the relationship; (ii) the traditional disclosures 
included in account-opening agreements; (iii) product-specific 
point-of-sale disclosures (e.g., prospectuses and alternative 
investment offering documents); and (iv) more detailed disclosures 
on the firm's website); IRI Letter (supporting a principles-based 
disclosure regime, which leverages the benefits of layered 
disclosure to combat information overload); Morgan Stanley Letter 
(concurring with the Commission's proposed layered approach to 
disclosure of material facts regarding the scope of the relationship 
with the client and fees, as well as material conflicts of interest 
associated with the recommendation); Stifel Letter; Mass Mutual 
Letter; Triad Advisors Letter; Investacorp Letter; Ladenburg Letter.
    \540\ See, e.g., Study Regarding Financial Literacy Among 
Investors As Required by Section 917 of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act, August 2012 at iv. A key finding 
of the SEC staff's 917 study was that Investors favor ``layered'' 
disclosure and, wherever possible, the use of a summary document 
containing key information about an investment product or service. 
That study described layered disclosure as an ``approach to 
disclosure in which key information is sent or given to the investor 
and more detailed information is provided online and, upon request, 
is sent in paper or by email.'' See Enhanced Disclosure and New 
Prospectus Delivery Option for Registered Open-End Management 
Investment Companies, Securities Act Release No. 8998 (Jan. 13, 
2009). This layered approach is ``intended to provide investors with 
better ability to choose the amount and type of information to 
review, as well as the format in which to review it (online or 
paper).'' Id. Other studies that considered the use of hyperlinks 
for layered disclosure in proposed Form CRS suggested that retail 
investors are generally interested in receiving additional 
information, but recognized the possibility that retail investors 
may not click on a hyperlink. See, e.g., RAND 2018 (finding 58% of 
participants selecting ``very likely'' and another 32% selecting 
``somewhat likely'' to click on a hyperlink relating to fees; 
although no other potential hyperlink generated a majority with 
``very likely'' usage, other potential hyperlinks concerning 
services, conflicts and investor education generated a majority when 
combining responses of ``very likely'' and ``somewhat likely'' to 
click on the hyperlink). See also Kleimann Communication Group, 
Inc., Report on Development and Testing of Model Client Relationship 
Summary, Presented to AARP and Certified Financial Planner Board of 
Standards, Inc. (Dec. 5, 2018), available at https://www.sec.gov/comments/s7-07-18/s70718-4729850-176771.pdf (indicating that while 
some participants were interested in additional information, others 
admitted they would not follow the links because it was extra 
effort, they were uninterested, or the link did not itself suggest 
what would be there).
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    We have considered these comments and results of investor testing 
and will continue to permit broker-dealers to use a layered approach to 
disclosure. We acknowledge that different investors have different 
preferences for the type and length of disclosures they receive, and 
that some investors may not read additional information provided in any 
particularized disclosure that supplements initial, standardized 
disclosure. Nonetheless, we believe that permitting broker-dealers to 
provide their retail customers with a standardized summary of 
information supplemented by more particularized information will help 
avoid the likelihood that retail customers receive a single, 
potentially voluminous disclosure document, and enable the many 
investors who prefer a shorter, summary document to have it available 
to them, with additional information available should they wish to have 
it. This approach to layering information is also consistent with our 
concurrent effort in Form CRS to provide retail investors with high 
level information and context concerning key material facts, 
supplemented by additional layers of information regarding their 
relationship.
    We also continue to believe that broker-dealers should have 
flexibility in determining when to make disclosures and whether, in 
light of their retail customer base, certain material facts would be 
more effectively conveyed in a more general manner in an initial 
written disclosure accompanied or followed by more specific information 
in a separate disclosure. Similarly, we believe that providing broker-
dealers with flexibility to best target their disclosures to their 
particular retail customer base will increase the likelihood that 
investors will view them.
    The Commission is not prescribing specific procedures obligating 
broker-dealers to fulfill the Disclosure Obligation in a particular 
way. Rather, Regulation Best Interest as adopted provides broker-
dealers with flexibility to provide disclosures that are consistent 
with the various ways in which broker-dealers may already provide 
disclosure to their customers.\541\ This could include, for example, 
providing multiple or ``layered'' disclosures either initially or over 
time, but that in total constitute full and fair disclosure of the 
information required by the Disclosure Obligation. While we are not 
setting forth a prescriptive approach regarding exactly when 
disclosures should be made as suggested by some commenters, we believe 
that a broker-dealer may determine that certain disclosures are most 
effective if they are made at multiple points of the relationship, or 
alternatively, certain material facts may be conveyed in a more general 
manner in an initial written disclosure accompanied or followed by more 
specific information.\542\
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    \541\ See Proposing Release at 21605.
    \542\ See id.
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Updating Disclosures
    Several commenters recommend that the Commission clarify under what 
circumstances a broker-dealer would be required to update prior 
disclosures made pursuant to the Disclosure Obligation.\543\ Among the 
suggestions are to only require broker-dealers to update their 
disclosures when there are material changes to the disclosed

[[Page 33372]]

information; \544\ require broker-dealers to update their disclosures 
at least 30 days before raising or imposing new fees; \545\ and require 
broker-dealers to update their disclosures when changes are made, as 
well as annually.\546\
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    \543\ See, e.g., LPL August 2018 Letter (recommending that the 
Commission provide additional guidance with respect to the updating 
and amendment requirements that apply to the Disclosure Obligation); 
CFA Institute Letter (recommending that the Commission require 
broker-dealers to provide updated disclosures at least 30 days 
before raising or imposing new fees); Bank of America Letter 
(recommending that the Commission require firms to update existing 
disclosures when there are changes to material conflicts of 
interest, as well as annually); NAIFA Letter (recommending that the 
Commission not require regular disclosure (e.g., quarterly, annual, 
etc.) of any new information items, unless the information has 
materially changed).
    \544\ See NAIFA Letter.
    \545\ See CFA Institute Letter.
    \546\ See Bank of America Letter.
---------------------------------------------------------------------------

    The Commission has carefully considered the commenters' suggestions 
and is providing guidance on a broker-dealer's duty to update 
disclosures made to customers under Regulation Best Interest. The 
Disclosure Obligation requires broker-dealers to provide their retail 
customers with full and fair disclosure of material facts related to 
several aspects of their relationship with their customers. Therefore, 
a broker-dealer cannot provide customers with full and fair disclosure 
if the disclosures contain materially outdated, incomplete, or 
inaccurate information. Additional disclosure will be necessary when 
any previously provided information becomes materially inaccurate, or 
when there is new relevant material information (e.g., a new material 
conflict of interest has arisen that is not addressed by the 
standardized disclosure).\547\ Therefore, a broker-dealer's duty to 
update disclosures made to its customers under Regulation Best Interest 
is based on the facts and circumstances.
---------------------------------------------------------------------------

    \547\ See Proposing Release at 21605.
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    While we are not prescribing an explicit timeframe in which 
required updates must be made, generally the Commission encourages 
broker-dealers to update their disclosures to reflect material changes 
or inaccuracies as soon as practicable, and thus generally should be no 
later than 30 days after the material change; in the meantime, broker-
dealers are encouraged to provide, supplement, or correct any written 
disclosure with oral disclosure as necessary prior to or at the time of 
the recommendation.\548\ However, if updated information is to be 
provided either orally, or after a recommendation, such disclosure must 
be made under the circumstances outlined in Section II.C.1, Oral 
Disclosure or Disclosure After a Recommendation.
---------------------------------------------------------------------------

    \548\ The 30-day period aligns with other requirements to update 
disclosures in similar contexts. For instance, NASD Notice to 
Members 92-11, Fees and Charges for Services (Feb. 1992) states that 
its member firms need to provide written notification to customers 
of all service charges when accounts are opened, and . . . written 
notification at least 30 days prior to the implementation or change 
of any service charge. Failure to do so could be construed as 
conduct inconsistent with just and equitable principles of trade 
under FINRA Rule 2010 (Standards of Commercial Honor and Principles 
of Trade).
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2. Care Obligation
    We proposed the Care Obligation to require a broker-dealer, when 
making a recommendation of any securities transaction or investment 
strategy involving securities to a retail customer, to exercise 
reasonable diligence, care, skill, and prudence to: (1) Understand the 
potential risks and rewards associated with the recommendation, and 
have a reasonable basis to believe that the recommendation could be in 
the best interest of at least some retail customers; (2) have a 
reasonable basis to believe that the recommendation is in the best 
interest of a particular retail customer based on that retail 
customer's investment profile and the potential risks and rewards 
associated with the recommendation; and (3) have a reasonable basis to 
believe that a series of recommended transactions, even if in the 
retail customer's best interest when viewed in isolation, is not 
excessive and is in the retail customer's best interest when taken 
together in light of the retail customer's investment profile. As we 
indicated in the Proposing Release, the Care Obligation was intended to 
incorporate and enhance existing suitability requirements applicable to 
broker-dealers under the federal securities laws by, among other 
things, imposing a ``best interest'' requirement that will require a 
broker-dealer to not place its own interest ahead of the retail 
customer's interest, when making recommendations.\549\
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    \549\ As discussed in the Fiduciary Interpretation, the duty of 
care of the investment adviser's fiduciary duty includes a duty to 
provide investment advisory services that are in the best interest 
of the client. See Fiduciary Interpretation at footnote 34.
---------------------------------------------------------------------------

    Commenters generally supported the proposed Care Obligation, 
including its principles-based approach, but many commenters requested 
additional guidance or clarification on how a broker-dealer could 
satisfy the Care Obligation under different circumstances and regarding 
specific products.\550\ Relatedly, several commenters requested further 
guidance regarding the role of costs and other relevant factors when 
making a best interest determination,\551\ while other commenters 
expressed concern over the usage of the term ``prudence'' \552\ or 
expressed concern that Regulation Best Interest is not a major change 
from FINRA's suitability rule.\553\ Numerous commenters also requested 
clarification on the meaning and scope of ``reasonably available 
alternatives'' and ``otherwise identical securities,'' including how 
the phrase ``reasonably available alternatives'' would apply in 
situations where a broker-dealer operated in an open architecture 
environment,\554\ or maintained a limited product menu such as where 
broker-dealers limited available offerings to proprietary 
products.\555\ Finally, several commenters recommended the Commission 
include other factors in building a retail customer's investment 
profile, such as longevity risk,\556\ market risk,\557\ or income 
profile.\558\
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    \550\ See, e.g., NASAA August 2018 Letter; Cambridge Letter; 
BlackRock Letter.
    \551\ See, e.g., Wells Fargo Letter; Primerica Letter; CFA 
Institute Letter.
    \552\ See, e.g., BISA Letter; Raymond James Letter; Transamerica 
August 2018 Letter.
    \553\ See, e.g., CFA August 2018 Letter (stating ``[n]owhere 
does the Commission explain how the standard differs from, or even 
whether it improves upon, the existing suitability standard under 
FINRA rules''); AFL-CIO April 2019 Letter (stating ``that the intent 
of [proposed Regulation Best Interest] is to codify, rather than 
enhance, protections investors currently receive under FINRA's 
suitability standard'').
    \554\ For purposes of this requirement, we use the term ``open 
architecture'' to mean a firm's product menu that includes both 
third-party and proprietary products, or as a concept wherein a firm 
offers a large range of products to their retail customers that are 
not limited, for example, to a small list of approved managers or 
funds (i.e., a product menu that is not limited to proprietary 
products or otherwise constrained to certain retail customers or 
registered representatives). See generally FINRA 2013 Conflicts 
Report; Morgan Stanley Letter.
    \555\ See, e.g., Fidelity Letter; ICI Letter; LPL August 2018 
Letter; SIFMA August 2018 Letter; Prudential Letter; Morningstar 
Letter.
    \556\ See, e.g., CCMC Letters; Lincoln Financial Letter; Pacific 
Life August 2018 Letter.
    \557\ See, e.g., Jackson National Letter.
    \558\ See, e.g., Lincoln Financial Letter.
---------------------------------------------------------------------------

    We are adopting the Care Obligation substantially as proposed, but 
with certain modifications and additional guidance to address comments. 
As discussed in more detail below, in response to comments, we are 
revising the Care Obligation to remove the term ``prudence,'' as we 
have concluded that its inclusion creates legal uncertainty and 
confusion, and it is redundant of what we intended in requiring a 
broker-dealer to exercise ``diligence, care, and skill,'' and its 
removal does not change the requirements under the Care Obligation. 
Accordingly, the Care Obligation will require broker-dealers to 
``exercise reasonable diligence, care, and skill'' to meet the three 
components of the Care Obligation.
    In addition, after careful consideration of the comments received, 
we are expressly adding cost to the rule text as a factor that a 
broker-dealer must consider in fulfilling the Care Obligation. While 
certain commenters expressed concerns about the prominence of cost and 
how cost would be balanced against other factors under the Care 
Obligation,\559\ other

[[Page 33373]]

commenters supported incorporating cost into the rule text.\560\ As 
noted in the Relationship Summary Adopting Release, participants in 
investor testing and roundtables also overwhelmingly supported 
including fees in the Relationship Summary, and believed that the 
``fees and costs'' section was the most important for determining which 
type of investment accounts and services are right for that 
person.\561\ We believe that while the factors that a broker-dealer 
should understand and consider when making a recommendation may vary 
depending upon the particular product or strategy recommended, cost--
along with potential risks and rewards--will always be a relevant 
factor that will bear on the return of the security or investment 
strategy involving securities.\562\ This would include, for example, 
both costs associated with the purchase of the security, as well as any 
costs that may apply to the future sale or exchange of the security, 
such as deferred sales charges or liquidation costs. Elevating cost to 
the rule text clarifies that this factor must always be considered when 
making a recommendation. Thus, a broker-dealer, in fulfilling its 
obligation to make a recommendation in the best interest of its retail 
customer, must exercise reasonable diligence, care, and skill to 
understand the ``potential risks, rewards, and costs'' associated with 
the recommendation and have a reasonable basis to believe that the 
recommendation is in the best interest of the retail customer based on 
these factors.
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    \559\ See, e.g., ICI Letter; Putnam Letter; Morgan Stanley 
Letter; Letter from Eric R. Dinallo, Executive Vice President, 
General Counsel, Guardian Life (Aug. 7, 2018) (``Guardian August 
2018 Letter'') (cautioning against inclusion of ``costs'' into rule 
text or overemphasizing its importance).
    \560\ See, e.g., AFL-CIO April 2019 Letter (stating ``If, as has 
been suggested, one goal is to ensure that brokers give greater 
consideration to costs in determining what investments to recommend, 
[Regulation Best Interest] should incorporate an explicit 
requirement to consider costs in the rule text.''); NASAA August 
2018 Letter; U. of Miami Letter (supporting addition of ``costs'' 
into rule text). See also CFA August 2018 Letter (supporting the 
Commission's emphasis of cost and associated financial incentives as 
more important factors, and stating ``[t]his requirement would be 
clearer, however, if it were incorporated into the rule text, which 
requires the broker to consider the `potential risks and rewards 
associated with the recommendation,' rather than the material 
characteristics, including costs, of the recommended investment or 
investment strategy.'').
    \561\ See Relationship Summary Adopting Release.
    \562\ See Vanguard Letter (``We agree that costs and 
remuneration should play a central role in meeting the revise best 
interest standards. Cost is a critical factor because of its 
compounding effect upon performance.'').
---------------------------------------------------------------------------

    Importantly, however, while cost, like potential risks and rewards, 
is always a factor that a broker-dealer must consider in making a 
recommendation, it is not a dispositive factor and its inclusion in the 
rule text is not meant to limit or foreclose the recommendation of a 
more costly or complex product that a broker-dealer has a reasonable 
basis to believe is in the best interest of a particular retail 
customer.\563\ Moreover, we are reiterating that the standard does not 
necessarily require the lowest cost option, and that while cost is an 
important factor that always needs to be taken into consideration in 
making a recommendation, it is not the only one.\564\ Rather, as 
explained more fully below, the evaluation of cost would be more 
analogous to a broker-dealer's best execution analysis, which does not 
require the lowest possible cost, but rather looks at whether the 
transaction represents the best qualitative execution for the customer 
using cost as one factor.\565\
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    \563\ See Proposing Release at 21587-21589; 21610-21612.
    \564\ See Proposing Release at 21610.
    \565\ Under the antifraud provisions of the federal securities 
laws and SRO rules, broker-dealers have a legal duty to seek to 
obtain best execution of customer orders. See Regulation NMS, 
Exchange Act Release No. 51808 (Jun. 9, 2005) (``Regulation NMS 
Release''); FINRA Rule 5310 (Best Execution and Interpositioning). A 
broker-dealer's duty of best execution requires a broker-dealer to 
seek to execute customers' trades at the most favorable terms 
reasonably available under the circumstances. See Regulation NMS 
Release at 160; see also Proposing Release at 21615. Certain 
commenters pointed to best execution analysis as an example of a 
rule or guidance that is facts-and-circumstances-based. See, e.g., 
CFA August 2018 Letter (``Just as compliance with the best execution 
standard will not always be met by sending trades to the exchange 
where the lowest cost is displayed, compliance with a best interest 
standard will not always be satisfied by recommending the lowest 
cost option.'').
---------------------------------------------------------------------------

    Several commenters expressed concern over the emphasis of ``cost'' 
and suggested that, for example, more emphasis be placed on additional 
or subjective factors beyond specific product attributes.\566\ Those 
commenters stated that the emphasis on cost may discourage certain 
products or investment strategies. Our intent is not to discourage or 
otherwise limit the recommendation of products or investment strategies 
where a broker-dealer concludes that the recommendation is in the best 
interest of the retail customer. Instead, we believe that cost will 
always be relevant to a recommendation and accordingly should be a 
required consideration as set forth in the rule text. It should never 
be the only consideration. Additional factors such as those cited by 
commenters also should be taken into consideration as the broker-dealer 
formulates a recommendation consistent with the best-interest 
standard.\567\
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    \566\ See, e.g., ICI Letter; BlackRock Letter; Putnam Letter; 
Transamerica August 2018 Letter; Northwestern Mutual Letter; see 
also Vanguard Letter (recognizing the importance of cost, but urging 
the Commission to maintain a principles-based approach recognizing 
the importance of ``holistic advice that necessarily contemplates 
factors beyond cost.'').
    \567\ See, e.g., BlackRock Letter (citing consideration of 
investors' needs and desired outcomes relative to service offerings 
of several different managers); Vanguard Letter (``considerations 
include important factors such as product structure, investment 
features, liquidity, volatility, issuer reputation, brand and 
business practices (securities lending activities, portfolio 
tracking error, or usage of derivatives in a portfolio)''); ICI 
Letter (citing several subjective factors, such as the ``nature and 
quality of a provider's services (including advantages to the 
investor of consolidating investments as a single firm, such as 
higher levels of service that may be offered), minimum initial 
investments, and firm reputation''); FIBA February 2019 Letter 
(citing ``highly personalized non-economic reasons underlying cross-
border investment'').
---------------------------------------------------------------------------

    Though we are declining to expressly define ``best interest'' in 
the rule text, as discussed above,\568\ we are providing guidance 
regarding the application of the Care Obligation and in particular what 
it means to make a recommendation in the retail customer's ``best 
interest.'' In addition, to emphasize the importance of determining 
that each recommendation is in the best interest of the retail customer 
and that it does not place the broker-dealer's interests ahead of the 
retail customer's interests, we are expressly incorporating into the 
rule text of Paragraph (a)(2)(ii)(B) and Paragraph (a)(2)(ii)(C) of 
Regulation Best Interest that a broker-dealer must have a reasonable 
basis to believe that the recommendation ``does not place the financial 
or other interest of the [broker-dealer] . . . ahead of the interest of 
the retail customer.'' While we acknowledge that a broker-dealer and an 
associated person can and will have some financial interest in a 
recommendation, as noted above, this addition to the Care Obligation 
makes clear these interests cannot be placed ahead of the retail 
customer's interests when making a recommendation.\569\
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    \568\ See Section II.A.2.
    \569\ See id. See also AFL-CIO April 2019 Letter (noting 
``Adopting a standard that explicitly states that brokers are 
prohibited form placing their own interests ahead of the retail 
customer's interests reinforces [investors' reasonable expectations 
that the financial professionals they rely on for investment advice 
will put their interests first]'' and asserting that ``a requirement 
to place the customer's interests ahead of the brokers' interests 
must be included in the operational provisions of Reg BI. . . .'').
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    Finally, we believe that by explicitly requiring in the rule text 
that the broker-dealer have a reasonable basis to believe that a 
recommendation is both in the retail customer's ``best interest'' and

[[Page 33374]]

does ``not place the financial or other interest'' of the broker-dealer 
ahead of the retail customer's interests, we are enhancing the Care 
Obligation by imposing obligations beyond existing suitability 
obligations. Under existing suitability requirements, a broker-dealer 
is required to make recommendations that are ``suitable'' for the 
customer. While certain cases and guidance have interpreted FINRA's 
suitability rule to require that ``a broker's recommendations must be 
consistent with his customers' best interests,'' and FINRA has further 
interpreted the requirement to be ``consistent with the customer's best 
interest'' to prohibit a broker-dealer from placing his or her 
interests ahead of the customer's interests, this obligation is not 
explicitly required by FINRA's rule (or its supplementary material), 
nor does the interpretation require recommendations to be in the best 
interest (as opposed to ``consistent with the best interest'') of a 
retail customer.\570\ We believe that requiring recommendations to be 
in the best interest is declarative of what must be done, and therefore 
stronger than, requiring recommendations to be ``consistent with'' the 
best interest of the retail customer, which we believe at a minimum 
creates ambiguity as to whether the recommendation must be in the 
retail customer's best interest or something less.\571\
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    \570\ See FINRA Regulatory Notice 12-25 at Q1. See also FINRA 
Letter to Senators Warren, Brown, and Booker (Aug. 3, 2018) (``FINRA 
2018 Letter'') (stating that ``[w]hile FINRA's suitability rule 
implicitly requires a broker-dealer's recommendations to be 
consistent with customer's best interests, the SEC's proposed best 
interest standard explicitly establishes the customer's best 
interest as an overarching standard of care for broker-dealers.'' 
(internal citations omitted)). Some commenters have also made this 
point. See, e.g., CFA August 2018 Letter (``In enforcing that 
standard, however, FINRA has only rarely and very narrowly enforced 
the obligation to do what is best for the customer--typically in 
cases that involve recommending the most appropriate share class of 
a particular mutual fund. . . . Indeed, as we detailed in our July 
2015 comment letter to the Department of Labor, most of the cases in 
which FINRA and the Commission have asserted an obligation for 
brokers to act in customers' best interest have involved egregious 
frauds rather than questions of whether customers' best interests 
were being served.'').
    \571\ See, e.g., CFA August 2018 Letter.
---------------------------------------------------------------------------

    The Care Obligation significantly enhances the investor protection 
provided as compared to current suitability obligations by: (1) 
Explicitly requiring in Regulation Best Interest that recommendations 
be in the best interest of the retail customer and do not place the 
broker-dealer's interests ahead of the retail customer's interests; (2) 
explicitly requiring by rule the consideration of costs when making a 
recommendation; and (3) applying the obligations relating to a series 
of recommended transactions (currently referred to as ``quantitative 
suitability'') irrespective of whether a broker-dealer exercises actual 
or de facto control over a customer's account.\572\ In addition, it is 
our view that a broker-dealer should consider ``reasonably available 
alternatives'' as part of having a ``reasonable basis to believe'' that 
the recommendation is in the best interest of the retail customer, 
which we also believe is an enhancement beyond existing suitability 
expectations.\573\
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    \572\ See FINRA 2018 Letter (noting that proposed Regulation 
Best Interest augments and enhances current requirements by, among 
other things: ``explicitly impos[ing] a `best interest' standard, 
making clear that a broker-dealer cannot put its interests ahead of 
the interests of its customers. While FINRA's suitability rule 
implicitly requires a broker-dealer's recommendations to be 
consistent with customers' best interests, the SEC's proposed best 
interest standard explicitly establishes the customer's best 
interest as an overarching standard of care for broker-dealers;'' 
``explicitly requir[ing] broker-dealers to consider `reasonably 
available alternatives' to a recommended security and justify any 
choice of a more costly product. . . . Although case law and FINRA 
guidance establish cost and available alternatives as factors to 
consider as part of a FINRA suitability assessment, particularly 
regarding mutual fund share classes, proposed Reg Bl expressly 
establishes the significance of these factors''; and ``remov[ing] 
the `control' element for purposes of quantitative suitability, 
which would make this obligation more enforceable.'') (internal 
citations omitted).
    \573\ See infra Section II.C.2.c, Application of the Care 
Obligation--Reasonably Available Alternatives and Otherwise 
Identical Securities.
---------------------------------------------------------------------------

a. Exercise Reasonable Diligence, Care, and Skill
    A broker-dealer is required to ``exercise reasonable diligence, 
care, and skill'' to satisfy the three components of the Care 
Obligation set forth in Regulation Best Interest. In the Proposing 
Release, we included ``prudence,'' and explained that ``prudence'' 
``conveys the fundamental importance of conducting a proper evaluation 
of any securities or investment strategy recommendation in accordance 
with an objective standard of care.'' \574\ Further, we solicited 
comment on all aspects of the Care Obligation, and also asked 
specifically whether there was adequate clarity and understanding 
regarding the term ``prudence,'' or whether other terms were more 
appropriate in the context of broker-dealer regulation.
---------------------------------------------------------------------------

    \574\ Proposing Release at 21609.
---------------------------------------------------------------------------

    Several commenters supported adopting a principles-based 
obligation, thus requiring the broker-dealer to assess the adequacy of 
a recommendation based on the facts and circumstances of each 
recommendation.\575\ We also received numerous comments asking for 
further guidance relating to recommendations of specific securities or 
asking how the Care Obligation applies to certain factual 
scenarios.\576\ With respect to the term ``prudence,'' a number of 
comments requested removal of the term, stating that such language is 
unnecessary given the other requirements to satisfy the Care 
Obligation, as well as the fact that the term introduces legal 
confusion and uncertainty.\577\ Other commenters supported the use of 
the term ``prudence'' because they believed that Regulation Best 
Interest's component obligations generally rested on a ``prudence'' 
standard or maintained that the Care Obligation ``echoes elements found 
in the common law `prudent person rule,' '' and thus thought its 
addition was appropriate to capture, or describe, these 
obligations.\578\
---------------------------------------------------------------------------

    \575\ See, e.g., SIFMA August 2018 Letter; Vanguard Letter; 
Morningstar Letter; Edward Jones Letter.
    \576\ See, e.g., SIFMA August 2018 Letter; Direxion Letter; 
Chapman Letter.
    \577\ See, e.g., Primerica Letter (stating ``. . . . the term 
[prudence] raises numerous interpretative issues and compliance 
risks. Regulatory and judicial interpretations of ERISA `prudence' 
and its requirements abound, but these are exclusive to employee 
benefit plan duties and do not address duties with respect to retail 
accounts for individual customers.''); Transamerica August 2018 
Letter (``The term `prudence' is one used primarily in the ERISA 
context and is not generally used in the federal securities laws. We 
believe inclusion of the term `prudence' in describing the care 
obligation is unnecessary and could lead to confusion in 
interpretation of the care obligation set forth in the Proposal''); 
IPA Letter (`` `Prudence' is an ERISA term based on trust law that 
is not generally used under the federal securities laws''). See also 
Fein Letter (discussing that the ``duties of loyalty and care are 
the core fiduciary standards that apply across all fiduciary fields, 
including trust law, agency law, and employee benefits law;'' that 
``[b]oth of these duties are reflected in the existing regulation of 
broker-dealers and investment advisers when they give investment 
advice to retail customers;'' and that the ``duty of care--also 
called `prudence'--requires a fiduciary to act with care, skill and 
diligence in fulfilling his designated functions.'') (internal 
citations omitted).
    \578\ See LPL August 2018 Letter (``We believe that each of the 
four component obligations identified in Regulation BI generally 
rests on a `prudence' standard that is the foundation of the common 
law principles and the Federal law that have governed the activities 
of financial services providers for decades. The obligation to 
provide prudent recommendations that are appropriate for an 
investor's circumstances is a principal component of the suitability 
obligations that apply to investment advisers under the [Advisers 
Act]'' (internal citations omitted); FPC Letter (stating that ``the 
duty of care, as described by both Reg BI and CFP Board Standards, 
echoes elements found in the common law `prudent person rule' which 
can serve to measure the reasonableness of a prudent professional's 
actions. . . .''); see also CFA August 2018 Letter; NAIFA Letter.
---------------------------------------------------------------------------

    After careful consideration of comments, we are revising the Care 
Obligation to remove the term

[[Page 33375]]

``prudence.'' Accordingly, the Care Obligation will require broker-
dealers to ``exercise reasonable diligence, care, and skill'' to meet 
the three components of the Care Obligation. We are persuaded by 
commenters that its inclusion in the proposed rule text to satisfy the 
components of the Care Obligation is superfluous and unnecessarily 
presents the possibility for confusion and legal uncertainty.\579\ We 
believe requiring broker-dealers ``to exercise reasonable diligence, 
care, and skill'' conveys ``the fundamental importance of conducting a 
proper evaluation of any securities recommendation in accordance with 
an objective standard of care'' \580\ that was intended by the 
inclusion of ``prudence.'' Removing ``prudence'' does not lessen nor 
otherwise change the requirements or our expectations under the Care 
Obligation, or Regulation Best Interest more broadly as it was 
duplicative of the phrase ``diligence, care, and skill.'' \581\ The 
revised obligation, in requiring the broker-dealer to ``exercise[ ] 
reasonable diligence, care and skill'' and to have a ``reasonable basis 
to believe that the recommendation is in the best interest . . . and 
does not place'' the interest of the broker-dealer ahead of the 
interest of the retail customer, will continue to require an analysis 
that is comparable to the notion of ``prudence'' as described in other 
regulatory frameworks,\582\ but does so using the terms ``diligence, 
skill, and care''--terminology with which broker-dealers are familiar 
and that is well understood under the federal securities laws.\583\ As 
such, we believe that the revised language will minimize the potential 
confusion and legal uncertainty created by using a term that is 
predominantly interpreted in other legal regimes,\584\ and will aid 
broker-dealers in achieving compliance with Regulation Best Interest as 
well as permit broker-dealers to utilize existing compliance and 
supervisory systems that already rely on this language.
---------------------------------------------------------------------------

    \579\ See supra footnote 577.
    \580\ Proposing Release at 21609.
    \581\ See, e.g., LPL August 2018 Letter (noting that the 
component obligations of Regulation Best Interest generally rest on 
``prudence'' concepts); Fein Letter.
    \582\ See Fein Letter (stating that the ``duty of care--also 
called `prudence'--requires a fiduciary to act with care, skill and 
diligence in fulfilling his designated functions'') (citing 
Restatement 3d of Agency, Sec.  8.08 Duties of Care, Competence, and 
Diligence (``[s]ubject to any agreement with the principal, an agent 
has a duty to the principal to act with care, competence, and 
diligence normally exercised by agents in similar circumstances. . . 
.'')). The DOL interpreted ``prudence'' to represent ``an objective 
standard of care that requires investment advice fiduciaries to 
investigate and evaluate investments, make recommendations, and 
exercise sound judgment in the same way that knowledgeable and 
impartial professionals would.'' BIC Exemption Release, 81 FR 21208 
at 21028-21029.
    \583\ See, e.g., Proposing Release at 21595, 21609-21613. The 
discussion that follows addresses what it means to ``exercise 
reasonable diligence, care, and skill'' in the context of each 
aspect of the Care Obligation.
    \584\ See supra footnote 577.
---------------------------------------------------------------------------

    Moreover, we note that certain commenters' support for the term 
``prudence'' was based on our interpretation of the Care Obligation in 
the Proposing Release.\585\ As noted above, the removal of the term 
``prudence'' does not change the obligations or our interpretation of 
the Care Obligation, which we believe are addressed by the ``diligence, 
care, and skill'' language and through Regulation Best Interest more 
broadly. In light of concerns regarding legal uncertainty associated 
with the term ``prudence,'' and our view that its inclusion or removal 
would not change the requirements or expectations of Regulation Best 
Interest, we have determined to remove it from the rule text.
---------------------------------------------------------------------------

    \585\ See, e.g., NAIFA Letter.
---------------------------------------------------------------------------

    Finally, in response to comments, we are retaining the facts-and-
circumstances determination for the reasons set forth in the Proposing 
Release,\586\ and providing additional guidance on the application of 
the components of the Care Obligation with respect to certain 
securities and under certain scenarios. As we noted in the Proposing 
Release, such an approach is consistent with how broker-dealers are 
currently regulated with respect to the suitability of their 
recommendations and would allow broker-dealers to utilize and 
incorporate pre-existing compliance systems. In addition, this approach 
is generally consistent with the principles-based approach applicable 
to the duty of care of investment advisers.\587\
---------------------------------------------------------------------------

    \586\ Proposing Release at 21587 (``[W]e preliminarily believe 
that whether a broker-dealer acted in the best interest of the 
retail customer when making a recommendation will turn on the facts 
and circumstances of the particular recommendation and the 
particular retail customer, along with the facts and circumstances 
of how the four specific components of Regulation Best Interest are 
satisfied.'').
    \587\ See Fiduciary Interpretation.
---------------------------------------------------------------------------

b. Understand Potential Risks, Rewards, and Costs Associated With 
Recommendation, and Have a Reasonable Basis To Believe That the 
Recommendation Could Be in the Best Interest of at Least Some Retail 
Customers
    Under the proposed ``reasonable basis'' component of the Care 
Obligation, broker-dealers would be required to understand the 
potential risks and rewards of the recommendation and have a reasonable 
basis to believe that the recommendation could be in the best interest 
of at least some retail customers. Although potential costs were not 
specifically included in the proposed rule text as a factor to be 
considered as part of a recommendation, the Proposing Release 
identified potential costs associated with a recommendation as an 
important factor to understand and consider as part of making a 
recommendation, and likewise as a key factor to consider when 
evaluating whether or not a broker-dealer had a reasonable basis to 
believe it was acting in the best interest of the retail customer when 
making the recommendation.\588\
---------------------------------------------------------------------------

    \588\ See Proposing Release at 21609-21612. See also supra 
footnote 572.
---------------------------------------------------------------------------

    After careful consideration of comments, the Commission is 
adopting, for the reasons set forth in the Proposing Release, Paragraph 
(a)(2)(ii)(A) of the Care Obligation substantially as proposed. 
However, as discussed above, in addition to requiring broker-dealers to 
understand the potential risks and rewards associated with the 
recommendation, we are also expressly requiring them to understand and 
consider the potential costs associated with a recommendation. 
Elevating costs to the rule text is consistent with a number of 
commenters' recommendations and, importantly, stresses that cost will 
always be a salient factor to be considered when making a 
recommendation.\589\ Additionally, this requirement that the broker-
dealer understands and considers costs is a distinct enhancement over 
existing reasonable basis suitability obligations, which do not 
expressly require this consideration.\590\ Nevertheless, we recognize--
and emphasize--that cost is one important factor among many factors, 
and thus provide additional guidance below regarding the importance of 
weighing and considering costs in light of other relevant factors and 
the retail customer's investment profile.
---------------------------------------------------------------------------

    \589\ See, e.g., AFL-CIO April 2019 Letter; NASAA August 2018 
Letter; U. of Miami Letter.
    \590\ See supra footnote 572.
---------------------------------------------------------------------------

    Paragraph (a)(2)(ii)(A) of Regulation Best Interest is intended to 
incorporate and build upon broker-dealer's existing ``reasonable-basis 
suitability'' obligations and would relate to the broker-dealer's 
understanding of the particular security or investment strategy 
recommended, rather than to any particular retail customer. Without 
establishing such a threshold understanding of its particular

[[Page 33376]]

recommended security or investment strategy involving securities, we do 
not believe that a broker-dealer could, as required by Regulation Best 
Interest, have a reasonable basis to believe that it is acting in the 
best interest of a retail customer when making a recommendation.\591\
---------------------------------------------------------------------------

    \591\ See Proposing Release at 21609-21610 (for further 
discussion regarding this requirement).
---------------------------------------------------------------------------

    In order to meet the requirement under Paragraph (a)(2)(ii)(A), a 
broker-dealer would need to undertake reasonable diligence, care, and 
skill to understand the nature of the recommended security or 
investment strategy involving a security or securities, as well as the 
potential risks, rewards--and now costs--of the recommended security or 
investment strategy, and have a reasonable basis to believe that the 
recommendation could be in the best interest of at least some retail 
customers based on that understanding. A broker-dealer must adhere to 
both components of Paragraph (a)(2)(ii)(A). For example, a broker-
dealer could violate the obligation by not understanding the potential 
risks, rewards, or costs of the recommended security or investment 
strategy, even if the security or investment strategy could have been 
in the best interest of at least some retail customers. Conversely, 
even if a broker-dealer understands the recommended security or 
investment strategy, the broker-dealer must still have a reasonable 
basis to believe that the security or investment strategy could be in 
the best interest of at least some retail customers.
    What would constitute reasonable diligence, care, and skill under 
Paragraph (a)(2)(ii)(A) will vary depending on, among other things, the 
complexity of and risks associated with the recommended security or 
investment strategy and the broker-dealer's familiarity with the 
recommended security or investment strategy.\592\ While every inquiry 
will be specific to the particular broker-dealer and the recommended 
security or investment strategy, broker-dealers generally should 
consider important factors such as the security's or investment 
strategy's investment objectives, characteristics (including any 
special or unusual features), liquidity, volatility, and likely 
performance in a variety of market and economic conditions; the 
expected return of the security or investment strategy; as well as any 
financial incentives to recommend the security or investment strategy. 
Together, this inquiry should allow the broker-dealer to develop a 
sufficient understanding of the security or investment strategy and to 
be able to reasonably believe that it could be in the best interest of 
at least some retail customers.
---------------------------------------------------------------------------

    \592\ See FINRA Rule 2111.05(a).
---------------------------------------------------------------------------

    This ``reasonable-basis'' component of the Care Obligation is 
especially important when broker-dealers recommend securities and 
investment strategies that are complex or risky.\593\ For example, in 
recent years, the Commission staff and FINRA have addressed broker-
dealer sales practice obligations under existing law relating to 
complex products, such as inverse or leveraged exchange-traded 
products.\594\ These products, which may be useful for some 
sophisticated trading strategies, are highly complex financial 
instruments and are typically designed to achieve their stated 
objectives on a daily basis.\595\ However, because of the effects of 
compounding, the performance of these products over longer periods of 
time can differ significantly from their stated daily objectives. Thus, 
broker-dealers recommending such products should understand that 
inverse and leveraged exchange-traded products that are reset daily may 
not be suitable for, and as a consequence also not in the best interest 
of, retail customers who plan to hold them for longer than one trading 
session, particularly in volatile markets.\596\ Without understanding 
the terms, features, and risks of inverse and leveraged exchange-traded 
products--as with the potential risks, rewards, and costs of any 
security or investment strategy--a broker-dealer could not establish a 
reasonable basis to recommend these products to retail customers.\597\ 
Further, these products may not be in the best interest of a retail 
customer absent an identified, short-term, customer-specific trading 
objective. Similarly, when a broker-dealer recommends a potentially 
high risk product to a retail customer--such as penny stocks or other 
thinly-traded securities--the broker-dealer should generally apply 
heightened scrutiny to whether such investments are in a retail 
customer's best interest.\598\
---------------------------------------------------------------------------

    \593\ See FINRA Rule 2111 (Suitability) FAQ at Q5.1 (``The 
reasonable-basis obligation is critically important because, in 
recent years, securities and investment strategies that brokers 
recommend to customers, including retail investors, have become 
increasingly complex and, in some cases, risky.). See also SEC v. 
Hallas, No. 17-cv-02999 (S.D.N.Y. filed Apr. 25, 2017).
    \594\ See FINRA Regulatory Notice 09-31, Non-Traditional ETFs--
FINRA Reminds Firms of Sales Practice Obligations Relating to 
Leveraged and Inverse Exchange-Traded Funds (June 2009); SEC staff 
and FINRA, Investor Alert, Leveraged and Inverse ETFs: Specialized 
Products with Extra Risks for Buy-and-Hold Investors (Aug. 1, 2009); 
SEC Office of Investor Education and Advocacy, Investor Bulletin: 
Exchange-Traded Funds (ETFs) (Aug. 2012).
    \595\ See id. See also Exchange-Traded Funds, Securities Act 
Release No. 10515 (Jun. 28, 2018); Use of Derivatives by Registered 
Investment Companies and Business Development Companies, Investment 
Company Act Release No. 31933 (Dec. 11, 2015) [80 FR 80883 (Dec. 28, 
2015)] (``Derivatives Proposing Release''); Direxion Letter 
(recognizing that leveraged ETFs are not appropriate for all 
customers, and thus the importance for broker-dealers to perform 
sufficient diligence to adequately ``understand the terms and 
features of such funds, including how they are designed to perform, 
how they achieve that objective, and the impact that market 
volatility, the ETF's use of leverage, and the customer's intended 
holding period will have on their performance'').
    \596\ See supra footnotes 593-595.
    \597\ See id.
    \598\ See, e.g., FINRA Regulatory Notice 17-32, Volatility-
Linked Exchange Traded Products--FINRA Reminds Firms of Sales 
Practice Obligations for Volatility-Linked Exchange-Traded Products 
(Oct. 2017) (explaining that ``The level of reasonable diligence 
that is required will rise with the complexity and risks associated 
with the security or strategy. With regard to a complex product such 
as a volatility-linked ETP, an associated person should be capable 
of explaining, at a minimum, the product's main features and 
associated risks.''); FINRA Regulatory Notice 12-03, Complex 
Products--Heightened Supervision of Complex Products (Jan. 2012) 
(stating that ``Reasonable diligence must provide the firm or 
registered representative `with an understanding of the potential 
risks and rewards associated with the recommended security or 
strategy.' This understanding should be informed by an analysis of 
likely product performance in a wide range of normal and extreme 
market actions. The lack of such an understanding when making the 
recommendation could violate the suitability rule.'') (internal 
citations omitted).
---------------------------------------------------------------------------

    Finally, several commenters expressed concern about the 
applicability of Regulation Best Interest to variable annuities and 
variable life insurance products.\599\ Variable annuities and variable 
life insurance products have generated special attention from 
regulators and their staff, such as statements regarding sales practice 
obligations and specific FINRA rules relating to the recommendation of 
variable annuities.\600\ These variable insurance products are often 
unique and have different features depending on the company providing 
the product, as well as depending on the chosen investment options, 
benefits, fees and expenses, liquidity restrictions, and other 
considerations.\601\ Consistent with

[[Page 33377]]

existing FINRA rules and existing suitability obligations under the 
federal securities laws and SRO rules, regulators and their staffs have 
stated that recommendations of these products would require careful 
attention and a specific understanding of certain factors, such as 
whether the product provides tax-deferred growth, or a death or living 
benefit, before a broker-dealer could establish an understanding of the 
product, and apply that understanding to a retail customer's investment 
profile in making a recommendation.
---------------------------------------------------------------------------

    \599\ See related discussion in Section II.C.2.c, Retail 
Customer Investment Profile.
    \600\ See, e.g., FINRA Rule 2330, Members Responsibilities 
Regarding Deferred Variable Annuities; FINRA Rule 2320, Variable 
Contracts of Insurance Companies; FINRA Regulatory Notice 10-05, 
Deferred Variable Annuities--FINRA Reminds Firms of Their 
Responsibilities Under FINRA Rule 2330 for Recommended Purchases or 
Exchange of Deferred Variable Annuities (Jan. 2010); SEC Updated 
Investor Bulletin: Variable Annuities (Oct. 30, 2018); SEC Investor 
Bulletin: Variable Life Insurance (Oct. 30, 2018).
    \601\ See id. See also Updated Disclosure Requirements and 
Summary Prospectus for Variable Annuity and Variable Life Insurance 
Contracts, Investment Advisers Act Release No. 10569 (Oct. 30, 2018) 
[83 FR 61730 (Nov. 30, 2018)] (``VA Summary Prospectus Proposal'').
---------------------------------------------------------------------------

    While we stress the importance of understanding the potential 
risks, rewards, and costs associated with a recommended security or 
investment strategy, as well as other factors depending on the facts 
and circumstances of each recommendation, we do not intend to limit or 
foreclose broker-dealers from recommending complex or more costly 
products or investment strategies where the broker-dealer has a 
reasonable basis to believe that a recommendation could be in the best 
interest of at least some retail customers and the broker-dealer has 
developed a proper understanding of the recommended product or 
investment strategy. As discussed below, once a broker-dealer develops 
an appropriate understanding of a securities product or investment 
strategy, including its potential costs, and believes it could be in 
the best interest of at least some retail customers, the broker-dealer 
will then need to apply that understanding to reasonably determine that 
the recommended product or investment strategy is in the particular 
retail customer's best interest at the time of the recommendation.
c. Have a Reasonable Basis To Believe the Recommendation Is in the Best 
Interest of a Particular Retail Customer Based on That Retail 
Customer's Investment Profile and the Potential Risks, Rewards, and 
Costs Associated With the Recommendation and Does Not Place the 
Interest of the Broker-Dealer Ahead of the Interest of the Retail 
Customer
    In the Proposing Release, we stated that beyond establishing an 
understanding of the recommended securities transaction or investment 
strategy, in order to act in the best interest of the retail customer, 
a broker-dealer would be required to have a reasonable basis to believe 
that a specific recommendation is in the best interest of the 
particular retail customer based on its understanding of the investment 
or investment strategy under Paragraph (a)(2)(ii)(A), and in light of 
the retail customer's investment objectives, financial situation, and 
needs. Accordingly, under proposed paragraph (a)(2)(ii)(A), the second 
sub-component of the Care Obligation would require a broker-dealer to 
``exercise reasonable diligence, care, skill, and prudence to . . . 
have a reasonable basis to believe that the recommendation is in the 
best interest of a particular retail customer based on that retail 
customer's investment profile and the potential risks and rewards 
associated with the recommendation.'' In the Proposing Release, the 
Commission further articulated that under this standard, a broker-
dealer could not have a reasonable basis to believe that the 
recommendation is in the ``best interest'' of the retail customer, if 
the broker-dealer put its interest ahead of the retail customer's 
interest. This was intended to incorporate a broker-dealer's existing 
well-established obligations under ``customer-specific suitability,'' 
but also to enhance these obligations by requiring that the broker-
dealer have a reasonable basis to believe that the recommendation is in 
the ``best interest'' of (rather than ``suitable for'') the retail 
customer.
    Commenters largely supported the Commission's proposed approach, 
but several commenters requested clarifying guidance regarding the 
importance of costs and other specific factors in a ``best interest'' 
evaluation, as well as more broadly how ``best interest'' was to be 
determined.\602\ For example, several commenters requested additional 
guidance on the role of costs and other ``relevant factors,'' including 
subjective and qualitative factors such as shareholder support 
services, redemption procedures, or qualifications of the investment 
adviser.\603\ Similarly, several commenters asked for clarification 
that ``best interest'' does not necessarily mean the lowest cost option 
or require the broker-dealer to look at every single possible 
security.\604\ Commenters also requested further direction regarding 
guidance in the Proposing Release related to the consideration of 
``reasonably available alternatives'' and ``otherwise identical 
securities,'' and requested certain modifications to the definition of 
``Retail Customer Investment Profile.'' \605\
---------------------------------------------------------------------------

    \602\ See, e.g., Wells Fargo Letter; Primerica Letter; Great-
West Letter; NASAA August 2018 Letter; Cambridge Letter; BlackRock 
Letter.
    \603\ See Chapman Letter; BlackRock Letter; Vanguard Letter; ICI 
Letter; Morgan Stanley Letter.
    \604\ See Great-West Letter; SIFMA August 2018 Letter.
    \605\ See, e.g., Committee of Annuity Insurers Letter; Guardian 
August 2018 Letter; IPA Letter; Morgan Stanley Letter; Invesco 
Letter; CFA August 2018 Letter.
---------------------------------------------------------------------------

    After careful consideration of these comments, for the reasons set 
forth in the Proposing Release, the Commission is adopting the 
``customer specific'' component of the Care Obligation substantially as 
set forth in the Proposing Release. However, as included under the 
reasonable basis component of the Care Obligation and for the reasons 
discussed above, the Commission is expressly incorporating ``costs'' 
into the rule text to emphasize that broker-dealers must consider the 
potential costs associated with a recommendation to a particular retail 
customer.
    As noted above, the Commission is also incorporating into the rule 
text that broker-dealers must have a reasonable basis to believe that 
the recommendation ``does not place the financial or other interest of 
the broker-dealer ahead of the interest of the retail customer.'' \606\ 
This addition is intended to make clear that while a broker-dealer 
typically will have some interest in a recommendation, the broker-
dealer cannot put that interest ahead of the retail customer's interest 
when making the recommendation.
---------------------------------------------------------------------------

    \606\ See related discussion in Section II.A.2; see also 
Fiduciary Interpretation.
---------------------------------------------------------------------------

    To address feedback from commenters, the Commission is also 
providing further interpretations and guidance regarding the 
application of the Care Obligation, and in particular, what it means to 
make a recommendation in a retail customer's best interest and not 
place the broker-dealer's interest ahead of the retail customer's 
interest. Specifically, recognizing that a facts and circumstances 
evaluation of a recommendation makes it difficult to draw bright lines 
around whether a particular recommendation would meet the Care 
Obligation, the Commission is providing further interpretations and 
guidance on how a broker-dealer could have a ``reasonable basis to 
believe'' that a recommendation is in the best interest of its retail 
customer and does not place the broker-dealer's interest ahead of the 
retail customer's interest, as well as circumstances when we believe 
that a broker-dealer could not have such a reasonable belief.

[[Page 33378]]

Factors To Consider Regarding a Recommendation to a Particular Retail 
Customer and Relevance of Cost
    Consistent with paragraph (a)(2)(ii)(A) of the Care Obligation, we 
are incorporating ``costs'' in the rule text of paragraph (a)(2)(ii)(B) 
of Regulation Best Interest as a relevant factor that, in addition to 
risks and rewards, must always be understood and considered by the 
broker-dealer prior to recommending a particular securities transaction 
or investment strategy involving securities to a particular retail 
customer. As discussed above, under paragraph (a)(2)(ii)(A) of the Care 
Obligation, a broker-dealer will be required to exercise reasonable 
diligence, care, and skill to understand the potential risks, rewards, 
and costs of a recommended security or investment strategy and have a 
reasonable basis to believe that it could be in the best interest of at 
least some retail customers.\607\ Paragraph (a)(2)(ii)(B) of the Care 
Obligation builds on this obligation and will require a broker-dealer 
to have a reasonable basis to believe, based on its understanding of 
the potential risks, rewards, and costs of the recommendation, and in 
light of the retail customer's investment profile, that the 
recommendation is in the best interest of a particular retail customer 
and does not place the broker-dealer's interest ahead of the retail 
customer's interest. Accordingly, when making a recommendation to a 
particular retail customer, broker-dealers must weigh the potential 
risks, rewards, and costs of a particular security or investment 
strategy, in light of the particular retail customer's investment 
profile. As discussed above,\608\ a broker-dealer's diligence, care, 
and skill to understand the potential risks, rewards, and costs of a 
security or investment strategy should generally involve a 
consideration of factors, depending on the facts and circumstances of 
the particular recommendation and the particular retail customer's 
investment profile, as discussed below.
---------------------------------------------------------------------------

    \607\ See Proposing Release at 21610-21611.
    \608\ See related discussion in Section II.C.2.a and Section 
II.C.2.b.
---------------------------------------------------------------------------

    While the factors noted above are examples of important factors to 
consider based on the particular security or investment strategy, this 
list is not exhaustive and additional factors, including those raised 
by commenters, could be relevant depending on the particular security 
or investment strategy being recommended and depending on the 
particular retail customer's investment profile. For example, prior to 
recommending a variable annuity to a particular retail customer, 
broker-dealers should generally develop a reasonable basis to believe 
that the retail customer will benefit from certain features of deferred 
variable annuities, such as tax-deferred growth, annuitization, or a 
death or living benefit.\609\
---------------------------------------------------------------------------

    \609\ Cf. also FINRA Rule 2330, Members' Responsibilities 
Regarding Deferred Variable Annuities. See Transamerica November 
2018 Letter.
---------------------------------------------------------------------------

    As stated in the Proposing Release, the importance of each factor 
in determining the customer-specific component of the Care Obligation 
will depend on the facts and circumstances of each recommendation. 
Thus, one or more factors may have more or less relevance--or may not 
be obtained or analyzed at all--if the broker-dealer has a reasonable 
basis for determining that the factors are not relevant. Regardless of 
which factors are evaluated--and equally important, which factors are 
not evaluated--a broker-dealer must have a reasonable basis to believe 
that the particular recommendation is in the best interest of the 
particular retail customer and does not place the broker-dealer's 
interest ahead of the retail customer's interest, consistent with the 
interpretations and guidance provided. For example, recommendations of 
the ``lowest cost'' security or investment strategy, without 
consideration of other factors, could violate Regulation Best Interest. 
In the same vein, it is important to consider that a recommendation may 
be considered to be in a retail customer's best interest when viewed in 
the context of the retail customer's portfolio even if seemingly not in 
a retail customer's best interest when viewed in isolation (e.g., 
inclusion of what otherwise might be seen as a risky investment in the 
portfolio of a risk-adverse customer, such as including hedging 
instruments in a conservative portfolio).
    The customer-specific component of the Care Obligation will rest on 
whether a broker-dealer had a reasonable basis to believe that the 
recommendation was in the best interest of the particular retail 
customer at the time of the recommendation, based on that retail 
customer's investment profile and the potential risks, rewards, and 
costs associated with the recommendation, and did not place the 
financial or other interest of the broker, dealer, or such natural 
person ahead of the interest of the retail customer. Thus, as discussed 
further below, the importance of each factor, and which factors to 
consider, will depend on the facts and circumstances of each 
recommendation, as well as the specific security or investment 
strategy.
    While the Care Obligation does not require broker-dealers to 
document the basis for a recommendation, broker-dealers may choose to 
take a risk based approach when deciding whether or not to document 
certain recommendations. For example, broker-dealers may wish to 
document an evaluation of a recommendation and the basis for the 
particular recommendation in certain contexts, such as the 
recommendation of a complex product, or where a recommendation may seem 
inconsistent with a retail customer's investment objectives on its 
face.\610\ Similarly, broker-dealers may consider using existing 
compliance measures, such as generating and reviewing exception reports 
that identify transactions that fall outside of firm-specified 
parameters to help evaluate and review for compliance with the Care 
Obligation. These measures are not meant to be exhaustive, but rather 
are examples of the sorts of compliance tools and methods broker-
dealers should generally consider using in evaluating whether 
recommendations are consistent with a retail customer's best interests.
---------------------------------------------------------------------------

    \610\ See FINRA Regulatory Notice 11-25 at FAQ 2 (explaining 
that FINRA Rule 2111 (Suitability) permits firms to take a risk-
based approach with respect to documenting suitability 
determinations). Regulation Best Interest similarly does not require 
documentation; however, as noted above, we encourage broker-dealers 
to take a risk-based approach when deciding whether or not to 
document certain recommendations.
---------------------------------------------------------------------------

Retail Customer Investment Profile
    The Proposing Release would have required a ``Retail Customer 
Investment Profile'' to include, but not be limited to, ``the retail 
customer's age, other investments, financial situation and needs, tax 
status, investment objectives, investment experience, investment time 
horizon, liquidity needs, risk tolerance, and any other information the 
retail customer may disclose to the broker, dealer, or a natural person 
who is an associated person of a broker or dealer in connection with a 
recommendation.'' \611\ The Proposing Release also explained that 
broker-dealers would be required to exercise ``reasonable diligence'' 
to ascertain the

[[Page 33379]]

retail customer's investment profile as part of satisfying proposed 
paragraph (a)(2)(i)(B), and that when retail customer information is 
unavailable despite a broker-dealer's reasonable diligence to obtain 
such information, a broker-dealer should consider whether it has 
sufficient understanding of the retail customer to properly evaluate 
whether the recommendation is in the retail customer's best 
interest.\612\ Furthermore, under the proposed rule, a broker-dealer 
would not meet its Care Obligation if it made a recommendation to a 
retail customer for whom it lacks sufficient information to have a 
reasonable basis to believe that the recommendation is in the best 
interest of that retail customer based on such customer's investment 
profile.
---------------------------------------------------------------------------

    \611\ Proposing Release at 21611 (noting the proposed definition 
of Retail Customer Investment Profile was consistent with FINRA Rule 
2111(a) (Suitability), which provides that ``A customer's investment 
profile includes, but is not limited to, the customer's age, other 
investments, financial situation and needs, tax status, investment 
objectives, investment experience, investment time horizon, 
liquidity needs, risk tolerance, and any other information the 
customer may disclose to the member or associated person in 
connection with such recommendation'').
    \612\ Id. This is similar to the approach articulated below, as 
well as in FINRA Regulatory Notice 12-25, which outlines what 
constitutes ``reasonable diligence'' under FINRA's suitability rule 
in attempting to obtain customer-specific information and that the 
reasonableness of the effort also will depend on the facts and 
circumstances. See FINRA Regulatory Notice 12-25 at Q16. Moreover, 
under Regulation Best Interest, as with the approach under FINRA's 
suitability rule, broker-dealers may generally rely on a retail 
customer's responses absent ``red flags'' indicating that the 
information is inaccurate. Id.
---------------------------------------------------------------------------

    In response to this definition and the related discussion, 
commenters identified several additional factors that they believed 
should be included or discussed as part of a retail customer's 
investment profile. For example, several commenters suggested adding 
``longevity risk,'' ``retirement income needs,'' or ``lifetime income 
needs'' as factors that should be included as part of an investor's 
investment profile.\613\ Other commenters suggested additional factors, 
such as, for trust accounts, considering the profile of trust 
beneficiaries and not the trustee, or adding a retail customer's 
``income profile.'' \614\
---------------------------------------------------------------------------

    \613\ See, e.g., IRI Letter, The Committee of Annuity Insurers 
Letter, CCMC Letters, Jackson National Letter, Pacific Life August 
2018 Letter, Lincoln Financial Letter, AXA Letter, Principal Letter; 
Transamerica November 2018 Letter; Letter from Mark F. Halloran, VP 
Managing Director, Business Development, Transamerica (Dec. 14, 
2018) (``Transamerica December 2018 Letter'').
    \614\ See, e.g., Jackson National Letter, Lincoln Financial 
Letter; Transamerica December 2018 Letter.
---------------------------------------------------------------------------

    While we agree that many of these factors will likely be relevant 
to a broker-dealer's recommendation of various securities or investment 
strategies involving securities, we are adopting the definition of 
``retail customer investment profile'' as proposed. We believe that the 
list of factors under ``retail customer investment profile'' is widely 
understood and importantly, offers broker-dealers the flexibility to 
consider additional factors as deemed necessary.\615\ Although many of 
the additional factors cited by commenters may be relevant to 
securities or investment strategy recommendations under certain facts 
and circumstances, we are not persuaded that we should add any specific 
factor or factors to the existing list of profile factors, particularly 
given that the list of factors is non-exhaustive and broker-dealers can 
consider additional factors as appropriate under the unique facts and 
circumstances of each recommendation. Thus, for example, where a 
broker-dealer making a variable annuity recommendation believes that 
longevity risk is an important factor for a particular retail customer 
and that such factor is necessary to develop a reasonable basis to 
believe that the product is in the best interest of that retail 
customer, that broker-dealer should consider and utilize that 
factor.\616\ We believe that this approach appropriately provides 
broker-dealers with a well-understood starting framework, but also 
gives broker-dealers the ability to consider additional factors based 
on the unique nature of its particular securities products, investment 
strategies, and retail customers.
---------------------------------------------------------------------------

    \615\ See, e.g., CCMC Letters; Jackson National Letter; Pacific 
Life August 2018 Letter; Committee of Annuity Insurers Letter; AXA 
Letter.
    \616\ See, e.g., AXA Letter; Committee of Annuity Insurers 
Letter; Pacific Life August 2018 Letter.
---------------------------------------------------------------------------

    Broker-dealers must obtain and analyze enough customer information 
to have a reasonable basis to believe that the recommendation is in the 
best interest of the particular retail customer. The significance of 
specific types of customer information generally will depend on the 
facts and circumstances of the particular case, including the nature 
and characteristics of the product or strategy at issue. Where retail 
customer information is unavailable despite a broker-dealer's 
reasonable diligence, the broker-dealer should carefully consider 
whether it has a sufficient understanding of the retail customer to 
properly evaluate whether the recommendation is in the best interest of 
that retail customer.\617\ In addition, a broker-dealer generally 
should make a reasonable effort to ascertain information regarding an 
existing customer's investment profile prior to the making of a 
recommendation on an ``as needed'' basis--that is, where a broker-
dealer knows or has reason to believe that the customer's investment 
profile has changed.\618\ The reasonableness of a broker-dealer's 
efforts to collect information regarding a customer's investment 
profile information depends on the facts and circumstances of a given 
situation, and the importance of each factor may vary depending on the 
facts and circumstances of the particular case.\619\ Under Regulation 
Best Interest, as with the approach under FINRA's suitability rule, 
broker-dealers may generally rely on a retail customer's responses 
absent ``red flags'' indicating that the information is 
inaccurate.\620\
---------------------------------------------------------------------------

    \617\ See supra footnotes 611-612 and accompanying text.
    \618\ See id.; see also Proposing Release at 21611-21612.
    \619\ See id.; see also FINRA Regulatory Notice 12-25 at Q16.
    \620\ See supra footnote 612.
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    Moreover, as noted in the Proposing Release, one or more factors 
may have more or less relevance, or may not be obtained or analyzed at 
all if the broker-dealer has a reasonable basis for determining that 
the factor is irrelevant to that particular best interest 
determination. However, consistent with existing obligations, where a 
broker-dealer determines not to obtain or analyze one or more of the 
factors specifically identified in the definition of ``Retail Customer 
Investment Profile,'' the broker-dealer should document its 
determination that the factor(s) are not relevant components of a 
retail customer's investment profile in light of the facts and 
circumstances of the particular recommendation.\621\
---------------------------------------------------------------------------

    \621\ FINRA Rule 2111.04.
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    Regulation Best Interest, as noted above, does not require 
documentation of the basis for believing a particular recommendation 
was in a particular retail customer's best interest.\622\ Nevertheless, 
broker-dealers may wish to consider documenting the basis for 
determining that the recommendation is in the best interest of the 
retail customer when it is not evident from the recommendation 
itself.\623\ Documentation by itself will not cure a recommendation in 
circumstances in which a broker-dealer could not have reasonably 
believed the recommendation was in the best interest of the retail 
customer at the time the recommendation was made.\624\
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    \622\ As discussed in Section II.C.1, we believe that the basis 
for and risks associated with a broker-dealer's recommendations in 
standardized terms (as opposed to individualized disclosure of the 
basis for each recommendation made) is a material fact relating to 
the scope and terms of the relationship that is required to be 
disclosed under the Disclosure Obligation.
    \623\ See supra footnote 610 and accompanying text.
    \624\ See FINRA Rule 2111 (Suitability) FAQ.

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[[Page 33380]]

Application of the Care Obligation--Reasonably Available Alternatives 
and Otherwise Identical Securities
    In the Proposing Release, we provided guidance on what types of 
recommendations would or would not be in the best interest of a 
particular retail customer. In particular, the Proposing Release stated 
that where a broker-dealer is choosing among identical securities 
available to the broker-dealer, it would be inconsistent with the Care 
Obligation to recommend the more expensive alternative for the 
customer.\625\ Similarly, in the Proposing Release, we noted our belief 
that it would be inconsistent with the Care Obligation if the broker-
dealer made a recommendation to a retail customer in order to: Maximize 
the broker-dealer's compensation, further the broker-dealer's business 
relationships, satisfy firm sales quotas or other targets, or win a 
firm-sponsored sales contest.\626\
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    \625\ Proposing Release at 21612.
    \626\ Id.
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    We also stated that under the Care Obligation a broker-dealer 
generally should consider reasonable alternatives, if any, offered by 
the broker-dealer in determining whether it has a reasonable basis for 
making the recommendation.\627\ The Proposing Release explained that 
this approach would not require a broker-dealer to analyze all possible 
securities, all other products, or all investment strategies to 
recommend the single ``best'' security or investment strategy for the 
retail customer, nor necessarily require a broker-dealer to recommend 
the least expensive or least remunerative security or investment 
strategy. Further, the Proposing Release indicated that under the Care 
Obligation, when a broker-dealer recommends a more expensive security 
or investment strategy over another reasonably available alternative 
offered by the broker-dealer, the broker dealer would need to have a 
reasonable basis to believe that the higher cost is justified (and thus 
nevertheless is in the retail customer's best interest) based on other 
factors (e.g., the product's or strategy's investment objectives, 
characteristics (including any special or unusual features), liquidity, 
risks and potential benefits, volatility and likely performance in a 
variety of market and economic conditions), in light of the retail 
customer's investment profile.\628\ Relatedly, we stated that a broker-
dealer could not meet the Care Obligation through disclosure 
alone.\629\
---------------------------------------------------------------------------

    \627\ Proposing Release at 21608-21610.
    \628\ Proposing Release at 21612 (emphasis in original). We 
similarly noted that ``when a broker-dealer recommends a more 
remunerative security or investment strategy over another reasonably 
available alternative offered by the broker-dealer, the broker-
dealer would need to have a reasonable basis to believe that--
putting aside the broker-dealer's financial incentives--the 
recommendation was in the best interest of the retail customer based 
on the factors noted [therein], in light of the retail customer's 
investment profile. Nevertheless, this does not mean that a broker-
dealer could not recommend the more remunerative of two reasonably 
available alternatives, if the broker-dealer determines the products 
are otherwise both in the best interest of--and there is no material 
difference between them from the perspective of--the retail 
customer, in light of the retail customer's investment profile.'' 
Id. (emphasis in original).
    \629\ Id. at 21612-21613 (further explaining that ``where a 
broker-dealer is choosing among identical securities with different 
cost structures, we believe it would be inconsistent with the best 
interest obligation for the broker-dealer to recommend the more 
expensive alternative for the customer, even if the broker-dealer 
had disclosed that the product was higher cost and had policies and 
procedures reasonably designed to mitigate the conflict under the 
Conflict of Interest Obligation, as the broker-dealer would not have 
complied with the Care Obligation. Such a recommendation, disclosure 
aside, would still need to be in the best interest of a retail 
customer, and we do not believe it would be in the best interest of 
a retail customer to recommend a higher-cost product if all other 
factors are equal.'') (internal citations omitted).
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    The Commission received numerous comments relating to the Proposing 
Release's discussion of ``reasonably available alternatives'' and 
regarding recommendations of ``otherwise identical securities.'' \630\ 
For example, commenters sought clarification regarding what factors 
need to be considered in the evaluation, and also how the evaluation 
could be performed in certain contexts, such as where a broker-dealer 
operates with an open architecture framework, recommends only a limited 
menu of products, or recommends only proprietary products.\631\ A 
majority of the IAC recommended that Regulation Best Interest should be 
clarified to require recommendations of ``the investments, investment 
strategies, accounts, or services, from among those that [the broker-
dealers, investment advisers, and their associated persons] have 
reasonably available to recommend, that they reasonably believe 
represent the best available options for the investor'' and that a 
``determination regarding the best reasonably available options should 
be based on a careful review of the investor's needs and goals, as well 
as the full range of the reasonably available products', strategies', 
accounts', or services' features, including, but by no means limited to 
cost.'' \632\ Several other commenters recommended that the Commission 
confirm that Regulation Best Interest will not require broker-dealers 
to offer an unlimited number of securities or investment 
strategies.\633\ Commenters also expressed concern over whether the 
consideration of ``reasonably available alternatives'' would 
effectively require a broker-dealer to document the basis of any 
recommendation, as well as concerns about disclosure's role in 
satisfying the Care Obligation.\634\ Finally, a majority of the IAC and 
other commenters sought clarification on whether broker-dealers were 
required to recommend only the single ``best'' product.\635\
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    \630\ See, e.g., Fidelity Letter; Vanguard Letter; MMI Letter; 
BlackRock Letter.
    \631\ See, e.g., CFA August 2018 Letter; Wells Fargo Letter; 
Fidelity Letter; Morgan Stanley Letter. See also LPL August 2018 
Letter (suggesting that its representatives could not conduct a 
meaningful comparison across ``all similar available securities'' 
and that, such recommendations would be subject to legal challenges 
in hindsight).
    \632\ IAC 2018 Recommendation (emphasis in original).
    \633\ See LPL August 2018 Letter (recommending that the 
Commission clarify that a financial professional can satisfy his or 
her obligations under Regulation Best Interest, even if he or she 
limits recommendations to a smaller number of product sponsors 
because financial professionals participating on large platforms 
may, in practice, be discouraged from conducting focused analysis of 
product offerings, instead opting for a more cursory review of a few 
high-level cost, risk, and performance metrics across all available 
products). See also Fidelity Letter; Cetera August 2018 Letter; 
SIFMA August 2018 Letter; Guardian August 2018 Letter; Prudential 
Letter.
    \634\ See, e.g., Fidelity Letter; Wells Fargo Letter.
    \635\ See 2018 IAC Recommendation (``The Commission should 
recognize that there will often not be a single best option and that 
more than one of the available options may satisfy this standard,'' 
and that ``compliance should be measured based on whether the broker 
or adviser had a reasonable basis for the recommendation at the time 
it was made, and not on how the recommendation ultimately performed 
for the investor. . . .''); see also SIFMA August 2018 Letter.
---------------------------------------------------------------------------

    The Care Obligation will require a broker-dealer to have a 
reasonable basis to believe, based on its understanding of the 
potential risks, rewards, and costs of the recommended security or 
investment strategy involving securities, and in light of the retail 
customer's investment profile, that the recommendation is in the best 
interest of a particular retail customer and does not place the broker-
dealer's interest ahead of the retail customer's interest. As noted 
above, determining what is in a retail customer's best interest is an 
objective evaluation turning on the facts and circumstances of the 
particular recommendation and the particular retail customer at the 
time the recommendation is made.\636\
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    \636\ As noted and further reiterated below, a broker-dealer 
will not be required to recommend the single ``best'' of all 
possible alternatives that might exist, in part because many 
different options may in fact be in the retail customer's best 
interest. See infra footnote 640 and accompanying text.
---------------------------------------------------------------------------

    Accordingly, as noted above, a broker-dealer would not satisfy the 
Care Obligation by simply recommending the least expensive or least 
remunerative

[[Page 33381]]

security without any further analysis of these other factors and the 
retail customer's investment profile. A broker-dealer could recommend a 
more expensive security or investment strategy if there are other 
factors about the product that reasonably allow the broker-dealer to 
believe it is in the best interest of the retail customer, based on 
that retail customer's investment profile. Similarly, a broker-dealer 
could recommend a more remunerative security or investment strategy if 
the broker-dealer has a reasonable basis to believe that there are 
other factors about the security or investment strategy that make it in 
the best interest of the retail customer, in light of the retail 
customer's investment profile.
    We also continue to have the view that, as part of determining 
whether a broker-dealer has a reasonable basis to believe that a 
recommendation is in the best interest of the retail customer, a 
broker-dealer generally should consider reasonably available 
alternatives offered by the broker-dealer. It is our view that such a 
consideration is an inherent aspect of making a ``best interest'' 
recommendation, and is a key enhancement over existing broker-dealer 
suitability obligations, which do not necessarily require a comparative 
assessment among such alternatives.\637\ Similarly, this concept has 
been applied in the context of guidance regarding suitability and 
heightened supervision of complex products, stating that when broker-
dealers are recommending complex or costly products, they should first 
consider whether less complex or costly products could achieve the same 
objectives for their retail customers.\638\
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    \637\ While enforcement actions and related guidance may be 
construed as interpreting the suitability obligation to include a 
consideration of available alternatives, it is generally limited to 
certain circumstances, such as recommendations of mutual funds with 
different share classes or recommendations of complex or costly 
products. See In re Application of Raghavan Sathianathan, Exchange 
Act Release No. 54722 at 21 (Nov. 8, 2006); In the Matter of Wendell 
D. Belden, 56 S.E.C. 496 (2003); FINRA Regulatory Notice 12-03. See 
also FINRA 2018 Letter; MSRB Rule G-42 (requiring a municipal 
advisor to inform its municipal entity or obligated person client 
whether it has investigated or considered other reasonably feasible 
alternatives to the recommended municipal securities transaction).
    Thus, although certain enforcement actions and guidance 
contemplate a consideration of available alternatives under certain 
situations, it is not a general expectation. Nevertheless, such 
statements serve as an example and evidence that the concept is not 
unfamiliar to broker-dealers.
    \638\ See FINRA Regulatory Notice 12-03 (``For example, 
registered representatives should compare a structured product with 
embedded options to the same strategy through multiple financial 
instruments on the open market, even with any possible advantages of 
purchasing a single product.''). See also supra footnote 635.
---------------------------------------------------------------------------

    In terms of conducting such an evaluation, a broker-dealer does not 
have to conduct an evaluation of every possible alternative, either 
offered outside of the firm (such as where the firm offers only 
proprietary or other limited range of products) or available on the 
firm's platform. We appreciate commenter concerns about the 
impracticality and potential impossibility of such a comparative 
evaluation, particularly where the firm offers numerous different 
products, many of which may have similar strategies but with other 
varying characteristics, including cost structures, that may apply 
differently based on the particular retail customer.\639\ We also 
recognize that different products are rarely perfectly equal, and that 
differences will be both quantitative and qualitative in nature. A 
broker-dealer will not be required to recommend the single ``best'' of 
all possible alternatives that might exist, in part because many 
different options may in fact be in the retail customer's best 
interest.\640\ We are sensitive to commenters' concern that this 
determination, to the extent it can be made at all, may be judged in 
hindsight even though Regulation Best Interest applies at the time of 
the recommendation.\641\
---------------------------------------------------------------------------

    \639\ See, e.g., Morgan Stanley Letter (``Large firms with an 
open architecture like Morgan Stanley offer an enormous range of 
products to their clients. To take but one example, Morgan Stanley 
offers approximately 300 large capitalization equity mutual funds to 
its retail customers.''); see also Morningstar Letter; Primerica 
Letter; ICI Letter; Chapman Letter (stating that ``identical'' is 
too stringent because they believe all securities have 
distinctions).
    \640\ Commenters suggesting different approaches acknowledged 
this concern. See, e.g., IAC 2018 Recommendation (``[T]he Commission 
should recognize there will often not be a single best option and 
that more than one of the available options may satisfy this 
standard.'').
    \641\ See LPL August 2018 Letter.
---------------------------------------------------------------------------

    In particular, we are not requiring a natural person who is an 
associated person of the broker-dealer to be familiar with every 
product on a broker-dealer's platform, particularly where a broker-
dealer operates in an open architecture framework or otherwise operates 
a platform with a large number of products or options.\642\ Such a 
requirement might not allow an associated person of a broker-dealer to 
develop a proper understanding of every security or investment 
strategy's potential risks, rewards, or costs, and thus it might not be 
possible to fulfill the obligation set forth in paragraph 
(a)(2)(ii)(A). Furthermore, such a requirement could encourage broker-
dealers to limit their product menus or otherwise restrict access to 
products and services currently available to retail customers, which is 
contrary to the purpose and goals of Regulation Best Interest.\643\
---------------------------------------------------------------------------

    \642\ Conversely, where a broker-dealer only has a few products, 
an associated person of the broker-dealer may be expected to 
understand and consider all of these options when recommending a 
security or investment strategy. We recognize that this facts-and-
circumstances approach does not provide a clear bright-line rule; 
however, we are providing further guidance below on a broker-
dealer's process for evaluating reasonably available alternatives 
and the scope herein. Furthermore, nothing in this discussion 
excuses a broker-dealer from satisfying the Care Obligation. An 
associated person of the broker-dealer cannot use a large platform 
as an excuse for not developing a proper understanding of a 
recommended security or investment strategy's potential risks, 
rewards, or costs.
    \643\ See LPL August 2018 Letter.
---------------------------------------------------------------------------

    As discussed above, the determination of whether a recommendation 
is in the ``best interest'' of the retail customer and does not place 
the interests of the broker-dealer ahead of the retail customer's 
interest must be based on information reasonably known to the 
associated person (based on her reasonable diligence, care, and skill) 
at the time the recommendation is made. Accordingly, in fulfilling the 
Care Obligation, the associated person should exercise reasonable 
diligence, care, and skill to consider reasonably available 
alternatives offered by the broker-dealer. This exercise would require 
the associated person to conduct a review of such reasonably available 
alternatives that is reasonable under the circumstances. Consistent 
with the Compliance Obligation discussed below, a broker-dealer should 
have a reasonable process for establishing and understanding the scope 
of such ``reasonably available alternatives'' that would be considered 
by particular associated persons or groups of associated persons (e.g., 
groups that specialize in particular product lines) in fulfilling the 
reasonable diligence, care, and skill requirements under the Care 
Obligation.
    What will be a reasonable determination of the scope of 
alternatives considered will depend on the facts and circumstances, at 
the time of the recommendation, including both the nature of the retail 
customer and the retail customer's investment profile, and the 
particular associated persons or groups of associated persons that are 
providing the recommendations. With respect to broker-dealers that 
materially limit the range of products or services that they recommend 
to retail customers (e.g., limits its product offerings to only 
proprietary or other limited menus of products), the Conflict of 
Interest

[[Page 33382]]

Obligation provision requires broker-dealers to have reasonably 
designed policies and procedures to identify and disclose the material 
limitations and any conflicts of interest associated with such 
limitations, and to prevent such limitations and associated conflicts 
of interest from causing the broker-dealer or associated person to make 
recommendations that place the interest of the broker-dealer or 
associated person ahead of the interest of the retail customer.\644\ 
Similarly, where a broker-dealer offers numerous products on its 
platform, a broker-dealer or an associated person could reasonably 
limit the universe of ``reasonably available alternatives'' if there is 
a reasonable process or methodology for limiting the scope of 
alternatives or the universe considered for a particular retail 
customer, particular category of retail customers, or the retail 
customer base more generally.\645\
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    \644\ See Section II.C.3. Broker-dealers would be required to 
disclose the conflict of interest, as well as the material facts 
associated with such a conflict pursuant to the Disclosure 
Obligation provision as described in Section II.C.1.
    \645\ We note that where a broker-dealer (or an associated 
person) limits the securities or investment strategies that are 
considered as ``reasonably available alternatives'' from the 
universe of securities or investment strategies involving securities 
offered by the broker-dealer, this limitation may constitute a 
material limitation placed on the securities or investment 
strategies involving securities that may be recommended, which the 
broker-dealer (or an associated person) would need to disclose and 
address as provided in the Disclosure and Conflict of Interest 
Obligations.
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    In addition to the particular retail customer's investment profile, 
we believe the scope of reasonably available alternatives considered 
could depend upon a variety of factors, including but not limited to, 
the associated person's customer base (including the general investment 
objectives and needs of the customer base), the investments and 
services available to the associated person to recommend (including 
limitations due to licensing of the associated person), and other 
factors such as specific limitations on the available investments and 
services with respect to certain retail customers (e.g., product or 
service income thresholds; product geographic limitations; or product 
limitations based on account type, such as those only eligible for IRA 
accounts). A reasonable process would not need to consider every 
alternative that may exist (either outside the broker-dealer or on the 
broker-dealer's platform) or to consider a greater number of 
alternatives than is necessary in order for the associated person to 
exercise reasonable diligence, care, and skill in providing a 
recommendation that complies with the Care Obligation.
    Importantly, where all reasonably available alternatives considered 
would be inconsistent with a retail customer's investment profile, a 
broker-dealer would not be able to form a reasonable belief that the 
best of these options is in the best interest of that retail customer. 
All recommendations to retail customers of securities or investment 
strategies are required to satisfy the Care Obligation, and broker-
dealers cannot use a limited product menu or a process to determine the 
scope of reasonably available alternatives considered to justify a 
recommendation that is not in the best interest of the retail customer.
    We recognize that the process by which a broker-dealer and its 
associated persons develop and make recommendations to retail 
customers, including the scope of reasonably available alternatives 
considered, will depend upon a variety factors, including the nature of 
the broker-dealer's business.\646\ The disclosure of this process 
pursuant to the Disclosure Obligation will provide critical information 
to retail customers and underscores our acknowledgment that we do not 
expect every broker-dealer or associated person to follow the same 
process. Instead, consistent with the Compliance Obligation, broker-
dealers and their associated persons must have a reasonable process for 
developing and making recommendations to retail customers in compliance 
with the Care Obligation, including the consideration of reasonably 
available alternatives, which will depend on the facts and 
circumstances.
---------------------------------------------------------------------------

    \646\ Accordingly, we believe that disclosure of this process is 
of fundamental importance to a retail customer's understanding of 
what services are being provided, and in deciding whether those 
services are appropriate to the retail customer's needs and goals, 
and have thus clarified that the basis for a broker-dealer's or an 
associated person's recommendations as a general matter (i.e., what 
might commonly be described as the firm's or associated person's 
investment approach, philosophy or strategy) is a material fact 
relating to the scope and terms of the relationship that must be 
disclosed pursuant to the Disclosure Obligation. See Section II.C.1.
---------------------------------------------------------------------------

    We emphasize that what is in the ``best interest'' of a retail 
customer depends on the facts and circumstances of a recommendation at 
the time it is made, including matching the recommended security or 
investment strategy to the retail customer's investment profile at the 
time of the recommendation, and the process for coming to that 
conclusion. Whether a broker-dealer has complied with the Care 
Obligation will be evaluated based on the facts and circumstances at 
the time of the recommendation (and not in hindsight) and will focus on 
whether the broker-dealer had a reasonable basis to believe that the 
recommendation is in best interest of the retail customer.
    Finally, broker-dealers or their associated persons are not 
required to prepare and maintain documentation regarding the basis for 
each specific recommendation, including an evaluation of a recommended 
securities transaction or investment strategy against similar available 
alternatives. In circumstances where the ``match'' between the retail 
customer profile and the recommendation appears less reasonable on its 
face (for example, where a retail customer's account objective is 
preservation of income and the recommendation involves higher risk, or 
where there are more significant conflicts of interest present), the 
more important the process will likely be for a broker-dealer to 
establish that it had a reasonable belief that the recommendation was 
in the best interest of the retail customer and did not place the 
broker-dealer's interest ahead of the retail customer. This could 
include reasonably designed policies and procedures to establish 
compliance with the Care Obligation, as required by the new Compliance 
Obligation, and could include maintaining supporting documentation for 
certain recommendations.\647\
---------------------------------------------------------------------------

    \647\ See supra footnote 610 and accompanying text.
---------------------------------------------------------------------------

Application of Care Obligation to Account Type Recommendations
    As discussed above, Regulation Best Interest will apply to 
recommendations by a broker-dealer of a securities account type. Thus, 
the Care Obligation will require a broker-dealer to have a reasonable 
basis to believe that a recommendation of a securities account type 
(e.g., brokerage or advisory, or among the types of accounts offered by 
the firm) is in the retail customer's best interest at the time of the 
recommendation and does not place the financial or other interest of 
the broker-dealer ahead of the interest of the retail customer.\648\
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    \648\ As discussed in Section II.B.2, whether and how Regulation 
Best Interest applies will depend on whether the financial 
professional making the recommendation is dually registered.
     In the section that follows we discuss how the Care Obligation 
will apply to recommendations to open an IRA or to roll over assets 
into an IRA.
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    We believe broker-dealers would need to consider various factors in 
determining whether a particular account is in a particular retail 
customer's best interest. For example, broker-dealers generally should 
consider: (1) The services and products provided in the account 
(ancillary

[[Page 33383]]

services provided in conjunction with an account type, account 
monitoring services, etc.); (2) the projected cost to the retail 
customer of the account; (3) alternative account types available; (4) 
the services requested by the retail customer; and (5) the retail 
customer's investment profile. Moreover, retail customer-specific 
factors, such as those identified in the definition of ``Retail 
Customer Investment Profile,'' may not be applicable or available in 
every context, and would depend on the facts and circumstances at the 
time of account type recommendation. For example, one or more factors 
may have more or less relevance, or information about those factors may 
not be obtained or analyzed at all where the broker-dealer has a 
reasonable basis for believing that a particular factor is or is not 
relevant.\649\ In addition, as discussed above, we recognize that 
factors other than cost may properly be considered when determining 
whether an account is in a retail customer's best interest.\650\
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    \649\ As discussed above, where a broker-dealer determines not 
to obtain or analyze one or more of the factors specifically 
identified in the definition of ``Retail Customer Investment 
Profile,'' the broker-dealer generally should document its 
determination that the factor(s) are not relevant components of a 
retail customer's investment profile in light of the facts and 
circumstances of the particular recommendation.
    \650\ See id.
---------------------------------------------------------------------------

    Where the financial professional making the recommendation is 
dually registered (i.e., an associated person of a broker-dealer and a 
supervised person of an investment adviser (regardless of whether the 
professional works for a dual-registrant, affiliated firms, or 
unaffiliated firms)) the financial professional would need to make this 
evaluation taking into consideration the spectrum of accounts offered 
by the financial professional (i.e., both brokerage and advisory taking 
into account any eligibility requirements such as account minimums), 
and not just brokerage accounts. For example, all other things being 
equal, it may be in the retail customer's best interest to recommend a 
brokerage account to the retail customer who intends to buy and hold a 
long-term investment (e.g., maintain an account primarily composed of 
bonds or mutual funds and has a stated buy-and-hold strategy), as 
opposed to an advisory account (i.e., it may not be in the retail 
customer's best interest in this context to pay an ongoing fee for a 
security that he or she plans to hold to maturity).\651\ On the other 
hand, it may not be in the retail customer's best interest to recommend 
a brokerage account where the retail customer plans to engage in at 
least a moderate level of trading and prefers to pay for advice in 
connection with such trading on the basis of a consistent recurring 
monthly or annual charge.\652\ Furthermore, where a retail customer 
holds a variety of investments, or prefers differing levels of services 
(e.g., both episodic recommendations from a broker-dealer and 
continuous advisory services including discretionary asset management 
from an investment adviser), it may be in the retail customer's best 
interest to recommend both a brokerage and an advisory account.
---------------------------------------------------------------------------

    \651\ See id.
    \652\ See id. We reiterate that this is a facts and 
circumstances determination, and that these examples are not meant 
to provide a bright line rule, but rather to illustrate certain 
considerations that a broker-dealer could consider when determining 
whether a recommended account type is in the best interest of the 
retail customer.
---------------------------------------------------------------------------

    Similarly, where the financial professional is only registered as 
an associated person of a broker-dealer (regardless of whether that 
broker-dealer entity is a dual-registrant or affiliated with an 
investment adviser), he or she would need to take into consideration 
only the brokerage accounts available.\653\ However, even if a broker-
dealer only offered brokerage accounts, the associated person would 
nevertheless need to have a reasonable basis to believe that the 
recommended account was in the best interest of the retail customer. 
For example, if the retail customer were seeking a relationship where 
the financial professional would have unlimited investment discretion 
(i.e., having responsibility for a customer's trading decisions),\654\ 
the associated person would not have a reasonable basis to believe that 
a brokerage account was in the best interest of the retail customer. 
Thus, as with limited product menus, a limited selection of account 
types would not excuse a broker-dealer from making a recommendation not 
in the best interest of the retail customer.
---------------------------------------------------------------------------

    \653\ For example, if the natural person that is an associated 
person of the broker-dealer is not registered as an investment 
adviser representative, but is associated with a broker-dealer that 
is a dual-registrant, that associated person would only need to 
consider the brokerage accounts offered by the firm, and not the 
firm's advisory accounts in making the recommendation.
    \654\ See Solely Incidental Interpretation.
---------------------------------------------------------------------------

Application of Care Obligation to IRA Rollovers and Related 
Recommendations
    Regulation Best Interest also applies to recommendations to open an 
IRA or to roll over assets into an IRA. Thus, the Care Obligation will 
require a broker-dealer to have a reasonable basis to believe that the 
IRA or IRA rollover is in the best interest of the retail customer at 
the time of the recommendation and does not place the financial or 
other interest of the broker-dealer ahead of the interest of the retail 
customer, taking into consideration the retail customer's investment 
profile and other relevant factors, as well as the potential risks, 
rewards, and costs of the IRA or IRA rollover compared to the 
investor's existing 401(k) account or other circumstances.\655\
---------------------------------------------------------------------------

    \655\ See infra Section II.C.2; see also FINRA Regulatory Notice 
13-45 (outlining several considerations regarding IRA rollovers).
---------------------------------------------------------------------------

    When making a recommendation to open an IRA, or to roll over 
workplace retirement plan assets into an IRA rather than keeping assets 
in a previous employer's workplace retirement plan (or rolling over 
assets to a new employer's workplace retirement plan), broker-dealers 
should consider a variety of factors, the importance of which will 
depend on the particular retail customer's needs and circumstances. In 
addition to the Factors to Consider Regarding a Recommendation to a 
Particular Retail Customer discussed above, as well as the Retail 
Customer's Investment Profile, broker-dealers should consider a variety 
of additional factors specifically salient to IRAs and workplace 
retirement plans, in order to compare the retail customer's existing 
account to the IRA offered by the broker-dealer. These factors should 
generally include, among other relevant factors: Fees and expenses; 
level of service available; available investment options; ability to 
take penalty-free withdrawals; application of required minimum 
distributions; protection from creditors and legal judgments; holdings 
of employer stock; and any special features of the existing 
account.\656\ With respect to available investment options, we caution 
broker-dealers not to rely on, for example, an IRA having ``more 
investment options'' as the basis for recommending a rollover. Rather, 
as with other factors, broker-dealers should consider available 
investment options in an IRA, among other relevant factors, in light of 
the retail customer's current situation and needs in order to develop a 
reasonable basis to believe that the rollover is in the retail 
customer's best interest.
---------------------------------------------------------------------------

    \656\ See id.
---------------------------------------------------------------------------

    While these examples may be relevant to an analysis of available 
options, this list is not meant to be exhaustive. Furthermore, each 
factor generally should be analyzed with respect to a particular retail 
customer in order for a broker-dealer to form a reasonable belief that 
the recommendation is in the best

[[Page 33384]]

interest of that retail customer and does not place the financial or 
other interest of the broker-dealer ahead of the interest of the retail 
customer. Finally, as described above, certain factors may have more or 
less relevance, or not be relevant at all, depending on the particular 
facts and circumstances of each recommendation.
d. Have a Reasonable Basis To Believe That a Series of Recommended 
Transactions, Even if in the Retail Customer's Best Interest When 
Viewed in Isolation, Is Not Excessive and Is the Retail Customer's Best 
Interest When Taken Together in Light of the Retail Customer's 
Investment Profile and Does Not Place the Interest of the Broker-Dealer 
Ahead of the Interest of the Retail Customer
    As proposed, the third component of the Care Obligation would 
require a broker-dealer to exercise reasonable diligence, care, skill, 
and prudence to have a reasonable basis to believe that a series of 
recommended transactions, even if in the retail customer's best 
interest when viewed in isolation, is not excessive and is in the 
retail customer's best interest when taken together in light of the 
retail customer's investment profile.\657\ The Proposing Release noted 
that this requirement is intended to incorporate and enhance a broker-
dealer's existing ``quantitative suitability'' obligation by applying 
the requirement irrespective of whether a broker-dealer exercises 
actual or de facto control over a customer's account, thereby making 
the obligation consistent with the current requirements for 
``reasonable basis suitability'' and ``customer specific suitability.'' 
\658\
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    \657\ Proposing Release at 21613.
    \658\ Proposing Release at 21613-21614.
---------------------------------------------------------------------------

    We received a few comments suggesting modifications to this 
component of the obligation. For example, one commenter recommended the 
Commission clarify the meaning of ``series of transactions,'' while a 
second commenter requested a carve-out for ``active traders'' who are 
``interested in trading individual stocks . . . with a great degree of 
regularity.'' \659\ Another commenter maintained that the quantitative 
suitability obligations should only apply to those accounts over which 
the member firm has ``control,'' and that if the Commission does not 
include the control element of FINRA Rule 2111 as part of the Care 
Obligation, that the Commission ``should at a minimum confirm that this 
requirement applies only to recommendations by a single associated 
person, not across multiple associated persons at the firm who act 
independently.'' \660\
---------------------------------------------------------------------------

    \659\ See Letter from Keith Lampi, President, Alternative and 
Direct Investment Securities Association (``ADISA'') (Aug. 7, 2018) 
(``ADISA Letter'') (recommending the Commission clarify the meaning 
of ``series of transactions''); Letter from Joseph C. Cascarelli, 
Corporate Counsel, Network 1 Financial Securities (Aug. 7, 2018) 
(``Network 1 Letter'') (suggesting a ``carve-out exemption formula'' 
from Regulation Best Interest to accommodate investors and their 
stockbrokers who specialize in ``active trading'').
    \660\ SIFMA August 2018 Letter.
---------------------------------------------------------------------------

    After considering these comments, the Commission is adopting the 
proposed ``quantitative care'' component of the Care Obligation as 
proposed. As noted in the Proposing Release, we believe that imposing 
the quantitative care obligation without a ``control'' element would 
provide consistency in the investor protections provided to retail 
customers by requiring a broker-dealer to always form a reasonable 
basis as to the recommended frequency of trading in a retail customer's 
account--irrespective of whether the broker-dealer ``controls'' or 
exercises ``de facto control'' over the retail customer's account.\661\ 
This would also be consistent with the other components of the Care 
Obligation, which apply regardless of whether a broker-dealer 
``controls'' or exercises ``de facto control'' over the retail 
customers' account.
---------------------------------------------------------------------------

    \661\ See Proposing Release at 21613-21614.
---------------------------------------------------------------------------

    While the Commission appreciates the concern raised about ``active 
traders'' and the concern relating to a retail customer that could 
maintain several accounts at the same firm, we nevertheless believe 
that retail customers could, and should, benefit from the protections 
of this requirement, namely the protection from a broker-dealer 
recommending a level of trading that is so excessive that the resulting 
cost-to-equity ratio or turnover rate makes a positive return virtually 
impossible.\662\ As we indicated in the Proposing Release, the fact 
that a customer may have some knowledge of financial markets or some 
``control'' should not absolve the broker-dealer of the ultimate 
responsibility to have a reasonable basis to believe that any 
recommendations it makes are in the best interest of the retail 
customer.\663\ Where a retail customer expresses a desire for ``active 
trading,'' \664\ a broker-dealer may take this factor into 
consideration when evaluating a recommendation; however, the broker-
dealer will nevertheless need to reasonably believe that a series of 
recommended transactions is in the best interest of the retail 
customer. We further note that Regulation Best Interest does not 
require a broker-dealer to refuse to accept a customer's order that is 
contrary to the broker-dealer's recommendation. Nor does Regulation 
Best Interest apply to self-directed or otherwise unsolicited 
transactions by a retail customer, whether or not he or she also 
receives separate recommendations from the broker-dealer.
---------------------------------------------------------------------------

    \662\ See id.
    \663\ See id.
    \664\ See Network 1 Letter.
---------------------------------------------------------------------------

    With respect to the concern about applying the requirement ``only 
to recommendations by a single associated person, not across multiple 
associated persons at the firm who act independently,'' \665\ we note 
that both the firm and their associated persons have to comply with the 
Care Obligation. If we took this commenter's suggestion, we are 
concerned we would potentially create a loophole and a perverse outcome 
that would allow for avoidance of the Care Obligation, and permit 
potentially excessive trading, by encouraging recommendations across a 
number of associated persons. We reiterate our position that, 
consistent with the other components of the Care Obligation under the 
Care Obligation, when a series of transactions is recommended to a 
retail customer, a broker-dealer must evaluate whether the series of 
recommended transactions places the broker-dealer's interest ahead of 
the retail customer's--this is true for both the associated person 
making the recommendation, as well as for the firm.\666\ This will 
necessarily depend on the facts and circumstances of each particular 
recommendation, and of each particular series of transactions; however, 
we note that, as part of developing a retail customer's investment 
profile, a broker-dealer is required to exercise reasonable diligence 
to ascertain the retail customer's investment profile, which would 
include seeking to obtain and analyze a retail customer's other 
investments.\667\
---------------------------------------------------------------------------

    \665\ See SIFMA 2018 Letter.
    \666\ See Proposing Release at 21613-21614.
    \667\ See supra Section II.C.2.c.
---------------------------------------------------------------------------

    Finally, with respect to the meaning of series of recommended 
transactions, what would constitute a ``series'' of recommended 
transactions would depend on the facts and circumstances, and would 
need to be evaluated with respect to a particular retail customer. In 
other words, a broker-dealer would need to reasonably believe that the 
level of trading (series of recommended transactions) is appropriate 
for a particular retail customer, and thus a bright line definition 
across all retail

[[Page 33385]]

customers would be unworkable. Moreover, providing a bright line 
definition could encourage firms to focus on a particular number of 
transactions rather than focusing on ensuring that a series of 
recommendations, taken together, are in the best interest of the retail 
customer. Finally, a ``series'' of recommended transactions is an 
established term under the federal securities laws and SRO rules that 
is evaluated in concert with existing guideposts, such as turnover 
rate,\668\ cost-to-equity ratio,\669\ and use of in-and-out 
trading,\670\ which have been developed over time and which serve as 
indicators of excessive trading.
---------------------------------------------------------------------------

    \668\ See, e.g., Carras v. Burns, 516 F.2d 251, 258 (4th Cir. 
1975); Shearson Lehman Hutton Inc., 49 S.E.C. 1119, 1122 at footnote 
10 (1989); Laurie Jones Canady, 54 S.E.C. 65, 74 (1999), Exchange 
Act Release No. 41250 (Apr. 5, 1999) (using the turnover rate for 
relevant period), petition denied, 230 F.3d 362 (D.C. Cir. 2000).
    \669\ See, e.g., Shearson Lehman, 49 S.E.C. at 1121 (stating 
that ``[o]ne test for excessive trading is the relationship between 
the account opening balance and the amounts of markups, commissions, 
and margin charges''); Michael E. Tennenbaum, 47 S.E.C. 703 (Jan.19, 
1982).
    \670\ See, e.g., Hecht v. Harris, Upham & Co., 283 F. Supp. 417, 
435-36 (N.D. Cal. 1968), modified in part and aff'd, 430 F.2d 1202 
(9th Cir. 1970); R.H. Johnson & Co., 36 S.E.C. 467 (1955); Behel, 
Johnson & Co., 26 S.E.C. 163 (1947). Cody v. S.E.C., 693 F.3d 251, 
260 (1st Cir. 2012).
---------------------------------------------------------------------------

3. Conflict of Interest Obligation
    We proposed the Conflict of Interest Obligation to require a 
broker-dealer entity \671\ to: (1) Establish, maintain, and enforce 
written policies and procedures reasonably designed to identify, and 
disclose, or eliminate all material conflicts of interest associated 
with recommendations covered by Regulation Best Interest; and (2) 
establish, maintain and enforce written policies and procedures 
reasonably designed to identify and disclose and mitigate, or 
eliminate, material conflicts of interest arising from financial 
incentives associated with such recommendations. This proposed approach 
reflected our view that establishing reasonably designed policies and 
procedures is critical to identifying and addressing conflicts of 
interest. In addition, the proposed approach would serve the 
Commission's goal of addressing conflicts of interest that may harm 
investors while providing flexibility to establish systems tailored to 
broker-dealers' business models.
---------------------------------------------------------------------------

    \671\ Unlike the Disclosure and Care Obligations, which apply to 
a broker or dealer and to natural persons who are associated persons 
of a broker or dealer, the Conflict of Interest Obligation (and the 
Compliance Obligation discussed in Section II.C.4 below) applies 
solely to the broker or dealer entity, and not to the natural 
persons who are associated persons of a broker or dealer. For 
purposes of discussing the Conflict of Interest Obligation and the 
Compliance Obligation, the term ``broker-dealer'' refers only to the 
broker-dealer entity, and not to such individuals. While the 
Conflict of Interest Obligation applies only to the broker-dealer 
entity, the conflicts of interest that the broker-dealer entity must 
analyze are conflicts (as defined in paragraph (c)(3) of the rule) 
between: (i) The broker-dealer entity and the retail customer, (ii) 
the natural persons who are associated persons and the retail 
customer, and (iii) the broker-dealer entity and the natural persons 
who are associated persons.
---------------------------------------------------------------------------

    The Commission solicited comment on the Conflict of Interest 
Obligation, including the specific requirements to create policies and 
procedures with respect to disclosure, mitigation, and elimination of 
conflicts of interest. Commenters requested changes to several aspects 
of the Conflict of Interest Obligation, including providing more 
clarity and guidance surrounding when specific conflicts need to be 
disclosed, mitigated or eliminated.\672\
---------------------------------------------------------------------------

    \672\ See, e.g., SIFMA August 2018 Letter; Primerica Letter; 
BISA Letter; CCMC Letters; Wells Fargo Letter.
---------------------------------------------------------------------------

    In consideration of these comments, we are adopting the Conflict of 
Interest Obligation with revisions to: (1) Create an overarching 
obligation to establish written policies and procedures to identify and 
at a minimum disclose, pursuant to the Disclosure Obligation, or 
eliminate all conflicts of interest associated with the recommendation; 
and (2) require broker-dealers to establish policies and procedures to 
be reasonably designed to mitigate or eliminate certain identified 
conflicts of interest.
    In addition to the overarching obligation, we specifically require 
broker-dealers to establish, maintain, and enforce written policies and 
procedures reasonably designed to: (i) Identify and mitigate any 
conflicts of interest associated with recommendations that create an 
incentive for a natural person who is an associated person of a broker 
or dealer to place the interest of the broker or dealer, or such 
natural person making the recommendation, ahead of the interest of the 
retail customer; (ii)(A) identify and disclose any material limitations 
placed on the securities or investment strategies involving securities 
that may be recommended (i.e., only make recommendations of proprietary 
or other limited range of products) to a retail customer and any 
conflicts of interest associated with such limitations, in accordance 
with the Disclosure Obligation, and (B) prevent such limitations and 
associated conflicts of interest from causing the broker, dealer, or a 
natural person who is an associated person of the broker or dealer to 
make recommendations that place the interest of the broker, dealer, or 
such natural person ahead of the interest of the retail customer; and 
(iii) identify and eliminate any conflicts of interest associated with 
sales contests, bonuses, and non-cash compensation that are based on 
the sales of specific securities or specific types of securities within 
a limited period of time.\673\
---------------------------------------------------------------------------

    \673\ Rule 15l-1 under the Exchange Act.
---------------------------------------------------------------------------

    Each of these changes and the requirements pursuant to the Conflict 
of Interest Obligation is discussed in more detail below.
a. Reasonably Designed Policies and Procedures
    We proposed to require broker-dealers to establish reasonably 
designed policies and procedures as we believe they are critical to 
identifying and addressing conflicts of interest \674\ and helping 
ensure compliance with the requirements to disclose conflicts of 
interest pursuant to the Disclosure Obligation.\675\ In addition, 
policies and procedures may minimize compliance costs that may be 
passed on to retail customers.\676\ As discussed in the Proposing 
Release, it would be reasonable for broker-dealers to use a risk-based 
compliance and supervisory system rather than requiring a detailed 
review of each recommendation and to have flexibility to tailor 
policies and procedures to their specific business models. The 
Commission also provided guidance on components a broker-dealer should 
consider including in its program with regard to the Conflict of 
Interest Obligation.\677\
---------------------------------------------------------------------------

    \674\ See FSI August 2018 Letter (``Experience shows that 
investors already ignore much of the enormous volume of regulatory 
disclosures they are being provided. Instead, a more realistic 
approach is to require broker-dealers to adopt written supervisory 
procedures to detect and manage conflicts of interest, to avoid 
those they can and take steps to mitigate the impact of those 
conflicts that can't be avoided.'').
    \675\ See Proposing Release at Section II.D.3.b. See also CCMC 
Letters (policies and procedures requirement should assist broker-
dealers in managing the potential impact of conflicts of interest); 
FPC Letter (acknowledging the importance of firms' policies and 
procedures when providing financial planning to act in the client's 
best interest).
    \676\ See Proposing Release at Section II.D.3.b. See also 
Cambridge Letter (``Cambridge believes the SEC's goals of 
facilitating disclosure and mitigating material conflicts of 
interest, while minimizing additional compliance costs that may be 
passed on to the retail customers can best be accomplished by 
requiring broker-dealers to adopt written supervisory procedures to 
detect and manage conflicts of interest, to avoid those they can and 
take steps to mitigate the impact of those conflicts that can't be 
avoided.'').
    \677\ Proposing Release at Section II.D.3.b.
---------------------------------------------------------------------------

    In response to the proposed policies and procedures requirement, 
some

[[Page 33386]]

commenters asserted that it was an effective means of addressing 
conflicts \678\ while others were concerned that the Commission was 
providing too much flexibility in addressing conflicts of 
interest.\679\ A few commenters expressed agreement with allowing a 
flexible risk-based approach tailored to a broker-dealer's business 
model as opposed to a detailed review of each recommendation.\680\ A 
few commenters expressed concern with the Commission's assertion that 
policies and procedures may minimize compliance costs that may be 
passed on to retail customers, noting the uncertainty surrounding how 
conflicts of interest should be addressed by policies and 
procedures.\681\ One commenter suggested that the Commission should 
adopt a safe harbor for the Conflicts of Interest Obligation by 
demonstrating compliance with certain existing FINRA rules.\682\ As 
discussed below under the new Compliance Obligation, some commenters 
suggested that the policies and procedures requirement should apply to 
aspects of the entire rule.\683\
---------------------------------------------------------------------------

    \678\ See Fidelity Letter; SIFMA August 2018 Letter; Morgan 
Stanley Letter.
    \679\ See, e.g., NASAA August 2018 Letter; CFA Institute Letter; 
Galvin Letter; Better Markets August 2018 Letter (policies and 
procedures should be ``actually designed'' to achieve those ends, 
not just ``reasonably designed'' to do so). But see IRI Letter 
(``The Conflict of Interest Obligation should be simplified and 
streamlined to give BDs the flexibility to determine appropriate 
steps to manage material conflicts.'').
    \680\ See Cambridge Letter; CCMC Letters. But see NASAA August 
2018 Letter (suggesting the Commission reconsider the risk-based 
approach to comply with its duties).
    \681\ See, e.g., Better Markets August 2018 Letter; CFA 
Institute Letter.
    \682\ See AXA Letter.
    \683\ See, e.g., NASAA August 2018 Letter (suggesting that, at a 
minimum, a firm's policies and procedures should require an analysis 
of the costs and risks of a product as well as the client's 
financial goals).
---------------------------------------------------------------------------

    In consideration of the comments received, we are adopting the 
approach with respect to reasonably designed policies and procedures to 
identify and address conflicts of interest set forth in the proposal 
substantially as proposed. As stated in the Proposing Release, we 
believe that broker-dealers should have flexibility to tailor their 
policies and procedures to their particular business model, focusing on 
specific areas of their business that pose the greatest risk of 
noncompliance and greatest risk of potential harm to retail customers 
as opposed to a detailed review of each recommendation.\684\
---------------------------------------------------------------------------

    \684\ See Proposing Release at II.D.3.b.
---------------------------------------------------------------------------

    While we recognize a commenter's statement \685\ that policies and 
procedures should be ``actually designed'' to address conflicts of 
interest, we do not believe that the design of policies and procedures 
should be measured against a standard of strict liability, but should 
instead be measured against a standard of reasonableness. In addition, 
we believe that policies and procedures are an effective tool to 
identify and address conflicts of interest, and would allow the 
Commission to identify and address potential compliance deficiencies or 
failures (such as inadequate or inaccurate policies and procedures, or 
failure to follow the policies and procedures) early on, reducing the 
chance of retail customer harm.\686\ We also believe that there is no 
one-size-fits all framework, and, as such, broker-dealers should have 
flexibility to reasonably design their policies and procedures to 
tailor them to account for their business model, given the structure 
and characteristics of their relationships with retail customers, 
including the varying levels and frequency of recommendations provided 
and the types of conflicts that may be presented. This requirement of 
``reasonably designed'' policies and procedures is also consistent with 
Commission rules and regulations in other contexts, including under the 
Advisers Act.\687\ Further, the Commission continues to believe that 
while not required components, as an effective practice, broker-dealers 
should consider including in their supervisory and compliance programs 
the components listed in the Proposing Release, which may be relevant 
in considering whether policies and procedures are reasonably 
designed.\688\
---------------------------------------------------------------------------

    \685\ See Better Markets August 2018 Letter.
    \686\ See infra footnote 809.
    \687\ See Rule 206(4)-7 under the Advisers Act. See also Section 
15(g) of the Exchange Act; 15E(g) of the Exchange Act.
    \688\ These components could include, among other things: 
policies and procedures outlining how the firm identifies conflicts, 
identifying such conflicts and specifying how the broker-dealer 
intends to address each conflict; robust compliance and monitoring 
systems; processes to escalate identified instances of noncompliance 
for remediation; procedures that designate responsibility to 
business line personnel for supervision of functions and persons, 
including determination of compensation; processes for escalating 
conflicts of interest; processes for periodic review and testing of 
the adequacy and effectiveness of policies and procedures; and 
training on policies and procedures. Proposing Release at Section 
II.D.3.b.
---------------------------------------------------------------------------

    The Commission is not providing a safe harbor to Regulation Best 
Interest for broker-dealers who demonstrate compliance with FINRA rules 
\689\ because, while FINRA rules may address specific conflicts of 
interest, Regulation Best Interest establishes a broader obligation to 
address conflicts both at the firm level and at the associated person 
level.\690\ As to commenters' concerns that the policies and procedures 
requirement provides too much flexibility and as discussed in more 
detail below, the Commission has changed the specific requirements to 
be addressed by the policies and procedures pursuant to the Conflict of 
Interest Obligation to provide more certainty to firms on which 
conflicts of interest should be addressed through disclosure, 
mitigation or elimination. While the Commission also understands 
concerns related to compliance costs, we believe that the revisions to 
the Conflict of Interest Obligation, including the greater specificity 
in the rule text, as well as the guidance provided below, will ease the 
adjustment of broker-dealers' existing supervisory and compliance 
systems and streamline compliance with Regulation Best Interest.
---------------------------------------------------------------------------

    \689\ See supra footnote 682.
    \690\ ``While FINRA has repeatedly emphasized the importance of 
identifying and managing conflicts and has a number of rules that 
address discrete conflicts of interest, there is currently no 
similarly broad conflicts provision in FINRA rules, including the 
suitability rule.'' See FINRA 2018 Letter.
---------------------------------------------------------------------------

b. Conflicts of Interest
    The Proposing Release distinguished between material conflicts of 
interest in general and material conflicts of interest arising from 
financial incentives. Under the Proposing Release, broker-dealers would 
be required to establish, maintain, and enforce policies and procedures 
to identify and, in the case of material conflicts of interest, 
disclose or eliminate, and in the case of financial incentives, 
disclose and mitigate, or eliminate material conflicts of interest 
arising from financial incentives.\691\
---------------------------------------------------------------------------

    \691\ See Proposing Release at Section II.D.3.
---------------------------------------------------------------------------

    The Commission proposed to interpret a material conflict of 
interest as a conflict of interest that a reasonable person would 
expect might incline a broker--consciously or unconsciously--to make a 
recommendation that is not disinterested.\692\ For material conflicts 
of interest arising from financial incentives associated with a 
recommendation, the Proposing Release discussed compensation practices 
established by the broker-dealer, including fees and other charges for 
the services provided and products sold; employee compensation or 
employment incentives (e.g., quotas, bonuses, sales contests, special 
awards, differential or variable compensation, incentives tied to 
appraisals or performance reviews); compensation practices involving 
third-parties, including both sales

[[Page 33387]]

compensation and compensation that does not result from sales activity, 
such as compensation for services provided to third-parties (e.g., sub-
accounting or administrative services provided to a mutual fund); 
receipt of commissions or sales charges, or other fees or financial 
incentives, or differential or variable compensation, whether paid by 
the retail customer or a third-party; sales of proprietary products or 
services, or products of affiliates; and transactions that would be 
effected by the broker-dealer (or an affiliate thereof) in a principal 
capacity.\693\
---------------------------------------------------------------------------

    \692\ Proposing Release at 21602.
    \693\ Id.
---------------------------------------------------------------------------

    In addition, the Commission proposed to limit conflicts of interest 
to those associated with recommendations as broker-dealers may provide 
a range of services not involving a recommendation, and such services 
are subject to general antifraud liability and specific requirements to 
address associated conflicts of interest.\694\
---------------------------------------------------------------------------

    \694\ See Proposing Release at 21617. In including this 
limitation, the Commission explained that it was not intending to 
change the disclosure obligations associated with these services 
under the general antifraud provisions of the federal securities 
laws.
---------------------------------------------------------------------------

    Recognizing the phrase ``financial incentives'' could be 
interpreted broadly, the Commission solicited comment on the proposed 
requirement and the distinction between the different requirements 
under the Conflict of Interest Obligation. In response, many commenters 
suggested that the scope of the description of financial incentives be 
narrowed as it was too broad and requested guidance or examples of 
material conflicts of interest that would not fall within the 
description of financial incentives.\695\ Specifically, a number of 
commenters suggested that the mitigation obligation should focus on 
financial incentives at the registered representative level as opposed 
to the firm level.\696\ A number of commenters suggested that the 
distinction between material conflicts and financial incentives should 
be removed altogether.\697\ Commenters also stated that the mitigation 
requirement is a higher standard of conduct than the investment adviser 
fiduciary duty which allows for conflicts to be addressed through 
disclosure sufficient for informed consent.\698\
---------------------------------------------------------------------------

    \695\ See, e.g., SIFMA August 2018 Letter; Primerica Letter; 
BISA Letter; Committee of Annuity Insurers Letter; IPA Letter; CFA 
Institute Letter.
    \696\ See, e.g., Primerica Letter; TIAA Letter; ICI Letter; 
Invesco Letter; Money Management Institute Letter; Committee of 
Annuity Insurers Letter.
    \697\ See, e.g., CFA August 2018 Letter; CFA Institute Letter; 
Morgan Stanley Letter; SIFMA August 2018 Letter; CCMC Letters.
    \698\ See Franklin Templeton Letter (stating that by including 
this heightened requirement for financial conflicts of interest, 
Regulation Best Interest would impose a higher standard on broker-
dealers than is required of investment advisers with respect to such 
conflicts); Primerica Letter (stating that by requiring broker-
dealers to disclose and mitigate or eliminate conflicts resulting 
from financial incentives, the standard is actually higher than the 
standard that applies under the Advisers Act); CCMC Letters (stating 
that the requirement to mitigate or eliminate material conflicts of 
interest arising from financial incentives effectively subjects 
broker-dealers to a higher standard than investment advisers, who 
are generally able to disclose conflicts of interest). See also UBS 
Letter; ASA Letter. Some commenters also suggested that the 
obligation to address conflicts of interest should be harmonized 
between broker-dealers and investment advisers. See, e.g., Schwab 
Letter.
---------------------------------------------------------------------------

    In consideration of comments and as discussed in more detail below, 
the Commission has restructured the Conflict of Interest Obligation to: 
(1) Create an overarching obligation to establish, maintain and enforce 
written policies and procedures that are reasonably designed to 
identify and at a minimum disclose (pursuant to the Disclosure 
Obligation), or eliminate, all conflicts of interest associated with 
the recommendation; and (2) adopt specific requirements with respect to 
such policies and procedures for the mitigation and elimination of 
identified conflicts of interest.
    In particular, we have revised the proposed policies and procedures 
requirement for mitigation to focus on conflicts of interest that 
create an incentive for an associated person to place his or her 
interests ahead of the interest of the retail customer as described 
below, by eliminating the distinction between material conflicts of 
interest and material conflicts of interest arising from financial 
incentives, and removing the affirmative mitigation requirement at the 
firm level. However, in light of this change, we are adding a new 
provision requiring broker-dealers to establish, maintain, and enforce 
written policies and procedures to specifically require broker-dealers 
to identify and disclose material limitations, and any associated 
conflicts of interest a broker-dealer places on the securities or 
investment strategies involving securities that may be recommended to 
the retail customer, such as recommendations being based on limited 
product menus (i.e., only make recommendations of proprietary or other 
limited range of products) and prevent such limitations and associated 
conflicts of interest from causing the broker-dealer to make 
recommendations that place its interest ahead of the retail customer. 
We believe the policies and procedures need to address those certain 
conflicts of interest inherent in the broker-dealer business model by 
heightened measures in order to prevent recommendations that are not in 
the best interest of the retail customer. Therefore, we are adding a 
provision requiring broker-dealers to establish, maintain, and enforce 
written policies and procedures reasonably designed to identify and to 
eliminate any conflicts of interest associated with sales contests, 
sales quotas, bonuses, and non-cash compensation that are based on the 
sale of specific securities or specific types of securities within a 
limited period of time.
    For purposes of Regulation Best Interest, and for the reasons 
described in more detail in the context of the Disclosure Obligation, 
we have also amended the rule text by eliminating ``material'' from 
``conflict of interest'' and codified the definition of a conflict of 
interest \699\ to mean an interest that might incline a broker-dealer--
consciously or unconsciously--to make a recommendation that is not 
disinterested.\700\ While ``material'' has been eliminated, pursuant to 
the Disclosure Obligation, broker-dealers are required to disclose all 
material facts relating to conflicts of interest associated with 
recommendations, consistent with the Proposing Release's intent of 
facilitating disclosure to assist retail customers in making informed 
investment decisions.\701\
---------------------------------------------------------------------------

    \699\ See Section II.D.1. To provide clarity that the 
interpretation of ``conflict of interest'' is limited to Regulation 
Best Interest, the Commission has revised the rule text to include a 
definition of the term.
    \700\ See id.
    \701\ Id.
---------------------------------------------------------------------------

    Regarding the application of the Conflict of Interest Obligation 
only to those conflicts of interest associated with recommendations, 
one commenter stated that given the lack of detail in the Proposing 
Release, broker-dealers may have difficulty determining whether 
material conflicts are associated with a recommendation and how to 
adequately address such conflicts, which could create inconsistent 
application of Regulation Best Interest.\702\ We continue to believe 
this approach is appropriate, for the reasons discussed in the 
Proposing Release \703\ and also believe

[[Page 33388]]

that our revised Conflict of Interest Obligation provides more 
specificity about how to address specific conflicts of interest, in 
conjunction with our Disclosure Obligation, which should address 
commenters' concerns.
---------------------------------------------------------------------------

    \702\ See State Attorneys General Letter. (``Given the lack of 
detail in the Proposed Rule, broker-dealers may have difficulty 
determining whether material conflicts are (1) ``associated with 
recommendations'' and therefore subject to disclosure or 
elimination; or (2) ``arising from financial incentives associated 
with such recommendations'' and therefore subject to disclosure and 
mitigation, or elimination. This ambiguity, while designed to give 
maximum flexibility to broker-dealers, may in fact result in 
inconsistent application of the Proposed Rule nationwide and further 
add to the existing confusion.'')
    \703\ See Proposing Release at 21618.
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c. Identifying Conflicts of Interest
    In the Proposing Release, the Commission stated that having a 
process to identify and appropriately categorize conflicts of interest 
is a critical first step to ensure that broker-dealers have reasonably 
designed policies and procedures to address conflicts of interest in 
order to comply with the Conflict of Interest Obligation. As stated in 
the Proposing Release, reasonably designed policies and procedures to 
identify conflicts of interest generally should do the following: (i) 
Define such conflicts in a manner that is relevant to a broker-dealer's 
business (i.e., conflicts of both the broker-dealer entity and the 
associated persons of the broker-dealer), and in a way that enables 
employees to understand and identify conflicts of interest; (ii) 
establish a structure for identifying the types of conflicts that the 
broker-dealer (and associated persons of the broker-dealer) may face; 
(iii) establish a structure to identify conflicts in the broker-
dealer's business as it evolves; (iv) provide for an ongoing (e.g., 
based on changes in the broker-dealer's business or organizational 
structure, changes in compensation incentive structures, and 
introduction of new products or services) and regular, periodic (e.g., 
annual) review for the identification of conflicts associated with the 
broker-dealer's business; and (v) establish training procedures 
regarding the broker-dealer's conflicts of interest, including 
conflicts of natural persons who are associated persons of the broker-
dealer, how to identify such conflicts of interest, as well as defining 
employees' roles and responsibilities with respect to identifying such 
conflicts of interest.\704\ Most commenters did not express a view on 
such guidance relating to the process of identifying conflicts of 
interest. Therefore, for the reasons discussed in the Proposing 
Release, we are reiterating this guidance here.
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    \704\ Id.
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d. Overarching Obligation Related to Conflicts of Interest
    As proposed, the first component of the Conflict of Interest 
Obligation would have required a broker-dealer to establish, maintain, 
and enforce written policies and procedures reasonably designed to 
identify, and disclose, or eliminate, all material conflicts of 
interest that are associated with recommendations covered by Regulation 
Best Interest. In guidance, the Commission stated that reasonably 
designed policies and procedures should establish a clearly defined and 
articulated structure for: determining how to effectively address 
material conflicts of interest identified (i.e., whether to eliminate 
or disclose (and mitigate, as required) the material conflict); and 
setting forth a process to help ensure that material conflicts are 
effectively addressed as required by the policies and procedures.
    As such, the requirement was intended to provide flexibility to 
broker-dealers regarding how to address conflicts of interest, whether 
through disclosure pursuant to the Disclosure Obligation, or 
elimination. The Commission also indicated that there may be situations 
in which disclosure alone is not sufficient, and broker-dealers may 
need to establish policies and procedures designed to eliminate the 
conflict or both disclose and mitigate it.\705\ The Commission also 
provided examples of how a broker-dealer could eliminate a 
conflict.\706\
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    \705\ See Proposing Release at 21619-21620.
    \706\ Id.
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    As discussed above, we received many comments generally on the 
Conflict of Interest Obligation, requesting clarification on which 
conflicts needed to be disclosed, versus those that should be mitigated 
or eliminated.\707\ Some commenters suggested that disclosure and 
informed consent should be considered to effectively address conflicts, 
similar to the approach taken under the Advisers Act.\708\ Some 
commenters suggested that disclosure alone was sufficient to address 
conflicts arising from financial incentives.\709\ For example, a few 
commenters identified specific types of conflicts they believed could 
be addressed by appropriate disclosure, such as third-party 
payments.\710\ A few commenters requested that the examples of how to 
eliminate conflicts of interest in the Proposing Release be 
removed.\711\
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    \707\ See supra footnote 672.
    \708\ See IPA Letter; Morgan Stanley Letter; ASA Letter.
    \709\ See, e.g., Committee of Annuity Insurers Letter; Stifel 
Letter; Mass Mutual Letter; SIFMA August 2018 Letter; HD Vest 
Letter; Primerica Letter.
    \710\ See, e.g., Invesco Letter; Transamerica August 2018 
Letter; Primerica Letter.
    \711\ See, e.g., ICI Letter (``This example suggests a firm that 
offers proprietary funds should consider relinquishing the advisory 
fees the firm or its affiliate receives for managing those funds as 
a means to address conflicts that selling such funds creates. This 
example is inconsistent with the SEC's explicit statements elsewhere 
in the Best Interest Proposal that Regulation Best Interest would 
not preclude a firm from offering proprietary products. . . .The SEC 
should clarify in any adopting release that firms selling 
proprietary funds are not obligated to credit fund advisory fees 
against other broker-dealer charges. The ability to charge fees to 
manage proprietary funds is critical to preserve the ability of 
firms to offer both proprietary and third-party funds.''); Committee 
of Annuity Insurers Letter (``This suggested method for elimination 
of material conflicts of interest relating to affiliated mutual 
funds presents a number of problematic issues. . . .This example is 
exacerbated in the context of variable annuities.'').
---------------------------------------------------------------------------

    After carefully considering comments, we are adopting, similar to 
the Proposing Release, an overarching requirement to establish, 
maintain, and enforce reasonably designed policies and procedures to 
identify and, at a minimum, disclose, in accordance with the Disclosure 
Obligation, or eliminate all conflicts of interest associated with the 
recommendation. However, as discussed in the following sections, we are 
otherwise revising the Conflict of Interest Obligation in response to 
these comments. Subparagraphs (a)(2)(iii)(B)-(D) of the rule text will 
now require policies and procedures that are reasonably designed to 
address specific conflicts of interest in areas that we believe create 
greater incentives for, and increased risk that, the broker-dealer or 
associated person may place its or his or her own interest ahead of the 
retail customer's interest, specifically conflicts of interest that: 
(1) Create certain incentives to associated persons; (2) conflicts of 
interest associated with material limitations on the securities or 
investment strategies involving securities, such as, limited product 
menus; and (3) sales contests, sales quotas, bonuses, and non-cash 
compensation based on the sales of specific securities or type of 
security within a limited period of time.
    In adopting this overarching requirement, we are reaffirming 
guidance in the Proposing Release on establishing a process to identify 
and determine how to address a conflict, as discussed above.\712\ 
Further, similar to the Proposing Release, while we are not requiring 
broker-dealers to develop policies and procedures to disclose and 
mitigate all conflicts of interest, we are requiring that broker-
dealers develop policies and procedures reasonably designed to ``at a 
minimum disclose, or eliminate'' all conflicts.\713\ We continue to 
believe that where a broker-dealer cannot fully and fairly disclose a 
conflict of interest in accordance with the Disclosure Obligation, the 
broker-dealer should eliminate the conflict or adequately mitigate 
(i.e., reduce) the

[[Page 33389]]

conflict such that full and fair disclosure in accordance with the 
Disclosure Obligation is possible. In some cases, conflicts of interest 
may be of a nature and extent that it would be difficult to provide 
disclosure that adequately conveys to a retail customer the material 
facts or the nature, magnitude and potential effect of the conflict for 
informed decision-making or where disclosure may not be sufficiently 
specific or comprehensible for the retail customer to understand 
whether and how the conflict will affect the recommendations he or she 
receives.\714\ Also, in certain situations, a broker-dealer, even if 
not required, may determine that in addition to addressing a conflict 
through disclosure, to take additional steps beyond disclosure to also 
mitigate the conflict of interest.
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    \712\ See Section II.C.3.c.
    \713\ Proposing Release at 21620.
    \714\ See id.; see also Fiduciary Interpretation (stating that 
where an investment adviser cannot fully and fairly disclose a 
conflict such that the client can provide informed consent, the 
adviser should eliminate the conflict or adequately mitigate (i.e., 
modify practices to reduce) the conflict such that full and fair 
disclosure and informed consent are possible).
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    The Commission acknowledges commenters' concerns regarding the 
examples of how to eliminate conflicts of interest that were provided 
in the Proposing Release. The Commission's intent was not to prevent 
firms from offering certain products to the extent that they are in a 
retail customer's best interest. In order to avoid confusion and to 
respond to commenters, we are not including these examples as final 
guidance here as we have instead decided to focus the rule text on 
specific conflicts of interest associated with certain sales practices 
based on the sale of specific securities that we require to be 
eliminated and thus such examples are not necessary. In discussing the 
separate mitigation and elimination requirements below, we provide 
guidance on the specific conflicts for which we are requiring these 
heightened measures beyond disclosure. However, while we have removed 
the examples of potential conflicts of interest that may be more 
appropriately avoided, we emphasize that pursuant to the overarching 
obligation, elimination of conflicts of interest is one method of 
addressing the conflict, in lieu of disclosure, which broker-dealers 
may find appropriate in certain circumstances even when not required by 
Regulation Best Interest.
e. Mitigation of Certain Incentives to Associated Persons
    We proposed to require firms to establish, maintain, and enforce 
written policies and procedures reasonably designed to identify and 
disclose and mitigate, or eliminate, material conflicts of interest 
arising from financial incentives with such recommendations. In 
proposing this requirement, we recognized the importance of the 
brokerage model as a potentially cost-effective option for investors, 
acknowledging that the compensation structures and arrangements within 
the business model create inherent conflicts \715\ but that such 
compensation may be appropriate in light of the time and experience 
necessary to understand investments. As such, we aimed to promote 
investor choice and access to products and instead of requiring broker-
dealers to establish policies and procedures to eliminate compensation 
structures and arrangements,\716\ required policies and procedures to 
mitigate those conflicts of interest.
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    \715\ See Proposing Release at II.D.3.e. See also Tully Report.
    \716\ While the Commission's goal is to promote access and 
choice to investors, as discussed in more detail in Section 
II.C.3.g, Elimination of Certain Conflicts of Interest, the 
Commission believes it is in the public interest and will enhance 
investor protection to require broker-dealers to reasonably design 
policies and procedures to eliminate certain conflicts of interest 
as we believe such conflicts create too strong of an incentive for a 
broker-dealer to make a recommendation that places the broker-
dealer's interest ahead of the retail customer's interest.
---------------------------------------------------------------------------

    We proposed a principles-based approach to provide flexibility to 
firms to develop and tailor policies and procedures that included 
conflict mitigation measures based on each firm's circumstances, for 
example, the size, retail customer base, nature and significance of the 
conflict, and complexity of the product.\717\ We stated that, depending 
on the conflict and the firm's assessment, more or less demanding 
measures may be appropriate.\718\ We provided examples of situations in 
which heightened mitigation measures may be appropriate and also 
suggested that broker-dealers assess their policies and procedures as 
they may be reasonably designed at the outset but may later cease to be 
reasonably designed based on subsequent events or information.\719\ 
Finally, we provided a non-exhaustive list of potential practices that 
we believe broker-dealers should consider including in their policies 
and procedures, and as discussed above, suggested that some practices 
may be more appropriately avoided as they may be difficult to 
mitigate.\720\
---------------------------------------------------------------------------

    \717\ Proposing Release at II.D.3.e.
    \718\ Id.
    \719\ Id.
    \720\ Id.
---------------------------------------------------------------------------

    As discussed above, many commenters expressed concern with the 
breadth of the mitigation requirement and requested that mitigation be 
limited to certain types of compensation \721\ or solely to financial 
incentives to the individual registered representative.\722\ Many 
commenters were also concerned about what they described as ambiguities 
in the Proposing Release, including the lack of a definition of the 
term ``mitigate'' \723\ and requested further guidance surrounding 
conflicts that needed to be mitigated versus those that can be 
disclosed.\724\ Some commenters suggested that supervision should be 
adequate mitigation and requested clarification on whether their 
existing supervisory practices, if compliant, were sufficient.\725\ As 
discussed above under Section II.C.3.b, a number of commenters 
expressed concern that the mitigation requirement is a higher standard 
of conduct than the investment adviser fiduciary duty and requested 
that it be aligned with the fiduciary duty.\726\
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    \721\ See, e.g., Cetera August 2018 Letter; SIFMA August 2018 
Letter. But see CFA August 2018 Letter (stating that the Commission 
has proposed an appropriately broad definition of material conflicts 
that arise out of financial incentives and that it should not be 
narrowed but a cleaner approach would be to eliminate the artificial 
distinction between those material conflicts of interest that arise 
from financial incentives and those that do not, and to apply the 
same obligation to disclose and mitigate all material conflicts, 
whatever the source).
    \722\ See, e.g., Primerica Letter; Committee of Annuity Insurers 
Letter; Cetera August 2018 Letter. See also Wells Fargo Letter 
(stating that receipt of fees and other revenue that does not 
otherwise result in a direct financial incentive at the registered 
representative level should be disclosed); ICI Letter (recommending 
revisions to the proposed conflict of interest obligation to focus 
the mitigation obligation on the fees, revenue, or other financial 
incentives that may influence the recommendation of a broker-dealer 
representative--the individual making the recommendation); Invesco 
Letter.
    \723\ See, e.g., UVA Letter.
    \724\ See, e.g., CFA August 2018 Letter; Wells Fargo Letter; 
Committee of Annuity Insurers Letter; NASAA August 2018 Letter; 
Cetera August 2018 Letter; Morningstar Letter.
    \725\ See, e.g., BISA Letter; AALU Letter; Primerica Letter; 
Committee of Annuity Insurers Letter.
    \726\ Supra footnote 698.
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    Many commenters expressed concern over some of the examples, and in 
particular neutral compensation factors, described as a potential 
mitigation measure.\727\ Similarly, some

[[Page 33390]]

commenters suggested that the Commission should take more of a 
principles-based approach as they viewed the Proposing Release as too 
prescriptive because it incorporated examples from the DOL Fiduciary 
Rule.\728\ One commenter expressed concern over the suggestion that 
heightened mitigation may be appropriate if a retail customer has a 
less sophisticated understanding, stating that it is unclear how 
mitigation would be measured and could create heightened costs and 
risks for firms.\729\ Finally, some commenters requested confirmation 
that certain practices are permissible such as use of compensation 
grids,\730\ receipt of revenue sharing,\731\ differential 
compensation,\732\ recommendations based on a limited range of products 
and proprietary products,\733\ and use of employment benefits.\734\
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    \727\ See, e.g., SIFMA August 2018 Letter; ICI Letter; Edward 
Jones Letter; Morgan Stanley Letter; Transamerica August 2018 
Letter; Ameriprise Letter; Capital Group Letter; Cetera August 2018 
Letter; CCMC Letters; Letter from Michelle Bryan Oroschakoff, Chief 
Legal Officer, LPL Financial (Dec. 18, 2018) (``LPL December 2018 
Letter'') (requesting confirmation that the non-exhaustive list of 
potential practices was intended merely as a list of examples and 
are not required mitigation practices); Mass Mutual February 2019 
Letter. But see NASAA August 2018 Letter (stating that neutral 
compensation across products could constitute appropriate 
mitigation), State Attorneys General Letter (suggesting differential 
compensation be permitted based solely on neutral factors).
    \728\ See, e.g., LPL August 2018 Letter; Cetera August 2018 
Letter; Davis Harman Letter.
    \729\ See Primerica Letter.
    \730\ See, e.g., SIFMA August 2018 Letter; Committee of Annuity 
Insurers Letter; Primerica Letter.
    \731\ See, e.g., SIFMA August 2018 Letter; Cetera August 2018 
Letter.
    \732\ See, e.g., Cetera August 2018 Letter; Transamerica August 
2018 Letter; Ameriprise Letter.
    \733\ See, e.g., NY Life Letter; Fidelity Letter; ICI Letter; 
T.Rowe Letter. These commenters suggested that disclosure would be 
an appropriate way to address conflicts of interest associated with 
limited product menus and proprietary products.
    \734\ See, e.g., AALU Letter.
---------------------------------------------------------------------------

    In response to commenters, we have revised the Proposing Release's 
requirement with respect to mitigation to require broker-dealers to 
establish policies and procedures reasonably designed to identify and 
mitigate any conflicts of interest associated with such recommendations 
that create an incentive for a natural person who is an associated 
person of a broker- dealer to place the interest of the broker-dealer, 
or such natural person ahead of the interest of the retail customer.
    We agree with commenters that it is appropriate to focus on the 
incentives that directly affect the associated person making a 
recommendation, because we believe those conflicts are most likely to 
undermine the associated person's ability to make a recommendation that 
is in the best interest of the retail customer, and thus present 
heightened risk of recommendations that are not in a retail customer's 
best interest and that place the associated person's or firm's 
interests ahead of the retail customer's interest.
    While disclosure can be an effective tool for retail customers to 
increase awareness of a conflict of interest,\735\ in certain cases, we 
do not believe that disclosure alone sufficiently reduces the potential 
effect that these conflicts of interest may have on recommendations 
made to retail customers.\736\ Instead, we believe that broker-dealers 
are most capable of identifying and addressing the conflicts that may 
affect the obligations of their associated persons with respect to the 
recommendations they make, and therefore are in the best position, to 
affirmatively reduce the potential effect of these conflicts of 
interest such that they do not taint the recommendation.
---------------------------------------------------------------------------

    \735\ See Section II.C.1, Disclosure Obligation; Relationship 
Summary Adopting Release.
    \736\ See, e.g., Tully Report; CFA August 2018 Letter; AARP 
August 2018 Letter; Warren Letter (``the [Commission] should not 
rely on disclosure alone to protect consumers.''). See also DOL 
Fiduciary Rule Release at 20950. ``Disclosure alone has proven 
ineffective to mitigate conflicts in advice.''
---------------------------------------------------------------------------

    We are persuaded by commenters \737\ that expressed concern that 
requiring broker-dealers to establish policies and procedures 
reasonably designed to mitigate all financial incentives, including any 
compensation, may result in broker-dealers narrowing their product 
shelf and compensation practices which would be inconsistent with the 
Commission's stated goal.\738\ As stated in the Proposing Release, 
while the Commission's goal in adopting Regulation Best Interest is to 
enhance investor protection by reducing the potential harm to retail 
customers from conflicts of interest that may affect broker-dealer 
recommendations, we want to do so while preserving, to the extent 
possible, access and choice for investors who prefer to pay for 
investment recommendations on a transaction-by-transaction basis, which 
is the ``pay as you go'' model that broker-dealers generally provide, 
as well as preserving retail customer choice of the level and types of 
advice provided and the products available.\739\ As such, transaction 
based-compensation need not be eliminated pursuant to Regulation Best 
Interest.
---------------------------------------------------------------------------

    \737\ See, e.g., Primerica Letter (``The SEC's current 
formulation of the conflicts obligation thus inappropriately, and we 
believe unintentionally, preferences advisory models over brokerage 
models.''); Transamerica August 2018 Letter (expressing concern that 
the proposed interpretation of financial incentives is overbroad and 
may result in broker-dealers narrowing their product shelf, which 
seems inconsistent with the SEC's stated goal of preserving the 
broker-dealer model to protect an investor's right to choose between 
brokerage and advisory accounts).
    \738\ The Commission recognizes that a broker-dealer's financial 
or other interest can and will inevitably exist.
    \739\ We are persuaded by commenters regarding the competitive 
issues for broker-dealers that could arise if we require mitigation 
of firm-level financial incentives, which is not required by an 
investment adviser's fiduciary duty, and could further encourage 
migration from the broker-dealer to investment adviser model and 
result in a loss of choice for retail customers. See Section I; CCMC 
Letters (``Imposing a standard on broker-dealers with respect to 
managing conflicts of interest that is greater than that imposed on 
investment advisers, on top of the additional regulatory obligations 
to which broker-dealers are subject that are not imposed on 
investment advisers, threatens to undermine the SEC's objective of 
preserving retail customer choice and access to the brokerage advice 
model and may introduce a new source of confusion when it comes to 
investors' understanding of the duties they are owed.''); AALU 
Letter (``Overly-rigid mitigation requirements could limit consumer 
choice of products and access to professional financial advice''). 
See also 913 Study; Proposing Release at 21575.
---------------------------------------------------------------------------

    Accordingly, rather than requiring mitigation of all firm-level 
financial incentives, we have determined to refine our approach by 
generally allowing firm-level conflicts to be generally addressed 
through disclosure.\740\ At the same time, we are persuaded by 
commenters \741\ that there are some conflicts that should be addressed 
through mitigation at the firm level due to the potential impact that 
we believe certain conflicts of interest (either at the associated 
person or firm level) may have on recommendations to retail customers; 
therefore we are requiring policies and procedures for mitigation or 
elimination of those conflicts (as identified in the rule text) and are 
not leaving it to the broker-dealer to determine whether disclosure 
alone is sufficient.\742\ We believe that this approach appropriately 
balances our goal of reducing the potential harm conflicts of interest 
may have on broker-dealers' recommendations to retail customers and 
preserving retail access (in terms of choice and cost) to brokerage 
products and services.
---------------------------------------------------------------------------

    \740\ As discussed above in the section about the Disclosure 
Obligation, the Commission believes that compliance with the 
Disclosure Obligation, including disclosure of the material facts 
relating to the scope and terms of the relationship with the retail 
customer and all conflicts of interest, should give sufficient 
information to enable a retail customer to make an informed decision 
with regard to the recommendation. See II.D.1.
    Nevertheless, as noted, there may be situations in which 
disclosure alone may not be sufficient to provide ``full and fair'' 
disclosure in accordance with the Disclosure Obligation discussed 
above, and the broker-dealer may need to take additional steps to 
mitigate or eliminate the conflict, consistent with an investment 
adviser's fiduciary duty. See Section II.C.3.d.
    \741\ See, e.g., CFA August 2018 Letter.
    \742\ See Section II.C.3.f and g.
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i. Guidance on Covered Incentives
    The Commission interprets this requirement to establish, maintain, 
and enforce reasonably designed policies and procedures to identify and 
mitigate

[[Page 33391]]

any conflicts of interest that create an incentive for the associated 
person to place the interest of the broker-dealer or such associated 
person ahead of the interest of the retail customer, to only apply to 
incentives provided to the associated person, whether by the firm or 
third-parties that are within the control of or associated with the 
broker-dealer's business.\743\ It would not cover external interests of 
the associated person not within the control of or associated with the 
broker-dealer's business.\744\ In the case of a dually registered 
individual, this requirement would generally only apply to incentives 
provided to the associated person when making a recommendation in a 
brokerage capacity and not when making a recommendation in an 
investment advisory capacity as the investment adviser fiduciary duty 
would apply to the advice given in that instance.\745\
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    \743\ The ability to control the compensation of associated 
person, including incentives, is an important mechanism by which 
broker-dealers exercise supervisory control over sales practices.
    \744\ For example, if an associated person of a broker-dealer 
participates in a securities transaction outside of the broker-
dealer and receives compensation, although the broker-dealer would 
need to approve the transactions and record it in its books and 
records under FINRA Rule 3280 (Private Securities Transaction of an 
Associated Person), as described in more detail above, this 
requirement to mitigate certain incentives to an associated person 
would not apply to compensation that is not an incentive provided by 
or in the control of the broker-dealer.
     Nevertheless, additional registration, disclosure or other 
obligations, and antifraud liabilities may apply to any other firm 
through which an associated person may have such external interests 
under federal or state law (for example, as a state-registered 
adviser). We also note that an associated person of a broker-dealer 
who receives transaction-based compensation and participates in a 
private securities transactions that is not in accordance with FINRA 
Rule 3280 should be mindful of the broker-dealer registration 
requirements under Section 15 of the Exchange Act.
    \745\ See Fiduciary Interpretation; Section II.B.3.
---------------------------------------------------------------------------

    The Commission generally considers the following as examples of 
incentives to an associated person that would need to be addressed 
under this revised provision: (i) Compensation from the broker-dealer 
or from third-parties, including fees and other charges for the 
services provided and products sold; (ii) employee compensation or 
employment incentives (e.g., incentives tied to asset accumulation and 
not prohibited under (a)(2)(iii)(D), as discussed below, special 
awards, differential or variable compensation, incentives tied to 
appraisals or performance reviews); and (iii) commissions or sales 
charges, or other fees or financial incentives, or differential or 
variable compensation, whether paid by the retail customer, the broker-
dealer or a third-party. These examples focus on compensation that 
varies based on the advice given, such as commissions, markups/
markdowns, loads, revenue sharing, and Rule 12b-1 fees.
ii. Guidance on Mitigation Methods
    By requiring that a broker-dealer establish policies and procedures 
reasonably designed to ``mitigate'' these conflicts of interest, we 
mean the policies and procedures must be reasonably designed to reduce 
the potential effect such conflicts may have on a recommendation given 
to a retail customer. Thus, whether or not a broker-dealer's policies 
and procedures are reasonably designed to mitigate such conflicts will 
be based on whether they are reasonably designed to reduce the 
incentive for the associated person to make a recommendation that 
places the associated person's or firm's interests ahead of the retail 
customer's interest.
    As noted in the Proposing Release, in lieu of mandating specific 
mitigation measures or a ``one-size fits all'' approach, we are 
providing broker-dealers with flexibility to develop and tailor 
reasonably designed policies and procedures that include conflict 
mitigation measures, based on each firm's circumstances.\746\ 
Reasonably designed policies and procedures should include mitigation 
measures that depend on the nature and significance of the incentives 
provided to the associated person and a variety of factors related to a 
broker-dealer's business model (such as the size of the broker-dealer, 
retail customer base (e.g., diversity of investment experience and 
financial needs), and the complexity of the security or investment 
strategy involving securities that is being recommended), some of which 
may be weighed more heavily than others. For example, more stringent 
mitigation measures may be appropriate in situations where the 
characteristics of the retail customer base in general displays less 
understanding of the incentives associated with particular securities 
or investment strategies; \747\ where the compensation is less 
transparent (for example, an incentive from a third-party or charge 
built into the price of the product or a transaction versus a straight 
commission); or in a situation involving a complex security or 
investment strategy.\748\ A broker-dealer could reasonably determine 
through its policies and procedures that the same mitigation measures 
could apply to a particular type of retail customer, type of security 
or investment strategy, or type of incentive across the board; or in 
some instances a broker-dealer may reasonably determine that some 
conflicts create incentives that may be more difficult to mitigate, and 
are more appropriately avoided in their entirety or for certain 
categories of retail customers.\749\
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    \746\ See Proposing Release at 21618. See also Letter from 
Steven W. Stone, Morgan, Lewis & Bockius LLP (May 3, 2019) (``Morgan 
Lewis Letter'') (``The Commission should recognize that firms may 
appropriately employ only some--or various combinations--of these 
approaches depending on their businesses and business models, 
compensation structures, and related conflicts of interest, and 
should not prescribe a one-size-fits-all approach to mitigating 
compensation-related conflicts.'').
    \747\ FINRA's heightened suitability requirements for options 
trading accounts require that a registered representative have ``a 
reasonable basis for believing, at the time of making the 
recommendation, that the customer has such knowledge and experience 
in financial matters that he may reasonably be expected to be 
capable of evaluating the risks of the recommended transaction, and 
is financially able to bear the risks of the recommended position in 
the complex product.'' FINRA Rule 2360(b)(19).
    \748\ See Proposing Release at 21620-21621.
    \749\ Id.
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    As noted in the Proposing Release, policies and procedures may be 
reasonably designed at the outset, but may later cease to be reasonably 
designed based on subsequent events or information obtained (for 
example, such as through supervision (e.g., exception testing) of 
associated person recommendations), and the actual experience of a 
broker-dealer should be used to revise the broker-dealer's measures as 
appropriate.\750\ Further, what are considered reasonable mitigation 
measures may vary based on the size of the firm.\751\ While many 
broker-dealers have programs currently in place to manage conflicts of 
interest, each broker-dealer will need to carefully consider whether 
its existing framework complies with this provision.\752\
---------------------------------------------------------------------------

    \750\ Id.
    \751\ In the FINRA Conflicts Report, FINRA identified certain 
mitigation measures firms implemented that we believe highlight 
differences in conflict management frameworks, based on the size of 
the firm. For example, large firms may address conflicts of interest 
through enterprise management or operational risk frameworks, and 
components of such programs, for example, risk and control self-
assessments, may provide an opportunity to identify and evaluate 
possible impacts. By contrast, small firms selling basic products 
may have a conflicts management framework that relies largely on the 
tone set by the firm owner coupled with required supervisory 
controls, particularly related to suitability, and the firm's 
compensation structure. See FINRA Conflicts Report. An effective 
practice FINRA observed at a number of firms is implementation of a 
comprehensive framework to identify and manage conflicts of interest 
across and within firms' business lines that is scaled to the size 
and complexity of their business. See FINRA Conflicts Report at 5.
    \752\ See Proposing Release at 21621.
---------------------------------------------------------------------------

    In response to commenters' concerns regarding the potential 
mitigation

[[Page 33392]]

methods described in the Proposing Release, and, in particular, the 
references to neutral factors,\753\ we would like to emphasize that 
this non-exhaustive list of factors is purely illustrative and the 
factors are not required elements.\754\ In providing these examples, we 
did not intend to take a prescriptive approach, as suggested by some 
commenters, but a principles-based approach designed to provide 
flexibility to broker-dealers, depending on their business model, level 
of conflicts, and the retail customers they serve.\755\
---------------------------------------------------------------------------

    \753\ See, e.g., Mass Mutual February 2019 Letter; Edward Jones 
Letter; IRI Letter; Capital Group Letter; SIFMA August 2018 Letter; 
Committee of Annuity Insurers Letter.
    \754\ See Proposing Release at 21621.
    \755\ See Proposing Release at 21622.
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    Among other things, firms may adopt a range of reasonable 
alternatives to meet the mitigation requirement of the Conflict of 
Interest Obligation. As noted above, we recognize that there are a 
number of different kinds of incentives and that, depending on the 
specific characteristics of an incentive, different levels and types of 
mitigation measures may be necessary. For example, incentives tied to 
asset accumulation generally would present a different risk and require 
a different level or kind of mitigation, than variable compensation for 
similar securities, which in turn may present a different level or kind 
of risk and may require different mitigation methods than differential 
or variable compensation or financial incentives tied to firm revenues. 
In certain instances, we believe that compliance with existing 
supervisory requirements and disclosure may be sufficient, for example, 
where a firm may develop a surveillance program to monitor sales 
activity near compensation thresholds.\756\
---------------------------------------------------------------------------

    \756\ FINRA Conflicts Report at 30-31.
---------------------------------------------------------------------------

    As discussed above, while not required elements, the Commission 
believes the following non-exhaustive list of practices could be used 
as potential mitigation methods for firms to comply with (a)(2)(iii)(B) 
of Regulation Best Interest:
     Avoiding compensation thresholds that disproportionately 
increase compensation through incremental increases in sales;
     minimizing compensation incentives for employees to favor 
one type of account over another; or to favor one type of product over 
another, proprietary or preferred provider products, or comparable 
products sold on a principal basis, for example, by establishing 
differential compensation based on neutral factors; \757\
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    \757\ As noted above, we are not requiring firms to establish 
differential compensation based on neutral factors but do believe 
firms could choose to do so as potential practice to promote 
compliance with the requirement to establish, maintain, and enforce 
written policies and procedures reasonably designed to identify and 
mitigate any conflicts of interest that create an incentive for an 
associated person to place its interest ahead of the interest of the 
retail customer.
---------------------------------------------------------------------------

     eliminating compensation incentives within comparable 
product lines by, for example, capping the credit that an associated 
person may receive across mutual funds or other comparable products 
across providers;
     implementing supervisory procedures to monitor 
recommendations that are: Near compensation thresholds; near thresholds 
for firm recognition; involve higher compensating products,\758\ 
proprietary products or transactions in a principal capacity; or, 
involve the roll over or transfer of assets from one type of account to 
another (such as recommendations to roll over or transfer assets in an 
ERISA account to an IRA) or from one product class to another; \759\
---------------------------------------------------------------------------

    \758\ See Morgan Lewis Letter (suggesting, among other things, 
that firms can conduct surveillance (whether transactions, periodic, 
or forensic) to identify activity that appears to be driven by 
compensation considerations--whether at the representative, team, or 
business level--rather than a customer's interest).
    \759\ See FINRA Exam Report 2017. FINRA observed a variety of 
effective practices in recommending the purchase and sale of UITs, 
including tailoring supervisory systems to products' features and 
sources of risk to customers.
---------------------------------------------------------------------------

     adjusting compensation for associated persons who fail to 
adequately manage conflicts of interest; and
     limiting the types of retail customer to whom a product, 
transaction or strategy may be recommended.\760\
---------------------------------------------------------------------------

    \760\ See, e.g., supra footnote 747; FINRA Regulatory Notice 12-
03, Heightened Supervision of Complex Products (Jan. 2012).
---------------------------------------------------------------------------

    While the Commission is providing flexibility so that broker-
dealers can determine the nature and extent of mitigation, whether a 
broker-dealer has developed policies and procedures reasonably designed 
to mitigate a conflict is not measured against industry practice 
(although such practice could be a useful point of reference). Each 
firm must look at the facts and circumstances surrounding the 
mitigation methods, the particular broker-dealer's business model, and 
whether or not the policies and procedures were reasonably designed for 
the particular firm to reduce the impact of the incentive in a manner 
to prevent the incentive from causing the associated person to place 
the broker-dealer's or the associated person's interest ahead of the 
retail customer's interest.
    In response to a commenter's concern that we suggested in the 
Proposing Release that some compensation conflicts may be more 
appropriately avoided for certain categories of retail customers,\761\ 
we would like to clarify that such a suggestion is an example and not a 
requirement. Nevertheless, we are adopting a requirement to establish, 
maintain, and enforce written policies and procedures reasonably 
designed to eliminate the incentives that we believe create the most 
problematic conflicts, namely incentives to associated persons that are 
tied to recommendations of specific securities or specific types of 
securities within a limited period of time as we believe these 
incentives cannot be adequately mitigated, and are likely to result in 
recommendations that place the interest of the broker-dealer or 
associated person ahead of the interests of the retail customer. 
Furthermore, in accordance with the Care Obligation, a broker-dealer, 
when making a recommendation, is required to, among other things, have 
a reasonable basis to believe that the recommendation is in the best 
interest of the particular retail customer.\762\ In particular, and 
consistent with existing suitability obligations, a broker-dealer is 
required to exercise ``reasonable diligence'' to ascertain (and 
consider) the retail customer's investment profile which, among other 
things, includes the retail customer's investment experience and risk 
tolerance.\763\ A broker-dealer that has established reasonably 
designed policies and procedures to mitigate the conflicts associated 
with the incentives provided to the associated person would 
nevertheless violate Regulation Best Interest if the recommendation 
does not comply with the Care Obligation.
---------------------------------------------------------------------------

    \761\ See Primerica Letter (``The SEC's statements in the 
Proposals regarding the additional protections broker-dealers should 
afford `less sophisticated' retail customers could create a sub-
class of retail customers that broker-dealers would have to identify 
based on subjective and poorly defined criteria, and potentially 
further restrict access to help with saving and investing for 
customers who need it most.'').
    \762\ See Section II.C.2.
    \763\ Id.
---------------------------------------------------------------------------

    Finally, in response to commenters' questions regarding the 
permissibility of specific practices, the Commission believes the 
revised, explicit requirements related to: Mitigation of incentives to 
associated persons as discussed herein; mitigation of any material 
limitations placed on the securities or investment strategies that may 
be recommended to retail customers; and elimination of certain

[[Page 33393]]

practices, as discussed below, sufficiently address these comments. To 
the extent the Commission has not identified a practice that needs to 
be eliminated, it would be permitted, subject to compliance with the 
requirements of Regulation Best Interest.
f. Mitigation of Material Limitations on Recommendations to Retail 
Customers
    As part of the proposed requirement to manage conflicts of interest 
arising from financial incentives through mitigation, firms would have 
been required to establish policies and procedures reasonably designed 
to mitigate the conflicts of interest associated with offering a 
limited range of products and proprietary products.
    We also solicited comment on information related to the magnitude 
of conflicts of interest when broker-dealers recommend, among other 
things, proprietary products and a limited range of products. In 
response, several commenters requested that the Commission confirm that 
a product menu limited to appropriate alternative investments offered 
by the broker-dealer would not violate Regulation Best Interest.\764\ 
Some commenters requested we clarify that, for certain customers, a 
firm can limit its offerings to proprietary products or products for 
which the firm receives revenue sharing payments if the limitation is 
properly disclosed and appropriate to meet the retail customer's 
needs.\765\
---------------------------------------------------------------------------

    \764\ See, e.g., SIFMA August 2018 Letter (requesting 
clarification on how a broker-dealer could satisfy the Conflict of 
Interest Obligation if the platform is limited to certain bond 
offerings); Fidelity Letter (stating that given the vast array of 
readily available investment options and the breadth of securities 
typically available to customers through broker-dealers, some 
limitation of the universe of investment options must be undertaken 
in order for a broker-dealer to adequately understand, compare and 
formulate a recommendation); Prudential Letter (``It is unclear what 
`significantly limits' means for firms that offer predominantly, but 
not exclusively, proprietary products. It is also unclear what 
constitutes a `small choice of investments.' Additional examples or 
more prescriptive instructions regarding when firms must disclose 
such limitations would be helpful.''). See also Guardian August 2018 
Letter; LPL August 2018 Letter; LPL December 2018 Letter.
    \765\ See, e.g., SIFMA August 2018 letter; CFA Institute Letter; 
Letter from Emanuel Alves, Senior Vice President and General 
Counsel, John Hancock Life Insurance Company (Aug. 3, 2018) (``John 
Hancock Letter''); Ameriprise Letter. See also NY Life Letter 
(recommending the Commission require disclosure of the limits on the 
universe of available products, while allowing further context so 
that firms describe the full scope and impact of those limits); 
SPARK Letter (recognizing that the SEC did not want to mandate 
specific mitigation procedures or a ``one-size-fits'' all'' approach 
but requesting further guidance in the case of, among other things, 
broker-dealers who only offer proprietary products or only offer 
limited investment menus). But see CFA August 2018 Letter 
(suggesting that simply stating that a firm offers a limited 
selection of investments may not be enough for an investor to 
understand the limitations).
---------------------------------------------------------------------------

    In consideration of these comments, and our revisions to remove 
firm-level conflicts from the proposed mitigation provision discussed 
above, we are adopting a new requirement to specifically address the 
conflicts of interest presented when broker-dealers place any material 
limitations on the securities or investment strategies that may be 
recommended to a retail customer (i.e., only make recommendations of 
proprietary or other limited ranges of products). While we generally 
believe that most firm-level conflicts of interest can be addressed 
through appropriate disclosure, this new provision focuses on the 
specific firm-level conflicts--namely, the conflicts associated with 
the establishment of a product menu--which we believe are most likely 
to affect recommendations made to retail customers and have the 
greatest potential to result in recommendations that place the interest 
of the broker-dealer or associated person ahead of the interest of the 
retail customer.\766\ Given the potential impact on recommendations to 
retail customer, we believe these conflicts should not be left to the 
broker-dealer to determine whether disclosure alone is sufficient, and 
are requiring broker-dealers to establish, maintain, and enforce 
written policies and procedures reasonably designed to (1) identify and 
disclose any material limitations broker-dealers place on their 
securities offerings or investment strategies involving securities and 
any associated conflicts of interest and (2) prevent such limitations 
and associated conflicts of interest from causing the broker-dealer to 
make recommendations that place the broker-dealer's interest ahead of 
the interest of the retail customer.
---------------------------------------------------------------------------

    \766\ See CFA August 2018 Letter (``[M]any broker-dealers 
currently restrict choice by only recommending from a limited menu 
of proprietary funds or by only recommending products from companies 
that make revenue sharing payments. If limits on investor choice are 
of concern to the Commission, surely such limits deserve equal 
scrutiny. After all, evidence suggests that the limited menus 
offered by some firms consist entirely of low quality products that 
impose excessive costs, deliver inferior returns, and expose 
investors to excessive risk.'')
---------------------------------------------------------------------------

    While we believe broker-dealers should be permitted to limit their 
product offerings from which they make recommendations to retail 
customers, provided that they comply with Regulation Best 
Interest,\767\ we are also concerned that without requiring a broker-
dealer to have a process in place to disclose and address negative 
effects of such limitations, retail customers may be unaware that a 
broker-dealer offers only a limited set of products and therefore would 
be unable to make an informed investment decision.\768\ We are also 
concerned that retail customers may be harmed by such limitations if 
they are more likely to result in recommendations that are not in the 
best interest of the retail customer.\769\
---------------------------------------------------------------------------

    \767\ See Section II.C.2 for a related discussion of the 
application of the Care Obligation to such limitations. See also 
AFL-CIO April 2019 Letter (recommending that the Commission make 
clear that it will hold firms accountable for developing a product 
menu that complies with the first prong of the proposed best 
interest standard and that under such approach, firms would 
periodically assess their product offerings against other products 
available in the marketplace in order to ensure that their offerings 
are competitive).
    \768\ See Disclosure Obligation at Section II.C.1.
    \769\ We believe that by including this requirement to address 
material limitations to product menus, which does not rely on 
disclosure alone, coupled with the requirements under the Care 
Obligation, we are addressing a commenter's concern that product 
limitations can limit investor choice which in turn harms investors. 
See CFA August 2018 Letter.
---------------------------------------------------------------------------

    Broker-dealers will be required to establish, maintain and enforce 
written policies and procedures reasonably designed to: (i) Identify 
and disclose any material limitations placed on the securities or 
investment strategies involving securities that may be recommended to a 
retail customer and any conflicts of interest associated with such 
limitations, in accordance with the Disclosure Obligation, and (ii) 
prevent such limitations and associated conflicts of interest from 
causing the broker, dealer, or a natural person who is an associated 
person of the broker or dealer to make recommendations that place the 
interest of the broker, dealer, or such natural person ahead of the 
interest of the retail customer.
    As discussed in the context of the Disclosure Obligation and the 
Relationship Summary, for purposes of this requirement, a ``material 
limitation'' \770\ placed on the securities or investment strategies 
involving securities would include, for example, recommending only 
proprietary products (i.e., any product that is managed, issued, or 
sponsored by the financial institution or any of its affiliates), a 
specific asset class, or products with third-party arrangements (i.e., 
revenue sharing).\771\ In addition, the fact that the broker-dealer 
recommends only products from a select

[[Page 33394]]

group of issuers could also be a material limitation.
---------------------------------------------------------------------------

    \770\ As discussed in Section II.C.1, Disclosure Obligation, a 
limitation is ``material'' if there is ``a substantial likelihood 
that a reasonable shareholder would consider it important.'' Basic, 
Inc. v. Levinson, 485 U.S. 224, 224 (1988). In the context of this 
Regulation Best Interest, this standard would apply in the context 
of retail customers, as defined.
    \771\ See II.C.1.; Relationship Summary Adopting Release.
---------------------------------------------------------------------------

    We recognize, however, that, as a practical matter, almost all 
broker-dealers limit their offerings of securities and investment 
strategies to some degree. We do not believe that disclosing the fact 
that a broker-dealer does not offer the entire possible range of 
securities and investment strategies would convey useful information to 
a retail customer, and therefore we would not consider this fact, 
standing alone, to constitute a material limitation.\772\ Rather, 
consistent with the examples of a ``material limitation'' provided 
above, whether the limitation is material will depend on the facts and 
circumstances of the extent of the limitation.
---------------------------------------------------------------------------

    \772\ See Basic, Inc. v. Levinson, 485 U.S. 224, 224 (1988).
---------------------------------------------------------------------------

    Adopting this revised requirement is critical to ensuring that 
retail customers are aware of any material limitations associated with 
a broker-dealer's recommendation and associated conflicts of interest 
and that broker-dealers, through their policies and procedures, 
establish processes to evaluate whether or not such a limited range of 
products is consistent with making recommendations that are in the 
retail customer's best interest and that do not place the interests of 
the broker-dealer or associated person ahead of the retail customer's 
interest, consistent with Care Obligation.\773\ Broker-dealers would be 
able to satisfy paragraph (a)(2)(iii)(C)(1) by identifying any material 
limitations and complying with the Disclosure Obligation which, as 
discussed above, requires disclosure of ``the type and scope of 
services provided to the retail customer, including any material 
limitations on the securities or investment strategies involving 
securities that may be recommended to the retail customer.'' \774\
---------------------------------------------------------------------------

    \773\ See Section II.C.2 and infra footnote 779.
    \774\ Section II.C.1.
---------------------------------------------------------------------------

    Similar to the requirement to establish, maintain, and enforce 
written policies and procedures reasonably designed to mitigate certain 
incentives to associated persons, firms will have flexibility to 
develop and tailor reasonably designed policies and procedures to 
prevent such limitations and the associated conflicts from causing the 
broker-dealer or associated person from placing their interest ahead of 
the retail customer's interest. In developing such policies and 
procedures, the Commission believes that firms should, for example, 
consider establishing product review processes for products that may be 
recommended, including establishing procedures for identifying and 
mitigating the conflicts of interests associated with the product, or 
declining to recommend a product where the firm cannot effectively 
mitigate the conflict, and identifying which retail customers would 
qualify for recommendations from this product menu.\775\ As part of 
this process, firms may consider evaluating the use of ``preferred 
lists,'' \776\ restricting the retail customers to whom a product may 
be sold, prescribing minimum knowledge requirements for associated 
persons who may recommend certain products,\777\ and conducting 
periodic product reviews to identify potential conflicts of interest, 
whether the measures addressing conflicts are working as intended, and 
to modify the mitigation measures or product selection 
accordingly.\778\ The Commission's intent is not to prevent firms from 
offering proprietary products or other limited range of products so 
long as firms comply with the Disclosure, Care,\779\ and Conflict of 
Interest Obligations. In fact, we believe that these limitations can be 
beneficial, such as by helping ensure that a broker-dealer and its 
associated persons understand the securities they are recommending, as 
required by the Care Obligation.\780\ This requirement is designed to 
allow firms to determine whether and how to restrict their menu of 
investment options based, among other things, on their retail customer 
base and area of expertise, while protecting the interests of retail 
customers when recommendations are made from such limited menus by 
requiring firms have a reasonably designed process to identify, 
disclose, and prevent the conflicts of interest associated with such 
limitations from resulting in recommendations that place the broker-
dealer's interests ahead of the retail customer's interest.
---------------------------------------------------------------------------

    \775\ For example, in its Conflicts Report, FINRA identified the 
following as effective practices to identify and manage conflicts of 
interest for new products: (i) A product review process to identify 
and mitigate conflicts of interest that may be associated with a 
product; (ii) evaluation of whether to decline to offer products to 
customers when the conflicts associated are too significant to be 
mitigated effectively; (iii) differentiation of product eligibility 
between institutional and retail clients; (iv) post-launch reviews 
of products to identify potential problems; (v) evaluation of 
registered representatives' ability to understand a product, provide 
training where necessary, and limit access to products for which 
they cannot demonstrate sufficient understanding to perform a 
suitability analysis and effectively explain a product and its risks 
to customers; and (vi) disclosure of product conflicts and risks. 
See FINRA Conflicts Report at 3, 18-25.
    \776\ See FINRA Conflicts Report at 24.
    \777\ Cf. FINRA Conflicts Report at 19 (stating that as an 
effective practice in evaluating new products, a product review 
committee may engage in these activities to address conflicts of 
interest).
    \778\ Cf., e.g., NASD Notice to Members 03-71, Non-Conventional 
Investments--NASD Reminds Members of Obligations When Selling Non-
Conventional Investments (Nov. 2003). Similarly, under the 
Compliance Obligation, we suggest that compliance policies and 
procedures' adequacy and effectiveness should be reviewed as 
frequently as necessary in connection with changes in business 
activities, affiliations, or regulatory and legislative 
developments. See Section II.D.4, Compliance Obligation.
    \779\ In particular, consistent with the Care Obligation and as 
discussed further in Section II.C.2, Care Obligation, as part of 
determining whether a broker-dealer has a reasonable basis to 
believe that a recommendation is in the best interest of the retail 
customer, broker-dealers generally need to evaluate reasonably 
available alternatives offered by the broker-dealer. When a broker-
dealer materially limits is product offerings or offers only a 
limited menu of products, it must still comply with the Care 
Obligation, and could not use its limited menu to justify 
recommending a product that does not satisfy this obligation. See 
Section II.C.2.
    \780\ See also supra footnote 775.
---------------------------------------------------------------------------

    We also note that the risk that limited product menus result in 
recommendations that are not in the retail customer's best interest is 
also addressed through the Care Obligation \781\ and required 
disclosure pursuant to the Disclosure Obligation.\782\
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    \781\ See id.
    \782\ Material limitations are material facts that need to be 
disclosed pursuant to the Disclosure Obligation. The Commission is 
concerned about the potential effect that such limitations have on 
the securities or investment strategies involving securities 
recommended to a retail customer, and any associated conflicts of 
interest, could have on the ability of a broker-dealer to make a 
recommendation in the best interest of the retail customer. See 
Disclosure Obligation at Section II.C.1.
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g. Elimination of Certain Conflicts of Interest
    Under Section 15(l)(2) of the Exchange Act, the Commission may 
examine and, where appropriate, promulgate rules prohibiting or 
restricting certain sales practices, conflicts of interest, and 
compensation schemes for brokers, dealers, and investment advisers that 
the Commission deems contrary to the public interest and protection of 
investors. As discussed below, the Commission finds that it is in the 
public interest and consistent with the protection of investors to 
require that broker-dealers establish, maintain, and enforce written 
policies and procedures reasonably designed to identify and eliminate 
any sales contests, sales quotas, bonuses, and non-cash compensation 
that are based on the sales of specific securities or specific types of 
securities within a limited period of time.

[[Page 33395]]

    In the Proposing Release, the Conflict of Interest Obligation would 
have required the establishment of policies and procedures reasonably 
designed to at a minimum disclose or eliminate all material conflicts 
of interest related to the recommendation (or to disclose and mitigate 
or eliminate those material conflicts of interest arising from 
financial incentives). We did not mandate the absolute elimination of, 
or policies and procedures reasonably designed to eliminate any 
particular conflicts.\783\ We were concerned that the absolute 
elimination of specified particular conflicts could mean a broker-
dealer may not receive compensation for its services.\784\ Our intent, 
rather, was to identify certain practices that may be more 
appropriately avoided for certain categories of retail customers, 
including, for example, sales contests, trips, prizes, and other 
similar bonuses based on sales of certain securities or accumulation of 
AUM.\785\
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    \783\ See Proposing Release at 21619.
    \784\ Id.
    \785\ See id. FINRA rules also establish restrictions on the use 
of non-cash compensation in connection with the sale and 
distribution of certain types of products. See FINRA Rules 2310, 
2320, 3221, and 5110.
---------------------------------------------------------------------------

    We also provided examples of how a broker-dealer could eliminate 
conflicts of interest.\786\ We requested comment on elimination, 
including suggestions of whether certain conflicts should be required 
to be eliminated and how broker-dealers could eliminate conflicts of 
interest. Specifically, we requested comment on whether the Commission 
should explicitly prohibit receipt of certain non-cash compensation 
(e.g., sales contests, trips, prizes, and other bonuses based on sales 
of certain securities, accumulation of AUM or any other factor).\787\
---------------------------------------------------------------------------

    \786\ Proposing Release at 21621-21622.
    \787\ Id.
---------------------------------------------------------------------------

    In response, several commenters requested greater certainty as to 
whether certain conflicts of interest should be eliminated and if so, 
which ones.\788\ Some commenters generally requested that certain sales 
contests and financial incentives be prohibited.\789\ Of these 
commenters, many expressed concern that product-based incentives could 
lead to recommendations that are not in a customer's best interest, 
with some commenters stating that firms could find ways to mitigate 
these conflicts \790\ and others advocating that they should be 
prohibited in their entirety.\791\ Other commenters requested 
clarification that incentives not tied to a particular investment 
product would be permitted and would not need to be eliminated.\792\ A 
number of commenters requested clarification that incentives based on 
asset growth would be permitted as they do not raise the same types of 
conflicts present with product-based sales.\793\ A number of commenters 
expressed concern that provisions requiring elimination of certain 
conflicts could be in conflict with current treatment under the 
Internal Revenue Code governing certain employee benefits.\794\
---------------------------------------------------------------------------

    \788\ See TIAA Letter (``If the SEC were to provide more 
specific direction as to which conflicts are significant enough to 
warrant complete elimination, broker-dealers would be better able to 
effectively address material conflicts of interest in a manner 
consistent with the SEC's goals and preferred approach.''); Wells 
Fargo Letter (``Rather than leaving broker-dealers vulnerable to 
second-guessing, the SEC should either provide more guidance on how 
such conflicts may be mitigated or simply identify a set of 
financial incentives that are prohibited.''); AXA Letter (``In the 
absence of clear guidance from the Commission as to which financial 
incentives must be eliminated, and not just mitigated and disclosed, 
broker-dealers may be forced to curtail otherwise legitimate 
practices and the sale of certain products and services out of an 
abundance of caution--thereby depriving investors of choice of 
offerings for which they might otherwise be suited. . . It would 
also be helpful if the Commission could provide additional examples 
of the types of conflicts (besides ``sales contests, trips, prizes . 
. . based on sales of certain securities'') that likely require 
elimination.''); see also Money Management Institute Letter; 
Northwestern Mutual Letter; AALU Letter.
    \789\ See, e.g., PIABA Letter (favoring a prohibition on 
compensation structures that would incentivize a broker to: 
Recommend a proprietary product or recommend one type of product 
line over another; and/or which would reward the sale of certain 
products within a product line''), Americans for Financial Reform 
(recommending prohibiting brokers from adopting practices, such as 
sales quotas and contests, that clearly incentivize their 
representatives to base their recommendations on their own financial 
interests rather than the customer's best interests); NASAA August 
2018 Letter (``[W]e encourage the Commission to proceed further by 
declaring these two practices--sales contests and preferential 
treatment of allocations--per se impermissible under Regulation Best 
Interest.''); Galvin Letter (identifying the following practices as 
per se violations of the standard as they are contrary to the 
requirement to provide advice that is in the true best interest of 
customers: Sales contests; sales quotas (especially for in-house 
products); and incentives to sell high-cost and high-risk products); 
See also Warren Letter; Better Markets August 2018 Letter; CFA 
August 2018 Letter. But see Primerica Letter (``The SEC should 
recognize that sales contests, trips, prizes, awards, and similar 
bonuses can be used to incentivize positive behavior and clarify 
there is no per se requirement to eliminate such incentives.'').
    \790\ See, e.g., SIFMA August 2018 Letter (``With respect to 
product-based sales contests, we agree that instances where a firm 
cannot adequately mitigate incentives that are misaligned with the 
customer's best interest, the firm should eliminate such sales 
contests. A firm, however, may be able to mitigate such conflicts 
through several methods. . .under a principles-based regime, we ask 
that the SEC allow firms to decide whether to mitigate or eliminate 
such conflicts.''); Cetera August 2018 Letter (``A commonly-cited 
example is sales contests or incentives that are focused on sales of 
a single product. While we agree that such arrangements may be per 
se inappropriate and Cetera does not permit them, this judgment is 
largely subjective. We suggest that reaching consensus on what other 
practices fall into this category would be well-nigh impossible. So 
long as a broker-dealer can demonstrate that it has made a good 
faith determination regarding identification and management of 
conflicts, it should not be subject to either regulatory action or 
private litigation based on those determinations.''); CFA Institute 
Letter (``Our view is that recommendations aimed at winning sales 
contests and meeting internal quotas are irreconcilable with the 
concept of a best interest standard and should not be allowed.'').
    \791\ See, e.g., PIABA Letter; CFA August 2018 Letter. See also 
Fidelity Letter (``The SEC has properly pointed out that certain 
conflicts of interest can be so problematic that it simply may not 
be possible to mitigate them effectively. For example, we agree that 
sales contests improperly favoring certain investment products over 
others involve uniquely troubling conflicts and should generally be 
impermissible.''); NY Life Letter (In this context, the proposal 
notes that single product sales contests create conflicts that may 
best be eliminated. We agree that it is inappropriate to use a 
contest or other non-cash compensation to incentivize the sale of a 
specific investment or variable insurance product over other 
available alternatives, irrespective of a consumer's situation and 
needs.'') But see AALU Letter (finding that the Commission should 
not prohibit currently-compliant compensation arrangements and 
business models, including non-cash compensation).
    \792\ See, e.g., SIFMA August 2018 Letter; Edward Jones Letter; 
NY Life Letter; Prudential Letter; LPL August 2018 Letter; 
Transamerica August 2018 Letter; Northwestern Mutual Letter; Letter 
from Eric R. Dinallo, Executive Vice President, General Counsel, 
Guardian Life (Feb. 6, 2019) (``Guardian February 2019 Letter''); 
Primerica Letter; Cambridge Letter. Some of these commenters stated 
that FINRA's rules and supervisory practices appropriately cover 
these incentives. See Transamerica August 2018 Letter; NY Life 
Letter; Northwestern Mutual Letter; Guardian August 2018 Letter; 
Primerica Letter.
    \793\ Generally these commenters believed that programs tied to 
assets under management, total production or revenue growth do not 
give associated persons an incentive to recommend specific 
securities that may be inconsistent with a customer's best interest. 
See, e.g., SIFMA August 2018 Letter; Bank of America Letter; Edward 
Jones Letter; Transamerica August 2018 Letter; ASA Letter; UBS 
Letter; Fidelity Letter; NY Life Letter; Money Management Institute 
Letter; IPA Letter.
    \794\ See AALU Letter; NY Life Letter; Guardian February 2019 
Letter; Northwestern Mutual Letter.
---------------------------------------------------------------------------

    After considering comments, we are modifying the rule text of the 
Conflict of Interest Obligation to include new paragraph 
(a)(2)(iii)(D), which requires the broker or dealer to establish, 
maintain, and enforce written policies and procedures reasonably 
designed to identify and eliminate any sales contests, sales quotas, 
bonuses, and non-cash compensation that are based on the sales of 
specific securities or specific types of securities within a limited 
period of time. In adopting this new requirement, the Commission 
believes it will provide certainty to broker-dealers regarding the 
types of practices where conflicts of interest are so pervasive such 
that they cannot be reasonably mitigated and must be

[[Page 33396]]

eliminated in their entirety, as we believe they create too strong of 
an incentive for the associated persons to make a recommendation that 
places their financial or other interest ahead of the interest of 
retail customers' interests and therefore would be inconsistent with 
Regulation Best Interest.\795\
---------------------------------------------------------------------------

    \795\ See Section I. See also AFL-CIO April 2019 Letter (``The 
Commission must provide greater clarity regarding how the obligation 
to eliminate or mitigate conflicts would apply to different types of 
conflicts. In particular, it must make clear that conflicts cannot 
be addressed through disclosure alone and that firms would be 
prohibited from artificially creating harmful incentives that 
undermine compliance with the best interest standard.'').
---------------------------------------------------------------------------

    The requirement is designed to eliminate sales contests, sales 
quotas, bonuses and non-cash compensation that are based on the sales 
of specific securities and specific types of securities within a 
limited period of time. We believe that these practices, particularly 
when coupled with a time limitation, create high-pressure situations 
for associated persons to engage in sales conduct contrary to the best 
interest of retail customers. For purposes of this requirement, we 
interpret non-cash compensation to mean any form of compensation 
received in connection with the sale and distribution of specific 
securities or specific types of securities that is not cash 
compensation, including but not limited to merchandise, gifts and 
prizes, travel expenses, meals and lodging except we do not intend it 
to cover certain employee benefits, including healthcare and retirement 
benefits.\796\ We recognize that some associated persons may focus 
their business on certain general categories of securities (e.g., 
mutual funds, variable annuities, bonds, or equities) and that broker-
dealers may provide compensation or other incentives related to such 
sales. As discussed further herein, this requirement is not designed to 
prohibit broker-dealers from providing such incentives, provided that 
they do not create high-pressure situations to sell a specifically 
identified type of security (e.g., stocks of a particular sector or 
bonds with a specific credit rating) within a limited period of time, 
such that the associated person cannot make a recommendation in the 
retail customer's best interest.
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    \796\ Infra footnote 803 and accompanying text.
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    We believe the conflicts created by these practices are in direct 
opposition to our goal of reducing the effect of conflicts of interest 
on broker-dealer recommendations to retail customers.\797\ We agree 
with many commenters that broker-dealers cannot reasonably be expected 
to make recommendations in a particular retail customer's best interest 
consistent with the requirements of the Care Obligation, if they are 
motivated to ``push'' certain securities or types of securities in 
order to win a contest or reach a target in order to receive a bonus or 
other non-cash compensation. We are also persuaded that it would be 
difficult, if not impossible, for a firm to establish reasonably 
designed policies and procedures to sufficiently mitigate the incentive 
created to put the broker-dealer's interest ahead of the retail 
customer's interest, as discussed above, as the point of these 
practices is simply to increase the sale a particular security or type 
of security, for example, in the context where a broker-dealer is 
attempting to reduce its inventory of or exposure to that security. 
Accordingly, we believe that these practices should be eliminated in 
order to enhance investor protection \798\ and achieve the goals of 
Regulation Best Interest.
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    \797\ See Section I.
    \798\ See Chairman Jay Clayton, Statement on Investor 
Roundtables Regarding Standards of Conduct for Investment 
Professionals Rulemaking (Aug. 22, 2018), available at https://www.sec.gov/news/public-statement/statement-clayton-082218. See also 
CFA Institute; CFA.
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    By explicitly requiring broker-dealers to establish, maintain, and 
enforce written policies and procedures reasonably designed to 
eliminate certain practices, we believe we are responding to commenters 
who requested certainty as to which specific incentives are 
prohibited.\799\ Also in response to commenters requesting 
clarification as to what practices would be permitted, the requirement 
to have reasonably designed written policies and procedures to 
eliminate sales contests, sales quotas, bonuses, and non-cash 
compensation applies only to those that are based on the sales of 
specific securities or types of securities, and does not apply to 
compensation practices based on, for example, total products sold, or 
asset growth or accumulation,\800\ and customer satisfaction. In 
addition, this elimination requirement would not prevent firms from 
offering only proprietary products, placing material limitations on the 
menu of products, or incentivizing the sale of such products through 
its compensation practices, so long as the incentive is not based on 
the sale of specific securities or types of securities within a limited 
period of time.\801\ While conflicts of interest are also associated 
with sales contests, sales quotas, bonuses and non-cash compensation 
that apply to, among other things, total products sold, or asset 
accumulation and growth, we agree with commenters \802\ these conflicts 
present less risk that the incentive would compromise compliance with 
the Care Obligation and Conflict of Interest Obligation such that a 
recommendation could be made that is in a retail customer's best 
interest and that does not place the place the interest of the broker-
dealer or associated person ahead of the interest of the retail 
customer.
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    \799\ See supra footnote 788 and accompanying text.
    \800\ See CCMC Letters (asserting that increasing assets under 
management is a natural outgrowth of serving clients well and is 
fundamentally different from sales contests based on a particular 
product); UBS Letter (stating that compensation and other rewards 
based on the growth of overall revenues or assets under management 
should continue to be permitted as they do not incent sales of one 
product over another but instead simply reward overall business 
growth).
    \801\ Although we are not defining what would constitute a 
``limited period of time,'' as noted above, we are concerned about 
time limitations that create high-pressure situations for associated 
persons to increase the sales of specific securities or specific 
types of securities which compromise the best interests of their 
customers.
    \802\ See, e.g., Ameriprise Letter (``We believe such concerns 
around incentives do not exist with respect to programs that reward 
asset growth or asset flows, or recruitment bonuses tied to assets 
under management or revenue growth because these programs do not 
give associated persons an incentive to recommend specific 
securities that may not be consistent with a customer's best 
interest.''); Empower Letter (``We also believe asset-gathering or 
account-retention incentives should not be subject to the same level 
of scrutiny as incentives aimed at increasing sales of particular 
securities. The potential for a conflict of interest to result in a 
bad outcome for a retail investor is much higher when a 
recommendation is related to individual securities rather than the 
type of account in which such securities should be held.'')
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    We also recognize that certain production requirements may exist 
for other reasons, specifically to maintain a contract of 
employment.\803\ As discussed above, we do not intend to prohibit the 
receipt of certain employee benefits by statutory employees, and do not 
believe this provision would apply, as we do not consider these 
benefits to be non-cash compensation for purposes of Regulation Best 
Interest. In addition, we do not intend to prohibit training or 
education meetings, including attendance at company-sponsored meetings 
such as annual conferences,\804\ provided that these meetings are not 
based on the sale of specific securities

[[Page 33397]]

or type of securities within a limited time period.
---------------------------------------------------------------------------

    \803\ See Prudential Letter; NY Life Letter; Guardian February 
2019 Letter; AALU Letter. Under the Internal Revenue Code, statutory 
employees are eligible for certain employee benefits such as 401(k) 
and health insurance. In order to qualify under this definition, 
full time life insurance sales agents must devote their principal 
business to the solicitation of life insurance or annuities 
primarily for one company. See Department of Treasury, Internal 
Revenue Service, Employer's Supplemental Tax Guide, Publication 15-A 
(2018), available at https://www.irs.gov/pub/irs-pdf/p15a.pdf.
    \804\ See Guardian August 2018 Letter; NY Life Letter.
---------------------------------------------------------------------------

    We emphasize that prohibiting certain incentives does not mean that 
all other incentives are presumptively compliant with Regulation Best 
Interest. As discussed above, such other incentives and practices that 
are not explicitly prohibited are permitted provided that the broker-
dealer establishes reasonably designed policies and procedures to 
disclose and mitigate the incentive created, and the broker-dealer and 
its associated persons comply with the Care Obligation. Nevertheless, 
if the firm determines that the conflicts associated with these 
practice are too difficult to disclose and mitigate, the firm should 
consider carefully assessing whether it is able to satisfy its best 
interest obligation in light of the identified conflict and in certain 
circumstances, may wish to avoid such practice entirely.
4. Compliance Obligation
    As proposed, under the Conflict of Interest Obligation, a broker-
dealer entity \805\ would be required to: (1) Establish, maintain, and 
enforce written policies and procedures reasonably designed to 
identify, and disclose, or eliminate all material conflicts of interest 
associated with recommendations covered by Regulation Best Interest; 
and (2) establish, maintain and enforce written policies and procedures 
reasonably designed to identify and disclose and mitigate, or 
eliminate, material conflicts of interest arising from financial 
incentives associated with such recommendations. As discussed above, in 
response to commenters, we have made modifications to the Conflict of 
Interest Obligation to more appropriately focus on the conflicts of 
interest that create an incentive for broker-dealers and their 
associated persons to place the interest of the broker-dealer or the 
associated person ahead of the interest of the retail customer.
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    \805\ See supra footnote 671.
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    We solicited comment on the proposed requirement to establish, 
maintain, and enforce certain policies and procedures as part of the 
Conflict of Interest Obligation, including whether we should require 
policies and procedures specifically to assist compliance with 
Regulation Best Interest. While commenters generally viewed the 
requirement to adopt policies and procedures as an effective means of 
addressing conflicts of interest,\806\ some commenters suggested 
broadening this requirement to a general policies and procedures 
obligation that would be reasonably designed to ensure that 
recommendations are made in the customer's best interest or reasonably 
designed to ensure compliance with Regulation Best Interest as a 
whole.\807\
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    \806\ See CFA August 2018 Letter; Fidelity Letter; Vanguard 
Letter; FPC Letter.
    \807\ See CFA August 2018 Letter; UBS Letter.
---------------------------------------------------------------------------

    After considering the comments received, we are adopting the 
Compliance Obligation, which requires, in addition to the policies and 
procedures required by the Conflict of Interest Obligation, that 
broker-dealer entities \808\ establish, maintain and enforce written 
policies procedures reasonably designed to achieve compliance with 
Regulation Best Interest. The Compliance Obligation creates an 
affirmative obligation under the Exchange Act with respect to the rule 
as a whole,\809\ while providing sufficient flexibility to allow 
broker-dealers to establish compliance policies and procedures that 
accommodate a broad range of business models.\810\ The Commission 
believes that the Compliance Obligation is important to help ensure 
that broker-dealers have strong systems of controls in place to prevent 
violations of Regulation Best Interest, including the component 
Disclosure and Care Obligations, in addition to the policies and 
procedures required pursuant to the Conflict of Interest Obligation, 
and to protect the interests of retail customers.\811\
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    \808\ Similar to the Conflict of Interest Obligation, the 
Compliance Obligation applies solely to the broker or dealer entity, 
and not to the natural persons who are associated persons of a 
broker or dealer. For purposes of discussing the Compliance 
Obligation, the term ``broker-dealer'' refers only to the broker-
dealer entity, and not to such individuals. See footnote 671 and 
accompanying text.
    \809\ As noted in the Proposing Release, broker-dealers are 
currently subject to supervisory obligations under Section 
15(b)(4)(E) of the Exchange Act and SRO rules, including the 
establishment of policies and procedures reasonably designed to 
prevent and detect violations of, and to achieve compliance with, 
the federal securities laws and regulations, as well as applicable 
SRO rules. See Proposing Release at 21622. Specifically, the 
Exchange Act authorizes the Commission to sanction a broker-dealer 
or any associated person that fails to reasonably supervise another 
person subject to the firm's or the person's supervision that 
commits a violation of the federal securities laws. Exchange Act 
Sections 15(b)(4)(E) and (b)(6)(A). The Exchange Act provides an 
affirmative defense against a charge of failure to supervise where 
reasonable procedures and systems for applying the procedures have 
been established and effectively implemented without reason to 
believe those procedures and systems are not being complied with. 
Id. While the Compliance Obligation creates an explicit requirement, 
we believe that broker-dealers would likely establish policies and 
procedures to comply with Regulation Best Interest pursuant to 
Section 15(b)(4)(E). In order to comply, broker-dealers could adjust 
their current systems of supervision and compliance, as opposed to 
creating new systems.
    \810\ This approach is similar to the one taken under rule 
206(4)-7 under the Advisers Act which requires policies and 
procedures reasonably designed to prevent violations of the Advisers 
Act, which should be tailored to address compliance considerations 
relevant to the operations of each adviser. See Compliance Programs 
of Investment Companies and Investment Advisers, Advisers Act 
Release No. 2204 (Dec. 17, 2003) (``Advisers Act Release 2204''). 
See also Questions Advisers Should Ask While Establishing or 
Reviewing Their Compliance Programs (May 2006), available at https://www.sec.gov/info/cco/adviser_compliance_questions.htm (``No one 
standard set of policies and procedures will address the 
requirements established by the Compliance Rule for all advisers 
because each adviser is different, has different business 
relationships and affiliations, and therefore, has different 
conflicts of interest.'').
    \811\ Similar to the discussion included under Section II.C.3.a, 
we believe that policies and procedures to comply with Regulation 
Best Interest would allow the Commission to identify and address 
potential compliance deficiencies or failures (such as inadequate or 
inaccurate policies and procedures, or failure to follow the 
policies and procedures) early on, reducing the chance of retail 
customer harm.
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    As with the policies and procedures requirement included in the 
Conflict of Interest Obligation, whether policies and procedures are 
reasonably designed to comply with Regulation Best Interest will depend 
on the facts and circumstances of a given situation.\812\ As such, the 
Compliance Obligation does not enumerate specific requirements that 
broker-dealers must include in their policies and procedures as broker-
dealers are too varied in their operations for rules to impose a single 
set of universally applicable specific required elements. Each broker-
dealer when adopting policies and procedures should consider the nature 
of that firm's operations and how to design such policies and 
procedures to prevent violations from occurring, detect violations that 
have occurred, and to correct promptly any violations that have 
occurred.\813\
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    \812\ See Section II.C.3.
    \813\ See Advisers Act Release 2204.
---------------------------------------------------------------------------

    A firm's compliance policies and procedures should be reasonably 
designed to address and be proportionate to the scope, size, and risks 
associated with the operations of the firm and the types of business in 
which the firm engages.\814\ As such, the Commission is not mandating 
specific requirements pursuant to the Compliance Obligation. In 
addition to the required policies and procedures, depending on the size 
and complexity of the firm, we believe a reasonably designed compliance 
program generally

[[Page 33398]]

would also include: \815\ Controls; remediation of non-compliance; 
\816\ training; \817\ and periodic review and testing.\818\
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    \814\ See Section II.C.3.a.
    \815\ Cf. FINRA Conflicts Report at 6 (identifying supporting 
structures, policies, processes, controls and training as critical 
to protect customers and the firm).
    \816\ Id. at 10 (``Most firms' policies describe an escalation 
process for handling those conflicts of interest that cannot be 
handled through other firm policies. . . .'').
    \817\ ``For firms, training is an important vehicle to 
communicate firm culture, specific requirements of a firm's code of 
conduct and its conflicts management framework.'' Id. at 15.
    \818\ Cf. Questions Advisers Should Ask While Establishing or 
Reviewing Their Compliance Programs (May 2006), available at https://www.sec.gov/info/cco/adviser_compliance_questions.htm; FINRA 
Conflicts Report.
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D. Record-Making and Recordkeeping

    In connection with proposed Regulation Best Interest, we proposed 
new record-making and recordkeeping requirements for broker-dealers 
with respect to certain information collected from or provided to 
retail customers. Specifically, we proposed amendments to Exchange Act 
Rules 17a-3 and 17a-4, which specify minimum requirements with respect 
to the records that broker-dealers must make, and how long those 
records and other documents must be kept, respectively. We received 
several comments on the proposed new requirements and are adopting them 
substantially as proposed with additional clarifications and guidance 
to address commenters' concerns.
    We proposed amending Rule 17a-3 \819\ to add a new paragraph 
(a)(25), which would require, for each retail customer to whom a 
recommendation of any securities transaction or investment strategy 
involving securities is or will be provided, a record of all 
information collected from and provided to the retail customer pursuant 
to Regulation Best Interest, as well as the identity of each natural 
person who is an associated person of a broker or dealer, if any, 
responsible for the account. The new paragraph would specify that the 
neglect, refusal, or inability of a retail customer to provide or 
update any such information would excuse the broker-dealer from 
obtaining that information.
---------------------------------------------------------------------------

    \819\ See Exchange Act Rule 17a-3.
---------------------------------------------------------------------------

    We are adopting the provision substantially as proposed but 
redesignating it as new paragraph (a)(35) of Rule 17a-3.\820\ We are 
also amending the text of paragraph (ii) of the amendment as adopted to 
refer to ``any information described in paragraph (a)(35)(i) of this 
section'' rather than the proposed ``any information required under 
paragraph (a)(25)(i) of this section.'' This is a non-substantive 
change reflecting the fact that paragraph (i) of the new provision 
requires a record of the information collected from a retail customer 
by the broker-dealer pursuant to Regulation Best Interest; it does not 
require the information itself directly as implied by the original 
wording of paragraph (i) of the proposed amendment. It is therefore 
more accurate to refer in paragraph (ii) to the information ``described 
in,'' rather than ``required under,'' paragraph (i), as well as to 
update the reference in paragraph (ii) to ``paragraph (a)(35)(i) of 
this section.''
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    \820\ The Commission is also reserving paragraphs (a)(24) 
through (a)(34) of Rule 17a-3 for use in connection with future 
rulemakings.
---------------------------------------------------------------------------

    Several commenters expressed concern that the proposed rule 
amendment would significantly expand recordkeeping requirements.\821\ 
One commenter expressed concern that the record retention requirements 
of the proposed new paragraph to Rule 17a-3 would apply to each 
recommendation made by the broker-dealer rather than to each account 
(as required by existing paragraph (a)(17) of Rule 17a-3, which 
operates on a per-account basis). Another commenter requested 
clarification that ``the current books and records requirement is 
sufficient to meet record-keeping requirements to satisfy Reg BI,'' 
adding that the Commission should ``affirm that Reg BI does not create 
new record-keeping requirements to prove that an advisor acted in a 
client's best interest.'' \822\
---------------------------------------------------------------------------

    \821\ See SIFMA August 2018 Letter; Edward Jones Letter; 
Primerica Letter.
    \822\ See Raymond James Letter.
---------------------------------------------------------------------------

    The Commission notes that the proposed new requirements of Rule 
17a-3 are not designed to create additional, standalone burdens for 
broker-dealers but instead to provide a means by which they can 
demonstrate, and Commission examiners can confirm, their compliance 
with the new substantive requirements of Regulation Best Interest. In 
response to commenter concerns that the proposed requirements would 
significantly expand their recordkeeping obligations, we reiterate 
that, as stated in the Proposing Release, broker-dealers should already 
be attempting to collect much of the information that would be required 
under Regulation Best Interest pursuant to the FINRA suitability rule 
and existing Exchange Act books and records rules. For example, we note 
that under existing Rule 17a-3(a)(17), broker-dealers that make 
recommendations for accounts with a natural person as customer or owner 
are already required to create and periodically update customer account 
information, although as part of developing a ``retail customer's 
investment profile,'' Regulation Best Interest may require broker-
dealers to seek to obtain certain retail customer information that is 
currently not required by Rule 17a-3(a)(17).\823\ In addition, 
Regulation Best Interest would require broker-dealers to disclose in 
writing the material facts relating to the scope and terms of their 
relationship with the retail customer and the material facts relating 
to conflicts of interest that are associated with the investment 
recommendations provided to the retail customer. As such, it would not 
be accurate to state, as suggested by the commenter, that the 
Commission's current books and records requirements for broker-dealers 
are sufficient to meet recordkeeping requirements to satisfy Regulation 
Best Interest. The additional books and records requirements the 
Commission is adopting today are designed to allow firms to demonstrate 
compliance with the substantive requirements of Regulation Best 
Interest.
---------------------------------------------------------------------------

    \823\ See Exchange Act Rule 17a-3(a)(17). As explained in the 
Proposing Release, Rule 17a-3(a)(17) applies to each account with a 
natural person as a customer or owner, while proposed Regulation 
Best Interest would apply to each recommendation of any securities 
transaction or investment strategy involving securities to a retail 
customer. Because of this difference, the Commission believes it 
would be appropriate to locate the record-making requirements 
related to Regulation Best Interest in a new paragraph of Rule 17a-3 
rather than in an amendment to paragraph (a)(17).
---------------------------------------------------------------------------

    We further note that the new record-making requirements would not 
require the duplication of existing records. Rather, if a broker-dealer 
relied upon previously existing records to demonstrate its compliance 
with Regulation Best Interest for a given recommendation, it would not 
be required to create and preserve duplicate copies but instead could 
create a new record noting which pre-existing documents were provided 
to the customer, or what customer information already being preserved 
by the broker-dealer was relied upon, to meet the obligations of 
Regulation Best Interest. However, reliance upon previously existing 
records would only be permissible so long as such records are 
preserved--a record noting that a document was relied upon would no 
longer meet the recordkeeping obligations of Regulation Best Interest 
if such document was no longer preserved by the broker-dealer.
    Commenters also requested that the Commission limit new 
recordkeeping requirements to customer profile information itself, not 
the ``related and

[[Page 33399]]

underlying communications.'' \824\ In response to these concerns, the 
Commission clarifies that new paragraph (a)(35) of Rule 17a-3 as 
adopted requires a record of all information collected from and 
provided to the retail customer pursuant to Regulation Best Interest. 
Regulation Best Interest does not reference, and the Commission does 
not intend that it require, ``related and underlying communications''--
rather, it applies only to the information that is actually provided to 
or obtained from the customer pursuant to Regulation Best Interest. 
Once again, the purpose of the new record-making provision is to allow 
broker-dealers to demonstrate their compliance with the substantive 
requirements of Regulation Best Interest. Complying with those 
substantive requirements will require broker-dealers to obtain from and 
provide to customers certain information, and new paragraph (a)(35) of 
Rule 17a-3 requires a record of such information. In response to 
comments received requesting clarification as to whether information 
provided to or obtained from a customer orally would be covered by the 
new record-making requirements,\825\ the Commission clarifies that the 
requirements of new paragraph (a)(35) of Rule 17a-3 apply to all 
information collected from or provided to a retail customer pursuant to 
Regulation Best Interest, whether provided orally or in writing 
(electronically or otherwise).\826\
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    \824\ See SIFMA August 2018 Letter; Morgan Stanley Letter.
    \825\ See SIFMA August 2018 Letter; Primerica Letter.
    \826\ In the case of information provided orally under the 
circumstances outlined in Section II.C.1, Disclosure Obligation, 
Oral Disclosure or Disclosure After a Recommendation, the broker-
dealer must maintain a record of the fact that oral disclosure was 
provided to the retail customer.
---------------------------------------------------------------------------

    Several commenters requested clarification that, except with 
respect to the specific recordkeeping requirements in the rule text, 
Regulation Best Interest does not require additional records (e.g., 
records to evidence best interest determinations on a recommendation-
by-recommendation basis).\827\ One commenter also stated that, as 
drafted, there are significant obstacles and costs, including increased 
privacy and cybersecurity risks, that would result from implementing 
the proposed new rule, in particular with respect to the ``all 
information collected from . . . . the retail customer'' 
requirement.\828\
---------------------------------------------------------------------------

    \827\ See SIFMA August 2018 Letter; Edward Jones Letter; Morgan 
Stanley Letter; CCMC Letters.
    \828\ See Primerica Letter.
---------------------------------------------------------------------------

    In response, the Commission clarifies that while the substantive 
requirements of Regulation Best Interest apply on a recommendation-by-
recommendation basis, consistent with our approach elsewhere, we are 
not requiring that broker-dealers create and maintain records to 
evidence best interest determinations on a recommendation-by-
recommendation basis. Nor have we determined to require broker-dealers 
to provide information to retail customers relating to the basis for 
each particular recommendation (i.e., disclose such information), and 
thus did not envision this information to come within the scope of Rule 
17(a)(35).
    Rather, in order to demonstrate compliance with Regulation Best 
Interest, a broker-dealer must be able to demonstrate that it had a 
reasonable basis to believe that each particular recommendation made to 
a retail customer was in the best interest of the customer at the time 
of the recommendation based on the customer's investment profile and 
the potential risks, rewards, and costs associated with the 
recommendation. As noted above, the Commission does not intend this to 
require, in practice, the creation of extensive new and potentially 
duplicative records for each and every recommendation to a retail 
customer. Instead, broker-dealers should be able to explain in broad 
terms the process by which the firm determines what recommendations are 
in its customers' best interests, and similarly to explain how that 
process was applied to any particular recommendation to a retail 
customer. However, we are not mandating that broker-dealers create and 
maintain a record of each such determination. Nonetheless, as noted 
above we are providing guidance suggesting that firms may wish to 
adequately document an evaluation of a recommendation and the basis for 
that recommendation in particular contexts, such as the recommendation 
of a complex product, or where a recommendation may seem inconsistent 
with a retail customer's investment objectives on its face.\829\
---------------------------------------------------------------------------

    \829\ See supra footnote 610 and accompanying text.
---------------------------------------------------------------------------

    In addition, in response to requests from commenters for 
confirmation that the proposed record-making requirements do not 
contemplate broker-dealers needing to create and maintain records of 
why certain products were recommended over others on a recommendation-
by-recommendation basis,\830\ we confirm that broker-dealers are not 
expected to maintain records comparing potential investments to one 
another so long as they are able to demonstrate that each individual 
recommendation actually made to a customer meets the requirements of 
Regulation Best Interest on its own. Regulation Best Interest applies 
to recommendations made to a retail customer, rather than to potential 
recommendations considered by the broker-dealer but not actually made 
to the customer.
---------------------------------------------------------------------------

    \830\ See SIFMA August 2018 Letter; CCMC Letters.
---------------------------------------------------------------------------

    In response to the commenter's privacy and cybersecurity concerns 
with respect to the proposed requirement to make a record of all 
information collected from the customer pursuant to Regulation Best 
Interest, as noted in the Proposing Release \831\ and Section II.C 
above, although a broker-dealer's customer obligations under Regulation 
Best Interest (e.g., the Care Obligation) go beyond those set forth in 
the FINRA's suitability rule, the concept of the ``customer's 
investment profile'' that a broker-dealer would be required to 
compile--that is, the customer information it would be required to 
obtain--pursuant to Regulation Best Interest is consistent with that 
under FINRA's suitability rule. As such, we believe that since broker-
dealers are already required to seek to obtain identical types of 
retail customer information pursuant to the FINRA suitability rule, 
broker-dealers should already have in place policies and procedures, 
including training programs, to address such privacy and cybersecurity 
concerns.
---------------------------------------------------------------------------

    \831\ Proposing Release at 21611 (noting that Retail Customer 
Investment Profile is consistent with FINRA Rule 2111(a) 
(Suitability)).
---------------------------------------------------------------------------

    We also proposed an amendment to paragraph (e)(5) of Rule 17a-4, 
which currently requires broker-dealers to maintain and preserve in an 
easily accessible place all account information required by paragraph 
(a)(17) of Rule 17a-3 for at least six years after the earlier of the 
date the account was closed or the date on which the information was 
replaced or updated.\832\ The proposed amendment would require broker-
dealers to retain any information that the retail customer provides to 
the broker-dealer or the broker-dealer provides to the retail customer 
pursuant to the proposed amendment to Rule 17a-3 being adopted today as 
Rule 17a-3(a)(35), in addition to the existing requirement to retain 
information obtained pursuant to Rule 17a-3(a)(17). As a result, 
broker-dealers would be required to retain all records of the 
information collected from or provided to each retail customer pursuant 
to Regulation Best Interest for at least six years after the earlier of 
the date the account was closed or the date

[[Page 33400]]

on which the information was replaced or updated. The Commission is 
adopting this amendment to Rule 17a-4(e)(5) substantially as proposed, 
with the proposed reference to paragraph (a)(25) of Rule 17a-3 replaced 
with a reference to paragraph (a)(35) to reflect the redesignation of 
the latter new rule provision as discussed above.
---------------------------------------------------------------------------

    \832\ See Exchange Act Rule 17a-4(e)(5).
---------------------------------------------------------------------------

    The Commission received several comments regarding the proposed 
amendment to Rule 17a-4 requesting clarification as to what 
communications would be required to be retained pursuant to the 
proposed rule amendment beyond those already required to be retained by 
existing paragraph (b)(4) of Rule 17a-4.\833\ Rule 17a-4(b)(4) requires 
broker-dealers to retain originals of all communications received and 
copies of all communications sent by the broker-dealer relating to its 
business as such for a period of not less than three years, the first 
two in an easily accessible place.
---------------------------------------------------------------------------

    \833\ See Exchange Act Rule 17a-4(b)(4); SIFMA August 2018 
Letter; Edward Jones Letter; Prudential Letter.
---------------------------------------------------------------------------

    In response, the Commission notes that while the records that a 
broker-dealer would be required to make in connection with Regulation 
Best Interest under new paragraph (a)(35) of Rule 17a-3 may be 
``business as such'' records, the Commission believes it is important, 
including for examination purposes, that broker-dealers separately 
retain records that specifically demonstrate compliance with Regulation 
Best Interest and new paragraph (a)(35) of Rule 17a-3 rather than 
simply including them in the much broader ``business as such'' category 
required to be retained under Rule 17a-4(b)(4). Rule 17a-3(e)(5) 
currently serves the purpose of allowing broker-dealers to demonstrate 
compliance with the customer information records required to be made 
pursuant to Rule 17a-3(a)(17), and the amendment to Rule 17a-3(e)(5) 
being adopted today will serve the same purpose with respect to records 
required to be retained by broker-dealers to demonstrate compliance 
with Regulation Best Interest and new paragraph (a)(35) of Rule 17a-3.
    Finally, as noted in the Proposing Release, the written policies 
and procedures that broker-dealers will be required to create pursuant 
to Regulation Best Interest are already currently required to be 
retained pursuant to Exchange Act Rule 17a-4(e)(7),\834\ which requires 
broker-dealers to retain compliance, supervisory, and procedures 
manuals (and any updates, modifications, and revisions thereto) 
describing the policies and practices of the broker-dealer with respect 
to compliance with applicable laws and rules, and supervision of the 
activities of each natural person associated with the broker-dealer, 
for a specified period of time. As such, we did not propose, and are 
not adopting, any additional recordkeeping requirements with respect to 
the written policies and procedures that broker-dealers will be 
required to create pursuant to Regulation Best Interest.
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    \834\ See Exchange Act Rule 17a-4(e)(7).
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E. Compliance Date

    We are providing a compliance date of June 30, 2020, consistent 
with the transition provisions described in the Relationship Summary 
Adopting Release.\835\ In light of the importance of the protections 
provided by Regulation Best Interest, we believe that this compliance 
date will provide adequate notice and opportunity for broker-dealers to 
comply with Regulation Best Interest, including by creating or updating 
the necessary disclosures and to developing, updating or establishing 
their policies and procedures and systems, as appropriate, to achieve 
compliance with Regulation Best Interest. On and after the Compliance 
Date, broker-dealers that provide recommendations of securities 
transactions or investment strategies that register with the Commission 
would be required to comply with Regulation Best Interest as of the 
date of registration.
---------------------------------------------------------------------------

    \835\ See Relationship Summary Adopting Release.
---------------------------------------------------------------------------

    While most commenters requested an implementation period of 18-24 
months,\836\ one commenter requested an implementation period of 12-18 
months.\837\ We believe the operational capability needed to develop 
processes to comply with Regulation Best Interest is sufficiently 
established by firms of all sizes and resources. While we understand 
commenters' requests for periods longer than 12 months after 
effectiveness, the Commission has determined, in light of the 
importance of the protections afforded by Regulation Best Interest to 
retail customers, that a Compliance Date of one year after 
effectiveness is an appropriate timeframe for firms to conduct the 
requisite operational changes to their systems to establish internal 
processes to comply with Regulation Best Interest.\838\
---------------------------------------------------------------------------

    \836\ See Cetera August 2018 Letter; SIFMA August 2018 Letter; 
HD Vest Letter (recommending that the Commission adopt a 24-month 
implementation period); Northwestern Mutual Letter; IRI Letter 
(recommending that the Commission adopt an 18-to-24-month 
implementation period); CCMC Letters; AXA Letter (recommending that 
the Commission adopt at least an 18-month implementation period); 
ACLI Letter; TIAA Letter (recommending that the Commission adopt an 
18-month implementation period).
    \837\ See Raymond James Letter (recommending that the Commission 
adopt a 12-18-month implementation period).
    \838\ See footnote 809 and accompanying text.
---------------------------------------------------------------------------

    The Commission also believes that it is important to coordinate the 
transition dates of the Relationship Summary requirements with those of 
Regulation Best Interest to ensure that all retail investors receive 
the full suite of protections and benefits afforded by the amended and 
new rules. Finally, the Commission staff intends to offer firms 
significant assistance and support during the transition period and 
thereafter with the aim of helping to ensure that the investor 
protections and other benefits of the final rule are implemented in an 
efficient and effective manner.

III. Economic Analysis

A. Introduction and Primary Goals of the Regulation, Comments on Market 
Failure and Quantification, and Broad Economic Considerations

1. Introduction and Primary Goals of the Regulation
    Regulation Best Interest enhances the broker-dealer standard of 
conduct beyond existing suitability obligations and aligns the standard 
of conduct with retail customers' reasonable expectations.
    Under Regulation Best Interest, broker-dealers and their associated 
persons will be required to act in the best interest of the retail 
customer at the time the recommendation is made, without placing the 
financial or other interest of the broker-dealer or an associated 
person making the recommendation ahead of the interests of the retail 
customer. They also will be required to address conflicts of interest 
by establishing, maintaining, and enforcing policies and procedures 
reasonably designed to identify and fully and fairly disclose material 
facts about conflicts of interest, and in instances where the 
Commission has determined that disclosure is insufficient to reasonably 
address the conflict, to mitigate or, in certain instances, eliminate 
the conflict. As a result, Regulation Best Interest should enhance the 
efficiency \839\ of recommendations that broker-dealers provide to 
retail customers, allow retail customers to better evaluate the 
recommendations received, improve retail customer protection when

[[Page 33401]]

receiving recommendations from broker-dealers, and, ultimately, reduce 
agency costs \840\ and other costs. Importantly, Regulation Best 
Interest is designed to preserve, to the extent possible, (1) access 
and choice for investors who may prefer the transaction-based model 
that broker-dealers generally provide, or the fee-based model that 
investment advisers generally provide, or a combination of both types 
of arrangements, and (2) retail customer choice of the level and types 
of services provided and the securities available. For example, retail 
customers who intend to buy and hold a long-term investment on a non-
discretionary basis may find that paying a one-time commission to a 
broker-dealer who recommends such an investment is more cost effective 
than paying an ongoing advisory fee to an investment adviser merely to 
hold the same investment.\841\ Retail customers who would prefer 
advisory accounts but have not yet accumulated sufficient assets to 
qualify for investment advisory accounts, which may require customers 
to have a minimum amount of assets, may similarly benefit from 
recommendations from broker-dealers. Other retail customers who hold a 
variety of investments, or prefer different levels of services from 
financial professionals, may benefit from having access to both 
brokerage and advisory accounts.
---------------------------------------------------------------------------

    \839\ See infra footnote 846 and accompanying text.
    \840\ See infra footnote 855 and accompanying text.
    \841\ See infra footnote 1353 and accompanying text.
---------------------------------------------------------------------------

    The Commission is mindful of the costs imposed by, and the benefits 
obtained from our rules. Whenever the Commission engages in rulemaking 
under the Exchange Act and is required to consider or determine whether 
an action is necessary or appropriate in the public interest. Section 
3(f) of the Exchange Act also requires the Commission to consider, in 
addition to the protection of investors, whether the action would 
promote efficiency, competition, and capital formation.\842\ Also, when 
making rules pursuant to the Exchange Act, S the Commission is required 
under Section 23(a)(2) to consider, among other matters, the impact any 
rule would have on competition and is prohibited from adopting any rule 
that would impose a burden on competition not necessary or appropriate 
in furtherance of the purposes of the Exchange Act.\843\ The following 
analysis considers, in detail, the economic effects that the Commission 
believes are likely to or may result from Regulation Best Interest. The 
analysis includes consideration of the benefits and costs to retail 
investors and broker-dealers, and also takes into account the broader 
implications of Regulation Best Interest for efficiency, competition, 
and capital formation.
---------------------------------------------------------------------------

    \842\ See 15 U.S.C. 77b(b) and 15 U.S.C. 78c(f).
    \843\ See 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    Where possible, the Commission has sought to quantify the likely 
economic effects of Regulation Best Interest. The Commission is 
providing both a qualitative assessment and quantified estimates of the 
potential effects of Regulation Best Interest, where feasible. The 
Commission has incorporated data and other information provided by 
commenters to assist it in the analysis of the economic effects of 
Regulation Best Interest.\844\ However, as explained below in more 
detail, because the Commission does not have, has not received, and, in 
certain cases, does not believe it can reasonably obtain data that may 
inform on certain economic effects, the Commission is unable to 
quantify certain economic effects. The Commission further notes that 
even in cases where it has some data or it has received some data 
regarding certain economic effects, the quantification of these effects 
is particularly challenging due to the number of assumptions that it 
would need to make to forecast how broker-dealers will respond to 
Regulation Best Interest, and how those responses will, in turn, affect 
the broader market for investment advice and the retail customers' 
participation in financial markets.
---------------------------------------------------------------------------

    \844\ See infra Section III.A.3.
---------------------------------------------------------------------------

2. Broad Economic Considerations
    Investors generally derive utility from consuming goods and 
services over their lifetime and from bequeathing wealth to 
others.\845\ The amount of goods and services that an investor can 
consume or the amount of wealth the investor can bequeath is limited by 
the value of the resources available to the investor over his or her 
lifetime. These resources generally vary across market and economic 
conditions and over time. An investor generally seeks to allocate his 
or her resources across market and economic conditions and over time to 
achieve the highest expected utility possible over his or her lifetime. 
For example, an investor may decide to save, and therefore allocate, a 
proportion of his or her wages to maximize his or her expected utility 
from bequeathing wealth toward his or her children's future education.
---------------------------------------------------------------------------

    \845\ See, e.g., Irving Fisher, Theory of Interest, as 
Determined by Impatience to Spend Income and Opportunity to Invest 
it (1930).
---------------------------------------------------------------------------

    Capital markets facilitate this allocation and reallocation of 
resources. An investor can allocate available resources across 
financial assets available to them in the capital markets, such that 
these resources become available to the investor at the times, and in 
the market and economic conditions, when he or she needs them. There 
may be many combinations of financial assets or investment strategies 
that achieve an investor's allocation goals, but each of these 
strategies may not necessarily provide the investor with the same 
benefits or cause the investor to bear the same costs. The expected 
benefit of allocating resources to an investment strategy depends on 
the expected utility to the investor from the expected payoff of the 
strategy and from whether this strategy pays off in the market and 
economic conditions and at the times that the investor cares about. 
Importantly, the various costs of allocating resources to any strategy 
reduce the resources available for consumption and saving.
    A rational investor seeks out investment strategies that are 
efficient in the sense that they provide the investor with the highest 
possible expected net benefit, in light of the investor's investment 
objective that maximizes expected utility.\846\ From the discussion 
above, an efficient investment strategy may depend on the investor's 
utility from consumption, including: (1) His or her risk tolerance; (2) 
time available for the funds to be invested, and not consumed; (3) the 
resources that the investor has currently available (e.g., current 
wealth) or anticipates to become available at some point in the future 
(e.g., future income); and (4) the cost to the investor of implementing 
the strategy. An investor's efficient investment strategy may change 
over time because the investor's preferences, as well as market 
conditions and investment performance, may change over time.
---------------------------------------------------------------------------

    \846\ See, e.g., Andreu Mas-Colell, Michael D. Whinston, & Jerry 
R. Green, Microeconomic Theory (1995), specifically Chapter 10: 
Competitive Markets for a discussion of efficient allocations of 
resources.
---------------------------------------------------------------------------

    In general, a typical investor may not have the knowledge or the 
time to identify efficient strategies on his or her own. In addition, 
investors may be limited in their access to information and their human 
computational capacity when evaluating choices.\847\ As

[[Page 33402]]

an alternative to attempting to identify efficient strategies on his or 
her own, an investor may solicit advice from financial professionals.
---------------------------------------------------------------------------

    \847\ See, e.g., Herbert A. Simon, A Behavioral Model of 
Rational Choice, 69 Q. J. Econ. 99 (1955) for one of the first works 
on bounded rationality. See also Richard H. Thaler, Behavioral 
Economics: Past, Present, and Future, 106 Am. Econ. Rev. 1577 (2016) 
for a discussion of the evolution of bounded rationality in 
economics.
---------------------------------------------------------------------------

    While there are many types of financial professionals \848\ that 
can provide advice related to a retail customer's finances, we focus 
here (and in Regulation Best Interest) on a type of professional that 
retail customers commonly access, namely broker-dealers and their 
associated persons.
---------------------------------------------------------------------------

    \848\ The list of financial professionals that can provide 
advice related to a retail customer's finances includes broker-
dealers and their associated persons, investment advisers, banks, 
and insurance agents.
---------------------------------------------------------------------------

    A broker is any person engaged in the business of effecting 
transactions in securities for the account of others.\849\ A dealer is 
any person engaged in the business of buying and selling securities for 
its own account, through a broker or otherwise.\850\ Within the scope 
of these definitions, a ``broker-dealer'' (or, a firm that fits both 
definitions) may offer a wide variety of services to retail customers. 
These services include buying and selling securities for the retail 
customer as well as providing limited personalized investment advice in 
the form of recommendations of whether or not to engage in securities 
transactions or investment strategies involving securities.\851\
---------------------------------------------------------------------------

    \849\ See Section 3(a)(4)(A) of the Securities Exchange Act.
    \850\ See Section 3(a)(5)(A) of the Securities Exchange Act.
    \851\ We focus our discussion on recommendations that are the 
focus of Regulation Best Interest but note that broker-dealers and 
their representatives provide a wide variety of ``agency services'' 
as described in footnote 1 of the Proposing Release. See, e.g., 913 
Study. See also infra Section III.B.1.a.
---------------------------------------------------------------------------

    Federal securities laws and SRO rules govern broker-dealers' 
conduct of business. Among other things, they require that a broker-
dealer or associated person ``have a reasonable basis to believe that a 
recommended transaction or investment strategy involving a security or 
securities is suitable for the customer, based on the information 
obtained through the reasonable diligence of the [firm] or associated 
person to ascertain the customer's investment profile.'' \852\ While a 
suitable recommendation must take into account the elements of a retail 
customer's investment profile that make securities transactions or an 
investment strategy efficient for that particular retail customer, this 
requirement for suitability may not lead to an efficient result for the 
retail customer.
---------------------------------------------------------------------------

    \852\ See FINRA Rule 2111 (Suitability); see also infra Section 
III.B.2.b.
---------------------------------------------------------------------------

    The efficiency of a recommendation to a retail customer may depend 
on: (1) The menu of securities transactions and investment strategies 
the broker-dealer or its associated persons considers and makes 
available to the retail customer; (2) the return distribution and the 
costs of these securities transactions and strategies; (3) the 
associated person's understanding of these investment options and the 
retail customer's objectives, such as the retail customer's risk 
tolerance and time preference; and (4) the retail customer's resource 
constraints.
    A recommendation provided by an associated person of the broker-
dealer may be influenced by the conflicts of interest that the 
associated person may have or the conflicts of interest that the 
broker-dealer may have at the time of the recommendation. These 
conflicts can arise as a result of how broker-dealers generate revenue 
from various securities or investment strategies that they make 
available to retail customers and how broker-dealers compensate their 
associated persons for providing recommendations to retail customers. 
In the United States, broker-dealers may earn transaction-based 
compensation that is commonly paid either directly by the retail 
customer (e.g., commissions and markups or markdowns) or indirectly 
through the investment sponsor (e.g., 12b-1 fees or revenue sharing). 
Broker-dealers may compensate their associated persons that provide 
recommendations to retail customers with a portion of the commissions 
and markups or markdowns these persons generate through their 
recommendations. Such financial incentives can vary depending on the 
investment product line, account type, or other factors (e.g., amount 
of customer assets brought into the broker-dealer or revenue generated 
from customer accounts).
    A retail customer generally chooses to accept or reject a 
recommendation supplied by the associated person of the broker-
dealer.\853\ Some retail customers may base their decisions on an 
assessment of whether the recommendations they receive would result in 
securities transactions or investment strategies that are efficient for 
them. These customers' assessment may depend on factors such as their 
perception of the associated person's ability to properly understand 
and account for the customer's objectives, any information they have 
about the associated person's or firm's conflicts of interest with 
respect to that recommendation, and the extent to which these conflicts 
are expected to result in less than efficient recommendations for the 
retail customer. However, other retail customers may rely in full or in 
part on factors less directly related to the recommendation at hand. 
Instead, they might rely on factors such as their level of trust with 
the associated person or firm, and in certain circumstances might be 
inclined to simply accept all of the associated person's 
recommendations without evaluating for themselves whether the 
recommendations are efficient.\854\
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    \853\ Note, however, that a retail customer may receive 
automated advice without involvement of an associated person of the 
broker-dealer. For example, a broker-dealer may generate 
recommendations through an asset allocation model. FINRA Regulatory 
Notice 12-25; See also FINRA Report on Digital Investment Advice 
(Mar. 2016).
    \854\ See, e.g., the discussion on investor trust in the markets 
for financial advice in Section III.B.4.a, infra. See also Gross 
Letter. See also Roman Inderst & Marco Ottaviani, How (not) to pay 
for advice: A framework for consumer financial protection, 105 the 
J. Fin. Econ 393 (2012) for a discussion of the economic surplus 
extracted by broker-dealers that provide recommendations to retail 
customers, and how this surplus relates to the factors that 
determine a retail customer's decision to accept or reject a 
recommendation.
---------------------------------------------------------------------------

    As noted above, broker-dealers or their associated persons may have 
conflicts of interest that could influence their recommendations to 
retail customers at the time when they are provided.
    A retail customer's choice to accept a particular recommendation 
often directly affects the compensation that an associated person or 
broker-dealer itself receives. For example, an associated person may 
receive greater compensation from selling certain securities or 
strategies relative to other securities or strategies. Differences in 
compensation across the securities or strategies offered by a broker-
dealer may add complexity to an associated person's incentives and may 
create conflict between the interests of the associated person, who 
desires to maximize his or her compensation, and the interests of the 
retail customer, who expects the recommended transaction to be 
efficient for him or her.
    In general, this conflict of interest may result in a broker-dealer 
recommending securities or investment strategies that are less 
efficient for the retail customer. For instance, the recommended 
securities or strategies may be enhancing the associated person's 
compensation at the expense of the retail customer. Put another way, 
because of the financial incentives, broker-dealers and their 
associated

[[Page 33403]]

persons may be motivated to recommend certain types or quantities of 
securities or strategies, and those recommendations may place the 
interests of the broker-dealer or its associated persons ahead of the 
interests of the retail customer, which may not result in the retail 
customer maximizing his or her expected net benefit. An inefficient 
recommendation may lead to various results for the retail customer, 
including inferior investment outcomes, such as risk-adjusted expected 
returns that are lower relative to other similar investments or 
investment strategies.
    A retail customer may accept a recommendation that is less 
efficient if he or she is unable to assess correctly the efficiency of 
the recommendation.
    The difference between the net benefit to the retail customer from 
accepting a less than efficient recommendation about a securities 
transaction or investment strategy, where the associated person or 
broker-dealer puts its interests ahead of the interests of the retail 
customer, and the net benefit the retail customer might expect from a 
similar securities transaction or investment strategy that is efficient 
for him or her, as defined above, is an agency cost.\855\ As discussed 
in the Proposing Release and above, this agency cost arises because of 
the conflicts of interest of the broker-dealer and its associated 
persons, and the differences between the information sets available to 
the broker-dealer and the retail customer at the time of the 
recommendation.
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    \855\ See, e.g., Michael C. Jensen, and William. H. Meckling, 
Theory of the Firm: Managerial Behavior, Agency Costs and Ownership 
Structure, 3 J. Fin. Econ. 305 (1976) for a more general discussion 
of agency costs.
---------------------------------------------------------------------------

    In certain principal-agent relationships, the principal may be able 
to reduce the agency costs that he or she is facing in various ways, 
including by structuring the agent's compensation in a way that better 
aligns the interest of the agent with that of the principal.\856\ A 
feature of the agency relationship between a retail customer (the 
principal) and a broker-dealer (the agent) that is common in many 
principal-agent relationships (including the investment adviser-client 
relationship) is that the retail customer generally does not have full 
transparency about the agent's compensation for providing advice and 
the sources of the agent's compensation. Thus, the retail customer, 
through the decision to accept or reject a recommendation received, has 
generally limited understanding of and control over the compensation 
that the broker-dealer and its associated person obtains from providing 
the recommendation. These limitations restrict the retail customer's 
ability to reduce the agency costs that he or she is facing.
---------------------------------------------------------------------------

    \856\ See, e.g., Stephen A. Ross, The Economic Theory of Agency: 
The Principal's Problem, 63 Am. Econ. Rev. ( Papers & Proc.) 134 
(1973).
---------------------------------------------------------------------------

    We also recognize that even if the retail customer were to have 
full transparency about the broker-dealer's and its associated person's 
compensation from providing advice, the retail customer's ability to 
reduce the agency costs may be constrained in other ways. For example, 
if the menu of securities from which the associated person of the 
broker-dealer offers recommendations is limited, the retail customer's 
and the associated person's ability to identify and select a more 
efficient investment may be constrained.
    Different retail customers may face different agency costs 
depending on whether they base their decision to act on a 
recommendation on an assessment of the efficiency of the 
recommendation. Specifically, as noted above, a retail customer that 
evaluates and uses a recommendation received based on an assessment 
about the efficiency of that recommendation may be more successful in 
identifying and controlling, albeit in a limited fashion, the 
compensation that the broker-dealer and its associated person receive 
from the recommendation--such as by being more likely to reject a less 
than efficient recommendation--compared to a retail customer that makes 
this decision without forming an assessment of the efficiency of the 
recommendation. Thus, the agency costs may be higher for those retail 
customers that make their decision of whether to act on a 
recommendation received without an assessment of the efficiency of the 
recommendation.
    While the discussion above focuses on the actions that the 
principal (i.e., the retail customer) can take to reduce the agency 
costs that he or she is facing, the agent can also take actions to 
reduce the agency costs to the principal. For example, in the agency 
paradigm, when the principal may forgo sharing a potentially large 
surplus with the agent because of the high agency costs, the agent may 
have an incentive to structure the terms of the relationship in a way 
that reduces the agency costs to the principal.\857\ In the agency 
relationship between a retail customer and a broker-dealer, given the 
features of the compensation that the broker-dealer and its associated 
persons receive for providing recommendations (e.g., this compensation 
does not depend on the value of the assets in a principal's account), 
the broker-dealer and its associated persons may not have sufficient 
incentive to take actions voluntarily that would reduce agency costs to 
the retail customer, such as voluntarily increasing transparency with 
respect to compensation.\858\
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    \857\ See, e.g., Sanford J. Grossman & Oliver D. Hart, The Costs 
and Benefits of Ownership: A Theory of Vertical and Lateral 
Integration, 94 J. Pol. Econ. 691 (1986) for a discussion of the 
actions that agents can take to reduce the agency costs to the 
principal in the context of the relationship between an owner (the 
principal) and a manager (the agent) when the agent that has a 
valuable investment opportunity that can only be financed by the 
principal.
    \858\ Limited transparency with respect to how broker-dealers 
and their associated persons are compensated from recommending a 
security and what constrains their menus of securities may make it 
difficult for retail customers to grasp the size of the agency costs 
that they are facing at the time when they receive the 
recommendation. As a result, this limited transparency may allow 
broker-dealers and their associated persons to extract informational 
rents (i.e., in the context of a transaction, compensation in excess 
of what is competitively feasible that stems solely from the 
informational advantage of one party over another) from the retail 
customers when providing recommendations. The adviser business model 
also has its own set of conflicted incentives to gather assets 
(based on AUM fees) or maximize the time that it takes to complete a 
job (if paid an hourly fee). Dual-registrants also have an incentive 
to recommend the type of account that is most profitable to the 
firm. See AFL-CIO April 2019 Letter. See also Morgan Lewis Letter 
(describing investment adviser compensation and conflicts disclosure 
in Form ADV); Bruce Ian Carlin & Gustavo Manso, Obfuscation, 
Learning, and the Evolution of Investor Sophistication, 24 Rev. Fin. 
Stud. 754 (2011) for a discussion about the relationship between 
informational rents and the opacity of recommended investments 
(e.g., securities with complex payoff structures).
---------------------------------------------------------------------------

    Although the dynamics of the agency relationship between a retail 
customer and a broker-dealer may not cause the broker-dealer to take 
steps to increase transparency, competitive factors in the broker-
dealer industry such as steps toward transparency taken by other 
broker-dealers may cause increased transparency in that relationship. 
Competitive dynamics are more effective in areas where comparisons can 
be more easily made. For example, in the market for mutual funds --
particularly index funds--comparability and competition, among other 
factors, have driven down fees significantly.\859\
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    \859\ Comparability among index funds that follow the same 
market index is facilitated in part by their passive style of 
investing. Actively managed funds that follow the same investment 
strategy can show different performance due to, among other things, 
the ``skill'' of the manager of outperforming the market (or any 
other benchmark). This skill is unobservable and generally hard to 
measure, which makes comparisons across actively managed funds 
difficult. In contrast, comparisons across index funds that follow 
the same market index and that have passive investment styles are 
based more on observable variables, such as fees, rather than 
unobservable variables, such as managerial skill. In this context, 
disclosure that is more salient with respect to these observable 
variables may facilitate comparisons across index funds.

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[[Page 33404]]

    While we do not have evidence to establish the degree to which 
broker-dealers can extract large informational rents from retail 
customers under the current legal and regulatory regime that governs 
the broker-dealers' standard of conduct, the existing agency costs of 
the relationship between the retail customer and the broker-dealer 
would likely be larger, absent the current legal and regulatory 
regime.\860\ In general, standards and regulation are effective means 
of reducing agency costs when principals (e.g., retail customers) and 
agents (e.g., broker-dealers) cannot reduce the agency costs on their 
own by negotiating to address the market frictions in their 
relationship through mechanisms available to them, such as bilateral 
contracting \861\ or ``side payments.'' \862\
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    \860\ See, e.g., Matthew L. Kozora, Security Recommendations and 
the Liabilities of Broker-Dealers (U.S. Sec. & Exch. Comm'n, Working 
Paper, May 1, 2016), available at https://www.sec.gov/files/Kozora_BD-Liability_05-2016.pdf, which provides evidence from 
investor awards in FINRA arbitrations that the author interprets as 
indicative of informational rents being nonzero. See also our more 
comprehensive discussion in Section III.B.3.c, infra, about 
potential investor harm associated with investment advice, including 
from potential informational rents.
    \861\ See Proposing Release at 21643.
    \862\ Another way principals and agents negotiate around market 
frictions is through ``side payments.'' In a transaction between two 
parties, a side payment is a monetary exchange from one party to 
another that is not part of the transaction. This mechanism is 
discussed in the literature on bilateral externalities, which 
focuses on how the actions of one party can affect the well-being of 
the other party. This mechanism also applies to the relationship 
between a broker-dealer and a retail customer because the action 
taken by a broker-dealer, namely providing a recommendation, may 
affect the well-being of the retail customer receiving that 
recommendation. In the literature on bilateral externalities, if the 
party taking these externality actions is unconstrained, the 
allocation of resources across the two parties may be inefficient. 
However, in certain circumstances, the parties can avoid this 
inefficient outcome through side payments that neutralize the effect 
of the externality on the allocations. See, e.g., Mas-Colell et al. 
(1995), supra footnote 846, specifically Part 3: Market Equilibrium 
and Market Failure for a discussion of bilateral externalities.
---------------------------------------------------------------------------

    Regulation Best Interest enhances the current standard of conduct 
for broker-dealers and codifies it in an Exchange Act rule. Regulation 
Best Interest is designed to: (1) Enhance the current standard of 
conduct applicable to broker-dealers and associated persons when they 
make a recommendation to a retail customer of any securities 
transaction or investment strategy involving securities; (2) reduce 
conflicts of interest that currently exist between retail customers and 
broker-dealers and their associated persons; and (3) reduce information 
asymmetries that currently limit the ability of retail customers to 
evaluate the efficiency of recommendations they receive from broker-
dealers and their associated persons. In each of these three ways, 
Regulation Best Interest is designed to reduce the agency costs in the 
relationship between broker-dealers and their retail customers, 
including in situations where the existing legal and regulatory regime 
that governs broker-dealers' standard of conduct has had limited 
effectiveness.
3. Comments on Market Failure of the Principal-Agent Relationship and 
Quantification; Comments That the Broker-Dealer, Commission-Based Model 
Should Be Severely Restricted or Eliminated
    The economic analysis in the Proposing Release characterized the 
relationship between a retail customer and a broker-dealer as one 
between a principal (the retail customer) and an agent (the broker-
dealer).\863\ The analysis noted that the potential conflict between 
interests and the differences between the information sets available to 
the agent and the principal may result in agency costs. It further 
noted that the inability of the broker-dealers and retail customers to 
overcome the market frictions underlying these agency costs may result 
in inefficient allocations of resources. An inability of the principal 
and the agent to efficiently negotiate around the frictions that 
produce agency costs and take actions that would increase the 
efficiency of their allocations is what economists refer to as a 
``market failure'' of the principal-agent relationship,\864\ generally, 
and of the agency relationship between the retail customer and the 
broker-dealer, specifically.\865\
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    \863\ See Proposing Release at 21629-21631.
    \864\ See, e.g., Mas-Colell et al. (1995), supra footnote 846.
    \865\ In general, because frictions such as asymmetric 
information are ever present, all markets and agency relationships 
have some degree of market failure.
---------------------------------------------------------------------------

    The analysis in the Proposing Release recognized that while the 
Commission cannot provide a quantified estimate of the magnitude of 
this agency cost, the existence of these costs and their persistence 
justifies regulatory intervention.\866\
---------------------------------------------------------------------------

    \866\ See Proposing Release at 21631.
---------------------------------------------------------------------------

    A number of commenters questioned this approach. Certain of these 
commenters stated that the Commission needs to more fully identify the 
market failure that needs to be addressed, and certain commenters 
stated that the Commission did not provide a quantitative assessment of 
the severity of the market failure that would prompt the need for 
regulatory intervention.\867\ We address these concerns below.
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    \867\ See, e.g., CFA August 2018 Letter at 105, noting that 
``[c]orrectly diagnosing the problem requires identifying and 
analyzing the market failure that has occurred in investment advice 
securities markets, as well as assessing the significance of that 
problem''; See also, e.g., Letter from Charles Cox, Former SEC Chief 
Economist, et al. (Feb. 6, 2019) (``Former SEC Senior Economists 
Letter'') at 2, noting that ``the Commission confronts important 
questions about advisers balancing their own compensation against 
the effect of that compensation on the customer's expected returns. 
We wonder if the extreme asymmetry of information and financial 
sophistication between advisers and many of their clients 
constitutes a market failure that the April proposals are intended 
to ameliorate.'' In addition, the Former SEC Senior Economists 
Letter raised three main concerns with the economic analysis in the 
Proposing Release: (1) The discussion of the potential problems in 
the customer-adviser relationship was incomplete and identified 
other features of the market for ongoing retail investment advice 
that might be problematic; (2) there was inadequate discussion and 
analysis of the existing economic literature on financial advice; 
and (3) there were questions of whether the disclosure requirements 
in the Proposing Release would provide meaningful information for 
customers. The economic analysis addresses these concerns. For 
instance, with respect to (1), Section III.A.2 provides a more in 
depth discussion of the potential problems that may arise when a 
broker-dealer provides recommendations to a retail customer. With 
respect to (2), Section III.B.3 engages more fully with the economic 
literature on financial advice. Finally, with respect to (3), 
Sections III.B.4, III.C.2, and III.C.4 provide discussions on the 
effectiveness of the disclosure requirements of Regulation Best 
Interest.
---------------------------------------------------------------------------

    With respect to the issue of appropriately identifying the market 
failure, one commenter questioned whether the relationship between the 
retail customer and the broker-dealer is a principal-agent 
relationship.\868\ This commenter stated that in many instances, a 
broker-dealer's provision of recommendations to a retail customer 
resembles an arm's length transaction (e.g., purchasing a car) that 
benefits the more informed broker-dealer at the expense of the less 
informed retail customer. This commenter disagreed with the 
Commission's broader view that the market failure stems from the agency 
costs of the relationship between

[[Page 33405]]

a broker-dealer and a retail customer,\869\ and instead stated that the 
market failure is due to conflicts of interest caused by the way 
broker-dealers and their associated persons are generally compensated 
for providing recommendations to retail customers.\870\ Similarly, 
another commenter stated that the Commission failed to discuss how the 
current compensation practices associated with providing 
recommendations to retail customers creates incentives for the broker-
dealer and its associated persons to favor one securities transaction 
or investment strategy over another when making recommendations to 
retail customers.\871\ This commenter further questioned whether the 
information asymmetry and the discrepancy in the level of financial 
sophistication between broker-dealers and their retail customers 
constitute a market failure.\872\ One commenter noted that the poor 
performance of actively managed funds that are being recommended by 
broker-dealers to small retail customers reflects a principal-agent 
problem that causes an ``enormous'' wealth transfer from retail 
customers to the financial industry, including broker-dealers.\873\ 
This commenter stated that this problem arises because of the broker-
dealer's commission-based compensation for providing recommendations 
and because of the information asymmetries between the broker-dealer 
and the retail customer at the time of the recommendation.\874\ This 
commenter also stated that recommendations subject to conflicts of 
interest may have no value for retail customers.\875\
---------------------------------------------------------------------------

    \868\ See CFA August 2018 Letter at 107, noting that ``[t]he 
Commission's economic analysis gets off to a faulty start by 
mischaracterizing, or at least over-simplifying, the broker-customer 
`advice' relationship, as a principal-agent relationship. While 
there are certainly instances where a broker and its customer can 
exhibit features of a bona fide principal-agent relationship--for 
example when executing a customer's order--it's not clear that, in 
the context of receiving investment recommendations, those same 
characteristics are present. Certainly, the brokerage industry 
expressly refutes this characterization, having argued successfully 
in the Fifth Circuit that brokers engage in nothing more than an 
arm's length commercial sales transaction, no different from a car 
dealer soliciting interest in inventory.''
    \869\ See CFA August 2018 Letter at 108, noting that 
``[t]ypically, principal-agent relationships don't involve third 
party payments to the agent, which can adversely affect the level of 
loyalty the agent provides to the principal.''
    \870\ See CFA August 2018 Letter at 107, noting that the 
Commission ``fails to acknowledge that conflicts of interest are a 
real problem that result in real harm to investors [. . .]'' and 
``[. . .] the Release fails to make clear whether the Commission is 
truly seeking to address the underlying problem of conflicts' 
harmful impact on investors.''
    \871\ See Former SEC Senior Economists Letter at 3, noting that 
``[n]owhere does the EA emphasize that an adviser's compensation 
provides numerous opportunities for her to favor one investment over 
another on the basis of the compensation it pays to her or to her 
firm.''
    \872\ See Former SEC Senior Economists Letter at 2. See also 
supra footnote 867 that describes in more detail the concerns raised 
by this commenter.
    \873\ See Letter from Monique Morrissey, Economist and Heidi 
Shierholz, Senior Economist and Director of Policy, EPI (Aug. 7, 
2018) (``EPI Letter'') at 6, noting that ``[i]n an equilibrium with 
knowledgeable investors, we would expect returns from active and 
passive strategies to be equal. The fact that actively-managed funds 
marketed to small investors tend to perform poorly reflects a market 
distortion--naivet[eacute]--or a `principal-agent problem' in 
economics parlance, which results in enormous transfers from 
investors to the financial industry.''
    \874\ See EPI Letter at 2, noting that ``[c]onflicts of interest 
between buyers and sellers are commonplace. Many salesmen, including 
brokers and car dealers, are paid on commission. However, it has 
long been recognized that markets for professional advice are 
different from markets for automobiles because information 
asymmetries are inherent in these transactions.''
    \875\ See EPI Letter at 8, noting that ``the SEC never considers 
that `advice' offered may not just be of lower quality than 
expected, but worse than no advice at all'' and that ``much of the 
`advice' provided by broker-dealers not only lacks value, but is 
actually harmful, steering savers to higher-cost products and costly 
services that will reduce their future standard of living compared 
to how they would fare in the absence of this `advice.' This may be 
true whether or not, in the absence of conflicted `advice,' 
investors would have availed themselves of more paid or free advice 
from more impartial sources.''
---------------------------------------------------------------------------

    As an initial matter, in response to comments regarding the need to 
discuss fully the existing market failure, it is important to recognize 
that the Commission has been studying and carefully considering the 
issues related to the broker-dealer-client relationship and the related 
standard of conduct for broker-dealers for many years, which led to the 
development of the Proposing Release and the economic analysis 
therein.\876\ In light of the comments on the Proposing Release, the 
extensive outreach by the Commission and staff, as well as investor 
testing, the Commission has more specifically and fully described the 
relationship between the broker-dealer and the client, the related 
market failure, and the resulting potential economic effects of 
Regulation Best Interest in addressing the market failure.\877\
---------------------------------------------------------------------------

    \876\ See Proposing Release at 21579-21583.
    \877\ See supra Section III.A.2.
---------------------------------------------------------------------------

    The Commission continues to believe that agency costs are at the 
root of existing allocative inefficiencies in the market for broker-
dealer advice. Moreover, this economic analysis recognizes that a 
proper understanding of the economic fundamentals of an investor's 
decision to allocate resources across market and economic conditions 
and over time is central to identifying the frictions that cause 
inefficiencies in the agency relationship between a broker-dealer and a 
retail customer.
    In response to the commenter that stated that in a principal-agent 
relationship agents do not receive compensation from third parties 
(e.g., investment sponsors), the Commission notes that the compensation 
that the investment sponsor provides to the agent is ultimately funded 
by the principal (i.e., the retail customer).\878\ In addition, in 
response to the commenter's concern that a broker-dealer's provision of 
recommendations to retail customers resembles an arm's length 
transaction that is ``no different from a car dealer soliciting 
interest in inventory,'' \879\ the Commission notes that under the 
current regulatory regime broker-dealers and their associated persons 
are subject to a suitability standard of conduct that has been 
interpreted to ``be consistent with [the] customer's best interests.'' 
\880\ In contrast, in an arm's length transaction, the parties involved 
are generally not subject to a standard of conduct that would constrain 
the more informed party from acting solely in its own interest.\881\ 
Finally, in response to the commenter's concern with respect to the 
identification of the market failure,\882\ the Commission notes that 
while conflicts of interest arise in many types of transactions, in 
certain instances the parties involved can negotiate an arrangement 
between themselves that would reduce the effect of conflicts of 
interest on the allocation of resources across the parties and improve 
the efficiency of this allocation. The Commission further notes that 
agency costs may deter the parties from engaging in privately 
negotiated arrangements that would improve the efficiency of the 
allocation of resources between the parties. From this perspective, the 
Commission believes that it is the agency costs rather than the 
conflicts of interest themselves that should be viewed as the source of 
the market failure.
---------------------------------------------------------------------------

    \878\ See supra footnote 869.
    \879\ See supra footnote 868.
    \880\ See infra footnote 979 and accompanying text.
    \881\ However, in certain markets, there may be market 
mechanisms in place that would prevent the more informed party to a 
transaction from acting solely in its own interest.
    \882\ See supra footnote 870.
---------------------------------------------------------------------------

    In response to the commenter that noted that the Commission did not 
discuss how the compensation received by the broker-dealer and its 
associated persons creates incentives to favor one security or 
investment strategy over another when making recommendations to retail 
customers,\883\ the Commission has incorporated into this economic 
analysis a detailed discussion of the incentives created by the current 
compensation practices associated with providing recommendations to 
retail customers.\884\ In addition, in response to the commenter's 
concerns about whether the information asymmetry and the discrepancy in 
the level of financial sophistication between retail customers and a 
broker-dealer and its associated persons are the source of market 
failure, the Commission notes that this economic analysis establishes a 
more

[[Page 33406]]

clear link between bounded rationality, including access to information 
and financial literacy of retail customers, and agency costs, and 
reflects our conclusion that the agency costs are at the root of the 
market failure.
---------------------------------------------------------------------------

    \883\ See supra footnote 871.
    \884\ See infra Section III.C.4.
---------------------------------------------------------------------------

    The Commission further notes that the so-called ``informational 
rent'' that a broker-dealer may be incentivized to extract from a 
retail customer to take advantage of the information asymmetry or the 
discrepancy in the level of financial sophistication is one component 
of the agency costs associated with the relationship between a retail 
customer and a broker-dealer. In addition, the Commission notes that 
the evidence on the size of the agency costs associated with such 
informational rents is limited.\885\ This evidence is not generally 
supportive of a commenter's assessment that the wealth transfer from 
retail customers to broker-dealers is ``enormous.'' \886\ The 
Commission agrees with this commenter, who stated that the way broker-
dealers are compensated for providing recommendations and the 
information asymmetry between retail customers and broker-dealers are 
important determinants of the agency costs. However, based on the 
evidence discussed below, the Commission disagrees with this 
commenter's assessment that the advice provided by the associated 
persons of the broker-dealer has no value.\887\
---------------------------------------------------------------------------

    \885\ See supra Section III.A.2 and infra Section III.B.3.
    \886\ See supra footnote 873.
    \887\ See infra Section III.B.3.b.
---------------------------------------------------------------------------

    With respect to the issue of measuring the severity of the market 
failure, some commenters stated that the Commission failed to take into 
account existing academic literature that provides evidence of investor 
harm caused by accepting advice from the associated persons of the 
broker-dealer. A subset of these commenters believed that the evidence 
provided in some of these academic studies is compelling and that the 
Commission should use it to quantify the severity of the market 
failure.\888\ One commenter also urged the Commission to supplement the 
academic evidence on investor harm with evidence from data available to 
the Commission from regulatory oversight.\889\
---------------------------------------------------------------------------

    \888\ See, e.g., CFA August 2018 Letter; EPI Letter; AARP August 
2018 Letter; Better Markets August 2018 Letter; Former SEC Senior 
Economists Letter.
    \889\ See CFA August 2018 Letter at 112. This commenter 
suggested that we present additional information about the existence 
and frequency of the potential harm to investors ``that results from 
conflicted brokerage `advice','' which may collectively be seen as 
misconduct by financial professionals.
---------------------------------------------------------------------------

    In response to these comments, the Commission maintains that the 
existence of misconduct that commenters requested the Commission to 
document does not render the approach taken in Regulation Best Interest 
irrational, inappropriate, or unreasonable, nor does it suggest that an 
alternative approach would be more effective in fulfilling the 
Commission's mission. The Commission is aware and understands the 
concerns raised by the commenters with regards to the evidence on 
investor harm and the extent to which such evidence can inform on our 
understanding of the severity of the market failure in the market for 
broker-dealer advice. As discussed in the Proposing Release and 
reiterated in this economic analysis, the Commission believes that 
retail investors can be harmed when they accept recommendations from a 
broker-dealer that places the financial or other interest of the 
broker-dealer or its associated persons ahead of the interests of the 
retail customers. In addition, this economic analysis engages more 
fully with the economic literature on financial advice and considers 
these studies in analyzing the costs and benefits associated with 
Regulation Best Interest.\890\
---------------------------------------------------------------------------

    \890\ See infra Section III.B.3.c.
---------------------------------------------------------------------------

B. Economic Baseline

    This section discusses, as it relates to this rulemaking, the 
current state of the broker-dealer and investment adviser markets; the 
current regulatory environment and market practices surrounding the 
provision of recommendations by broker-dealers; evidence on the 
potential value and harm of investment advice; and how issues related 
to trust, financial literacy, and disclosure effectiveness affect 
conflicts between investors and financial professionals. The economic 
baseline has been revised and expanded relative to the Proposing 
Release to address comments, discussed more fully below.
1. Providers of Financial Services \891\
---------------------------------------------------------------------------

    \891\ In addition to broker-dealers and Commission-registered 
investment advisers discussed below in the baseline, there are a 
number of other entities, such as state-registered investment 
advisers, commercial banks and bank holding companies, and insurance 
companies, which also provide financial advice services to retail 
customers; however, because of unavailability of data, the 
Commission is unable to estimate the number of some of those other 
entities that are likely to provide financial advice to retail 
customers as well as their size and the scope of services they 
provide. A number of broker-dealers (see infra footnote 899) have 
non-securities businesses, such as insurance or tax services. As of 
December 2018, there were approximately 17,300 state-registered 
investment advisers. The Department of Labor in its Regulatory 
Impact Analysis identifies approximately 398 life insurance 
companies that could provide advice to retirement investors. See 
infra footnote 1002.
---------------------------------------------------------------------------

a. Broker-Dealers
    Regulation Best Interest will affect the market for broker-dealer 
services, including firms that are dually registered as broker-dealers 
and investment advisers \892\ and broker-dealers affiliated with an 
investment adviser.\893\ The market for broker-dealer services 
encompasses a small set of large and medium sized broker-dealers and 
thousands of smaller broker-dealers competing for niche or regional 
segments of the market.\894\ The market for broker-dealer services 
includes many different markets for a variety of services, including 
(1) managing orders for customers and routing them to various trading 
venues; (2) providing advice to customers that is in connection with 
and reasonably related to their primary business of effecting 
securities transactions; \895\ (3) holding retail customers' funds and 
securities; (4) handling clearance and settlement of trades; (5) 
intermediating between retail customers and carrying/clearing brokers; 
(6) dealing in corporate debt and equities, government bonds, and 
municipal bonds, among other securities; (7) privately placing 
securities; and (8) effecting transactions in mutual funds that involve 
transferring funds directly to the issuer. Some broker-dealers may 
specialize in just one narrowly defined service, while

[[Page 33407]]

others may provide a wide variety of services.
---------------------------------------------------------------------------

    \892\ Not all firms that are dually registered as an investment 
adviser and a broker-dealer offer both brokerage and advisory 
accounts to retail investors. For example, some dually registered 
firms offer advisory accounts to retail investors but offer only 
brokerage services, such as underwriting services, to institutional 
clients. For purposes of the discussion of the baseline in this 
economic analysis, a dually registered firm is any firm that is 
dually registered with the Commission as an investment adviser and a 
broker-dealer.
    \893\ Some broker-dealers may be affiliated with investment 
advisers and not dually registered. From Question 10 on Form BD, 
2,098 (55.7%) broker-dealers report that, directly or indirectly, 
they control, are controlled by, or are under common control with an 
entity that is engaged in the securities or investment advisory 
business. Comparatively, 2,421 (18.2%) SEC-registered investment 
advisers report an affiliate that is a broker-dealer in Section 7A 
of Schedule D of Form ADV, including 1,878 SEC-registered investment 
advisers that report an affiliate that is a registered broker-
dealer. Approximately 77% of total regulatory AUM are managed by the 
2,421 SEC-registered investment advisers.
    \894\ See Risk Management Controls for Brokers or Dealers with 
Market Access, Securities Exchange Act Release No. 63241 (Nov. 3, 
2010) [75 FR 69791, 69822 (Nov. 15, 2010)]. For simplification, we 
present our analysis as if the market for broker-dealer services 
encompasses one broad market with multiple segments, even though, in 
terms of competition, it could also be discussed in terms of 
numerous interrelated markets.
    \895\ See Solely Incidental Interpretation.
---------------------------------------------------------------------------

    As of December 2018, there were approximately 3,764 registered 
broker-dealers with over 140 million customer accounts. In total, these 
broker-dealers have over $4.3 trillion in total assets, which are total 
broker-dealer assets as reported on Form X-17a-5.\896\ More than two-
thirds of all brokerage assets and close to one-third of all customer 
accounts are held by the 17 largest broker-dealers, as shown in Table 
1, Panel A.\897\ Of the broker-dealers registered with the Commission 
as of December 2018, 563 broker-dealers were dually registered as 
investment advisers.\898\ These firms hold over 90 million (63%) 
customer accounts. Approximately 539 broker-dealers (14%) report at 
least one type of non-securities business, including insurance, 
retirement planning, mergers and acquisitions, and real estate, among 
others.\899\ Approximately 73.5% of registered broker-dealers report 
retail customer activity.\900\
---------------------------------------------------------------------------

    \896\ Assets are estimated by Total Assets (allowable and non-
allowable) from Part II of the FOCUS filings (Form X-17A-5 Part II, 
available at https://www.sec.gov/files/formx-17a-5_2.pdf) and 
correspond to balance sheet total assets for the broker-dealer. The 
Commission does not have an estimate of the total amount of customer 
assets for broker-dealers. We estimate broker-dealer size from the 
total balance sheet assets as described above.
    \897\ Approximately $4.24 trillion of total assets of broker-
dealers (98%) are at broker-dealers with total assets in excess of 
$1 billion. Of the 33 dual-registrants in the group of broker-
dealers with total assets in excess of $1 billion, total assets for 
these dual-registrants are $2.32 trillion (54%) of aggregate broker-
dealer assets. Of the remaining 99 broker-dealers with total assets 
in excess of $1 billion that are not dual-registrants, 91 have 
affiliated investment advisers.
    \898\ This number includes the number of broker-dealers who are 
also registered as state investment advisers. For purposes of the 
discussion of the baseline in this economic analysis, a dual-
registrant is any firm that is dually registered with either the 
Commission or a state as an investment adviser and a broker-dealer. 
Excluding state registered advisers, there are 359 entities that are 
dually registered with the Commission as an investment adviser and a 
broker-dealer.
    \899\ We examined Form BD filings to identify broker-dealers 
reporting non-securities business. For the 393 broker-dealers 
reporting such business, staff analyzed the narrative descriptions 
of these businesses on Form BD, and identified the most common types 
of businesses: Insurance (202), management/financial/other 
consulting (99), advisory/retirement planning (71), mergers and 
acquisitions (70), foreign exchange/swaps/other derivatives (28), 
real estate/property management (30), tax services (15), and other 
(146). Note that a broker-dealer may have more than one line of non-
securities business.
    \900\ The value of customer accounts is not available from FOCUS 
data for broker-dealers. Therefore, to obtain estimates of firm size 
for broker-dealers, we rely on the value of broker-dealers' total 
assets as obtained from FOCUS reports. Retail sales activity is 
identified from Form BR, which categorizes retail activity broadly 
(by marking the ``sales'' box) or narrowly (by marking the 
``retail'' or ``institutional'' boxes as types of sales activity). 
We use the broad definition of sales as we preliminarily believe 
that many firms will just mark ``sales'' if they have both retail 
and institutional activity. However, we note that this may capture 
some broker-dealers that do not have retail activity, although we 
are unable to estimate that frequency.
---------------------------------------------------------------------------

    Panel B of Table 1 is limited to the broker-dealers that report 
some retail investor activity. As of December 2018, there were 
approximately 2,766 broker-dealers that served retail investors, with 
over $3.8 trillion in total assets (89% of total broker-dealer assets) 
and almost 139 million (97%) customer accounts.\901\ Of those broker-
dealers serving retail investors, 452 were dually registered as 
investment advisers.\902\ The number of broker-dealers that serve 
retail customers (i.e., 2,766) likely overstates the number of broker-
dealers that will be subject to Regulation Best Interest, because not 
all broker-dealers that serve retail investors provide recommendations 
to retail investors. We do not have reliable data to determine the 
precise number of broker-dealers that provide recommendations (and the 
extent to which broker-dealers that provide recommendations do so, as 
opposed to executing unsolicited trades), and as a result, we have 
assumed, for purposes of this Section III and Sections IV (Paperwork 
Reduction Act Analysis) and V (Final Regulatory Flexibility Act 
Analysis) that 2,766 broker-dealers will be subject to Regulation Best 
Interest.
---------------------------------------------------------------------------

    \901\ Total assets and customer accounts for broker-dealers that 
serve retail customers also include institutional accounts. Data 
available from Form BD and FOCUS data is not sufficiently granular 
to identify the percentage of retail and institutional accounts at 
firms.
    \902\ Excluding state registered advisers, there are 359 
entities that are dually registered with the Commission as an 
investment adviser and a broker-dealer. Of the 31 dual-registrants 
in the group of retail broker-dealers with total assets in excess of 
$500 million, total assets for these dual-registrants are nearly 
$2.01 trillion (53%) of aggregate retail broker-dealer assets (Table 
1, Panel B). Of the remaining 81 retail broker-dealers with total 
assets in excess of $500 million that are not dual-registrants, 76 
have affiliated investment advisers.
    \903\ The data is obtained from FOCUS filings as of December 
2018. Note that there may be a double-counting of customer accounts 
among, in particular, the larger broker-dealers as they may report 
introducing broker-dealer accounts as well in their role as clearing 
broker-dealers.
    \904\ In addition to the approximately 143 million individual 
accounts at broker-dealers, there are approximately 302,000 omnibus 
accounts (0.2% of total accounts at broker-dealers), with total 
assets of $32.1 billion, across all 3,764 broker-dealers, of which 
approximately 99% are held at broker-dealers with greater than $1 
billion in total assets. See also supra footnote 897. Omnibus 
accounts reported in FOCUS data are the accounts of non-carrying 
broker-dealers with carrying broker-dealers. These accounts may have 
securities of multiple customers (of the non-carrying firm), or 
securities that are proprietary assets of the non-carrying broker-
dealer. We are unable to determine from the data available how many 
customer accounts non-carrying broker-dealers may have. The data 
does not allow the Commission to parse the total assets in those 
accounts to determine to whom such assets belong. Therefore, our 
estimate may be under inclusive of all customer accounts held at 
broker-dealers.
    \905\ Customer Accounts includes both broker-dealer and 
investment adviser accounts for dual-registrants.

                      Table 1--Panel A: Registered Broker-Dealers as of December 2018 \903\
                       [Cumulative broker-dealer total assets and customer accounts] \904\
----------------------------------------------------------------------------------------------------------------
                                                                                                    Cumulative
                                              Total number of     Number of        Cumulative       number of
    Size of broker-dealer (total assets)            BDs             dually        total assets       customer
                                                                registered BDs     (billion)      accounts \905\
----------------------------------------------------------------------------------------------------------------
>$50 billion................................               17               10           $2,879       40,550,200
$1 billion to $50 billion...................              114               23            1,363       96,037,591
$500 million to $1 billion..................               35                7               23          397,814
$100 million to $500 million................              105               20               23        1,603,818
$10 million to $100 million.................              490              115               17        4,277,432
$1 million to $10 million...................            1,021              182              3.6          460,748
<$1 million.................................            1,982              206              0.5            5,675
                                             -------------------------------------------------------------------
    Total...................................            3,764              563            4,309      143,333,278
----------------------------------------------------------------------------------------------------------------


[[Page 33408]]


                     Table 1--Panel B: Registered Retail Broker-Dealers as of December 2018
                          [Cumulative broker-dealer total assets and customer accounts]
----------------------------------------------------------------------------------------------------------------
                                                                                                    Cumulative
                                              Total number of     Number of        Cumulative       number of
    Size of broker-dealer (total assets)            BDs             dually        total assets       customer
                                                                registered BDs     (billion)         accounts
----------------------------------------------------------------------------------------------------------------
>$50 billion................................               16                8           $2,806       40,545,792
$1 billion to $50 billion...................               75               18              990       91,991,118
$500 million to $1 billion..................               21                5               13          365,632
$100 million to $500 million................               84               17               18        1,603,818
$10 million to $100 million.................              378               96               14        3,762,620
$1 million to $10 million...................              783              153              2.8          450,132
<$1 million.................................            1,409              155              0.4            5,672
                                             -------------------------------------------------------------------
    Total BDs \906\.........................            2,766              452            3,844      138,724,784
----------------------------------------------------------------------------------------------------------------

    Table 2 reports information on brokerage commissions,\907\ fees, 
and selling concessions from the fourth quarter of 2018 for all broker-
dealers, including dual-registrants.\908\ We observe significant 
variation in the sources of revenues for broker-dealers, with large 
broker-dealers, on average, generating substantially higher levels of 
aggregate commission and fee revenues (on a nominal basis) than smaller 
broker-dealers. On average, broker-dealers, including those that are 
dually registered as investment advisers, earn about $5.1 million per 
quarter in revenue from commissions and nearly four times that amount 
in fees,\909\ although the Commission notes that fees encompass various 
types of fees, not just fees for advisory services.\910\ The level of 
revenues earned by broker-dealers (including dually registered firms) 
for commissions and fees increases with broker-dealer size, but also 
tends to be more heavily weighted toward commissions for broker-dealers 
with less than $10 million in assets and is weighted more heavily 
toward fees for broker-dealers with assets in excess of $10 million. 
For example, for the 114 broker-dealers with assets between $1 billion 
and $50 billion, average revenues from commissions are approximately 
$45 million, while average revenues from fees are approximately $225 
million.\911\
---------------------------------------------------------------------------

    \906\ Total BDs includes all retail-facing broker-dealers, 
including those dual-registrants that have retail-facing broker-
dealers.
    \907\ Mark-ups or mark-downs are not included as part of the 
brokerage commission revenue in FOCUS data; instead, they are 
included in Net Gains or Losses on Principal Trades, but are not 
uniquely identified as a separate revenue category.
    \908\ Source: FOCUS data.
    \909\ Fees, as detailed in the FOCUS data, include fees for 
account supervision, investment advisory services, and 
administrative services. Beyond the broad classifications of fee 
types included in fee revenue, we are unable to determine whether 
fees such as Rule 12b-1 fees, sub-accounting, or other such service 
fees (e.g., payments by an investment company for personal service 
and/or maintenance of shareholder accounts) are included. The data 
covers both broker-dealers and dually registered firms. FINRA's 
Supplemental Statement of Income, Line 13975 (Account Supervision 
and Investment Advisory Services) denotes that fees earned for 
account supervision are those fees charged by the firm for providing 
investment advisory services where there is no fee charged for trade 
execution. Investment Advisory Services generally encompass 
investment advisory work and execution of client transactions, such 
as wrap arrangements. These fees also include fees charged by 
broker-dealers that are also registered with the Commodity Futures 
Trading Commission (``CFTC''), but do not include fees earned from 
affiliated entities (Item A of question 9 under Revenue in the 
Supplemental Statement of Income).
    \910\ With respect to the FOCUS data, additional granularity of 
what services comprise ``advisory services'' is not available. See 
also Solely Incidental Interpretation.
    \911\ An estimate of total fees in this size category would be 
114 broker-dealers with assets between $1 billion and $50 billion 
multiplied by the average fee revenue of $225 million, or $25.65 
billion in total fees.
---------------------------------------------------------------------------

    In addition to revenue generated from commissions and fees, broker-
dealers may also receive revenues from other sources, including margin 
interest, underwriting, research services, and third-party selling 
concessions, such as from sales of investment company (``IC'') shares. 
As shown in Table 2, Panel A, these selling concessions are generally a 
smaller fraction of broker-dealer revenues than either commissions or 
fees, except for broker-dealers with total assets between $10 million 
and $100 million. For these broker-dealers, revenue from third-party 
selling concessions is the largest category of revenues and constitutes 
approximately 42% of total revenues earned by these firms.
    Table 2, Panel B below provides aggregate revenues by revenue type 
(commissions, fees, or selling concessions from sales of IC shares) for 
broker-dealers delineated by whether the broker-dealer is also a dual-
registrant. Broker-dealers dually registered as investment advisers 
have a significantly larger fraction of their revenues from fees 
compared to commissions or selling concessions, whereas broker-dealers 
that are not dually registered generate approximately 42% of their 
advice-related revenues as commissions and only 33% of their advice-
related revenues from fees, although we lack granularity to determine 
whether advisory services, in addition to supervision and 
administrative services, contribute to fees at standalone broker-
dealers.
---------------------------------------------------------------------------

    \912\ The data is obtained from December 2018 FOCUS reports and 
averaged across size groups.
    \913\ Fees, as detailed in the FOCUS data, include fees for 
account supervision, investment advisory services, and 
administrative services. The data covers both broker-dealers and 
dually registered firms.

            Table 2--Panel A: Average Broker-Dealer Revenues From Revenue Generating Activities \912\
----------------------------------------------------------------------------------------------------------------
                                                                                                   Sales of IC
    Size of broker-dealer in total assets            N           Commissions       Fees \913\         shares
----------------------------------------------------------------------------------------------------------------
>$50 billion................................               17     $170,336,258     $414,300,268      $23,386,192
$1 billion-$50 billion......................              114       45,203,225      225,063,257       53,671,602
500 million-1 billion.......................               35        8,768,547       30,141,270        5,481,248
100 million-500 million.....................              105       12,801,889       33,726,336       16,610,013
10 million-100 million......................              490        3,428,843        8,950,892        9,092,971

[[Page 33409]]

 
1 million-10 million........................            1,021          996,130        1,037,825          652,905
<1 million..................................            1,982          197,907          269,459           85,219
                                             -------------------------------------------------------------------
    Average of All Broker-Dealers...........            3,764        5,092,808       21,948,551        4,368,823
----------------------------------------------------------------------------------------------------------------


 Table 2--Panel B: Aggregate Total Revenues From Revenue Generating Activities for Broker-Dealers Based on Dual-
                                                Registrant Status
----------------------------------------------------------------------------------------------------------------
                                                                                                   Sales of IC
             Broker-dealer type                      N           Commissions       Fees \914\         shares
                                                                  (billion)        (billion)        (billion)
----------------------------------------------------------------------------------------------------------------
Dually Registered as IAs....................              563            $4.62           $17.56            $2.65
Standalone Registered BDs...................            3,201             4.07             3.22             2.55
                                             -------------------------------------------------------------------
    All.....................................            3,764             8.69            20.78             5.20
----------------------------------------------------------------------------------------------------------------

    As shown in Table 3, based on responses to Form BD, broker-dealers' 
most commonly provided business lines include private placements of 
securities (62.7% of broker-dealers); retail sales of mutual funds 
(55.4%); acting as a broker or dealer retailing corporate equity 
securities over the counter (52.0%); acting as a broker or dealer 
retailing corporate debt securities (47.2%); acting as a broker or 
dealer selling variable contracts, such as life insurance or annuities 
(41.0%); acting as a broker of municipal debt/bonds or U.S. government 
securities (39.8% and 37.4%, respectively); acting as an underwriter or 
selling group participant of corporate securities (31.2%); and 
investment advisory services (26.4%), among others.\915\
---------------------------------------------------------------------------

    \914\ See id.
    \915\ Form BD requires applicants to identify the types of 
business engaged in (or to be engaged in) that accounts for 1% or 
more of the applicant's annual revenue from the securities or 
investment advisory business. Table 3 provides an overview of the 
types of businesses listed on Form BD, as well as the frequency of 
participation in those businesses by registered broker-dealers as of 
December 2018.

                     Table 3--Lines of Business at Retail Broker-Dealers as of December 2018
----------------------------------------------------------------------------------------------------------------
                                                                                              Total
                                                                               ---------------------------------
                               Line of business                                    Number of        Percent of
                                                                                 broker-dealers   broker-dealers
----------------------------------------------------------------------------------------------------------------
Private Placements of Securities..............................................            1,735            62.70
Mutual Fund Retailer..........................................................            1,533            55.40
Broker or Dealer Retailing:
    Corporate Equity Securities OTC...........................................            1,438            51.97
    Corporate Debt Securities.................................................            1,306            47.20
    Variable Contracts........................................................            1,132            40.91
Municipal Debt/Bonds Broker...................................................            1,101            39.79
U.S. Government Securities Broker.............................................            1,035            37.41
Put and Call Broker or Dealer or Options Writer...............................              993            35.89
Underwriter or Selling Group Participant--Corporate Securities................              862            31.15
Non-Exchange Member Arranging For Transactions in Listed Securities by                      785            28.37
 Exchange Member..............................................................
Investment Advisory Services..................................................              730            26.38
Broker or Dealer Selling Tax Shelters or Limited Partnerships--Primary Market.              619            22.37
Trading Securities for Own Account............................................              614            22.19
Municipal Debt/Bonds Dealer...................................................              475            17.17
U.S. Government Securities Dealer.............................................              339            12.25
Solicitor of Time Deposits in a Financial Institution.........................              308            11.13
Underwriter--Mutual Funds.....................................................              237             8.57
Broker or Dealer Selling Interests in Mortgages or Other Receivables..........              216             7.81
Broker or Dealer Selling Oil and Gas Interests................................              207             7.48
Broker or Dealer Making Inter-Dealer Markets in Corporate Securities OTC......              207             7.48
Broker or Dealer Involved in Networking, Kiosk, or Similar Arrangements                     197             7.12
 (Banks, Savings Banks, Credit Unions)........................................
Internet and Online Trading Accounts..........................................              192             6.94
Exchange Member Engaged in Exchange Commission Business Other than Floor                    171             6.18
 Activities...................................................................
Broker or Dealer Selling Tax Shelters or Limited Partnerships--Secondary                    164             5.93
 Market.......................................................................
Commodities...................................................................              162             5.85
Executing Broker..............................................................              107             3.87
Day Trading Accounts..........................................................               89             3.22
Broker or Dealer Involved in Networking, Kiosk, or Similar Arrangements                      88             3.18
 (Insurance Company or Agency)................................................
Real Estate Syndicator........................................................               94             3.40
Broker or Dealer Selling Securities of Non-Profit Organizations...............               71             2.57

[[Page 33410]]

 
Exchange Member Engaged in Floor Activities...................................               61             2.20
Broker or Dealer Selling Securities of Only One Issuer or Associate Issuers...               43             1.55
Prime Broker..................................................................               21             0.76
Crowdfunding FINRA Rule 4518(a)...............................................               21             0.76
Clearing Broker in a Prime Broker.............................................               14             0.51
Funding Portal................................................................                8             0.29
Crowdfunding FINRA Rule 4518(b)...............................................                5             0.18
Number of Retail-Facing Broker-Dealers........................................            2,766  ...............
----------------------------------------------------------------------------------------------------------------

b. Investment Advisers
    Other parties that could be affected by Regulation Best Interest 
are SEC- or state-registered investment advisers, because Regulation 
Best Interest could affect the competitive landscape in the market for 
the provision of financial advice.\916\ This section first discusses 
SEC-registered investment advisers, followed by a discussion of state-
registered investment advisers.
---------------------------------------------------------------------------

    \916\ In addition to SEC-registered investment advisers, which 
are the focus of this section, Regulation Best Interest could also 
affect banks, trust companies, insurance companies, and other 
providers of financial advice.
---------------------------------------------------------------------------

    As of December 2018, there were approximately 13,300 investment 
advisers registered with the Commission. The majority of SEC-registered 
investment advisers report that they provide portfolio management 
services for individuals and small businesses.\917\
---------------------------------------------------------------------------

    \917\ Of the approximately 13,300 SEC-registered investment 
advisers, 8,410 (63.24%) report in Item 5.G.(2) of Form ADV that 
they provide portfolio management services for individuals and/or 
small businesses. In addition, there are approximately 17,300 state-
registered investment advisers, of which 125 are also registered 
with the Commission. Approximately 13,900 state-registered 
investment advisers are retail facing (see Item 5.D of Form ADV).
---------------------------------------------------------------------------

    Of all SEC-registered investment advisers, 359 identify themselves 
as dually registered broker-dealers.\918\ Further, 2,421 investment 
advisers (18%) report an affiliate that is a broker-dealer, including 
1,878 investment advisers (14%) that report an SEC-registered broker-
dealer affiliate.\919\ As shown in Panel A of Table 4 below, in 
aggregate, investment advisers have over $84 trillion in AUM. A 
substantial percentage of AUM at investment advisers is held by 
institutional clients, such as investment companies, pooled investment 
vehicles, and pension or profit sharing plans; therefore, the total 
number of accounts for investment advisers is only 29% of the number of 
customer accounts for broker-dealers.
---------------------------------------------------------------------------

    \918\ See supra footnote 892.
    \919\ Item 7.A.1 of Form ADV.
---------------------------------------------------------------------------

    Based on staff analysis of Form ADV data, approximately 62% of 
registered investment advisers (8,235) have some portion of their 
business dedicated to retail investors, including both high net worth 
and non-high net worth individual clients,\920\ as shown in Panel B of 
Table 4.\921\ In total, these firms have approximately $41.4 trillion 
of AUM.\922\ Approximately 8,200 registered investment advisers (61%) 
serve almost 32 million non-high net worth individual clients and have 
approximately $4.8 trillion in AUM, while approximately 8,000 
registered investment advisers (60%) serve approximately 4.8 million 
high net worth individual clients with $6.15 trillion in AUM.\923\
---------------------------------------------------------------------------

    \920\ We note that the data on individual clients obtained from 
Form ADV may not be exactly the same as who would be a ``retail 
customer'' as defined in Regulation Best Interest because the data 
obtained from Form ADV regarding clients who are individuals does 
not involve any test of use for personal, family, or household 
purposes.
    \921\ We use the responses to Items 5.D.(a)(1), 5.D.(a)(3), 
5.D.(b)(1), and 5.D.(b)(3) of Part 1A of Form ADV. If at least one 
of these responses was filled out as greater than 0, the firm is 
considered as providing business to retail investors. Part 1A of 
Form ADV.
    \922\ The aggregate AUM reported for these investment advisers 
that have retail investors includes both retail AUM as well as any 
institutional AUM also held at these advisers.
    \923\ Estimates are based on IARD system data as of December 31, 
2018. The AUM reported here is specifically that of those non-high 
net worth clients. Of the 8,235 investment advisers serving retail 
investors, 318 are also dually registered as broker-dealers.

                   Table 4--Panel A: Registered Investment Advisers (RIAs) as of December 2018
                                        [Cumulative RIA AUM and accounts]
----------------------------------------------------------------------------------------------------------------
                                                                  Number of                         Cumulative
      Size of investment adviser (AUM)         Number of RIAs       dually       Cumulative AUM     number of
                                                               registered RIAs     (billion)         accounts
----------------------------------------------------------------------------------------------------------------
>$50 billion................................              270               15          $59,264       20,655,756
$1 billion to $50 billion...................            3,453              121           22,749       13,304,154
$500 million to $1 billion..................            1,635               47            1,151        1,413,099
$100 million to $500 million................            5,927              119            1,397        5,135,070
$10 million to $100 million.................            1,070               24               59          310,031
$1 million to $10 million...................              162                3              0.8           69,664
<$1 million.................................              782               30             0.02           13,976
                                             -------------------------------------------------------------------
    1Total..................................           13,299              359           84,621       41,081,750
----------------------------------------------------------------------------------------------------------------


[[Page 33411]]


               Table 4--Panel B: Retail Registered Investment Advisers (RIAs) as of December 2018
                                        [Cumulative RIA AUM and accounts]
----------------------------------------------------------------------------------------------------------------
                                                                  Number of                         Cumulative
      Size of investment adviser (AUM)         Number of RIAs       dually       Cumulative AUM     number of
                                                               registered RIAs     (billion)         accounts
----------------------------------------------------------------------------------------------------------------
>$50 billion................................              119               14          $30,291       20,592,326
$1 billion to $50 billion...................            1,614              111            9,570       13,224,188
$500 million to $1 billion..................            1,007               44              700        1,392,842
$100 million to $500 million................            4,548              113            1,026        5,287,584
$10 million to $100 million.................              706               23               40          308,285
$1 million to $10 million...................              102                3              0.5           69,534
<$1 million.................................              169               10             0.02           13,946
                                             -------------------------------------------------------------------
    Total IAs \924\.........................            8,235              318           41,434       40,887,325
----------------------------------------------------------------------------------------------------------------

    In addition to SEC-registered investment advisers, other investment 
advisers are registered with state regulators.\925\ As of December 
2018, there are 17,268 state-registered investment advisers,\926\ of 
which 125 are also registered with the Commission. Of the state-
registered investment advisers, 204 are dually registered as broker-
dealers, while approximately 4.6% (786) report a broker-dealer 
affiliate. In aggregate, state-registered investment advisers have 
approximately $334 billion in AUM. Eighty-two percent of state-
registered investment advisers report that they provide portfolio 
management services for individuals and small businesses, compared to 
63% for Commission-registered investment advisers.
---------------------------------------------------------------------------

    \924\ Total IAs includes all retail-facing investment advisers, 
including those dual-registrants that have retail-facing SEC-
registered broker-dealers and SEC-registered investment advisers.
    \925\ Item 2.A. of Part 1A of Form ADV and Advisers Act rules 
203A-1 and 203A-2 require an investment adviser to register with the 
SEC if it (1) is a large adviser that has $100 million or more of 
regulatory AUM (or $90 million or more if an adviser is filing its 
most recent annual updating amendment and is already registered with 
the SEC); (2) is a mid-sized adviser that does not meet the criteria 
for state registration or is not subject to examination; (3) meets 
the requirements for one or more of the revised exemptive rules 
under section 203A; (4) is an adviser (or subadviser) to a 
registered investment company; (5) is an adviser to a business 
development company and has at least $25 million of regulatory AUM; 
or (6) receives an order permitting the adviser to register with the 
Commission. Although the statutory threshold is $100 million, the 
SEC raised the threshold to $110 million to provide a buffer for 
mid-sized advisers with AUM close to $100 million to determine 
whether and when to switch between state and Commission 
registration. Advisers Act rule 203A-1(a).
    \926\ There are 70 investment advisers with latest reported 
regulatory AUM in excess of $110 million but that are not listed as 
registered with the SEC. None of these 70 investment advisers has 
exempted status with the Commission. For the purposes of this 
rulemaking, these are considered potentially erroneous submissions.
---------------------------------------------------------------------------

    Approximately 81% of state-registered investment advisers (13,927) 
have some portion of their business dedicated to retail investors,\927\ 
and in aggregate, these firms have approximately $324 billion in 
AUM.\928\ Approximately 13,910 (81%) state-registered advisers serve 14 
million non-high net worth retail clients and have approximately $137 
billion in AUM, while over 11,497 (67%) state-registered advisers serve 
approximately 170,000 high net worth retail clients with $169 billion 
in AUM.\929\
---------------------------------------------------------------------------

    \927\ We use the responses to Items 5.D.(a)(1), 5.D.(a)(3), 
5.D.(b)(1), and 5.D.(b)(3) of Part 1A. If at least one of these 
responses was filled out as greater than 0, the firm is considered 
as providing business to retail investors. Form ADV Part 1A.
    \928\ The aggregate AUM reported for these investment advisers 
that have retail investors includes both retail AUM as well as any 
institutional AUM also held at these advisers.
    \929\ Estimates are based on IARD system data as of February 10, 
2018. The AUM reported here is specifically that of those non-high 
net worth investors. Of the 13,927 state-registered investment 
advisers serving retail investors, 134 may also be dually registered 
as broker-dealers.
---------------------------------------------------------------------------

c. Trends in the Relative Numbers of Providers of Financial Services
    Over time, the relative number of broker-dealers and investment 
advisers has changed. Figure 1 presented below shows the time series 
trend of growth in broker-dealers and SEC-registered investment 
advisers between 2005 and 2018. Over the last 14 years, the number of 
broker-dealers has declined from over 6,000 in 2005 to less than 4,000 
in 2018, while the number of investment advisers has increased from 
approximately 9,000 in 2005 to over 13,000 in 2018. This change in the 
relative numbers of broker-dealers and investment advisers over time 
likely is a reflection of the market for investment advice, and 
potentially of the choices available to retail investors regarding how 
to receive or pay for such advice, the nature of the advice, and the 
attendant conflicts of interest.

[[Page 33412]]

[GRAPHIC] [TIFF OMITTED] TR12JY19.000

    Increases in the number of investment advisers and decreases in the 
number of broker-dealers could have occurred for a number of reasons, 
including changes in regulation and the enforcement of regulation, 
anticipation of possible regulatory changes, technological innovation 
(e.g., the increase in automated advisers, which are often colloquially 
referred to as ``robo-advisors'' and online trading platforms), product 
proliferation (e.g., index mutual funds and exchange-traded products), 
and industry consolidation driven by economic and market conditions, 
particularly among broker-dealers.\930\ Commission staff has observed 
the transition by broker-dealers from traditional brokerage services to 
also providing investment advisory services (often under an investment 
adviser registration, whether federal or state), and many firms have 
been more focused on offering fee-based accounts because they provide a 
more steady source of revenue than accounts that charge commissions and 
are dependent on transactions.\931\ Broker-dealers have indicated that 
the following factors have contributed to this migration: Provision of 
revenue stability or increase in profitability,\932\ perceived lower 
regulatory burden, and provisions of more services to retail 
customers.\933\ Some firms have reported record profits as a result of 
moving clients into fee-based accounts, and cite that it provides 
``stability and high returns.'' \934\

    \930\ See Hester Peirce, Dwindling Numbers in the Financial 
Industry, Brookings Center on Markets and Regulation Report (May 15, 
2017), available at https://www.brookings.edu/research/dwindling-numbers-in-the-financial-industry/ (``Brookings Report''), which 
notes that ``SEC restrictions have increased by almost thirty 
percent [since 2000],'' and that regulations post-2010 were driven 
in large part by the Dodd-Frank Act. Further, the Brookings Report 
observation of increased regulatory restrictions on broker-dealers 
only reflects CFTC or SEC regulatory actions, but does not include 
regulation by FINRA, other SROs, National Futures Association 
(``NFA''), or the Municipal Securities Rulemaking Board (``MSRB'').
    \931\ Beyond Commission observations, the Brookings Report, 
supra footnote 930, also discusses the shift from broker-dealer to 
investment advisory business models for retail investors, in part 
due to the DOL Fiduciary Rule. Declining transaction-based revenue 
due to declining commission rates and competition from discount 
brokerage firms has made fee-based securities and services more 
attractive to providers of such securities and services. Although 
discount brokerage firms generally provide execution-only services 
and do not compete directly in the advice market with full service 
broker-dealers and investment advisers, entry by discount brokers 
has contributed to lower commission rates throughout the broker-
dealer industry. Further, fee-based activity generates a steady 
stream of revenue regardless of the customer trading activity, 
unlike commission-based accounts. See also Angela A. Hung, et al., 
Investor and Industry Perspectives on Investment Advisers and 
Broker-Dealers, RAND Institute for Civil Justice Technical Report 
(2008), available at https://www.rand.org/content/dam/rand/pubs/technical_reports/2008/RAND_TR556.pdf (``2008 RAND Study''), which 
discusses a shift from transaction-based to fee-based brokerage 
accounts prior to recent regulatory changes.
    \932\ Commission staff examined a sample of recent Form 10-K or 
Form 10-Q filings of large broker-dealers, many of which are dually 
registered as investment advisers, that have a large fraction of 
retail customer accounts to identify relevant broker-dealers. See, 
e.g., Edward Jones 3/14/2019 Form 10-K available at https://www.sec.gov/Archives/edgar/data/815917/000156459019007788/ck0000815917-10k_20181231.htm; Raymond James 11/21/2018 Form 10-K 
available at https://www.sec.gov/Archives/edgar/data/720005/000072000518000083/rjf-20180930x10k.htm; Stifel 2/20/2019 Form 10-K 
available at https://www.sec.gov/Archives/edgar/data/720672/000156459019003474/sf-10k_20181231.htm; Wells Fargo 2/27/2019 10-K 
available at https://www.sec.gov/Archives/edgar/data/72971/000007297119000227/wfc-12312018x10k.htm; and Ameriprise 2/23/2018 
Form 10-K available at https://www.sec.gov/Archives/edgar/data/820027/000082002718000008/amp12312017.htm. We note that discussions 
in Form 10-K and 10-Q filings of this sample of broker-dealers here 
may not be representative of other large broker-dealers or of small 
to mid-size broker-dealers.
    \933\ See infra Section III.B.2.e.ii, which discusses industry 
trends, particularly in response to the DOL Fiduciary Rule.
    \934\ See Hugh Son, Morgan Stanley Wealth-Management Fees Climb 
to All-Time High, Bloomberg, Jan. 18, 2018, https://www.bloomberg.com/news/articles/2018-01-18/morgan-stanley-wealth-management-fees-hit-record-on-stock-rally. Morgan Stanley increased 
the percentage of client assets in fee-based accounts from 37% in 
2013 to 44% in 2017, while decreasing the dependence on transaction-
based revenues from 30% to 19% over the same time period. See Morgan 
Stanley Strategic Update (Jan. 18, 2018), available at https://www.morganstanley.com/about-us-ir/shareholder/4q2017-strategic-update.pdf. See also Lisa Beilfuss & Brian Hershberg, WSJ Wealth 
Adviser Briefing: The Reinvention of Morgan and Merrill, Adviser 
Profile, Wall St. J., Jan. 25, 2018, https://blogs.wsj.com/moneybeat/2018/01/25/wsj-wealth-adviser-briefing-the-reinvention-of-morgan-and-merrill-adviser-profile/.

---------------------------------------------------------------------------

[[Page 33413]]

    Further, there has been a substantial increase in the number of 
retail clients at investment advisers, both high net worth clients and 
non-high net worth clients as shown in Figure 2. Although the number of 
non-high net worth retail customers of investment advisers dipped 
between 2010 and 2012, it increased by more than 12 million new non-
high net worth retail clients between 2012 and 2017, and has declined 
since 2017. With respect to AUM, we observe a similar, albeit more 
pronounced pattern for non-high net worth retail clients as shown in 
Figure 3. For high net worth retail clients, there has been a 
pronounced increase in AUM since 2012, although AUM has leveled off 
since 2015 and there also has been leveling and subsequent reduction in 
AUM for non-high net worth retail clients over a similar time period.
[GRAPHIC] [TIFF OMITTED] TR12JY19.001


[[Page 33414]]


[GRAPHIC] [TIFF OMITTED] TR12JY19.002

BILLING CODE 8011-01-Cd. Registered Representatives of Broker-Dealers, 
Investment Advisers, and Dually Registered Firms
    We estimate the number of associated natural persons of broker-
dealers through data obtained from Form U4, which generally is filed 
for individuals who are engaged in the securities or investment banking 
business of a broker-dealer that is a member of an SRO (``registered 
representatives'').\935\ Similarly, we approximate the number of 
supervised persons of registered investment advisers through the number 
of registered investment adviser representatives (or ``registered 
IARs''), who are supervised persons of investment advisers who meet the 
definition of investment adviser representatives in Advisers Act rule 
203A-3 and are registered with one or more state securities authorities 
to solicit or communicate with clients.\936\
---------------------------------------------------------------------------

    \935\ The number of associated natural persons of broker-dealers 
may be different from the number of registered representatives of 
broker-dealers because clerical/ministerial employees of broker-
dealers are associated persons but are not required to register with 
FINRA. Therefore, the registered representative number does not 
include such persons. However, we do not have data on the number of 
associated natural persons and therefore are not able to provide an 
estimate of the number of associated natural persons. We believe 
that the number of registered representatives is an appropriate 
approximation because they are the individuals at broker-dealers 
that provide advice and services to customers.
    \936\ See Advisers Act, [17 CFR 275.203A-3 (2019)]. However, we 
note that the data on numbers of registered IARs may undercount the 
number of supervised persons of investment advisers who provide 
investment advice to retail investors because not all supervised 
persons who provide investment advice to retail investors are 
required to register as IARs. For example, Commission rules exempt 
from IAR registration supervised persons who provide advice only to 
non-individual clients or to individuals that meet the definition of 
``qualified client.'' In addition, state securities authorities may 
impose different criteria for requiring registration as an 
investment adviser representative.
---------------------------------------------------------------------------

    We estimate the number of registered representatives and registered 
IARs, including dually-registered representatives, (together 
``registered financial professionals'') at broker-dealers, investment 
advisers, and dual-registrants by considering only the employees of 
those firms that have Series 6 or Series 7 licenses or are registered 
with a state as a registered representative or investment adviser 
representative.\937\ We only consider employees at firms who have 
retail-facing business, as defined previously.\938\ We observe in Table 
5 that approximately 60% of registered financial professionals are 
employed by dually registered entities. The percentage varies by the 
size of the firm. For example, for firms with total assets between $1 
billion and $50 billion, 67% of all registered financial professionals 
in that size category are employed by dually registered firms. Focusing 
on dually registered firms only, approximately 60.5% of total 
registered financial professionals at these firms are dually registered 
representatives; approximately 39.1% are only registered 
representatives; and less than one percent are only registered 
investment adviser representatives.
---------------------------------------------------------------------------

    \937\ We calculate these numbers based on Form U4 filings. 
Representatives of broker-dealers, investment advisers, and issuers 
of securities must file this form when applying to become registered 
in appropriate jurisdictions and with SROs. Firms and 
representatives have an obligation to amend and update information 
as changes occur. Using the examination information contained in the 
form, we consider an employee a registered financial professional if 
he or she has an approved, pending, or temporary registration status 
for either Series 6 or 7 (registered representative) or is 
registered as an investment adviser representative in any state or 
U.S. territory (IAR). We limit the firms to only those that do 
business with retail investors, and only to licenses specifically 
required as a registered representative or IAR.
    \938\ See supra footnotes 900 and 927.

[[Page 33415]]



        Table 5--Total Registered Representatives at Broker-Dealers, Investment Advisers, and Dually Registered Firms With Retail Investors \939\
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                           % of reps. in   % of reps. in   % of reps. in   % of reps. in    % reps. in
Size of firm (total assets for standalone BDs and dually   Total number       dually       standalone BD   standalone BD   standalone IA   standalone IA
        registered firms; AUM for standalone IAs)            of reps.       registered        w/an IA        w/o an IA        w/a BD         w/o a BD
                                                                               firms         affiliate       affiliate       affiliate       affiliate
--------------------------------------------------------------------------------------------------------------------------------------------------------
>$50 billion............................................          84,461              73               7               0              19               1
$1 billion to $50 billion...............................         170,256              67              11               0              15               7
$500 million to $1 billion..............................          29,874              71               5               1               7              16
$100 million to $500 million............................          66,924              51              27               0               4              18
$10 million to $100 million.............................         106,178              55              42               2               1               1
$1 million to $10 million...............................          33,790              35              54              11               0               0
<$1 million.............................................          12,522               8              52              36               3               1
                                                         -----------------------------------------------------------------------------------------------
    Total Licensed Representatives......................         504,005              60              23               2               9               6
--------------------------------------------------------------------------------------------------------------------------------------------------------

    In Table 6 below, we estimate the number of employees who are 
registered representatives, registered investment adviser 
representatives, or dually registered representatives.\940\ Similar to 
Table 5, we calculate these numbers using Form U4 filings. Here, we 
also limit the sample to employees at firms that have retail-facing 
businesses as discussed previously.\941\
---------------------------------------------------------------------------

    \939\ The classification of firms as dually registered, 
standalone broker-dealers, and standalone investment advisers comes 
from Forms BD, FOCUS, and ADV as described earlier. The number of 
representatives at each firm is obtained from Form U4 filings. Note 
that all percentages in the table have been rounded to the nearest 
whole percentage point.
    \940\ We calculate these numbers based on Form U4 filings.
    \941\ See supra footnotes 900 and 927.
---------------------------------------------------------------------------

    In Table 6, approximately 25% of registered employees at registered 
broker-dealers or investment advisers are dually registered 
representatives. However, this proportion varies significantly across 
size categories. For example, for firms with total assets between $1 
billion and $50 billion,\942\ approximately 35% of all registered 
employees are dually registered representatives. In contrast, for firms 
with total assets below $1 million, 13% of all employees are dually 
registered representatives.
---------------------------------------------------------------------------

    \942\ Firm size is defined as total assets from the balance 
sheet for broker-dealers and dual-registrants (source: FOCUS 
reports) and as AUM for investment advisers (source: Form ADV). We 
are unable to obtain customer assets for broker-dealers, and for 
investment advisers, we can only obtain information from Form ADV as 
to whether the firm assets exceed $1 billion. We recognize that our 
approach of using firm assets for broker-dealers and customer assets 
for investment advisers does not allow for direct comparison; 
however, our objective is to provide measures of firm size and not 
to make comparisons between broker-dealers and investment advisers 
based on firm size. Across both broker-dealers and investment 
advisers, larger firms, regardless of whether we stratify on firm 
total assets or AUM, have more customer accounts, are more likely to 
be dually registered, and have more representatives or employees per 
firm than smaller broker-dealers or investment advisers.

   Table 6--Number of Employees at Retail-Facing Firms Who Are Registered Representatives, Investment Adviser
                                         Representatives, or Both \943\
----------------------------------------------------------------------------------------------------------------
                                                                Percentage of    Percentage of
  Size of firm (total assets for standalone   Total number of       dually         registered     Percentages of
  BDs and dually registered firms; AUM for       employees        registered    representatives     IARs only
               standalone IAs)                                 representatives        only
----------------------------------------------------------------------------------------------------------------
>$50 billion................................          218,539               19               16                1
$1 billion to $50 billion...................          328,842               35               12                4
$500 million to $1 billion..................           43,211               18               40               10
$100 million to $500 million................          119,214               23               24                9
$10 million to $100 million.................          176,559               20               39                1
$1 million to $10 million...................           56,230               17               39                1
<$1 million.................................           18,334               13               46                3
                                             -------------------------------------------------------------------
    Total Employees at Retail-Facing Firms..          960,929               25               23                4
----------------------------------------------------------------------------------------------------------------

    Approximately 87% of investment adviser representatives are dually 
registered representatives. This percentage is relatively unchanged 
from 2010. According to information provided in a FINRA comment letter 
in connection with the 913 Study, 87.6% of registered investment 
adviser representatives were dually registered as registered 
representatives as of mid-October 2010.\944\ In contrast, approximately 
52% of registered representatives were dually registered as investment 
adviser representatives at the end of 2018.\945\
---------------------------------------------------------------------------

    \943\ See supra footnotes 899, 920, 940, and 942. Note that all 
percentages in the table have been rounded to the nearest whole 
percentage point.
    \944\ See Letter from Angela C. Goelzer, FINRA, to Jennifer B. 
McHugh, Senior Advisor to the Chairman, U.S. Securities and Exchange 
Commission, re: File Number 4-606; Obligations of Brokers, Dealers 
and Investment Advisers (Nov. 3, 2010), at 1, available at https://www.sec.gov/comments/4-606/4606-2836.pdf.
    \945\ In order to obtain the percentage of IARs that are dually 
registered as registered representatives of broker-dealers, we sum 
the representatives at dually registered entities and those at 
investment advisers across size categories to obtain the aggregate 
number of representatives in each of the two categories. We then 
divide the aggregate dually registered representatives by the sum of 
the dually registered representatives and the IARs at investment 
adviser-only firms. We perform a similar calculation to obtain the 
percentage of registered representatives of broker-dealers that are 
dually registered as IARs.
---------------------------------------------------------------------------

e. Investor Account Statistics
    Investors seek financial advice and services to achieve a number of 
different goals, such as saving for retirement or children's college 
education. Approximately 73% of adults live in a

[[Page 33416]]

household that invests.\946\ The OIAD/RAND survey indicates that non-
investors are more likely to be female, to have lower family income and 
educational attainment, and to be younger than investors.\947\ 
Approximately 35% of households that do invest do so through accounts 
such as broker-dealer or advisory accounts.\948\
---------------------------------------------------------------------------

    \946\ See OIAD/RAND, defining ``investors'' as persons ``owning 
at least one type of investment account, (e.g., an employer-
sponsored retirement account, a non-employer sponsored retirement 
account such as an IRA, a college savings investment account, or 
some other type of investment account such as a brokerage or 
advisory account), or owning at least one type of investment asset 
(e.g., mutual funds, exchange-traded funds or other funds; 
individual stocks; individual bonds; derivatives; and annuities).''
    \947\ Id. at 36.
    \948\ Id. at 39.
---------------------------------------------------------------------------

    As shown above in Figures 2 and 3, the number of retail investors 
and their AUM associated with investment advisers has increased 
significantly, particularly since 2012. As of December 2016, nearly 
$24.2 trillion is invested in retirement accounts, of which $7.5 
trillion is in IRAs.\949\ A total of 43.3 million U.S. households have 
either an IRA or a brokerage account; an estimated 20.2 million U.S. 
households have a brokerage account, and 37.7 million households have 
an IRA (including 72% of households that also hold a brokerage 
account).\950\ With respect to IRA accounts, one commenter documents 
that 43 million U.S. households own either traditional or Roth IRAs and 
that approximately 70% are held with financial professionals, with the 
remainder being direct market.\951\ Further, this commenter finds that 
approximately 64% of households have aggregate IRA (traditional and 
Roth) balances of less than $100,000, and approximately 36% of 
investors have balances below $25,000. As noted in one study, the 
growth of assets in traditional IRAs comes from rollovers from 
workplace retirement plans; for example, 58% of traditional IRAs 
consist of rollover assets, and contributions due to rollovers exceeded 
$460 billion in 2015 (the most recently available data).\952\
---------------------------------------------------------------------------

    \949\ See Sarah Holden & Daniel Schrass, The Role of IRAs in 
U.S. Households' Saving for Retirement, 2016, ICI Res. Persp., Jan. 
2017, available at https://www.ici.org/pdf/per17-08.pdf. See also 
ICI Letter.
    \950\ The data is obtained from the Federal Reserve System's 
2016 Survey of Consumer Finances (``SCF Survey''), a triennial 
survey of approximately 6,200 U.S. households, and imputes weights 
to extrapolate the results to the entire U.S. population. As noted, 
some survey respondent households have both a brokerage and an IRA. 
See Board of Governors of the Federal Reserve System, Survey of 
Consumer Finances (2016), available at https://www.federalreserve.gov/econres/scfindex.htm. The SCF Survey data 
does not directly examine the incidence of households that could use 
advisory accounts instead of brokerage accounts; however, some 
fraction of IRA accounts reported in the survey could be those held 
at investment advisers.
    \951\ See Sarah Holden & Daniel Schrass, The Role of IRAs in US 
Households' Saving for Retirement, 2018, ICI Res. Persp., Dec. 2018, 
available at https://www.ici.org/pdf/per24-10.pdf. See also ICI 
Letter.
    \952\ See Holden & Schrass (2018), supra footnote 951.
---------------------------------------------------------------------------

    While the number of retail investors obtaining services from 
investment advisers and the aggregate value of associated AUM has 
increased, the OIAD/RAND study also suggests that the general 
willingness of investors to use planning or to take financial advice 
regarding strategies, securities, or accounts is relatively fixed over 
time.\953\ With respect to the account assets associated with retail 
investors, the OIAD/RAND survey also estimates that approximately 10% 
of investors who have brokerage or advisory accounts hold more than 
$500,000 in assets, while approximately 47% hold $50,000 in assets or 
less. Altogether, investors who have brokerage or advisory accounts 
typically trade infrequently, with approximately 31% reporting no 
annual transactions and an additional approximately 30% reporting three 
or fewer transactions per year.\954\
---------------------------------------------------------------------------

    \953\ See OIAD/RAND at 50 (noting that this conclusion was 
limited by the methodology of comparing participants in a 2007 
survey with those surveyed in 2018).
    \954\ See OIAD/RAND.
---------------------------------------------------------------------------

    With respect to particular securities, commenters have provided us 
with additional information about ownership of mutual funds and IRA 
account statistics. For example, one commenter stated that 56 million 
U.S. households and nearly 100 million individual investors own mutual 
funds, of which 80% are held through 401(k) and other work-based 
retirement plans, while 63% of investors hold mutual funds outside of 
those plans.\955\ Of those investors who own mutual funds outside of 
workplace retirement plans, approximately 50% use financial 
professionals, while nearly one-third purchase direct-sold funds either 
directly from the fund company or through a discount broker.\956\
---------------------------------------------------------------------------

    \955\ See ICI Letter; see also Sarah Holden, Daniel Schrass, & 
Michael Bogdan, Ownership of Mutual Funds, Shareholder Sentiment, 
and Use of the internet, 2018, ICI Res. Persp., Nov. 2018, available 
at https://www.ici.org/pdf/per22-06.pdf.
    \956\ See Holden et al. (2018), supra footnote 955. See also ICI 
Letter.
---------------------------------------------------------------------------

    Table 7 below provides an overview of account ownership segmented 
by account type (e.g., IRA, brokerage, or both) and investor income 
category based on the SCF Survey.\957\
---------------------------------------------------------------------------

    \957\ See SCF Survey, supra footnote 950. To the extent that 
investors have IRA accounts at banks that are not also registered as 
broker-dealers, our data may overestimate the numbers of IRA 
accounts held by retail investors that could be subject to 
Regulation Best Interest.

                         Table 7--Ownership by Account Type in the U.S. by Income Group
                                      [As reported by the 2016 SCF Survey]
----------------------------------------------------------------------------------------------------------------
                                                                                                      % Both
                         Income category                            % Brokerage     % IRA only     brokerage and
                                                                       only                             IRA
----------------------------------------------------------------------------------------------------------------
Bottom 25%......................................................             1.2             7.6             2.4
25%-50%.........................................................             3.2            14.5             5.4
50%-75%.........................................................             4.1            21.4            11.4
75%-90%.........................................................             7.5            33.4            16.5
Top 10%.........................................................            12.0            24.7            43.9
Average.........................................................             4.4            18.3            11.6
----------------------------------------------------------------------------------------------------------------

    With respect to the nature of the accounts held by investors and 
whether they are managed by financial professionals, the OIAD/RAND 
survey finds that 36% of its sample of participants report that they 
currently use a financial professional and approximately 33% receive 
some kind of recommendation service.\958\ Of the

[[Page 33417]]

subset of those investors who report holding a brokerage, advisory, or 
similar account, approximately 33% self-direct their own account, 25% 
have their account managed by a financial professional, and 10% have 
their account advised by a financial professional.\959\ For those 
investors who take financial advice, the OIAD/RAND study suggests that 
they may differ in characteristics from other investors. The survey 
further finds that investors who take financial advice are generally 
older, retired, and have a higher income than other investors, but also 
may have lower educational attainment (e.g., high school or less) than 
other investors.\960\
---------------------------------------------------------------------------

    \958\ See OIAD/RAND at 48. In a focus group preceding the 
survey, focus group participants provided a number of reasons for 
not using a financial professional in making investments, including 
being unable or unwilling to pay the fees, doing their own financial 
research, being unsure of how to work with a professional, and being 
concerned about professionals selling securities without attending 
to investors' plans and goals.
    \959\ See OIAD/RAND at 46.
    \960\ See OIAD/RAND at 48.
---------------------------------------------------------------------------

    Similarly, one question in the SCF Survey asks what sources of 
information households' financial decision-makers use when making 
decisions about savings and investments. Respondents can list up to 
fifteen possible sources from a preset list that includes ``Broker'' or 
``Financial Planner'' as well as ``Banker,'' ``Lawyer,'' 
``Accountant,'' and a list of non-professional sources.\961\ Panel A of 
Table 8 below presents the breakdown of where households who have 
brokerage accounts seek advice about savings and investments. The table 
shows that of those respondents with brokerage accounts, 23% (4.7 
million households) use advice services of broker-dealers for savings 
and investment decisions, while 49% (7.8 million households) take 
advice from a ``financial planner.'' Approximately 36% (7.2 million 
households) seek advice from other sources such as bankers, 
accountants, and lawyers. Almost 25% (5.0 million households) do not 
use advice from the above sources.
---------------------------------------------------------------------------

    \961\ See SCF Survey, supra footnote 950, which specifically 
asks participants ``Do you get advice from a friend, relative, 
lawyer, accountant, banker, broker, or financial planner? Or do you 
do something else?'' See Federal Reserve Codebook for 2016 Survey of 
Consumer Finances (2016), available at https://www.federalreserve.gov/econres/files/codebk2016.txt. Other response 
choices presented by the survey include ``Calling Around,'' 
``Magazines,'' ``Self,'' ``Past Experience,'' ``Telemarketer,'' and 
``Insurance Agent,'' as well as other choices. Respondents could 
also choose ``Do Not Save/Invest.'' The SCF Survey allows for 
multiple responses, so these categories are not mutually exclusive. 
However, we would note that the list of terms in the question does 
not specifically include ``investment adviser.''
---------------------------------------------------------------------------

    Panel B of Table 8 below presents the breakdown of advice received 
by households who have an IRA. Approximately 15% (5.7 million 
households) rely on advice services of their broker-dealers and 48% 
(18.3 million households) obtain advice from financial planners. 
Approximately 41% (15.5 million households) seek advice from bankers, 
accountants, or lawyers, while the 25% (9.5 million households) use no 
advice or seek advice from other sources.

   Table 8--Panel A: Sources of Advice for Households Who Have a Brokerage Account in the U.S. by Income Group
                                                      \962\
----------------------------------------------------------------------------------------------------------------
                                                                                % Taking advice
                                              % Taking advice  % Taking advice   from lawyers,     % Taking no
               Income category                  from brokers    from financial    bankers, or     advice or from
                                                                   planners       accountants     other sources
----------------------------------------------------------------------------------------------------------------
Bottom 25%..................................            20.55            53.89            35.64            24.30
25%-50%.....................................            22.98            38.03            43.92            32.36
50%-75%.....................................            20.75            52.00            31.42            23.61
75%-90%.....................................            22.56            48.94            32.25            28.10
Top 10%.....................................            25.29            50.53            38.47            21.06
Average.....................................            23.02            49.02            35.99            24.94
----------------------------------------------------------------------------------------------------------------


      Table 8--Panel B: Sources of Advice for Households Who Have an IRA in the U.S. by Income Group \963\
----------------------------------------------------------------------------------------------------------------
                                                                                % Taking advice
                                              % Taking advice  % Taking advice   from lawyers,     % Taking no
               Income category                  from brokers    from financial    bankers, or     advice or from
                                                                   planners       accountants     other sources
----------------------------------------------------------------------------------------------------------------
Bottom 25%..................................            12.14            38.30            43.69            31.85
25%-50%.....................................             9.79            43.82            40.67            32.74
50%-75%.....................................            14.93            45.20            41.23            25.23
75%-90%.....................................            14.68            52.14            41.65            24.26
Top 10%.....................................            21.40            55.40            40.03            18.56
Average.....................................            15.25            48.45            41.17            25.28
----------------------------------------------------------------------------------------------------------------

    The OIAD/RAND survey notes that for survey participants who 
reported working with a specific individual for investment advice, 70% 
work with a dual-registrant, 5.4% with a broker-dealer, and 5.1% with 
an investment adviser.\964\
---------------------------------------------------------------------------

    \962\ See SCFR Survey, supra footnote 950.
    \963\ Id.
    \964\ See OIAD/RAND at 53. As documented by OIAD/RAND, retail 
investors surveyed had difficulty in accurately identifying the type 
of relationship that they have with their financial professional.
---------------------------------------------------------------------------

f. Financial Incentives of Firms and Financial Professionals
    Commission experience indicates that there is a broad range of 
financial incentives provided by standalone broker-dealers and dually 
registered firms to their financial professionals.\965\ While some 
firms provide base pay for their financial professionals ranging from 
approximately $45,000 to $85,000 per year, many firms provide 
compensation only through a percentage of commissions, plus 
performance-

[[Page 33418]]

based awards, such as individual or team bonuses based on 
production.\966\ Commission-based compensation to financial 
professionals range from 30% to 95% of total commissions paid to the 
firm on a particular transaction, although this compensation is 
generally reduced by various costs and expenses attributable to the 
financial professional (e.g., clearing costs associated with some 
securities, charges related to an SRO or the Securities Investor 
Protection Corporation (``SIPC''), and insurance, among others).
---------------------------------------------------------------------------

    \965\ Information on compensation and financial incentives 
generally relates to 2016 compensation arrangements for a sample of 
approximately 20 firms, comprising both standalone broker-dealers 
and dually registered firms. We acknowledge that the information 
provided in this baseline may not be representative of the 
compensation structures more generally because of the diversity and 
complexity of services and securities offered by standalone broker-
dealers and dually registered firms.
    \966\ Commission experience indicates that some firms award 
production bonuses based on commissions generated, while other firms 
provide awards based on AUM.
---------------------------------------------------------------------------

    Several firms have varying commission-based compensation rates 
depending on the investment type being sold. For example, compensation 
ranges from 76.5% for stocks, bonds, options, and commodities to 90% 
for open-ended mutual funds, private placements, and unit investment 
trusts. Several firms charge varying commissions on securities 
depending on the amount of security sold (e.g., rates on certain 
proprietary mutual funds range from 0.75% to 5.75% depending on the 
share class), but do not provide those rates to financial professionals 
based on investment type. Some firms also provide incentives for their 
financial professionals to recommend proprietary securities and 
services over third-party or non-proprietary securities. Commission 
rates for some firms, however, decline as the dollar amount sold 
increases, and such rates vary across asset classes as well (e.g., 
within a given share class, rates range from 1.50% to 5.75% depending 
on the dollar amount of the fund sold). With respect to compensation to 
individual financial professionals, if compensation rates for mutual 
funds are approximately 90% (as discussed above, for example), 
financial professionals can earn between 0.68% and 5.18%, depending on 
the type and amount of security sold.
    For financial professionals who do not earn commission-based 
compensation, some firms charge retail customers flat fees ranging from 
$500 to $2,500, depending on the level of service required, such as 
financial planning, while others charge hourly rates ranging from $150 
to $350 per hour. For dually registered firms that charge clients based 
on a percentage of AUM, the average percentage charge varies based on 
the size of the account: The larger the AUM, the lower the percentage 
fee charged. Percentage-based fees for the sample firms range from 
approximately 1.5% for accounts below $250,000 to 0.5% for accounts in 
excess of $1 million.\967\ If compensation rates range between 30% and 
95%, a firm charging a customer $500 can provide compensation to the 
financial professional between $150 and $475 for each financial plan 
provided. For fee-based accounts, assuming that a retail customer has 
an account worth $250,000, the firm will charge account-level fees of 
$3,750 ($250,000 x 1.5%), and the financial professional can earn 
between $1,170 and $3,560 annually for each account. However, accounts 
may also be subject to additional fees beyond those described here and 
the financial professionals also may receive additional compensation.
---------------------------------------------------------------------------

    \967\ We note that some firms could have higher or lower 
commission-based compensation rates or asset-based fee percentages 
than those provided here. For example, based on a review of Form ADV 
Part 2A (the brochure) of several large dual-registrants (not 
included in the sample above), asset-based fees for low AUM accounts 
could range as high as 2.0% to 3.0%, with the average fee for high 
AUM accounts ranging between 0.5% to 1.5%. See also AdvisoryHQ, 
Average Financial Advisor Fees in 2018-2019: Fees Charged by 
Advisory & Wealth Management Firms, https://www.advisoryhq.com/articles/financial-advisor-fees-wealth-managers-planners-and-fee-only-advisors/. The AdvisoryHQ report shows that average asset-based 
fees range from 1.18% for accounts less than $50,000 to less than 
0.60% for accounts in excess of $30 million, while fixed-fees range 
from $7,500 for accounts less than $500,000 to $55,000 for accounts 
in excess of $7.5 million. Again, we note that these are charges to 
clients and are not indicative of the total compensation earned by 
the financial professional per account.
---------------------------------------------------------------------------

    In addition to ``base'' compensation, most firms also provide 
bonuses (based on either individual or team performance) or variable 
compensation, ranging from approximately 10% to 83% of base 
compensation. These bonuses could be awarded based on either 
commissions generated or AUM. While the majority of firms base at least 
some portion of their bonuses on production, usually in the form of 
total gross revenue, other forms of bonus compensation are derived from 
customer retention, customer experience, and manager assessment of 
performance. Moreover, some firms use a tiered system within their 
compensation grids depending on firm experience and production levels. 
Financial professionals' variable compensation can also increase when 
they enroll retail customers in advisory accounts versus other types of 
accounts, such as brokerage accounts. Some firms also provide 
transition bonuses for financial professionals with prior work 
experience based on historical trailing production levels and AUM. 
Although many firms do not have any incentive-based contests or 
programs, some firms award non-cash incentives for meeting certain 
performance, best practices, or customer service goals, including 
trophies, dinners with senior officers, and travel to annual meetings 
with other award winners.\968\
---------------------------------------------------------------------------

    \968\ See FINRA Regulatory Notice 16-29, Gifts, Gratuities and 
Non-Cash Compensation Rules--FINRA Requests Comment on Proposed 
Amendments to Its Gifts, Gratuities and Non-Cash Compensation Rules 
(Aug. 2016). At the time this notice was published, FINRA's 
impression was that investment-specific internal sales contests for 
non-cash compensation were not widely used.
---------------------------------------------------------------------------

2. Regulatory Baseline and Current Market Practices
    Broker-dealers' current standards of conduct are governed by 
federal and state law and regulation as well as the rules and guidance 
of SROs,\969\ particularly, for the purposes of this rulemaking, those 
related to the suitability of recommendations and disclosure of 
conflicts of interest. In response to comment letters that stated the 
Proposing Release did not fully consider the current market practices, 
we have provided an overview of these practices reported by commenters 
and from industry studies.\970\ Together, these laws and regulations 
comprise the regulatory baseline.
---------------------------------------------------------------------------

    \969\ Generally, all registered broker-dealers that deal with 
the public must become members of FINRA, a registered national 
securities association, and may choose to become exchange members. 
See Exchange Act section 15(b)(8) and Exchange Act rule 15b9-1. 
FINRA is the sole national securities association registered with 
the SEC under section 15A of the Exchange Act. Accordingly, for 
purposes of discussing a broker-dealer's regulatory requirements 
when providing advice, we focus on FINRA's regulation, examination, 
and enforcement with respect to member broker-dealers.
    \970\ See, e.g., AALU Letter; Letter from John L. Thornton, Co-
Chair, Committee in Capital Markets Regulation (Jul. 18, 2018) 
(``CCMR Letter''); CFA August 2018 Letter; Davis & Harman Letter; 
EPI Letter; Lincoln Financial Letter; NASAA August 2018 Letter; UVA 
Letter (which stated that the Proposing Release did not adequately 
address current market practices and/or provide industry studies and 
surveys of those practices).
---------------------------------------------------------------------------

a. Federal and State Securities Laws
    Under the antifraud provisions of the federal securities laws and 
SRO rules, broker-dealers are required to deal fairly with their 
customers.\971\ In addition, broker-dealers must comply with a wide

[[Page 33419]]

range of specific obligations specified in the Exchange Act and the 
rules thereunder. Moreover, there is a body of case law holding that 
broker-dealers that exercise discretion or control over customer 
assets, or have a relationship of trust and confidence with their 
customers, may owe customers a fiduciary duty, depending on the 
circumstances.\972\ Additionally, some states provide through statute 
or regulation, among other requirements such as minimum requirements 
for sales practices, that broker-dealers have some form of state-
specific fiduciary duty to their customers in at least some 
circumstances. Substantial variation exists among states' fiduciary 
standards, ranging from states with express fiduciary standards that 
apply to broker-dealers to those with limited or no such 
standards.\973\
---------------------------------------------------------------------------

    \971\ See, e.g., FINRA Rule 2010 (Standards of Commercial Honor 
and Principles of Trade); NASD Interpretive Material 2310-2, Fair 
Dealing with Customers (``Implicit in all member and registered 
representative relationships with customers and others is the 
fundamental responsibility for fair dealing. Sales efforts must 
therefore be undertaken only on a basis that can be judged as being 
within the ethical standards of [FINRA's] Rules, with particular 
emphasis on the requirement to deal fairly with the public.''); 
Charles Hughes & Co. v. SEC, 139 F.2d 434 (2d Cir. 1943), cert. 
denied, 321 U.S. 786 (1944); Hanly v. SEC, 415 F.2d 589, 596 (2d 
Cir. 1969); see also e.g., 913 Study at 51 and footnote 221.
    \972\ See, e.g., U.S. v. Skelly, 442 F.3d 94, 98 (2d Cir. 2006) 
(fiduciary duty found ``most commonly'' where ``a broker has 
discretionary authority over the customer's account''); United 
States v. Szur, 289 F.3d 200, 211 (2d Cir. 2002) (``Although it is 
true that there `is no general fiduciary duty inherent in an 
ordinary broker/customer relationship,' a relationship of trust and 
confidence does exist between a broker and a customer with respect 
to those matters that have been entrusted to the broker.'') 
(citations omitted); Leib v. Merrill Lynch, Pierce, Fenner & Smith, 
Inc., 461 F. Supp. 951, 953-954 (E.D. Mich. 1978), aff'd, 647 F.2d 
165 (6th Cir. 1981) (recognizing that a broker who has de facto 
control over non-discretionary account generally owes customer 
duties of a fiduciary nature; looking to customer's sophistication, 
and the degree of trust and confidence in the relationship, among 
other things, to determine duties owed); Arleen W. Hughes, Exchange 
Act Release No. 4048 (Feb. 18, 1948) (Commission Opinion), aff'd sub 
nom. Hughes v. SEC, 174 F.2d 969 (D.C. Cir. 1949) (``Release 4048'') 
(noting that fiduciary requirements generally are not imposed upon 
broker-dealers who render investment advice as an incident to their 
brokerage unless they have placed themselves in a position of trust 
and confidence, and finding that Hughes was in a relationship of 
trust and confidence with her clients). See also Gross Letter (which 
discussed the obligations of broker-dealers with discretionary or de 
facto control over customer accounts); Solely Incidental 
Interpretation.
    \973\ See AARP August 2018 Letter; PIABA Letter; U. of Miami 
Letter. See also Michael S. Finke & Thomas Patrick Langdon, The 
Impact of the Broker-Dealer Fiduciary Standard on Financial Advice 
(Working Paper, Mar. 9, 2012) for a discussion of state fiduciary 
standards. One comment letter also provided an extensive overview of 
the fiduciary obligations of state-registered investment advisers, 
``typified by an expectation of undivided loyalty where the adviser 
acts primarily for the benefit of its clients.'' See NASAA February 
2019 Letter at 22 and footnote 40. This comment letter also stated 
that ``[s]ome states also extend these fiduciary obligations beyond 
investment advisers to brokers, especially in dual-hatted 
scenarios,'' and that these fiduciary obligations were extended even 
when broker-dealers handled non-discretionary accounts. Id. at 23-24 
and footnote 41.
---------------------------------------------------------------------------

b. FINRA Rule 2111: Suitability
    FINRA Rule 2111 (the ``Suitability Rule'') requires that a broker-
dealer or associated person have a reasonable basis to believe that a 
recommended securities transaction or investment strategy involving 
securities is suitable for the retail customer.\974\ A broker-dealer 
cannot disclaim away its suitability obligation under the Suitability 
Rule.\975\ We reviewed the Suitability Rule and drew upon it and 
enhanced the suitability requirement in developing Regulation Best 
Interest.\976\ FINRA also requires additional specific suitability 
obligations with respect to certain types of securities or 
transactions, such as variable insurance products and derivatives 
securities, including options and securities-based futures.\977\
---------------------------------------------------------------------------

    \974\ See FINRA Rule 2111, supra footnote 161. As a ``General 
Principle,'' the rule states that associated persons have a 
``fundamental responsibility for fair dealing'' and that the rule is 
intended to promote ethical sales practices and high standards of 
commercial conduct. See FINRA Rule 2111.01. See also, In re 
Application of Raghavan Sathianathan, Exchange Act Release No. 54722 
at 10 (Nov. 8, 2006) (``Sathianathan's recommendations . . . were 
unsuitable because they were designed to maximize his own 
commissions rather than to establish a suitable portfolio.''). See 
also 913 Study at 59 and footnote 187.
    \975\ FINRA Rule 2111.02 (Disclaimers).
    \976\ See supra footnote 161. The primary requirements for the 
Suitability Rule are described in the Proposing Release at Section 
IV.B.2.a.
    \977\ See, e.g., FINRA Rule 2330 (Members' Responsibilities 
Regarding Deferred Variable Annuities); FINRA Rule 2360 (Options); 
FINRA Rule 2370 (Securities Futures); FINRA Rule 2821 (Sales 
Practices for Deferred Variable Annuities including a Suitability 
Obligation). See also 913 Study at 65-66.
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    As discussed by several commenters,\978\ the regulatory baseline 
also includes FINRA guidance on best practices, such as guidance 
regarding suitability, which provides guidance on how broker-dealers 
and associated persons should comply with suitability obligations when 
making recommendations to customers. FINRA guidance regarding 
suitability includes Regulatory Notice 12-25, which states that under 
the Suitability Rule, ``a broker's recommendations must be consistent 
with his customers' best interests,'' \979\ as well as other regulatory 
notices that provide guidance on the suitability of specific securities 
or investment strategies involving securities, including, but not 
limited to, mutual funds, variable contracts including annuities, 
structured and complex securities, leveraged and inverse exchange-
traded products, and IRA rollovers.\980\
---------------------------------------------------------------------------

    \978\ See CFA August 2018 Letter; Bank of America Letter; 
Transamerica August 2018 Letter.
    \979\ See FINRA Regulatory Notice 12-25; see also FINRA 
Regulatory Notice 13-31, Suitability--FINRA Highlights Examination 
Approaches, Common Findings and Effective Practices for Complying 
With its Suitability Rules (Sep. 2013) (which provides ``. . . 
effective practices . . . to help firms enhance compliance and 
supervision under the suitability rule'').
    \980\ See, e.g., NASD Notice to Members 94-16, NASD Reminds 
Members Of Mutual Fund Sales Practice Obligations (Mar. 1994) and 
NASD Notice to Members 95-80, NASD Further Explains Members 
Obligations and Responsibilities Regarding Mutual Funds Sales 
Practices (Sep. 1995) (mutual fund suitability and sales practices); 
NASD Notice to Members 96-86, NASD Regulation Reminds Members and 
Associated Persons that Sales of Variable Contracts are Subject to 
NASD Suitability Requirements (Dec. 1996) and NASD 99-35, NASD 
Reminds Members of Their Responsibilities Regarding Sales of 
Variable Annuities (May 1999) (suitability and sales practices of 
variable contracts and variable annuities); NASD Notice to Members 
05-59, NASD Provides Guidance Concerning the Sale of Structure 
Products; and FINRA Regulatory Notice 12-03, Complex Products--
Heightened Supervision of Complex Products (Jan. 2012); (suitability 
and sales practices of structured and complex products); FINRA 
Regulatory Notice 09-31, FINRA Reminds Firms of Sales Practice 
Obligations Relating to Leveraged and Inverse Exchange-Traded Funds 
(June 2009) (sales practices of leveraged and inverse ETFs); and 
FINRA Regulatory Notice 13-45, Rollovers to Individual Retirement 
Accounts--FINRA Reminds Firms of Their Responsibilities Concerning 
IRA Rollovers (Dec. 2013) (obligations when recommending a rollover 
or transfer of assets from a sponsored retirement plan to an IRA).
---------------------------------------------------------------------------

c. FINRA Report on Conflicts of Interest
    In 2013, FINRA published as guidance a Report on Conflicts of 
Interest (``FINRA Conflicts Report'') to provide an overview of 
effective practices that broker-dealers could employ to manage and 
mitigate conflicts of interest.\981\ In the report, FINRA provides 
suggestions for broker-dealers for addressing conflicts of interest 
related to three broad areas: A firm-level approach to identify and 
manage conflicts of interest; the production and distribution of new 
securities; and compensation and other financial incentives of 
associated persons.\982\ With respect to new securities, the FINRA 
Conflicts Report recommends, among other things, new security review 
committees and disclosure of conflicts related to recommendations of 
new securities to customers.\983\ The FINRA Conflicts Report also 
provides guidance to broker-dealers on managing conflicts of interest 
that arise from compensation and financial incentives of broker-
dealers. For example, the FINRA Conflicts Report recommends increased 
surveillance of recommendations near compensation thresholds and 
capping compensation credits across similar

[[Page 33420]]

investment types to prevent representatives from preferentially 
recommending securities that yield the largest compensation.\984\
---------------------------------------------------------------------------

    \981\ See FINRA Conflicts Report, supra footnote 459. See also 
IRI Letter, which notes that the FINRA Conflicts Report ``. . . 
provides valuable guidance as to the elements of an effective 
practice framework for managing BDs' conflicts of interest. . .'' 
See also SIFMA August 2018 Letter; CFA August 2018 Letter; Raymond 
James Letter; Ameriprise Letter; ACLI Letter; Fein Letter.
    \982\ See FINRA Conflicts Report, supra footnote 459.
    \983\ Id.
    \984\ Id.
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d. Other Broker-Dealer Obligations: Disclosure, Supervision, and 
Compensation
    Broker-dealers are subject to other disclosure obligations under 
the federal securities laws and SRO rules. For instance, under existing 
antifraud provisions of the Exchange Act, a broker-dealer has a duty to 
disclose material adverse information to its customers.\985\ Broker-
dealers found to be acting as fiduciaries also have a duty to disclose 
material conflicts of interest.\986\ Broker-dealers are also prohibited 
from making misleading statements.\987\ Courts have found that broker-
dealers, in making recommendations, should have disclosed that they 
were: Acting as a market maker for the recommended security; trading as 
a principal with respect to the recommended security; engaging in 
revenue sharing with a recommended mutual fund; or ``scalping'' a 
recommended security.\988\
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    \985\ A broker-dealer may be liable if it does not disclose 
``material adverse facts of which it is aware.'' See, e.g., Chasins 
v. Smith, Barney & Co., 438 F.2d 1167, 1172 (2nd Cir. 1970); SEC v. 
Hasho, 784 F. Supp. 1059, 1110 (S.D.N.Y. 1992); In the Matter of 
RichMark Capital Corp., Exchange Act Release No. 48758 (Nov. 7, 
2003) (Commission Opinion) (``When a securities dealer recommends 
stock to a customer, it is not only obligated to avoid affirmative 
misstatements, but also must disclose material adverse facts of 
which it is aware. That includes disclosure of `adverse interests' 
such as `economic self-interest' that could have influenced its 
recommendation.'') (citations omitted). See also Relationship 
Summary Proposal.
    \986\ See, e.g., United States v. Szur, 289 F.3d 200, 212 (2d 
Cir. 2002) (broker's fiduciary relationship with customer gave rise 
to a duty to disclose commissions to customer, which would have been 
relevant to customer's decision to purchase stock); Arleen W. 
Hughes, Exchange Act Release No. 4048 (Feb. 18, 1948) (Commission 
Opinion), aff'd sub nom. Hughes v. SEC, 174 F.2d 969, 976 (D.C. Cir. 
1949) (broker-dealer acted in the capacity of a fiduciary and, as 
such, broker-dealer was under a duty to make full disclosure of the 
nature and extent of her adverse interest when engaging in principal 
transactions, ``including her cost of the securities and the best 
price at which the security might be purchased in the open 
market'').
    \987\ See Proposing Release at footnotes 175-177 and 205, and 
accompanying text. See Exchange Act Sections 10(b) and 15(c).
    \988\ See 913 Study at footnotes 251-54. See also id. at 
footnotes 225-232 (which discuss existing SRO rules on disclosures).
---------------------------------------------------------------------------

    Broker-dealers are also currently subject to supervisory 
obligations under Section 15(b)(4)(E) of the Exchange Act and SRO 
rules, including the establishment of policies and procedures 
reasonably designed to prevent and detect violations of, and to achieve 
compliance with, the federal securities laws and regulations, as well 
as applicable SRO rules.\989\ Specifically, the Exchange Act authorizes 
the Commission to sanction a broker-dealer or any associated person 
that fails to reasonably supervise another person subject to the firm's 
or the person's supervision that commits a violation of the federal 
securities laws.\990\ The Exchange Act provides an affirmative defense 
against a charge of failure to supervise where reasonable procedures 
and systems for applying the procedures have been established and 
effectively implemented without reason to believe those procedures and 
systems are not being complied with. Further, under the federal 
securities laws and FINRA rules, prices for securities and broker-
dealer compensation are required to be fair and reasonable, taking into 
consideration all relevant circumstances.\991\
---------------------------------------------------------------------------

    \989\ See supra footnote 809. See also Proposing Release at 
21622.
    \990\ Exchange Act Sections 15(b)(4)(E) and (b)(6)(A).
    \991\ See, e.g., Exchange Act Sections 10(b) and 15(c); FINRA 
Rules 2121 (Fair Prices and Commissions), 2122 (Charges for Services 
Performed), and 2341 (Investment Company Securities). See also FINRA 
Rule 3221 (Non-Cash Compensation). Several commenters stated that, 
as part of their overall business practices, they use non-cash 
compensation (e.g., firm-sponsored business conferences), which they 
believe is in compliance with existing FINRA Rule 3221 on non-cash 
compensation practices. See Guardian August 2018 Letter; NY Life 
Letter.
---------------------------------------------------------------------------

    Broker-dealers also register with and report information, including 
about their business and affiliates, to the Commission, the SROs, and 
other jurisdictions through Form BD.\992\ Form BD requires information 
about the background of the applicant, its principals, controlling 
persons, and employees, as well as information about the type of 
business in which the broker-dealer proposes to engage and all control 
affiliates engaged in the securities or investment advisory 
business.\993\ Once a broker-dealer is registered, it must keep its 
Form BD current by amending it promptly when the information is or 
becomes inaccurate for any reason.\994\ In addition, firms report 
similar information and additional information--such as written 
customer complaints and other disciplinary matters-- to FINRA pursuant 
to FINRA Rule 4530 (Reporting Requirements).
---------------------------------------------------------------------------

    \992\ See Relationship Summary Proposal at 21472; see also 
generally Form BD.
    \993\ See generally Form BD.
    \994\ See Exchange Act rule 15b3-1(a).
---------------------------------------------------------------------------

e. DOL Fiduciary Rule as It Relates to Current Market Practice
    This section discusses the recently vacated DOL Fiduciary 
Rule,\995\ the implications for broker-dealers, and the industry 
response to the DOL Fiduciary Rule. Although the DOL Fiduciary Rule was 
vacated by the Fifth Circuit Court of Appeals in June, we discuss the 
DOL Fiduciary Rule as part of the baseline because certain broker-
dealers and other industry participants may have adjusted their 
practices in order to plan for the implementation of the requirements 
of this rule. It is possible that some of these broker-dealers may 
continue to operate their business using these adjusted practices, 
while other may have reverted to the pre-DOL Fiduciary Rule practices. 
Below, we discuss actual and potential costs, as well as changes in 
services and securities offerings, in response to the DOL Fiduciary 
Rule as reported by industry participants through surveys. We also 
describe how, following the Fifth Circuit Court of Appeals decision 
vacating the DOL Fiduciary Rule, certain of those costs have been 
reduced and the trend toward reduction in retail investor access to 
services and securities offerings that may have been caused in part by 
the DOL Fiduciary Rule appears to have ended and may be reversing.
---------------------------------------------------------------------------

    \995\ See supra footnote 32.
---------------------------------------------------------------------------

i. Department of Labor's Fiduciary Rule and Temporary Enforcement 
Policy
    As noted above, prior to the Fifth Circuit decision, many firms 
took steps to come into compliance with the DOL Fiduciary Rule, and in 
particular, the BIC Exemption and other PTEs, including changes to 
business practices.\996\
---------------------------------------------------------------------------

    \996\ See supra footnotes 32-34 and accompanying text.
---------------------------------------------------------------------------

    Following the decision by the Fifth Circuit, the DOL acknowledged 
that uncertainty about fiduciary obligations and the scope of exemptive 
relief under the prohibited transaction provisions of ERISA and the 
Internal Revenue Code following the court's decision could temporarily 
disrupt existing investment advice arrangements during the transition 
period, and also that financial institutions had devoted significant 
resources to comply with PTEs issued in connection with the DOL 
Fiduciary Rule, including the BIC Exemption.\997\ Based on these 
concerns, the DOL issued a temporary enforcement policy stating that it 
would not pursue claims against fiduciaries working in good faith to 
comply with the BIC Exemption's Impartial Conduct Standards for 
transactions that would have been exempted by the BIC Exemption or 
treat such fiduciaries as violating applicable

[[Page 33421]]

prohibited transactions rules.\998\ Prior to the Fifth Circuit 
decision, some broker-dealers that offered services to IRAs and other 
retirement accounts may have implemented changes to services and 
securities to comply with and meet the conditions of the BIC Exemption 
and other PTEs, including the Impartial Conduct Standards.\999\ 
Although the Commission does not currently have data on the number of 
firms that may have devoted resources to comply with the PTEs,\1000\ 
the Commission can broadly estimate the maximum number of broker-
dealers that could have undertaken changes in order to comply with 
requirements of the PTEs from the number of broker-dealers that have 
retail customer accounts. Approximately 73.5% (2,766) of registered 
broker-dealers report sales to retail customers.\1001\ Similarly, 
approximately 8,235 (62% of) investment advisers serve high net worth 
and non-high net worth individual clients. The Commission understands 
that these numbers are an upper bound and likely overestimate the 
broker-dealers and investment advisers that provide retirement account 
services and began compliance with the requirements of the PTEs.\1002\
---------------------------------------------------------------------------

    \997\ See U.S. Department of Labor Field Assistance Bulletin 
2018-02, available at https://www.dol.gov/agencies/ebsa/employers-and-advisers/guidance/field-assistance-bulletins/2018-02.
    \998\ Id.
    \999\ See, e.g., Michael Wursthorn, A Complete List of Brokers 
and Their Approach to `The Fiduciary Rule', Wall St. J., Feb. 6, 
2017, https://www.wsj.com/articles/a-complete-list-of-brokers-and-their-approach-to-the-fiduciary-rule-1486413491?mod=article_inline 
for a discussion of how broker-dealers adjusted certain practices in 
response to the DOL Fiduciary Rule.
    \1000\ In order to perform this analysis, the Commission would 
need to know which financial firms offer services to IRAs and other 
retirement accounts. Under the current reporting regimes for both 
broker-dealers and investment advisers, they are not required to 
disclose whether (or what fraction of) their accounts are held by 
retail investors in retirement accounts.
    \1001\ As of December 2018, 3,764 broker-dealers have filed Form 
BD. Retail sales by broker-dealers were obtained from Form BR. See 
supra footnote 900.
    \1002\ The Department of Labor Regulatory Impact Analysis (``DOL 
RIA'') identifies approximately 4,000 broker-dealers (FINRA, 2016), 
of which approximately 2,500 are estimated to have either ERISA 
accounts or IRA accounts serviced by broker-dealers, similar to the 
estimates that we provide above. In addition to broker-dealers, the 
DOL RIA estimates that other providers of ERISA or IRA accounts 
include: Approximately 10,600 federally registered investment 
advisers and 17,000 state-registered investment advisers (NASAA 
2012/2013 Report), of which approximately 17,000 of federal and 
state investment advisers that are not dually registered, 
approximately 6,000 ERISA plan sponsors (2013 Form 5500 Schedule C), 
and approximately 400 life insurance companies (2014 SNL Financial 
Data). See U.S. Department of Labor, Regulating Advice Markets: 
Definition of the Term 'Fiduciary', Conflicts of Interest, 
Retirement Investment Advice: Regulatory Impact Analysis for Final 
Rule and Exemptions (Apr. 2016), available at https://www.dol.gov/sites/default/files/ebsa/laws-and-regulations/rules-and-regulations/completed-rulemaking/1210-AB32-2/ria.pdf.
---------------------------------------------------------------------------

ii. Industry Response to DOL Fiduciary Rule
    Although the DOL Fiduciary Rule became effective in June 2017, the 
DOL provided transitional relief through July 2019,\1003\ which is now 
indefinitely extended under the temporary enforcement policy put in 
place in June 2018 following the Fifth Circuit decision. As described 
above, a significant subset of broker-dealers have retail customers 
with retirement accounts and would have been affected by the DOL 
Fiduciary Rule, and at least some broker-dealers began taking steps to 
effectuate compliance with the DOL Fiduciary Rule. A number of 
commenters stated that we did not sufficiently consider the existing 
regulatory environment and the current market practices of firms and 
financial professionals in light of the DOL's Fiduciary Rule and other 
existing rules and regulations.\1004\ Below, we discuss the industry 
response to the DOL Fiduciary Rule and the effect of the Fifth Circuit 
decision on broker-dealers.
---------------------------------------------------------------------------

    \1003\ See supra footnote 1002.
    \1004\ See, e.g., AALU Letter; CCMC Letters; CCMR Letter; CFA 
August 2018 Letter; Davis & Harman Letter; EPI Letter; Lincoln 
Financial Letter; Morningstar Letter; NASAA August 2018 Letter; 
Wells Fargo Letter.
---------------------------------------------------------------------------

    In the Proposing Release, we predominantly based our discussion of 
the industry and customer effects of the DOL Fiduciary Rule on 
information from a single industry study.\1005\ Commenters provided 
additional citations to industry studies,\1006\ which describe changes 
in market practices across a broader-sample of broker-dealers in 
response to the DOL Fiduciary Rule.\1007\ In these studies, certain of 
the survey participants reported that they responded to the DOL 
Fiduciary Rule and the BIC Exemption by reducing certain services and 
access to advice to small retirement accounts. Certain participants 
further reported that they encouraged customers toward self-directed 
accounts and/or advisory accounts, including robo-advisors. Certain 
other participants reported that they reduced or eliminated certain 
securities within certain types of retirement accounts that they 
offered. Finally, certain participants reported that they increased 
certain fees for some of their customers. However, as it is generally 
the case with survey analysis, the surveys in the aforementioned 
studies are subject to potential selection biases (i.e., the sample of 
respondents is not necessarily random) and methodological limitations 
(e.g., the design of the questionnaire may influence the choices made 
by the respondents). Given these limitations, it is generally not clear 
whether the results of these studies capture significant or marginal 
changes in broker-dealer practices, and whether these changes are 
indicative of broader trends in the market for advice in response to 
the DOL Fiduciary Rule.
---------------------------------------------------------------------------

    \1005\ See SIFMA Study, supra footnote 33. The SIFMA Study 
surveyed 21 SIFMA members and captured 43% of U.S. ``financial 
advisors'' (132,000 out of 310,000), 35 million retail retirement 
accounts, and 27% of qualified retirement savings assets ($4.6 
trillion out of $16.9 trillion). The types of retirement accounts 
serviced by the participants in the SIFMA Study were not defined.
    \1006\ See, e.g., CCMC Letters; Davis & Harman Letter; EPI 
Letter; Lincoln Financial Letter.
    \1007\ See, e.g., Financial Services Roundtable & Harper 
Polling, Department of Labor Fiduciary Rule: National Survey of 
Financial Professionals (July 2017), available at https://www.sec.gov/comments/ia-bd-conduct-standards/cll4-2641320-161289.pdf 
(see Appendix A) (``FSR Study''). The FSR Study surveyed 600 
financial advisers in July 2017, including certified financial 
planners, chartered financial analysts, broker-dealers, and dually 
registered representatives. See also Center for Capital Markets 
Competitiveness, Fiduciary Rule: Initial Impact Analysis, FTI 
Consulting Report Presented to the U.S. Chamber of Commerce (Sept. 
7, 2017), available at https://www.centerforcapitalmarkets.com/wp-content/uploads/2017/07/Fiduciary-Rule-Initial-Impact-Analysis.pdf 
(``Chamber Study''). The Chamber Study surveyed 14 financial 
advisory companies (insurance companies, securities manufacturers, 
and broker-dealers) responsible for $10 trillion in AUM and nearly 
26 million investment accounts. The types of accounts serviced by 
the participants in the Chamber Study were not defined. See also 
A.T. Kearney, The $20 Billion Impact of the New Fiduciary Rule on 
the U.S. Wealth Management Industry, Perspective for Discussion 
(Oct. 2016), available at https://www.atkearney.com/documents/10192/7041991/DOL+Perspective+-+August+2016.pdf/b2a2176b-c821-41d9-b12e-d3d2b0807d69 (``Kearney Study''). We note that the development of 
business models and practices discussed herein reflect changes made 
voluntarily by firms in response to the DOL Fiduciary Rule, but were 
not necessarily required by the DOL Fiduciary Rule.
---------------------------------------------------------------------------

Changes to Services and Securities
    A number of studies indicated that, as a result of the DOL 
Fiduciary Rule, certain industry participants had already or were 
planning to alter their menu of services and securities that they made 
available to retail customers. For example, of the 21 SIFMA members 
that participated in the SIFMA Study, 53% eliminated or reduced access 
to certain brokerage advice services and 67% migrated away from open 
choice to fee-based or limited brokerage services.\1008\ Another study 
also discussed a shift from commission-based accounts to fee-based 
accounts but offered no details about the sample or the methodology 
employed to arrive

[[Page 33422]]

at the estimates.\1009\ Finally, another study documented that at least 
29% of their survey participants expected to move clients, particularly 
those with low account balances, to robo-advisors.\1010\ In addition, a 
number of media articles describe several cases of broker-dealers that 
have adjusted their practices with respect to the range of accounts 
offered as a result of the DOL Fiduciary Rule.\1011\
---------------------------------------------------------------------------

    \1008\ See SIFMA Study, supra footnote 33.
    \1009\ See Kearney Study (provided by the Davis & Harman and 
Lincoln Financial Letters).
    \1010\ See FSR Study, which states that ``[a]dvisors who say the 
average net worth of their clients is under $25,000 are more likely 
to say they will definitely, probably, or have already directed more 
clients to robo advisor services, both online and at call centers 
(43% vs. 29% overall).''
    \1011\ For example, in response to the DOL Fiduciary Rule, J.P. 
Morgan and Merrill Lynch phased out commission-based retirement 
plans and instead charged fees based on AUM. See Crystal Kim, BofA, 
JPMorgan, and the Fiduciary Rule: Will They or Won't They, Barron's, 
Mar. 15, 2017, https://www.barrons.com/articles/bofa-jpmorgan-and-the-fiduciary-rule-will-they-or-wont-they-1489588442. However, upon 
the Fifth Circuit's ruling on the DOL Fiduciary Rule, J.P. Morgan 
and Merrill Lynch reversed their earlier decision and began to offer 
commission-based retirement plans again. See Jed Horowitz, JPMorgan 
to Remove Some Fiduciary Rule Handcuffs, Others May Follow, 
AdvisorHub, May 4, 2018, https://advisorhub.com/jpmorgan-to-remove-some-fiduciary-rule-handcuffs-others-may-follow/; Imani Moise, 
Merrill Lynch Does about Face on Fiduciary-Era Policy, Reuters, Aug. 
30, 2018, https://www.reuters.com/article/us-bank-of-america-fiducuary/merrill-lynch-does-about-face-on-fiduciary-era-policy-idUSKCN1LF1R9. See also Daisy Maxey, Winners and Losers in a Post-
Fiduciary World, Wall St. J., May 24, 2017, available at https://www.wsj.com/articles/winners-and-losers-in-a-post-fiduciary-world-1495638708; Nir Kaissir, Merrill Lynch Can't Restore the Bad Old 
Days of Conflicts, Bloomberg, Sept. 4, 2018, available at https://www.bloomberg.com/opinion/articles/2018-09-04/merrill-lynch-can-t-restore-the-bad-old-days-of-conflicts.
---------------------------------------------------------------------------

    Further, industry studies noted that certain of their respondents 
changed their securities offerings as a result of the DOL Fiduciary 
Rule.\1012\ For example, 95% of the SIFMA Study participants altered 
their securities offerings by reducing or eliminating certain asset or 
share classes; 86% of the respondents reduced the number or type of 
mutual funds (e.g., 29% eliminated no-load funds, while 67% reduced the 
number of mutual funds), and 48% reduced annuity securities 
offerings.\1013\ Similarly, another study found that nearly 30% of 
survey participants eliminated or reduced securities or services 
available to retirement investors in response to the DOL Fiduciary 
Rule,\1014\ while the Chamber Study noted that 13.4 million accounts of 
the companies surveyed had limited access to certain securities, 
including mutual funds, variable annuities, and exchange-traded 
funds.\1015\ Finally, the SIFMA Study states that although the DOL 
Fiduciary Rule applied only in connection with services for retirement 
accounts, certain of the survey participants had implemented the 
changes to both retirement and non-retirement accounts.\1016\ These 
studies do not discuss the attributes of the securities that the 
participants chose to no longer offer. In addition, as noted above, 
survey analysis is subject to certain limitations that, generally, 
complicate the interpretation of their results. For instance, it is not 
generally clear whether the results of these studies capture 
significant or marginal changes in broker-dealer practices, and whether 
these changes are indicative of broader trends in the market for advice 
in response to the DOL Fiduciary Rule.
---------------------------------------------------------------------------

    \1012\ While the industry studies discussed in this section 
examined shifts in services and securities provided to retail 
investors, one limitation of these studies is that they did not 
discuss whether the quality of advice provided to retail investors 
also changed as a result.
    \1013\ See SIFMA Study, supra footnote 33.
    \1014\ See American Bankers Association, ABA Survey: Department 
of Labor Fiduciary Rule (July 20, 2017), available at https://www.aba.com/Advocacy/Issues/Documents/dol-fiduciary-rule-survey-summary-report.pdf (``ABA Study''). The ABA Study conducted a survey 
of 57 banks about their understanding of the DOL Fiduciary Rule on 
securities and services available to retirement investors. See also 
Kearney Study, which anticipated a shift from mutual funds to 
exchange-traded funds, and that ``certain high-cost investment 
products (such as variable annuities) will be phased out as the 
business model is no longer viable under [the DOL Fiduciary Rule].'' 
See also FSR Study, which reported that 63% of its survey 
participants anticipated fewer investment options and 56% had 
already reduced or anticipated reducing the number of mutual funds 
offered to retirement customers.
    \1015\ See Chamber Study. See also Editorial Board, Tom Perez's 
Fiduciary Flop, Wall St. J., Mar. 18, 2018, https://www.wsj.com/articles/tom-perezs-fiduciary-flop-1521412228, which noted that some 
firms restricted sales of commission-based securities such as load 
mutual funds and variable annuities in retirement accounts.
    \1016\ See, e.g., SIFMA Study, supra footnote 33.
---------------------------------------------------------------------------

    Besides the studies mentioned above, a number of media articles 
provide anecdotal evidence of broker-dealers that chose to no longer 
offer certain securities.\1017\ Some commenters also provided data 
about historical trends in certain product markets.\1018\ For example, 
one commenter provided data for the market of mutual funds and showed 
that between 2007 and 2018, the percentage of assets in load mutual 
funds declined from 27% to 12%, while no-load share classes increased 
from 51% to 71% over the same time period.\1019\ Further, this 
commenter stated that this shift has occurred because of the growth in 
assets in 401(k) plans and other retirement accounts, as well as the 
increase in the number of advisory accounts, both of which tend to 
invest in no-load share classes.
---------------------------------------------------------------------------

    \1017\ See Alex Steger, Exclusive: UBS to Cut over 800 Funds 
from Platform, City Wire, Mar. 13, 2018, https://citywireusa.com/professional-buyer/news/exclusive-ubs-to-cut-over-800-funds-from-platform/a1100101; Michael Thrasher, Ameriprise Drops Hundreds of 
Funds Offered to Brokerage Clients, WealthManagement.com, June 8, 
2017, https://www.wealthmanagement.com/industry/ameriprise-drops-hundreds-funds-offered-brokerage-clients; Hugh Son, Morgan Stanley 
to Reduce Wealth Fees Even with Rule Uncertainty, Bloomberg, Jan. 
26, 2017, https://www.bloomberg.com/news/articles/2017-01-26/morgan-stanley-to-proceed-with-wealth-changes-ahead-of-new-rules; Margarida 
Correia, LPL Puts Final Touches on Product Lineups in Preparation 
for Fiduciary Rule, Financial Planning, Mar. 9, 2017, https://www.financial-planning.com/news/lpl-puts-final-touches-on-product-lineups-in-preparation-for-fiduciary-rule?tag=00000154-3e16-d45e-a175-7f9f48a20001; Bruce Kelly, Wells Fargo Advisors Restricting 
Investments for Retirement Accounts, Investment News, May 24, 2017, 
https://www.investmentnews.com/article/20170524/FREE/170529959/wells-fargo-advisors-restricting-investments-for-retirement-accounts.
    \1018\ See, e.g., ICI Letter.
    \1019\ See id.
---------------------------------------------------------------------------

    However, the DOL Fiduciary Rule may have caused certain product 
markets to adjust.\1020\ For example, innovations, including the 
introduction of T and clean share classes of mutual funds, can be 
regarded as a paradigm shift in terms of how product sponsors 
compensate broker-dealers for distribution services. One commenter 
noted that these products may reduce the expected fund underperformance 
net of costs for retail investors relative to A shares by nearly 50 
basis points annually.\1021\
---------------------------------------------------------------------------

    \1020\ See, e.g., James Chen, Clean Shares, Investopedia, 
available at https://www.investopedia.com/terms/c/clean-shares.asp, 
stating that ``[t]he mutual fund industry introduced clean shares, 
along with T shares, in response to the Department of Labor's 
fiduciary rule.''
    \1021\ See Letter from Aron Szapiro, Director of Policy 
Research, Morningstar (Sept. 2017).
---------------------------------------------------------------------------

The Effect of Costs and Fees
    Some firms may have responded to the DOL Fiduciary Rule by either 
presenting customers with the option to enter into different and 
potentially more costly advice relationships compared to a brokerage 
advice relationship or by passing some of the compliance costs to 
customers.\1022\ However, one study observed that 63% of the responding 
firms that limited or eliminated access to advised brokerage services 
stated that they had at least some customers who chose to move to self-
directed accounts rather than fee-based accounts and cited the reasons 
that customers provided as (1) ``did not want to move to a fee-based 
account,'' (2) ``was not in the retirement investor's best interest to 
move to a fee-

[[Page 33423]]

based account,'' (3) ``did not meet the account minimums,'' or (4) 
``wished to maintain positions in certain asset classes which were not 
eligible for a fee-based account.'' \1023\ Another study further 
observed that nearly 40% of the responding firms believed that the 
relationship with their customers had been altered as a result of the 
DOL Fiduciary Rule and that customers with smaller account balances 
were nearly ten times more likely to have been negatively affected by 
the DOL Fiduciary Rule than customers with larger account 
balances.\1024\ Further, another study observed that 68% of the 
responding firms were less likely to provide services to smaller 
accounts, and 46% anticipated that they may service fewer clients 
overall.\1025\
---------------------------------------------------------------------------

    \1022\ See supra footnote 1011 (which describes how certain 
firms responded to the DOL Fiduciary Rule and later reversed changes 
in response to the Fifth Circuit decision).
    \1023\ See SIFMA Study, supra footnote 33.
    \1024\ See ABA Study.
    \1025\ See FSR Study. See also Chamber Study, which found that 
some survey participants have added minimum account balances and 
have migrated away from commission-based models toward fee-based 
models.
---------------------------------------------------------------------------

    One study observed that, generally, based on the numbers provided 
by the respondents, a fee-based account can be more costly than a 
brokerage account; however, such comparison is generally hard to make 
without knowing the securities in the two types of accounts, and it is 
not clear that the survey made this clear to respondents.\1026\ One 
study \1027\ observed that approximately 52% of its survey participants 
indicated that they may pass on the costs associated with complying 
with the DOL Fiduciary Rule to clients in the form of higher fees, 
while another study stated that more than 6 million client accounts of 
the survey participants may be subject to higher costs and fees as a 
result of the DOL Fiduciary Rule, although it is not clear whether this 
estimate assumes full adoption of the DOL Fiduciary Rule.\1028\
---------------------------------------------------------------------------

    \1026\ See SIFMA Study. We note that only a subset of the SIFMA 
Study participants provided information on the costs associated with 
brokerage and advisory accounts. See CFA August 2018 Letter. The 
SIFMA Study did not provide any information on the set of firms 
comprised in this subset that provided information on brokerage and 
advisory costs. See also ICI Letter (which provided similar 
estimates for fees and costs attributable to brokerage and advisory 
accounts).
    \1027\ See FSR Study.
    \1028\ See Chamber Study.
---------------------------------------------------------------------------

Estimated Costs of Compliance and Effects on Compensation Structures
    One study observed that survey respondents were expecting to incur 
compliance costs as a result of the DOL Fiduciary Rule that would vary 
by the size of the respondent.\1029\ For instance, large firms with net 
capital in excess of $1 billion were expected to have start-up and 
ongoing compliance costs of $55 million and $6 million, respectively, 
while firms between $50 million and $1 billion in net capital were 
expected to have start-up and ongoing compliance costs of $16 million 
and $3 million, respectively. The study further estimated that the 
total start-up compliance costs for large and medium-size firms 
combined would have been approximately $4.7 billion, while ongoing 
costs would have been approximately $700 million per year.
---------------------------------------------------------------------------

    \1029\ See SIFMA Study. As a general matter, we note that the 
estimates reported by industry studies, including this study, are 
based on a rulemaking with more extensive requirements for changes 
to business models than those required by Regulation Best Interest.
---------------------------------------------------------------------------

    Another study observed that the costs of complying with DOL 
Fiduciary Rule would encompass technology, legal, process changes, 
educational, and training costs for firms.\1030\ This study forecasted 
that the DOL Fiduciary Rule may cause a $2 trillion redistribution in 
assets from broker-dealers to investment advisers, robo-advisors, and 
self-directed accounts, and a nearly $20 billion decrease in revenues 
to the entire financial services industry, including broker-dealers.
---------------------------------------------------------------------------

    \1030\ See Kearney Study.
---------------------------------------------------------------------------

    The study further forecasted that as a result of the DOL Fiduciary 
Rule product sponsors ``will be incentivized to streamline product 
offerings, lower fees, and improve performance,'' and investor would 
pay $7.5 billion less in mutual fund and ETF expenses by the end of 
2010. However, as noted above, this study does not provide details 
about how it obtained its estimates.
    Several media articles provide some anecdotal evidence suggesting 
that as a response to the DOL Fiduciary Rule some broker-dealers began 
to alter the compensation structures of their registered 
representatives.\1031\ For example, some broker-dealers have indicated 
that they adjusted their compensation structures by equalizing 
commissions and deferred sales charges across similar securities.\1032\ 
Other broker-dealers banned sales quotas, contests, special awards, and 
bonuses,\1033\ including deferred bonuses as part of recruitment 
efforts.\1034\ However, following the decision by the Fifth Circuit to 
vacate the DOL Fiduciary Rule, some firms reinstated back-end 
recruiting bonuses.\1035\
---------------------------------------------------------------------------

    \1031\ See Son (2017), supra footnote 1017; Tara Siegel Bernard, 
Do Financial Advisers Have to Act in Your Interest? Maybe, N.Y. 
Times, Mar. 22, 2018, https://www.nytimes.com/2018/03/22/your-money/financial-advisers-customer-interest.html.
    \1032\ See, e.g., Andrew Welsch, Facing Higher Costs, Raymond 
James Cuts Adviser Pay in Rare Move, Financial Planning, July 11, 
2017, https://onwallstreet.financial-planning.com/news/facing-higher-costs-raymond-james-cuts-adviser-pay-in-rare-move?tag=00000151-16d0-def7-a1db-97f024310000.
    \1033\ See Bernard (2018).
    \1034\ See Mason Braswell, Morgan Stanley Resumes Recruiting 
Offers--Slimmer and DOL-Compliant, AdvisorHub, Nov. 3, 2016, https://advisorhub.com/morgan-stanley-resumes-recruiting-offers-slimmer-and-dol-compliant/; Deon Roberts, Wells Fargo Overhauling Bonuses to 
Comply with New Rules on Financial Advisers, Charlotte Observer, 
Dec. 14, 2016, https://www.charlotteobserver.com/news/business/banking/bank-watch-blog/article120961138.html.
    \1035\ See Mason Braswell, Farewell Fiduciary Rule? Morgan 
Stanley Sweetens Recruiting Bonuses, AdvisorHub, May 1, 2018, 
https://advisorhub.com/farewell-fiduciary-rule-morgan-stanley-sweetens-recruiting-bonuses/. ``Back-end'' bonuses are expressly 
contingent on the achievement of sales or asset targets. See U.S. 
Department of Labor, Conflict of Interest FAQs (Part I--Exemptions) 
(Oct. 27, 2016), available at https://www.dol.gov/sites/default/files/ebsa/about-ebsa/our-activities/resource-center/faqs/coi-rules-and-exemptions-part-1.pdf.
---------------------------------------------------------------------------

iii. Additional Evidence of Current Market Practices
    In this section, we include information on Commission observations 
on the broker-dealer industry. Commission experience indicates that 
there have been a number of changes to the broker-dealer industry and 
its business practices over time.\1036\ Consistent with the trend 
baseline provided in Section III.B.1.c and industry studies and 
anecdotal evidence described above, we have observed firms choosing to 
do business with retail investors as investment advisers, not as 
broker-dealers, by either migrating existing brokerage accounts to 
advisory accounts or directing new retail customers to advisory 
accounts.
---------------------------------------------------------------------------

    \1036\ Information on the broker-dealer industry and business 
practices comes from a variety of Commission resources and generally 
relates to market trends and changes to business practices that have 
emerged in recent years and is comprised of both standalone broker-
dealers and dually registered firms. With respect to industry 
trends, Commission resources generally verify data cited above in 
Section III.B.2.e.ii. We acknowledge that the information provided 
in this baseline may not be representative of business practices 
more generally because of the diversity and complexity of services 
and securities offered by standalone broker-dealers and dually 
registered firms.
---------------------------------------------------------------------------

    Beyond broker-dealer trends in business practices, Commission 
experience also indicates that some broker-dealers have responded to 
the DOL Fiduciary Rule and the Fifth Circuit decision vacating the DOL 
Fiduciary Rule by modifying their existing business practices. For 
example, some firms, consistent with anecdotal evidence discussed 
above, eliminated brokerage IRA accounts in response to the DOL 
Fiduciary Rule; however, upon the Fifth Circuit decision, the firms 
reinstituted

[[Page 33424]]

brokerage IRAs. Other examples of changes following the Fifth Circuit 
decision include changes to incentive-based compensation in certain 
types of accounts and principal trading restrictions.
3. Investment Advice and Evidence of Potential Investor Harm
    A number of commenters expressed the view that the Proposing 
Release did not fully document the problems attributed to potential 
conflicts of interest stemming from the broker-dealer model and the 
resulting harm to retail customers.\1037\ In order to address these 
commenters' concerns, we analyze academic and industry studies to 
present an overview of the market for advice for retail 
customers.\1038\ Below, we discuss which types of investors seek 
investment advice; the benefits attained through investment advice for 
retail investors; limitations to the value of that advice that stem 
from agency costs, particularly those related to conflicts of interest 
arising from financial professional compensation; and evidence of 
potential investor harm. Where appropriate, we note limitations to the 
application of various academic studies that form the basis of other 
economic analyses, which investigate potential investor harm attributed 
to recommendations received from financial professionals.
---------------------------------------------------------------------------

    \1037\ See, e.g., AARP August 2018 Letter; Better Markets August 
2018 Letter; CFA August 2018 Letter; EPI Letter; U. of Miami Letter; 
Morningstar Letter; PIABA Letter; Letter from Ron A. Rhoades, 
Director, Personal Financial Planning Program and Assistant 
Professor of Finance, Gordon Ford College of Business, Western 
Kentucky University (Aug. 6, 2018) (``Rhoades August 2018 Letter''); 
Former SEC Senior Economists Letter.
    \1038\ Although the discussion here generally focuses on studies 
provided by comment letters, at times we have included additional 
references either to more fully articulate specific arguments or to 
provide counterarguments to studies provided by comment letters in 
an effort to present a complete overview of pertinent literature. 
Because the studies we cite in this section generically discuss 
investment advice or advice rather than recommendations, and use a 
variety of terms to describe financial professionals or firms (e.g., 
brokers, advisers, or financial advisers) and investors (e.g., 
investors, customers, or clients), in the discussion that follows, 
we use generic terms of advice or investment advice, financial 
professional, firm, and retail investor or investor. Although we 
believe that the studies generally discuss advice as it relates to 
broker-dealers or investment advisers, because of generic terms 
used, such as ``financial adviser,'' it is possible that other types 
of advice providers (e.g., commercial banks, tax consultants, etc.) 
could be included in some of the studies cited below. However, 
because not all authors clearly define which financial professionals 
are included in a given study, we are unable to provide an 
exhaustive list of all types of financial professionals that make up 
the market for advice.
---------------------------------------------------------------------------

a. Who Seeks Investment Advice \1039\
---------------------------------------------------------------------------

    \1039\ One limitation of the majority of the studies examined is 
that we are unable to distinguish whether the retail investor is 
seeking and/or receiving investment advice from a broker-dealer or 
an investment adviser (or some other type of financial 
professional). The studies generally do not have sufficiently 
granular data to distinguish broker-dealer customers from investment 
adviser clients. Further, for studies where retail investors can be 
distinguished by their investment choices (e.g., purchasing direct-
sold versus broker-sold funds), we are unable to determine whether 
differences exist between broker-sold funds sold by broker-dealers 
and broker-sold funds sold by investment advisers. As discussed 
below, some commenters expressed the view that buy-and-hold retail 
investors were more likely to prefer the services of brokerage 
accounts over advisory accounts. See infra footnote 1055.
---------------------------------------------------------------------------

    Approximately 37% of U.S. households currently engage with 
financial professionals according to OIAD/RAND; however, households who 
hire these professionals are not uniformly distributed among the U.S. 
population.\1040\ In addition to OIAD/RAND, a number of academic 
studies, provided with comment letters, examine characteristics of 
investors and their propensity for seeking (and following) investment 
advice. Older, wealthier, more educated, and financially more literate 
retail investors are more likely to seek and act on advice obtained 
from financial professionals, suggesting that investors who may benefit 
most from advice (younger, less educated, and less financially 
sophisticated) are least likely to obtain it.\1041\ Several studies 
examine the choice by retail investors to select into broker-sold or 
direct-sold mutual funds. These studies find less financially 
sophisticated investors are more likely to purchase ``broker-sold'' 
funds and therefore more likely to receive advice from a financial 
professional.\1042\
---------------------------------------------------------------------------

    \1040\ According to OIAD/RAND, the use of financial 
professionals varies by both income and education levels. For 
example, 38% of retail investors with income greater than $100,000 
engage with financial professionals, while only 13.7% of retail 
investors with incomes below $25,000 did so. Another study, the 
Survey of Consumer Finance, indicates that the use of financial 
professionals by American households is closer to 60%, but also 
includes financial planners, accountants, lawyers, and bankers, in 
addition to broker-dealers and investment advisers. See SCF Survey, 
supra footnote 950.
    \1041\ See, e.g., Utpal Bhattacharya et al., Is Unbiased 
Financial Advice to Retail Investors Sufficient? Answers from a 
Large Field Study, 25 Rev. Fin. Stud. 975 (2012); Daniel Hoechle et 
al., The Impact of Financial Advice on Trade Performance and 
Behavioral Biases, 21 Rev. Fin. 871 (2017); Jeremy Burke & Angela A. 
Hung, Do Financial Advisors Influence Savings Behavior?, RAND Labor 
and Population Report Prepared for the Department of Labor (2015), 
available at https://www.rand.org/content/dam/rand/pubs/research_reports/RR1200/RR1289/RAND_RR1289.pdf; Claude Montmarquette 
& Nathalie Viennot-Briot, Econometric Models on the Value of Advice 
of a Financial Advisor, CIRANO Project Report No. 2012RP-17 (July 
2012), available at https://www.cirano.qc.ca/pdf/publication/2012RP-17.pdf; Andreas Hackethal, Michael Haliassos, & Tullio Jappelli, 
Financial Advisors: A Case of Babysitters?, 36 J. Banking & Fin. 509 
(2012). See also AARP August 2018 Letter; CFA August 2018 Letter; 
FPC Letter; Primerica Letter; Wells Fargo Letter (which provided 
several studies cited here; other studies (e.g., Hoechle et al. 
(2017)) are included because they capture characteristics of the 
investors most likely to seek and act on financial advice that are 
not captured by the studies suggested by the commenters). Studies 
also note that the characteristics of investors most likely to seek 
advice are also likely to be those most attractive to financial 
professionals as they have more assets to manage. See Michael S. 
Finke, Financial Advice: Does it Make a Difference? (Working Paper, 
May 5, 2012) (which describes the relationship between investors and 
financial professionals).
    \1042\ See, e.g., Christopher J. Malloy & Ning Zhu, Mutual Fund 
Choices and Investor Demographics (Working Paper, Mar. 14, 2004), 
available at https://pdfs.semanticscholar.org/16a1/8daed89c3c48a765ad3a265018b4d27bd0f4.pdf; John Sabelhaus, Daniel 
Schrass, & Steven Bass, Characteristics of Mutual Fund Investors, 
2008, ICI Res. Fundamentals, Feb. 2009, available at https://www.ici.org/pdf/fm-v18n2.pdf; John Chalmers & Jonathan Reuter, Is 
Conflicted Advice Better than No Advice? (Working Paper, Sept. 14, 
2015), available at https://www.semanticscholar.org/paper/Is-Conflicted-Investment-Advice-Better-than-No-Chalmers-Reuter/3337ce8c3a72bf55dac43f407fd104b93aec863b. See also AARP August 2018 
Letter; CFA August 2018 Letter; EPI Letter (which provided the 
Chalmers & Reuter (2015) citation; Malloy & Zhu (2004) and Sabelhaus 
et al. (2009) are included because they capture aspects of the 
mutual fund selection decision by retail investors that are not 
captured by the studies suggested by the commenters). We provide a 
more detailed discussion of these studies below in Section 
III.B.3.c.
---------------------------------------------------------------------------

    As we detail below, retail investors bear costs associated with 
obtaining advice from financial professionals, which may deter some 
investors, especially those with limited wealth or income, from seeking 
investment advice. However, an investor's lack of sophistication may 
also prevent the investor from obtaining or using investment advice 
even when advice is provided at no cost. One paper examines the 
outcomes from a large sample of active retail investors of a large 
broker-dealer.\1043\ These retail investors received unsolicited and 
unbiased advice from the broker-dealer at no cost. Although the advice 
was designed to improve the efficiency of the investors' portfolios, 
only 5% of investors accepted the offer to receive the free advice. 
Moreover, those that did accept the advice rarely followed the advice. 
Investors who participated in the study had only minimal improvements 
to their portfolio efficiency. The authors cite lack of financial 
sophistication and lack of familiarity or trust as reasons why the 
unsolicited advice was not followed.\1044\
---------------------------------------------------------------------------

    \1043\ See Bhattacharya et al. (2012), supra footnote 1041.
    \1044\ See id.

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[[Page 33425]]

b. Benefits and Limitations of Investment Advice
    A number of commenters provided academic studies of benefits that 
investors may obtain from hiring financial professionals.\1045\ One 
benefit of hiring a firm or financial professional is that professional 
advice can help the average retail investor overcome common 
``investment mistakes'' that he or she may make when investing.\1046\ 
Common ``investment mistakes'' made by retail investors include limited 
allocation of assets to equities, under-diversification, excessive 
trading, and home bias.\1047\ These studies also attempt to identify 
reasons why retail investors persistently make inefficient investment 
choices.
---------------------------------------------------------------------------

    \1045\ See infra footnote 1048.
    \1046\ See Bhattacharya et al. (2012), supra footnote 1041. 
``Investment mistakes'' are investors' actions that would go against 
what a rational investor would do when undertaking efficient 
investment decisions (here and below, infra footnote 1047, we 
provide studies that analyze common ``investment mistakes'' made by 
retail investors). For example, evidence suggests that retail 
investors tend to trade too frequently. See Brad M. Barber & 
Terrance Odean, Trading is Hazardous to Your Wealth: The Common 
Stock Performance of Individual Investors, 55 J. FIN. 773 (2000).
    \1047\ As described in Bhattacharya et al. (2012), supra 
footnote 1041, possible explanations for common ``investment 
mistakes'' may arise from behavioral biases (e.g., cognitive 
errors), the cost of information acquisition, or the selection of 
the financial professional. See, e.g., Luigi Guiso, Paolo Sapienza, 
& Luigi Zingales, People's Opium? Religion and Economic Attitudes, 
50 J. Monetary Econ. 225 (2003); Laurent E. Calvet, John Y. 
Campbell, & Paolo Sodini, Down or Out: Assessing the Welfare Costs 
of Household Investment Mistakes, 115 J. Pol. Econ. 707 (2007); 
Barber & Odean (2000), supra footnote 1046; Karen K. Lewis, Trying 
to Explain Home Bias in Equities and Consumption, 37 J. Econ. 
Literature 571 (1999).
---------------------------------------------------------------------------

    Beyond correcting potential ``investment mistakes,'' academic 
studies document a multitude of other benefits that accrue to retail 
investors as a result of seeking investment advice, including, but not 
limited to: Higher household savings rates, setting long-term goals and 
calculating retirement needs, more efficient portfolio diversification 
and asset allocation, increased confidence and peace of mind, 
improvement in financial situations, and improved tax efficiency.\1048\ 
For example, one study notes that investors who engaged financial 
professionals for at least 15 years had approximately 173% more assets 
on average than investors who did not hire financial professionals, 
driven by higher household savings rates and increased asset allocation 
to non-cash instruments.\1049\ Further, financial professionals may be 
able to help retail investors overcome information asymmetries that 
exist between firms that supply securities and their customers that 
retail investors would not be able to disentangle on their own.\1050\
---------------------------------------------------------------------------

    \1048\ See, e.g., Mitchell Marsden, Catherine D. Zick, & Robert 
N. Mayer, The Value of Seeking Financial Advice, 32 J. Fam. & Econ. 
Issues 625 (2011); Jinhee Kim, Jasook Kwon, & Elaine A. Anderson, 
Factors Related to Retirement Confidence: Retirement Preparation and 
Workplace Financial Education, 16 J. Fin. Counseling & Plan. 77 
(2005); Michael S. Finke, Sandra J. Huston, & Danielle D. 
Winchester, Financial Advice: Who Pays, 22 J. Fin. Counseling & 
Plan. 18 (2011); Daniel Bergstresser, John M.R. Chalmers, & Peter 
Tufano, Assessing the Costs and Benefits of Brokers in the Mutual 
Fund Industry, 22 Rev. Fin. Stud. 4129 (2009); Ralph Bluethgen, 
Steffen Meyer, & Andreas Hackethal, High-Quality Financial Advice 
Wanted! (Working Paper, Feb. 2008), available at https://citeseerx.ist.psu.edu/viewdoc/summary?doi=10.1.1.596.2310; Neal M. 
Stoughton, Youchang Wu, & Josef Zechner, Intermediated Investment 
Management, 66 J. Fin. 947 (2011). Marsden et al. (2011) documents 
benefits attributable to hiring a financial professional, such as 
better retirement account diversification and savings goals, but 
does not find that hiring a financial professional measurably 
increases the amount of overall wealth accumulation for those 
investors. See also, Burke & Hung (2015), supra footnote 1041, for 
additional studies on the causal relation between the use of a 
financial professional and wealth accumulation. Francis M. Kinniry 
et al., Putting a Value on Your Value: Quantifying Vanguard 
Advisor's Alpha, Vanguard Research (Sept. 2016), available at 
https://www.vanguard.com/pdf/ISGQVAA.pdf, estimates the value to 
investors associated with obtaining financial advice of 
approximately 3% in net returns to investors, associated with 
suitable asset allocation, managing expense ratios, behavioral 
coaching, alleviating home bias, among others. See also AARP August 
2018 Letter; CCMC Letters; CFA August 2018 Letter; Edward Jones 
Letter; Letter from Brian M. Nelson (Jul. 10, 2018) (``Nelson 
Letter'') (which provided several of these studies; other studies 
were included because they capture aspects of the benefits of advice 
for retail investors that are not captured by the studies suggested 
by the commenters (e.g., Marsden et al. (2011), Finke et al. 
(2011)).
    \1049\ See Montmarquette & Vionnet-Briot (2012), supra footnote 
1041. While this study describes the benefits of hiring financial 
professionals on asset accumulation, it also notes that termination 
of relationships with financial professionals resulted in a 
significant loss of overall investment asset value. See Primerica 
Letter; Wells Fargo Letter (which provided references to this 
academic study).
    \1050\ See Roman Inderst & Marco Ottaviani, Financial Advice, 50 
J. Econ. Literature 494 (2012). See also AARP August 2018 Letter.
---------------------------------------------------------------------------

    Commenters also provided academic studies which discussed the 
limitations of the advice received from financial professionals, 
including how both direct and indirect costs of advice can reduce 
returns earned by investors.\1051\ How financial professionals are 
compensated can erode the value of advice in two primary ways: (1) The 
direct costs associated with purchasing advice detract from returns 
over time; \1052\ and (2) the indirect costs to retail investors that 
arise from conflicts of interest between financial professionals and 
investors. Financial professionals are generally compensated directly 
by retail investors in three principal ways: Commission-based (e.g., 
broker-dealers), fee-based on AUM (e.g., investment advisers), and flat 
or hourly fees (e.g., financial planners), although some financial 
professionals may receive compensation in multiple ways for providing 
advice to the same investor.\1053\
---------------------------------------------------------------------------

    \1051\ See, e.g., AARP August 2018 Letter; CFA August 2018 
Letter; EPI Letter; Letter from Ron A. Rhoades, Director, Personal 
Financial Planning Program and Assistant Professor of Finance, 
Gordon Ford College of Business, Western Kentucky University (Dec. 
6, 2018) (``Rhoades December 2018 Letter'').
    \1052\ As noted in one study, the direct costs (fees and 
expenses) may not be transparent to retail investors. Coupled with 
conflicts of interest that can bias any advice provided, information 
asymmetry between financial professionals and retail investors may 
be large. See Finke (2012), supra footnote 1041.
    \1053\ For example, investment advisers and supervised persons 
may receive account-level advisory fees, and may also receive 
compensation for the sale of securities or other investment 
products, including asset-based sales charges or service fees for 
the sale of mutual funds to their advisory clients. See Items 5.C, 
5.E, and 14.A of Form ADV Part 2A; Items 4.A.2, 4.B, and 5 of Form 
ADV Part 2B. When we refer to advisers and supervised persons 
receiving fees for the sale of securities or other investment 
products, we generally mean advisers that are also registered 
broker-dealers or advisers whose affiliated broker-dealers receive 
these fees. Form ADV instructs advisers that if they receive 
compensation in connection with the purchase or sale of securities, 
they should carefully consider the applicability of broker-dealer 
registration requirements of the Exchange Act and any applicable 
state securities statutes. See Form ADV, Part 2A, Note to Item 5.E.
---------------------------------------------------------------------------

    One study estimates that the average annual costs associated with 
commission-based accounts are approximately 75 bps, while the average 
fee-based account costs 130 bps.\1054\ We acknowledge that in addition 
to the fees charged for particular types of services, other expenses 
may be incurred that reduce returns earned by investors, some of which 
may be earned by the financial professional or the firm and paid by the 
firm's product or service providers (e.g., fund loads, 12b-1 fees, and 
shareholder servicing fees).
---------------------------------------------------------------------------

    \1054\ See John H. Robinson, Who's the Fairest of Them All? A 
Comparative Analysis of Financial Advisor Compensation Models, 20 J. 
Fin. Plan. 56 (2007). See also AARP August 2018 Letter. One study, 
however, argues that when the direct costs associated with 
commissions are combined with the estimated agency costs, there is 
little difference in the costs between commission-based and fee-
based advice. See Quinn Curtis, The Fiduciary Rule Controversy and 
the Future of Investment Advice (Univ. of Va. Sch. of Law, Law & 
Econ. Research Paper Series No. 2018-04, Mar. 2018). See also UVA 
Letter. We note that services provided may also vary between 
brokerage and advisory accounts, which could also affect differences 
in costs paid by retail investors.
---------------------------------------------------------------------------

    Some commenters expressed the view that certain investors (e.g., 
buy-and-hold investors) may prefer to pay a single commission relative 
to an ongoing fee-

[[Page 33426]]

based obligation that is tied to AUM in their account.\1055\ We note 
that this choice may be dependent on the investor's holding period and 
other ongoing expenses that affect an investor's net return over time. 
For example, a buy-and-hold investor that chooses an account where fees 
are based on AUM may pay more over time than a similar buy-and-hold 
investor that pays a single commission. Further, some commission-based 
securities, such as mutual funds, may have ongoing expenses, including 
12b-1 fees, which could lead to an erosion of net returns over 
time.\1056\ Such ongoing expenses, however, may not be adequately 
accounted for by investors when making investment decisions about the 
type of account to open and what type of security to purchase.\1057\ 
Several commenters provided analyses to show the expected effect of 
one-time costs and ongoing expenses (e.g., operating costs or advisory 
fees) to investors from both commission-based and fee-based 
perspectives, conditional on the investor's holding period.\1058\
---------------------------------------------------------------------------

    \1055\ See, e.g., Cetera August 2018 Letter; AALU Letter; 
Pacific Life August 2018 Letter; NAIFA Letter; Empower Retirement 
Letter; CCMR Letter; Primerica Letter.
    \1056\ See CFA August 2018 Letter; EPI Letter. See also ICI 
Letter (which described a shift from load to no load funds, 
decreasing expense ratios, and a decline in the percentage of funds 
that charge 12b-1 fees).
    \1057\ See infra footnote 1084 and corresponding discussion.
    \1058\ See, e.g., Cetera August 2018 Letter and November 2018 
Letter; Pacific Life August 2018 Letter.
---------------------------------------------------------------------------

    Separately, investors may face indirect costs that are a result of 
agency problems that emerge when financial professionals seek to 
maximize their own compensation and take actions that place their own 
interests ahead of the investors that they are supposed to serve.\1059\ 
A number of commenters and academic studies have stated that 
commission-based compensation is more likely to contribute to conflicts 
of interest between financial professionals and retail investors than 
fee-based compensation.\1060\ Other commenters, however, indicated that 
commission-based compensation provides benefits to investors.\1061\ One 
study finds that conflicts of interest are likely to be present in all 
forms of compensation earned by financial professionals. For example, 
fee-based compensation could result in so-called ``reverse churning'' 
and a disincentive to reduce AUM, even if that would be in the 
investor's best interest, while flat-fee models can lead to shirking 
and overbilling.\1062\ However, due to limitations on the data 
available regarding fee-based advice, most of the academic studies to 
date regarding conflicts of interest focus on commission-based 
compensation models. As such, the potential conflicts associated with 
the fee-based compensation models, including fee-based compensation 
earned by broker-dealers, have not been subject to as much analysis. 
Studies show that commission-based compensation potentially leads to 
biased advice, including excessive trading in accounts and 
recommendations to purchase high-commission securities, both of which 
benefit the financial professional and may lead to lower net 
returns.\1063\
---------------------------------------------------------------------------

    \1059\ See Jeremy Burke et al., Impacts of Conflicts of Interest 
in the Financial Services Industry (RAND Labor & Population, Working 
Paper No. WR-1076, Feb. 2015), available at https://www.rand.org/pubs/working_papers/WR1076.html; Hamid Mehran & Rene M. Stulz, The 
Economics of Conflicts of Interest in Financial Institutions, 85 J. 
Fin. Econ. 267 (2007). See also Letter from D. Bruce Johnsen, 
Professor of Law, Scalia Law School, George Mason University (Aug. 
7, 2018) (``Johnsen Letter''); Robinson (2007), supra footnote 1054. 
Broker-dealers may act in a brokerage (i.e., agency) capacity or a 
dealer (i.e., principal) capacity. See Proposing Release at Section 
I. While the discussion is framed in terms of agency problems, it is 
applicable to both capacities.
    \1060\ See IPA Letter; CFA August 2018 Letter.
    \1061\ See AALU Letter; Invesco Letter; ACLI Letter; NAIFA 
Letter. See Burke et al. (2015), supra footnote 1059 for a survey on 
the academic literature on conflicts of interest.
    \1062\ See Robinson (2007), supra footnote 1054.
    \1063\ See, e.g., Stoughton et al. (2011), supra footnote 1048; 
Roman Inderst & Marco Ottaviani, Misselling Through Agents, 99 Am. 
Econ. Rev. 883 (2009); Max Beyer, David de Meza, & Diane Reyniers, 
Do Financial Advisor Commissions Distort Client Choice?, 119 Econ. 
Letters 117 (2013). See also AARP August 2018 Letter. Financially 
unsophisticated investors, as discussed by Stoughton et al. (2011), 
are those most likely to purchase inefficient assets.
---------------------------------------------------------------------------

    Financial professionals also may benefit from other forms of 
transaction-based payment from customers, such as mark-ups and mark-
downs; for instance, one study documents that the size of the mark-up 
or mark-down is significantly positively related to whether the broker-
dealer solicits the transaction and whether the broker-dealer acts in a 
principal capacity.\1064\ Because mark-ups and mark-downs are payments 
from the customer to the broker-dealer, they give rise to conflicts of 
interest between a broker-dealer and his or her customer at the time of 
a recommendation, particularly if they are opaque to the customer, at 
the time of the recommendation. Mechanisms, including regulation,\1065\ 
disclosure, and reputation,\1066\ may be able to mitigate the risk of 
financial professionals acting on conflicts of interest to the 
detriment of their customers.\1067\ In addition to direct payments of 
commissions from retail investors, financial professionals may receive 
payments from third parties, such as securities issuers, which can 
increase costs to investors through higher management fees and reduced 
net returns, and provide incentives to recommend these securities over 
those that do not provide such incentives.\1068\
---------------------------------------------------------------------------

    \1064\ See Allen Ferrell, The Law and Finance of Broker-Dealer 
Mark-Ups (Harvard John M. Olin Ctr. for Law, Econ., and Bus., 
Discussion Paper, Apr. 6, 2011), available at https://www.finra.org/sites/default/files/NoticeAttachment/p123492.pdf. See AARP August 
2018 Letter.
    \1065\ See, e.g., antifraud provisions of the federal securities 
laws, FINRA Rule 2121 (Fair Prices and Commissions); MSRB Rules G-15 
and G-30, amended pursuant to Exchange Act Release No. 79347 (Nov. 
17, 2016) [81 FR 84637] (Nov. 23, 2016); and FINRA Rules 2121 and 
2232, amended pursuant to Exchange Act Release No. 79346 (Nov. 17, 
2016) [81 FR 84659] (Nov. 23, 2016).
    \1066\ See William P. Rogerson, Reputation and Product Quality, 
14 Bell J. Econ. 508 (1983); Benjamin Klein & Keith B. Leffler, The 
Role of Market Forces in Assuring Contractual Performance, 89 J. 
Pol. Econ. 615 (1981); W. Bentley MacLeod, Reputations, 
Relationships, and Contract Enforcement, 45 J. Econ. Literature 595 
(2007) for theoretical models of the effect of reputation on 
investment quality. See AARP August 2018 Letter. For example, FINRA 
and MSRB introduced rules in May 2018 regarding mark-up disclosure 
rules for same-day trades, allowing investors to be able to see what 
they have paid for riskless principal transactions (FINRA Rule 2232 
and MSRB Rule G-15). The Commission has also brought enforcement 
cases for undisclosed excessive markups under Exchange Act Rule 10b-
5.
    \1067\ See, e.g., Inderst & Ottaviani (2012), supra footnote 
1050. See also Bolton et al. (2007), infra footnote 1073, which 
posits that competition or consolidation affect reputation costs and 
provide a disciplining mechanism for providers of financial advice. 
Although various mechanisms exist to address agency problems in 
general, such as monitoring, bonding, and contracting (see, e.g., 
Finke (2012), supra footnote 1041), the agency problem between 
financial professionals and retail investors is not necessarily one 
that can be solved cost-effectively through these approaches. See 
infra Section III.A.2 for a discussion of limitations to these 
approaches. See also Curtis (2018), supra footnote 1054. See also 
AARP August 2018 Letter; CFA August 2018 Letter; UVA Letter.
    \1068\ See Stoughton et al. (2011), supra footnote 1048. The 
authors also state that ``[i]n addition to the advisory fees charged 
to the clients, wrap account managers may receive rebates from fund 
management companies as well,'' and that wrap accounts have 
increased in popularity. See also Mark Egan, Brokers vs. Retail 
Investors: Conflicting Interests and Dominated Products, J. Fin. 
(forthcoming 2019). See also AARP August 2018 Letter; CFA August 
2018 Letter.
---------------------------------------------------------------------------

    While a number of studies suggest that conflicts of interest may 
lead to investor harm, one study, which provides a survey of the 
literature on conflicts of interest, states that ``although conflicts 
of interest are omnipresent when contracting is costly and parties are 
imperfectly informed, there are important factors that mitigate their 
impact and, strikingly, it is possible for customers of financial 
institutions to benefit from the existence of such conflicts . . . The 
existence of a conflict of interest . . . does not mean that . . . the 
customers of that

[[Page 33427]]

institution will be harmed . . . [A] variety of mechanisms help control 
conflicts of interest and their impact [e.g., a financial institution's 
reputation].'' \1069\ Another study of commission-based compensation in 
the United Kingdom indicates that commission-based compensation leads 
to significant bias in certain types of securities (e.g., with profit 
bonds or distribution bonds) and financial professionals and when bias 
exists, retail investors are harmed and the costs associated with such 
harm are significant; however, the study also states that the advice 
market in the United Kingdom is not overrun with bias (``adviser 
recommendations are not dominated by self-interest'') and the market 
for advice generally works well.\1070\
---------------------------------------------------------------------------

    \1069\ See Mehran & Stulz (2007), supra footnote 1059. See also 
Johnsen August 2018 Letter.
    \1070\ See Robert Laslett, Tim Wilsdon, & Kyla Malcolm, 
Polarisation: Research into the Effect of Commission Based 
Remuneration on Advice, Charles River Associates Report Submitted to 
the U.K. Financial Services Authority (Jan. 2002), available at 
https://www.crai.com/sites/default/files/publications/polarisation-research-into-the-effect-of-commission-based-remuneration-on-advice.pdf. Laslett et al. (2002) estimate harm resulting from 
biased advice of approximately [pound]140 million per year. 
Following the ban on commission-based compensation in the U.K. in 
2013, another study finds that while the quality of financial advice 
increases, increased costs of providing advice lead some financial 
professionals to turn away small retail investors. See Tracey 
McDermott & Charles Roxbury, Financial Advice Market Review, 
Financial Conduct Authority and HM Treasury Final Report (Mar. 
2016), available at https://www.fca.org.uk/publication/corporate/famr-final-report.pdf (which provides an overview of the effects of 
the Retail Distribution Review by the Financial Conduct Authority in 
the United Kingdom). Further, McDermott & Roxbury (2016) report that 
financial advice costs approximately [pound]150 per hour and that 
giving retirement advice requires an average of nine hours on the 
part of the financial professional.
---------------------------------------------------------------------------

    Although financial professionals may aid retail investors in 
correcting common investing mistakes and overcoming informational 
hurdles associated with securities transactions or investment 
strategies, the average retail investor may not be able to assess the 
quality of advice received from financial professionals.\1071\ The 
difficulty in assessment can arise from several sources, including a 
large degree of heterogeneity in the quality of advice, insufficient 
financial literacy on the part of investors, and information asymmetry 
between the financial professional and investors.\1072\ Information 
asymmetry arises when information necessary to assess the quality of 
the advice received may not be available to the retail investor, even 
when it is available to the financial professional. For example, a 
financial professional may disclose conflicts of interest that could 
affect the advice provided, but the information may not be sufficiently 
precise to help a retail investor gauge how those conflicts affect the 
advice provided.
---------------------------------------------------------------------------

    \1071\ A number of studies consider advice to be a credence 
good, which is a type of good with qualities that cannot be observed 
by the consumer after purchase, making it difficult to assess its 
utility. See, e.g., Roman Inderst, Consumer Protection and the Role 
of Advice in the Market for Retail Financial Services, 167 J. 
Institutional & Theoretical Econ. 4 (2011) (which provides a review 
of investors' ability to assess the quality of investment advice).
    \1072\ See, e.g., Bluethgen et al. (2008), supra footnote 1048. 
Although this study documents reasons why investors may be unable to 
assess the quality of advice, the focus is on using adviser 
characteristics as screening mechanisms to alleviate the first 
complication noted, the high degree of heterogeneity in the quality 
of advice. The paper finds that good predictors of high quality 
advice include the financial professional's cognitive ability (e.g., 
analytical skills, rationality, and financial knowledge), how 
financial professionals are compensated (financial professionals 
that have a high fraction of commission-based revenue are less 
likely to recommend high quality investments, e.g., index funds), 
and the firm's business model. See also Finke (2012), supra footnote 
1041; AARP August 2018 Letter. See also Relationship Summary 
Adopting Release.
---------------------------------------------------------------------------

    Conflicts of interest, therefore, can erode the benefits of advice 
provided to retail investors, particularly if investors are unaware 
that the conflicts exist or if they do not understand the implications 
of conflicts.\1073\ Financial professionals may use this information 
asymmetry, particularly with unsophisticated investors, to capture 
economic rents for themselves, and this could exacerbate biases that 
investors sometimes exhibit, such as return chasing or under-
diversification.\1074\ One experimental study sent ``mystery shoppers'' 
to broker-dealers and investment advisers in several large cities in 
the United States and found that financial professionals provided 
recommendations that benefited themselves and exacerbated behavioral 
biases on the part of investors, including return chasing or 
recommendations of high-cost actively managed funds.\1075\
---------------------------------------------------------------------------

    \1073\ See, e.g., Inderst & Ottaviani (2012), supra footnote 
1050; Patrick Bolton, Xavier Freixas, & Joel Shapiro, Conflicts of 
Interest, Information Provision, and Competition in the Financial 
Services Industry, 85 J. Fin. Econ. 297 (2007). See also AARP August 
2018 Letter.
    \1074\ See, e.g., Marco Ottaviani, The Economics of Advice 
(Working Paper, May 2000), available at https://faculty.london.edu/mottaviani/EOA.pdf (included because they capture aspects of the 
information asymmetries between retail investors and financial 
professionals that are not captured by the studies suggested by the 
commenters); Miriam Krausz & Jacob Paroush, Financial Advising in 
the Presence of Conflict of Interests, 54 J. Econ. & Bus. 55 (2002); 
Inderst & Ottaviani (2012), supra footnote 1050; Stoughton et al. 
(2011), supra footnote 1048. See also AARP August 2018 Letter.
    \1075\ See Sendhil Mullainathan, Markus Noeth, & Antoinette 
Schoar, The Market for Financial Advice: An Audit Study (Nat'l 
Bureau of Econ. Research, Working Paper No. 17929, Mar. 2012), 
available at https://www.nber.org/papers/w17929.pdf. See also AARP 
August 2018 Letter; CFA August 2018 Letter; EPI Letter. Although the 
Mullainathan et al. (2012) study included both broker-dealers and 
investment advisers, the study notes that most professionals in 
their sample focused on the lower end of the retail spectrum and 
tended to be compensated through commissions rather than fees based 
on AUM. See also Santosh Anagol, Shawn Cole, & Shayak Sarkar, 
Understanding the Advice of Commissions Motivated Agents: Evidence 
from the Indian Life Insurance Market (Harvard Bus. Sch., Working 
Paper No. 12-055, Oct. 2015), available at https://www.hbs.edu/faculty/Publication%20Files/12-055_13c23c02-e57f-4aea-9630-316aa4b772ce.pdf, which used a similar audit approach to evaluate 
the quality of advice provided by life insurance agents in India, 
and found that agents recommended unsuitable products and strategies 
that paid high commissions.
---------------------------------------------------------------------------

    Although financial professionals may be hired to help overcome 
``investment mistakes'' made by investors,\1076\ a number of studies 
show that financial professionals themselves may be subject to the same 
behavioral biases as unadvised retail investors, such as return chasing 
and overconfidence.\1077\ One study, using data on Canadian investors 
and their financial professionals, observes that financial 
professionals appear to have the same ``misguided beliefs'' as their 
investors, and therefore do not correct, and may even exacerbate common 
investment mistakes.\1078\ In that study, financial professionals 
invested in the same manner that they recommended to their

[[Page 33428]]

clients; they traded excessively, chased returns, bought expensive 
actively managed funds, under-diversified their portfolios, and earned 
similar net returns. Further, these financial professionals continued 
to follow similar investment strategies as those they recommended to 
their clients, even after they had left the industry, suggesting that 
they believed their own investment advice.\1079\
---------------------------------------------------------------------------

    \1076\ See supra footnote 1046.
    \1077\ See, e.g., Mullinathan et al. (2012), supra footnote 
1075; Terrance Odean, Are Investors Reluctant to Realize Their 
Losses?, 53 J. Fin. 1775 (1998); Zur Shapira & Itzhak Venezia, 
Patterns of Behavior of Professionally Managed and Independent 
Investors, 25 J. Banking & Fin. 1573 (2001). See also AARP August 
2018 Letter. See also Anagol et al. (2015), supra footnote 1075, 
which documents that life insurance agents in India purchase the 
same inefficient products that they recommend to their clients. One 
study of Canadian financial professionals and their clients observed 
a commonality among portfolios of a given financial professional, 
and that the financial professional's own portfolio allocations 
strongly predicted the asset allocations of his or her customers, 
indicating limited customization, regardless of the customer's risk 
tolerance, age, or financial sophistication. Although the results of 
this paper indicate that conflicts of interest are unlikely to 
motivate advice because financial professionals and their investors 
hold similar portfolios, it does raise questions of the high cost of 
financial advice when customization is limited. See Stephen Foerster 
et al., Retail Financial Advice: Does One Size Fit All?, 72 J. Fin. 
1441 (2017) (included because they capture insights into how 
financial professionals may be subject to similar biases as retail 
investors that are not captured by the studies suggested by the 
commenters). See Robinson (2007), supra footnote 1054.
    \1078\ See Juhani T. Linnainmaa, Brian T. Melzer, & Alessandro 
Previtero, The Misguided Beliefs of Financial Advisors (Kelley Sch. 
of Bus., Research Paper No. 18-9, May 2018), available at https://www.aleprevitero.com/wp-content/uploads/2018/06/SSRN-id3101426.pdf. 
See also CFA August 2018 Letter.
    \1079\ Linnainmaa et al. (2018), supra footnote 1078, also 
suggest that conflicts of interest may not be driven by financial 
professionals, but instead are between the firm and its clients, and 
that firms deliberately hire financial professionals who believe 
their misguided (and ultimately expensive) advice. In light of their 
findings, the authors suggest that regulation designed to stem 
conflicts of interest could be ineffective if aligning investors and 
financial professionals does not alter the advice that they provide, 
could raise barriers to entry that could reduce the amount of advice 
available, and may limit investor choice.
---------------------------------------------------------------------------

c. Evidence of Potential Investor Harm
    A number of commenters provided citations to academic studies that 
analyze the evidence of potential investor harm driven by conflicts of 
interest of financial professionals.\1080\ A number of these studies, 
including Bergstresser et al. (2009), Del Guercio and Reuter (2014), 
and Christoffersen, Evans, and Musto (2013), underpinned the economic 
analyses of the Council of Economic Advisors 2015 Study (``CEA Study'') 
and the DOL RIA assessment of the aggregate harm borne by retail 
investors in retirement plans due to conflicts of interest.\1081\ Below 
we discuss evidence of potential investor harm attributable to 
recommendations of certain investments by financial professionals, 
including mutual funds, 401(k) plans, corporate bonds, and non-traded 
REITs. We then discuss the aggregate measures of investor harm 
estimated by the CEA Study and the DOL RIA and the limitations of those 
estimates.
---------------------------------------------------------------------------

    \1080\ See, e.g., AARP August 2018 Letter; Better Markets August 
2018 Letter; CFA August 2018 Letter; EPI Letter; State Attorneys 
General Letter.
    \1081\ See Letter from Linda Agerbak (Jun. 21, 2018) (``Agerbak 
Letter''); Better Markets August 2018 Letter; CFA August 2018 
Letter; EPI Letter; Letter from Public Citizen (Aug. 7, 2018) 
(``Public Citizen Letter''); State Attorneys General Letter; Former 
SEC Senior Economists Letter. See also Bergstresser et al. (2009), 
supra footnote 1048; Diane Del Guercio & Jonathan Reuter, Mutual 
Fund Performance and the Incentive to Generate Alpha, 69 J. Fin. 
1673 (2014); Susan E.K. Christoffersen, Richard Evans, & David K. 
Musto, What Do Consumers' Fund Flows Maximize? Evidence from Their 
Brokers' Incentives, 68 J. Fin. 201 (2013). See Office of the 
President of the United States, Council of Economic Advisers, The 
Effects of Conflicted Investment Advice on Retirement Savings (Feb. 
2015), available at https://obamawhitehouse.archives.gov/sites/default/files/docs/cea_coi_report_final.pdf. See also DOL RIA, supra 
footnote 1002. Both the CEA Study and the DOL RIA assumed that the 
DOL Fiduciary Rule would eliminate all conflicts of interest and, 
therefore, all of the harms to retirement investors resulting from 
conflicts. See also Curtis (2018) and infra footnote 1103. By 
contrast, Regulation Best Interest would not require elimination or 
mitigation of firm-level conflicts, and will require written 
policies and procedures reasonably designed to eliminate or mitigate 
of some representative-level conflicts, which means that some 
conflicts and their attendant harms may remain, especially at the 
firm level. The disclosure requirements of Regulation Best Interest, 
however, may empower some customers to push back on broker-dealer 
conflicts of interest and more generally may have a deterrent 
effect.
---------------------------------------------------------------------------

    Directly addressing the question of whether and how brokerage 
customers or advisory clients are affected by conflicts of interest 
(e.g., through quantification) requires measurement of the effect of 
advice, subject to different levels of conflict, received from broker-
dealers or investment advisers. Most data currently available to 
researchers does not make distinctions between types of firms or 
financial professionals, and generally aggregates all firms or 
financial professionals into a single category of financial 
professionals (e.g., ``adviser'' or ``financial adviser''). Further, an 
investor's propensity to choose a particular type of relationship may 
be correlated with the investor's skill or choice of investment and, 
therefore, may introduce bias into studies that are able to 
differentiate between types of advice relationships. Despite these 
limitations, by examining the existing academic literature, discussed 
below, we are able to gain qualitative insight into, and address 
commenter concerns, about conflicts of interest in the market for 
financial advice and the potential harm to investors.
    The majority of studies to date that investigate the potential harm 
to investors arising from potential conflicts of interest have 
generally centered on findings based on analysis of investments in 
mutual funds. Due to the readily available data for mutual funds, the 
literature is rich with studies exploring various aspects of those 
securities, including the performance of funds, relationships between 
flows and performance or expenses, and differences in performance of 
funds depending on the distribution channel. These studies have further 
been used by commenters and other providers of economic analyses to 
estimate the magnitude of investor harm potentially stemming from 
conflicts of interest as it relates to mutual fund investments.\1082\
---------------------------------------------------------------------------

    \1082\ See CEA Study, supra footnote 1081, and DOL RIA, supra 
footnote 1002. See also EPI Letter; Better Markets August 2018 
Letter; St. John's U. Letter; Letter from Royce A. Charney, 
President, Trust Administrators (Aug. 7, 2018) (``Charney Letter''); 
Agerbak Letter; CFA August 2018 Letter.
---------------------------------------------------------------------------

    Evidence suggests that there is a strong relationship between past 
performance and subsequent fund flows, even when funds do not 
persistently outperform, suggesting that investors and/or their 
financial professionals may engage in return-chasing behavior.\1083\ 
Several studies also examine the effect of mutual fund costs, and find 
that (1) fund flows are negatively related to front-end loads, but are 
relatively insensitive to fund-level operating expenses (e.g., 12b-1 
fees), indicating that investors may be aware of upfront costs when 
selecting funds, but may be less attuned to the effect on net returns 
of ongoing operating expenses; \1084\ and (2) unsophisticated investors 
are more likely to pay higher fees than sophisticated investors and are 
less likely to expend search costs to look for lower-fee funds.\1085\ 
Retail investors, however, can benefit when funds commence operation of 
an institutional ``twin'' fund as overall expenses decrease and 
managerial effort increases, suggesting that retail investors may not 
be able to monitor fund managers as effectively as institutional 
investors.\1086\
---------------------------------------------------------------------------

    \1083\ See Judith Chevalier & Glenn Ellison, Risk Taking by 
Mutual Funds as a Response to Incentives, 105 J. Pol. Econ. 1167 
(1997); Jonathan B. Berk & Richard C. Green, Mutual Fund Flows and 
Performance in Rational Markets, 112 J. Pol. Econ. 1269 (2004); Brad 
M. Barber, Terrance Odean, & Lu Zheng, Out of Sight, Out of Mind: 
The Effects of Expenses on Mutual Fund Flow, 78 J. Bus. 2095 (2005); 
Erik R. Sirri & Peter Tufano, Costly Search and Mutual Fund Flows, 
53 J. Fin. 1589 (1998). In the theoretical model provided by Berk 
and Green (2004), active funds do not outperform passive funds 
because investors compete to invest in strong past performers (i.e., 
they chase returns), driving these funds' returns to the competitive 
level. See also AARP August 2018 Letter; CFA August 2018 Letter.
    \1084\ See Barber et al. (2005), supra footnote 1083.
    \1085\ See Todd Houge & Jay Wellman, The Use and Abuse of Mutual 
Fund Expenses, 70 J. Bus. Ethics 23 (2007). See AARP August 2018 
Letter.
    \1086\ See Richard B. Evans & Rudiger Fahlenbrach, Institutional 
Investors and Mutual Fund Governance: Evidence from Retail-
Institutional Fund Twins, 25 Rev. Fin. Stud. 3530 (2012). See AARP 
August 2018 Letter. The authors identify funds as ``twins'' if they 
share the same manager, investment objectives, fund families, and 
have a gross return correlation of 0.95 or greater.
---------------------------------------------------------------------------

    Analyses in the CEA Study and the DOL RIA focus on the 
underperformance of certain broker-sold funds, potentially driven by 
conflicts of interest and a misalignment of incentives between 
financial professionals and investors.\1087\ A number of studies 
document that actively managed load mutual funds purchased by investors 
through a financial professional underperform

[[Page 33429]]

other types of mutual funds.\1088\ For example, several studies find 
that actively managed load funds underperform a buy-and-hold strategy 
by between 1.56% and 2.28% annually, while other studies show that 
actively managed load funds underperform no-load funds by between 1% 
and 1.5% per year.\1089\ This underperformance could be driven by poor 
market timing of investors (e.g., return chasing),\1090\ or because 
increased expenditures by the funds on marketing and advertising 
successfully attract retail flows, and such expenses decrease net 
returns to investors over time.\1091\ Fees and expenses, as documented 
by several studies, are two of the most reliable predictors of future 
returns, and fees should reflect performance (e.g., funds with high 
fees hypothetically should have better ex post performance in order to 
justify the fees), as at least some portion of the fees are dedicated 
to portfolio management; however, these studies consistently find a 
negative relationship between fees and performance--lower cost funds on 
average are more likely to generate higher performance net of fees than 
high cost funds.\1092\
---------------------------------------------------------------------------

    \1087\ See CEA Study, supra footnote 1081, and DOL RIA, supra 
footnote 1002.
    \1088\ See Bergstresser et al. (2009), supra footnote 1048; Del 
Guercio & Reuter (2014), supra footnote 1081.
    \1089\ See, e.g., Mercer Bullard, Geoffrey Friesen, & Travis 
Sapp, Investor Timing and Fund Distribution Channels (Working Paper, 
2008); Geoffrey C. Friesen & Travis R.A. Sapp, Mutual Fund Flows and 
Investor Returns: An Empirical Examination of Fund Investor Timing 
Ability, 31 J. Banking & Fin. 2796 (2007); Matthew R. Morey, Should 
You Carry the Load? A Comprehensive Analysis of Load and No-Load 
Mutual Fund Out-of-Sample Performance, 27 J. Banking & Fin. 1245 
(2003). See also Eugene F. Fama & Kenneth R. French, Luck Versus 
Skill in the Cross-Section of Mutual Fund Returns, 65 J. Fin. 1915 
(2010), which notes that although some active managers may 
outperform passive benchmarks while others underperform, on average, 
the alpha attributable to active management will net to zero; 
therefore, net of fees, on average, and the alpha earned by actively 
managed funds will be reduced by the aggregate amount of fees and 
expenses of active management. See also William F. Sharpe, The 
Arithmetic of Active Management, 47 Fin. Analysts J. 7 (1991). See 
AARP August 2018 Letter; CFA August 2018 Letter.
    \1090\ See, e.g., Bullard et al. (2008), supra footnote 1089; 
Friesen & Sapp (2007), supra footnote 1089.
    \1091\ One study documents that heavily advertised funds 
outperform their benchmarks prior to the marketing efforts, but do 
not outperform their benchmarks in the post-advertising period. 
These funds, however, attract significantly more inflows, relative 
to a control group. See Prem C. Jain & Joanna Shuang Wu, Truth in 
Mutual Fund Advertising: Evidence on Future Performance and Fund 
Flows, 55 J. Fin. 937 (2000). See also Nikolai Roussanov, Hongxun 
Ruan, & Yanhao Wei, Marketing Mutual Funds (Nat'l Bureau of Econ. 
Research, Working Paper No. 25056, Sept. 2018), available at https://www.nber.org/papers/w25056.pdf. See AARP August 2018 Letter; CFA 
August 2018 Letter; EPI Letter.
    \1092\ See Javier Gil-Bazo & Pablo Ruiz-Verdu, The Relation 
Between Price and Performance in the Mutual Fund Industry, 64 J. 
Fin. 2153 (2009); Russel Kinnel, Predictive Power of Fees: Why 
Mutual Fund Fees Are So Important, Morningstar Manager Research (May 
2016); William F. Sharpe, The Arithmetic of Investment Expenses, 69 
Fin. Analysts J. 34 (2013). Gil-Bazo & Ruiz-Verdu (2009) find that 
actively managed funds with the worst performance charge, on 
average, the highest fees. See AARP August 2018 Letter; CFA August 
2018 Letter.
---------------------------------------------------------------------------

    A number of studies, also cited by the DOL RIA and the CEA Study, 
explore the distinction between broker-sold funds and direct-sold 
funds, and the effect of the distribution channel on fund flows and 
performance. When examining a sample of only broker-sold funds, one 
study shows that funds that pay higher fees to financial professionals 
or charge higher excess loads generate greater fund inflows.\1093\ 
Moreover, broker-sold funds, on average, underperform direct-sold funds 
by between 23 bps and 255 bps per annum, with most studies observing 
average underperformance of approximately 100 bps (1%) per year.\1094\
---------------------------------------------------------------------------

    \1093\ See Christoffersen et al. (2013), supra footnote 1081; 
Chalmers & Reuter (2015), supra footnote 1042; Jasmin Sethi, Jake 
Spiegel, & Aron Szapiro, Conflicts of Interest in Mutual Fund Sales: 
What Do the Data Tell Us?, 6 J. Retirement 46 (2019). Christoffersen 
et al. (2013) and Sethi et al. (2019) measure excess loads by first 
estimating the baseline (average) load paid with regressions of 
loads on a number of explanatory variables, then using the residuals 
from these regressions (excess loads) to explain fund flows and 
performance. See also Morningstar Letter; Letter from Aron Szapiro, 
Director of Policy Research, Morningstar, Inc., et al. (Aug. 24, 
2018) (``Morningstar Letter Supplement''). Sethi et al. (2019) find, 
however, that the relation between excess loads and fund flows 
tapered off after the DOL Fiduciary Rule was adopted, suggesting 
that the DOL Fiduciary Rule may have discouraged financial 
professionals from directing flows to funds with high excess loads.
    \1094\ See, e.g., Bergstresser et al. (2009), supra footnote 
1048; Chalmers & Reuter (2015), supra footnote 1042; Xuanjuan Chen, 
Tong Yao, & Tong Yu, Prudent Man or Agency Problem? On the 
Performance of Insurance Mutual Funds, 16 J. Fin. Intermediation 175 
(2007). See AARP August 2018 Letter.
---------------------------------------------------------------------------

    Further, conflicts of interest appear to depend upon the choice of 
investment (e.g., broker-sold versus direct-sold funds) as well as the 
magnitude of the costs (e.g., mutual fund loads). One study suggests 
that the market for funds is segmented: More financially sophisticated 
investors select direct-sold funds, which unbundle portfolio management 
from advice of financial professionals, while less financially 
sophisticated investors purchase broker-sold funds, which combine 
portfolio management and advice.\1095\ Another study focuses 
exclusively on broker-sold funds, but segments those funds into groups 
that depend on the size of excess loads and whether the funds are sold 
by affiliated or unaffiliated brokers.\1096\ That study observes that 
funds with a one-standard deviation increase in excess loads are 
related to a reduction in future performance of between 34 bps and 49 
bps in the following year. As detailed in Bergstresser et al. (2009), 
the broker-sold channel is likely to include funds sold through both 
broker-dealers and investment advisers; however, the data provided to 
the authors is not granular enough to be able to distinguish the 
performance characteristics of the two distinct channels.\1097\
---------------------------------------------------------------------------

    \1095\ See Del Guercio & Reuter (2014), supra footnote 1081. 
Moreover, this study finds that broker-sold actively managed funds 
underperform broker-sold index funds by between 1.1% and 1.3% per 
year, which the authors suggest may reflect an agency conflict. See 
also Diane Del Guercio, Jonathan Reuter, & Paula A. Tkac, Broker 
Incentives and Mutual Fund Market Segmentation (Nat'l Bureau of 
Econ. Research, Working Paper No. 16312, Aug. 2010), available at 
https://www.nber.org/papers/w16312.pdf. See AARP August 2018 Letter; 
CFA August 2018 Letter. Although some of the growth in direct-sold 
funds comes from passive investing (e.g., index funds), greater than 
75% of the number of direct-sold funds are actively managed (as of 
2012). See Jonathan Reuter, Revisiting the Performance of Broker-
Sold Mutual Funds (Working Paper, Nov. 2, 2015), available at 
https://www2.bc.edu/jonathan-reuter/research/brokers_revisited_201511.pdf.
    \1096\ See Christoffersen et al. (2013), supra footnote 1081.
    \1097\ See Bergstresser et al. (2009), supra footnote 1048. The 
Bergstresser et al. study also notes that many funds in the direct-
sold channel may be recommended by fee-based advisers, whose 
services ``are typically paid for with an advisory fee that is 
outside of the fund expenses or distribution costs. As a practical 
matter, the `direct' channel may not be as direct as one might 
imagine.''
---------------------------------------------------------------------------

    A number of commenters stated that the Proposing Release did not 
appropriately account for existing economic analyses produced by the 
CEA Study and the DOL RIA to measure the potential harm to investors 
from conflicts of interest.\1098\ The CEA Study and the DOL RIA use the 
literature on underperformance of broker-sold mutual funds as the 
foundation for their analyses on the potential harm of retail 
investors, focusing on harm specifically directed at retirement 
savings. Applying an estimate of approximately 1% underperformance to 
broker-sold funds, which is consistent with estimates of 
underperformance provided by several studies,\1099\ the CEA Study and 
the DOL

[[Page 33430]]

RIA apply different methods and approaches to calculate the aggregate 
dollar harm for retail investors in their retirement accounts.\1100\ 
Based on $1.7 trillion invested in potentially conflicted funds, the 
CEA Study estimates annual harm to retirement investors of 
approximately $17 billion.\1101\ Similarly, the DOL RIA, which 
estimates potential loss due to conflicts of interest of between 50 bps 
and 100 bps per year, produces ten-year aggregate estimates of investor 
harm of between $95 billion and $189 billion stemming from the 
underperformance of broker-sold mutual funds.
---------------------------------------------------------------------------

    \1098\ See also ARA August 2018 Letter; EPI Letter; Better 
Markets August 2018 Letter; St. John's U. Letter; Charney Letter; 
Agerbak Letter; CFA August 2018 Letter.
    \1099\ See Bergstresser et al. (2009), supra footnote 1048; Del 
Guercio & Reuter (2014), supra footnote 1081; Christoffersen et al. 
(2013), supra footnote 1081. A number of commenters, regarding the 
DOL RIA, indicated that both the CEA Study, supra footnote 1081, and 
the DOL RIA, supra footnote 1002, misinterpreted estimated effects 
described in the Christoffersen et al. (2013) paper, and overstated 
the potential harm associated with funds with high excess loads by 
more than double the actual estimate had the interpretation been 
correct. See Craig M. Lewis, The Flawed Cost-Benefit Analysis 
Underlying the Department of Labor's Fiduciary Rule (White Paper, 
Aug. 2017), available at https://www.sec.gov/comments/ia-bd-conduct-standards/cll4-2268185-160965.pdf; Public Interest Comment from Mark 
Warshawsky & Hester Peirce, George Mason University Mercatus Center 
(Apr. 17, 2017), available at https://www.mercatus.org/system/files/warshawsky-dol-fiduciary-rule-pic-v1.pdf. See also Curtis (2018), 
supra footnote 1054.
    \1100\ See CEA Study, supra footnote 1081, and DOL RIA, supra 
footnote 1002.
    \1101\ See CEA Study, supra footnote 1081.
---------------------------------------------------------------------------

    The level of underperformance due to fund selection is highly 
sensitive to the data sample, including the sample period, as well as 
the methodology employed to calculate performance. Many of the studies 
used to support the analyses underlying the CEA Study and the DOL RIA 
rely on data obtained prior to 2011. However, since 2011 there have 
been a number of advances in the market for mutual funds (e.g., shifts 
from load to no-load funds and increase in no-load funds without 12b-1 
fees), likely leading some of the inferences drawn from those studies 
to be dated and not reflective of the current market environment.\1102\ 
A number of commenters indicated potential flaws associated with the 
approach and interpretation of the analyses used by the CEA Study and 
the DOL RIA.\1103\ One study updates the Del Guercio and Reuter (2014) 
sample using data from between 2003 and 2012 and tests the robustness 
of the methodology by examining the underperformance of broker-sold 
funds relative to direct-sold funds.\1104\ While underperformance of 
broker-sold funds still existed, depending on the methodology and 
empirical approach used, the underperformance of these funds was 
reduced to between 20 bps and 70 bps, with the majority of the 
estimation approaches falling to between 20 bps and 50 bps, indicating 
a reduction in the underperformance of broker-sold funds relative to 
earlier studies.\1105\ Another study replicates the Christoffersen et 
al. (2013) analysis of excess loads on underperformance using data from 
between 2010 and 2017, and finds that after 2010, funds with high 
excess loads did not underperform funds with low excess loads, which 
the authors interpret as evidence that financial professionals have 
improved their recommendations over time.\1106\ Taken together, these 
recent studies on fund selection suggest that the magnitude of 
potential investor harm likely is not as large as that estimated by the 
CEA Study and the DOL RIA when more recent data is used to compute the 
underperformance of broker-sold mutual funds.
---------------------------------------------------------------------------

    \1102\ See ICI Letter and Section III.B.2.e.ii, supra.
    \1103\ See Lewis (2017), supra footnote 1099; Warshawsky & 
Peirce (2017), supra footnote 1099. See also Curtis (2018), supra 
footnote 1054. To date, only one academic study of which we are 
aware (Curtis (2018)) has analyzed the DOL Fiduciary Rule and the 
DOL RIA, and discusses issues with the approach taken by the DOL RIA 
in estimating the benefits and costs of the DOL Fiduciary Rule, 
noting that the DOL RIA likely underestimates the potential costs of 
the rule. This study also indicates that the net benefits of the DOL 
Fiduciary Rule are expected to be close to zero because the DOL 
Fiduciary Rule may not completely eliminate conflicts of interest 
and the actual cost of investment advice at the intermediary-level 
was excluded from the DOL RIA computation of benefit. Once the 
calculation accounted for costs of advice, Curtis (2018) estimates 
that the total costs attributed to conflicts of interest, including 
underperformance of some securities, is only slightly higher than 
the costs associated with advice that is free of conflicts.
    \1104\ See Reuter (2015), supra footnote 1095.
    \1105\ Reuter (2015), supra footnote 1095, states that ``[t]hese 
changes suggest that the average broker-sold fund has become more 
competitive with the average direct-sold fund''; however additional 
research would be required to determine if these changes are driven 
by existing fund families, new fund families, or some combination of 
factors. When performance is value-weighted, Reuter (2015) discusses 
that brokers appear to direct clients toward funds that pay 
``higher-than-average distribution costs.''
    \1106\ See Sethi et al. (2019), supra footnote 1093. The authors 
note that the underperformance of high excess load funds becomes 
statistically insignificant in the analysis only with the inclusion 
of prior-year performance of the fund (which Christoffersen et al. 
(2013), supra footnote 1081, include in one of their models). The 
authors suggest that the reduction in flows to funds with excess 
loads could be due in part to the DOL Fiduciary Rule; however, they 
also note that their analysis does not reveal a clear association 
between the DOL Fiduciary Rule and returns. The authors further cite 
to Holden et al. (2018), supra footnote 955, which discusses the 
shift away from load mutual funds to no-load funds over time. See 
also ICI Letter; Morningstar Letter; Morningstar Letter Supplement.
---------------------------------------------------------------------------

    Another recent study replicates and extends the Friesen and Sapp 
(2007) and Bullard et al. (2008) analyses of market timing ability by 
investors in mutual fund sales and purchases to newer data (2007 
through 2016).\1107\ The study shows that the difference between dollar 
returns and buy-and-hold returns (``performance gap'') declined from 
1.56% between 1991 and 2004 to 1.01% between 2007 and 2016 for a 
combined sample of load and no-load funds, suggesting a moderation in 
market timing errors in the most recent period. However, the excess 
performance gap (the difference between the performance gap on load 
funds and no load funds) has slightly increased between 2007 and 2016, 
from approximately 1% to 1.12%, indicating that, to the extent that 
load funds are sold by financial professionals and that all inflows and 
outflows are due solely to market timing motivations, investors who 
hold load funds are more prone to market timing errors than investors 
in no-load funds, and these errors are not being corrected by financial 
professionals. The studies discussed above acknowledge that 
interpretation of the empirical result that broker-sold funds 
underperform direct-sold funds is subject to another caveat because 
there is likely to be a selection bias in the type of investor that 
utilizes the direct-sold fund channel relative to those investors who 
rely on financial professionals for advice and recommendations about 
which funds to purchase. A similar selection bias is likely to exist 
for investors who purchase no-load funds versus those that purchase 
load funds from financial professionals. For example, although numerous 
studies discussed above suggest that financial advice is more likely to 
be obtained by older, more financially sophisticated, and wealthier 
investors,\1108\ Chalmers and Reuter (2015) observe that younger, less 
financially experienced, and less wealthy investors are more likely to 
buy broker-sold funds.\1109\
---------------------------------------------------------------------------

    \1107\ See Karthik Padmanabhan, Constantijn Panis, & Timothy 
Tardiff, The Ability of Investors to Time Purchases and Sales of 
Mutual Funds (Working Paper, Nov. 1, 2017) (see also Department of 
Labor April 2019 memo). See, e.g., Bullard et al. (2008), supra 
footnote 1089; Friesen & Sapp (2007), supra footnote 1089.
    \1108\ See supra Section III.B.3.a.
    \1109\ See supra footnote 1042.
---------------------------------------------------------------------------

    Beyond mutual funds, a nascent literature is emerging on other 
securities that may be prone to conflicts of interest by financial 
professionals.\1110\ Recent

[[Page 33431]]

studies have examined potential conflicts of interest in markets for 
more complex investments, including reverse convertible corporate bonds 
and non-traded REITs. One study uses a sample of reverse convertible 
corporate bonds that differ only in the financial incentives provided 
to financial professionals and the coupon rate, and finds that 
investors are more likely to purchase--based on the advice given--the 
inferior bond (lower coupon, all else equal) with the higher ``kick-
back'' to the broker-dealer, which appears to be driven by conflicts of 
interest between the financial professional and the investors.\1111\ In 
an examination of non-traded REITs, one study documents that retail 
investors in non-traded REITs underperformed by over $45 billion 
relative to a portfolio of traded REITs, and that nearly one-third of 
that underperformance was driven by upfront fees used to compensate 
broker-dealers.\1112\
---------------------------------------------------------------------------

    \1110\ Some commenters (see, e.g., CFA August 2018 Letter; AARP 
August 2018 Letter; EPI Letter) also provided studies about 
conflicts of interest in 401(k) plans which have shown that (i) plan 
sponsors tilt securities toward high-cost securities (see Ian Ayres 
& Quinn Curtis, Beyond Diversification: The Pervasive Problem of 
Excessive Fees and ``Dominated Funds'' in 401(k) Plans, 124 Yale 
L.J. 1476 (2015)); (ii) plans have inadequate or excessive 
investment choices (see Edwin J. Elton, Martin J. Gruber, & 
Christopher R. Blake, The Adequacy of Investment Choices Offered by 
401(K) Plans, 90 J. Pub. Econ. 1299 (2006); Sheena Sethi-Iyengar, 
Gur Huberman, & Wei Jiang, How Much Choice is Too Much? 
Contributions to 401(k) Retirement Plans, in Pension Design and 
Structure: New Lessons from Behavioral Finance (Olivia S. Mitchell & 
Stephen P. Utkuss eds., 2004)); (iii) plans may include proprietary 
funds even when other funds perform better (see Veronika K. Pool, 
Clemens Sialm, & Irina Stefanescu, It Pays to Set the Menu: Mutual 
Fund Investment Options in 401(K) Plans, 71 J. Fin. 1779 (2016)); 
and (iv) funds included in 401(k) plans underperform passive 
benchmarks by approximately 31 bps annually (see Edwin J. Elton, 
Martin J. Gruber, & Christopher T. Blake, How do Employer's 401(K) 
Mutual Fund Selections Affect Performance?, Ctr. for Retirement 
Research at Bos. Coll., Issue in Brief No. 13-1 (Jan. 2013), 
available at https://crr.bc.edu/wp-content/uploads/2013/01/IB_13-1-508.pdf).
    \1111\ See Egan (2019), supra footnote 1068.
    \1112\ See Craig McCann, Fiduciary Duty and Non-Traded REITs, 
Investments & Wealth Monitor, July/Aug. 2015, at 39, available at 
https://www.slcg.com/pdf/workingpapers/Fiduciary%20duty%20and%20Non-traded%20REITs.pdf. See CFA August 2018 Letter.
---------------------------------------------------------------------------

    Finally, although a significant amount of empirical evidence 
suggests that there may be investor harm due to conflicts of interest 
between financial professionals and investors, because of changes to 
the mutual fund industry (e.g., shifts from load to no-load funds and 
the introduction of new share classes),\1113\ increased 
competition,\1114\ and the anticipation of regulation designed to 
ameliorate potential conflicts of interest, several new studies 
indicate that potential harm to investors arising from conflicts of 
interest may be declining.\1115\ One survey paper concludes that 
although the empirical evidence is consistent with financial 
professionals having conflicts of interest that may harm consumers, 
``none of the articles concludes that clients would have been better 
off by foregoing advice. Even if people receive lower returns . . . 
consulting with an advisor may provide intangible benefits that 
consumers value,'' and ``it is important to bear in mind that these 
studies may have data limitations and in general cannot account for 
selection issues and the intangible benefits that investors receive 
from financial advisors.'' \1116\
---------------------------------------------------------------------------

    \1113\ See ICI Letter and Holden et al. (2018), supra footnote 
951. See also Capital Group Letter; Money Management Institute 
Letter; FPC Letter at footnote 73. As noted above, innovations, 
including the introduction of T and clean share classes of funds may 
reduce the expected fund underperformance net of costs for retail 
investors relative to A shares by nearly 50 basis points annually. 
See supra footnote 1021 and accompanying text. See also supra 
footnote 1020 and accompanying text.
    \1114\ See LPL December 2018 Letter; Morgan Stanley Letter 
(which discuss the migration to open architecture platforms).
    \1115\ See Reuter (2015), supra footnote 1042; Sethi et al. 
(2019), supra footnote 1093. See also CFA August 2018 Letter; EPI 
Letter; Morningstar Letter; Morningstar Letter Supplement. We 
include recent studies provided by commenters to present the current 
baseline of empirical findings on potential investor harm stemming 
from conflicts of interest.
    \1116\ See Burke et al. (2015), supra footnote 1059. The DOL 
RIA, supra footnote 1002, and some commenters, however, have stated 
that no advice is a better alternative to advice subject to 
conflicts of interest. See also EPI Letter; Betterment Letter; PIABA 
Letter; CFA August 2018 Letter. The DOL RIA suggests that investors 
who obtain advice subject to conflicts of interest are worse off due 
to the costs associated with obtaining such advice (e.g., 
underperformance) than had they not sought or received advice at 
all.
---------------------------------------------------------------------------

4. Trust, Financial Literacy, and the Effectiveness of Disclosure
    A number of commenters stated that the Proposing Release did not 
sufficiently address how issues related to trust in financial 
professionals, investors' level of financial literacy or 
sophistication, and limitations on the effectiveness of disclosure 
likely exacerbate the problems of information asymmetry and potential 
conflicts of interest between retail investors and financial 
professionals.\1117\ In order to address commenters' concerns, we 
examined and discuss below both academic and industry research on how 
trust and financial literacy could affect the recommendations provided 
by financial professionals to retail investors, as well as the 
effectiveness and limitations of disclosure in ameliorating potential 
conflicts of interest.
---------------------------------------------------------------------------

    \1117\ See AARP August 2018 Letter; CFA August 2018 Letter; FPC 
Letter; Rhoades December 2018 Letter; EPI Letter.
---------------------------------------------------------------------------

a. Trust in Investment Advice
    In seeking financial advice, a retail investor places not only 
money but also trust in a financial professional. Commenters stated 
that retail investors will follow the advice of their ``trusted 
advisors,'' because they believe ``financial professional[s] will place 
the investor's financial interest before his or her own.'' \1118\ 
Moreover, one industry study of over 800 investors notes that ``96% of 
U.S. investors report that they trust their financial professional and 
97% believe their financial professional has their best interest in 
mind.'' \1119\ Academic studies have explored the issue of trust and 
how it affects financial decisions of investors. Studies in this strand 
of academic literature find that higher levels of trust increase 
investors' propensity to seek investment advice and hire financial 
professionals,\1120\ increase levels of stock market 
participation,\1121\ and increase willingness to take on higher-risk 
investments.\1122\ Regarding the importance of trust in established 
advice relationships, some studies find that trust in financial 
professionals is greater when investors have lower financial literacy 
or when purchasing complex products, such as insurance products.\1123\ 
Further, as trust in

[[Page 33432]]

financial professionals grows, investors may be more likely to delegate 
all investment decisions to the financial professional, irrespective of 
their level of financial education.\1124\
---------------------------------------------------------------------------

    \1118\ See Letter from Christine Lazaro, President, PIABA (Dec. 
7, 2018) (``PIABA December 2018 Letter''). See also, e.g., Rhoades 
December 2018 Letter; Gross Letter; Letter from William W. McGinnis, 
W. McGinnis Advisors (Aug. 7, 2018) (``McGinnis Letter''); EPI 
Letter; Betterment Letter; State Attorneys General Letter; Better 
Markets August 2018 Letter; OIAD/RAND (providing a survey on 
academic literature on trust). One survey notes, however, that 
approximately 15% of survey participants do not consult with 
financial professionals because they ``don't trust them.'' See 
Cetera November 2018 Letter.
    \1119\ See CCMC Letters. See also Center for Capital Markets 
Competitiveness, Working with Financial Professionals: Opinions of 
American Investors (2018), available at https://www.centerforcapitalmarkets.com/wp-content/uploads/2018/04/CCMC_InvestorPolling_v5-1.pdf.
    \1120\ See Jeremy Burke & Angela A. Hung, Trust and Financial 
Advice (RAND Labor & Population, Working Paper No. WR-1075, Jan. 
2015), available at https://www.dol.gov/sites/default/files/ebsa/laws-and-regulations/rules-and-regulations/proposed-regulations/1210-AB32-2/trust-and-financial-advice.pdf. This study indicates 
that increased financial trust is associated with higher levels of 
both seeking and following investment advice. See also AARP August 
2018 Letter; FPC Letter; CFA August 2018 Letter.
    \1121\ See Luigi Guiso, Paola Sapienza, & Luigi Zingales, 
Trusting in the Stock Market, 63 J. Fin. 2557 (2008). Guiso et al. 
(2008) find that higher levels of trust in financial professionals 
by investors is associated with a 50% increase in the probability of 
buying stocks and a 3.4% increase in the proportion of equity 
investments in the aggregate portfolio. See Rhoades December 2018 
Letter.
    \1122\ See Nicola Gennaioli, Andrei Shleifer, & Robert Vishny, 
Money Doctors, 70 J. Fin. 91 (2015). This study suggests that 
increased trust in financial professionals by investors alleviates 
anxiety in undertaking higher-risk investments (e.g., equities) 
(included because they capture aspects of the benefits of higher 
levels of trust in financial professionals by retail investors that 
are not captured by the studies suggested by the commenters).
    \1123\ See Thomas Pauls, Oscar Stolper, & Adreas Walter, Broad-
Scope Trust and Financial Advice (Working Paper, Nov. 17, 2016), 
available at https://www.researchgate.net/publication/314235638_Broad-scope_trust_and_financial_advice; David de Meza, 
Bernd Irlenbusch, & Diane Reyniers, Disclosure, Trust and Persuasion 
in Insurance Markets (IZA Discussion Paper Series, No. 5060, July 
2010), available at https://repec.iza.org/dp5060.pdf. See also OIAD/
RAND, which shows that investors most likely in need of investor 
protection (e.g., financially unsophisticated) are most likely to 
place their trust in financial professionals. See also Letter from 
AFL-CIO et al. (Dec. 7, 2018) (``AFL-CIO December 2018 Letter'').
    \1124\ See Riccardo Calcagno, Maela Giofre, & Maria Cesira Urzi-
Brancati, To Trust is Good, but to Control is Better: How Investors 
Discipline Financial Advisors' Activity, 140 J. Econ. Behav. & Org. 
287 (2017). See OIAD/RAND.
---------------------------------------------------------------------------

    Several commenters stated that some financial professionals respond 
to the trust that retail investors place in them by acting on their 
conflicts of interest, which could benefit the financial professional 
at the expense of the investor.\1125\ In addition, some studies have 
shown that higher levels of trust by retail investors can provide 
incentives for financial professionals to provide conflicted investment 
advice or undertake actions that benefit themselves at the expense of 
their customers. For example, one study found that because investors 
trust their financial professionals to provide higher ex ante expected 
returns on their risky investments, firms employing those professionals 
increased fees above levels that, in the author's view, were consistent 
with a competitive equilibrium, resulting in lower ex post net returns 
to investors.\1126\ Further, this study documents that, although a 
relationship with a trusted professional can encourage investors to 
invest in financial markets when it is efficient for them to do so, in 
some cases financial professionals may instead provide more conflicted 
investment advice or inefficient advice in order to satisfy the desires 
of investors who trust them (e.g., undertaking lottery-like behavior by 
investing in the riskiest securities).\1127\ Although trust in 
financial professionals can help alleviate certain behavioral biases 
and encourage participation in the securities markets, one commenter 
stated that ``[r]etail customers who place their trust in salespeople 
that market services as acting in their best interest can end up paying 
excessively high costs for higher risk or underperforming investments 
that only satisfy a suitability standard, not a fiduciary standard.'' 
\1128\
---------------------------------------------------------------------------

    \1125\ See, e.g., Rhoades December 2018 Letter; EPI Letter; 
Better Markets August 2018 Letter.
    \1126\ See Calcagno et al. (2017), supra footnote 1124.
    \1127\ See id.
    \1128\ See AARP August 2018 Letter. See also PIABA Letter; St. 
John's U. Letter. See also Joseph C. Peiffer & Christine Lazaro, 
Major Investor Losses Due to Conflicted Advice: Brokerage Industry 
Advertising Creates the Illusion of a Fiduciary Duty, PIABA Report 
(Mar. 25, 2015), available at https://piaba.org/sites/default/files/newsroom/2015-03/PIABA%20Conflicted%20Advice%20Report.pdf.
---------------------------------------------------------------------------

b. Financial Literacy and Investment Advice
    As discussed above, financial literacy affects those who seek 
investment advice from financial professionals. One commenter noted 
that ``[a]s consumers move closer to retirement, they may be more 
vulnerable to the negative impact of advice that is not in their best 
interest for three reasons: (1) The assets they have to invest are 
larger; (2) they may lack strong financial literacy skills; and (3) 
reduced cognition may affect financial decision making.'' \1129\ A 
number of studies have shown that financial literacy is significantly 
related to retirement planning and wealth accumulation by retail 
investors.\1130\ Generally, studies find that investors who are more 
financially literate or sophisticated are more likely to seek 
investment advice and are more likely to follow that advice than less 
financially sophisticated investors.\1131\ Further, one study shows 
that investors with lower financial literacy who do not seek investment 
advice underperform investors with higher financial literacy who seek 
investment advice by more than 50 bps on average, and these losses are 
predominantly driven by under-diversification of their 
portfolios.\1132\
---------------------------------------------------------------------------

    \1129\ See AARP August 2018 Letter.
    \1130\ See, e.g., Jere R. Behrman et al., Financial Literacy, 
Schooling, and Wealth Accumulation (Nat'l Bureau of Econ. Research, 
Working Paper No. 16452, Oct. 2010), available at https://www.nber.org/papers/w16452.pdf; Hans-Martin von Gaudecker, How Does 
Household Portfolio Diversification Vary with Financial Literacy and 
Financial Advice?, 70 J. Fin. 489 (2015) (included in response to 
comment letters that expressed views about limited financial 
literacy by some retail investors).
    \1131\ See supra Section III.B.3. See also Riccardo Calcagno & 
Chiara Monticone, Financial Literacy and the Demand for Financial 
Advice, 50 J. Banking & Fin. 363 (2015), who observe that investors 
with lower levels of financial literacy are less likely to consult 
advisers and avoid risky assets; however, when they do seek advice, 
they generally delegate investment decisions to their financial 
professionals. Lusardi & Mitchell (2011) indicate that investors who 
are more financially sophisticated are more likely to plan for 
wealth accumulation and be successful in their planning. See 
Annamaria Lusardi & Olivia S. Mitchell, Financial Literacy and 
Planning: Implications for Retirement Wellbeing (Nat'l Bureau of 
Econ. Research, Working Paper No. 17078, May 2011), available at 
https://www.nber.org/papers/w17078.pdf. See AARP August 2018 Letter.
    \1132\ See von Gaudecker (2015), supra footnote 1130. This study 
finds that losses borne by investors with lower financial literacy 
are predominantly driven by under-diversification of their 
portfolios.
---------------------------------------------------------------------------

    A number of studies link retail investor demographic 
characteristics to financial literacy and document that financial 
illiteracy, although widespread, is most significant among investors 
with lower levels of educational attainment, women, and 
minorities.\1133\ Moreover, many studies have examined the relationship 
between age, cognition, and financial literacy, and have shown that 
older investors, on average, are the least likely to be financially 
literate, and that financial literacy degrades as investors age.\1134\ 
A number of these studies show, however, that investors with low levels 
of financial literacy are likely to be over-confident in their 
financial abilities. For example, several studies that explore the 
relationship between age and financial literacy show that confidence in 
financial decision making does not decline with age, and potentially 
leads to poor decisions (e.g., paying higher mortgage rates).\1135\ 
Although over-confident investors with low levels of financial literacy 
could potentially benefit most from seeking and following investment 
advice, one study shows that over-confident investors are less likely 
to seek advice and perceive it as less valuable.\1136\
---------------------------------------------------------------------------

    \1133\ See Lusardi & Mitchell (NBER 2011), supra footnote 1131. 
See also Annamaria Lusardi & Olivia S. Mitchell, Financial Literacy 
and Retirement Planning in the United States, 10 J. Pension Econ. & 
Fin. 509 (2011). See AARP August 2018 Letter.
    \1134\ See Michael S. Finke, John Howe & Sandra J. Huston, Old 
Age and Decline in Financial Literacy (Working Paper, Aug. 24, 
2011), who document that financial literacy scores decline by 
approximately 1% each year over the age of 60. See also Annamaria 
Lusardi, Olivia S. Mitchell, & Vilsa Curto, Financial Literacy and 
Financial Sophistication Among Older Americans (Nat'l Bureau of 
Econ. Research, Working Paper No. 15469, Nov. 2009), available at 
https://www.nber.org/papers/w15469.pdf; Keith Gamble et al., Aging 
and Financial Decision Making, 61 Mgmt. Sci. 2603 (2015). See AARP 
August 2018 Letter.
    \1135\ See Finke et al. (2011) and Gamble et al. (2015), supra 
footnote 1134.
    \1136\ See Marc M. Kramer, Financial Literacy, Overconfidence 
and Financial Advice Seeking (Working Paper, Dec. 19, 2014), 
available at https://efmaefm.org/0EFMAMEETINGS/EFMA%20ANNUAL%20MEETINGS/2015-Amsterdam/papers/EFMA2015_0067_fullpaper.pdf.
---------------------------------------------------------------------------

    One potential problem, however, for investors with lower financial 
literacy is that they may not be able to distinguish the quality of 
their financial professional or the advice that they receive.\1137\ One 
study documents that small traders, relative to large institutional 
investors, are unable to recognize biases in recommendations

[[Page 33433]]

provided by securities analysts, and therefore follow analyst 
recommendations to buy and sell securities without considering other 
information produced by the analyst.\1138\ Additionally, financial 
literacy may influence the quality of advice that financial 
professionals are willing to provide their clients. Some financial 
professionals appear to be more likely to provide superior information 
to more financially literate investors, who may be able to discern the 
quality of the advice, and more likely to provide inferior and 
potentially more conflicted information to investors who are less 
financially literate.\1139\
---------------------------------------------------------------------------

    \1137\ See Lauren E. Willis, Against Financial-Literacy 
Education, 94 Iowa L. Rev. 197 (2008). See AARP August 2018 Letter.
    \1138\ See Ulrike Malmendier & Devin Shanthikumar, Are Small 
Investors Naive About Incentives?, 85 J. Fin. Econ. 457 (2007). See 
AARP August 2018 Letter.
    \1139\ See Willis (2008), supra footnote 1137, and Calcagno & 
Monticone (2015), supra footnote 1131. See also John A. Turner, 
Bruce W. Klein, & Norman P. Stein, Financial Illiteracy Meets 
Conflicted Advice: The Case of Thrift Savings Plan Rollovers 
(Working Paper, Apr. 2015), available at https://gflec.org/wp-content/uploads/2015/04/Turner-0408Assessing-the-Standard-for-Financial-Advice.pdf, which documents that financial professionals 
often suggest rolling over from thrift savings plans to more 
expensive plans (e.g., IRAs), and that such behavior is pervasive 
among both broker-dealers and investment advisers. See AARP August 
2018 Letter.
---------------------------------------------------------------------------

c. Evidence on the Effectiveness and Limitations of Disclosure
    Regulation Best Interest relies in part on disclosure of certain 
material facts to retail customers.\1140\ A number of commenters, 
however, stated that we failed to sufficiently account for limitations 
of disclosure in the Proposing Release of Regulation Best 
Interest.\1141\ One commenter stated that ``studies show that 
regulation by disclosure alone can actually undermine investor 
protection by emboldening advisers to ignore the client's best interest 
once they have `checked the disclosure box,' and by rendering investors 
even more vulnerable to conflicted advice once they receive 
disclosures.'' \1142\ Another commenter asserted that the 
ineffectiveness of disclosure arises because of investors' failure to 
understand the disclosure, inadequate time to read and process the 
information, cognitive dissonance, and trust in financial 
professionals' oral representations over written disclosures, among 
others.\1143\ Below, we discuss studies that have identified 
characteristics that make disclosure effective as well as limitations 
to the effectiveness of disclosure to investors, in particular focusing 
on issues related to disclosure of conflicts of interest and how 
disclosure could inflate potential conflicts between financial 
professionals and investors.
---------------------------------------------------------------------------

    \1140\ See supra Section II.C.1.
    \1141\ See AARP August 2018 Letter; Better Markets August 2018 
Letter; State Attorneys General Letter; EPI Letter; Morningstar 
Letter; Warren Letter; UVA Letter.
    \1142\ See Better Markets August 2018 Letter. See infra footnote 
1148 for studies submitted by this commenter.
    \1143\ See State Attorneys General Letter. See also EPI Letter.
---------------------------------------------------------------------------

    Characteristics of effective disclosures include saliency of 
information, clear and concise information delivered in a transparent 
manner, and increased use of visual and interactive design, among 
others.\1144\ One study, examining the effect of disclosure of fees and 
costs for mutual funds, observes that disclosures that prominently 
feature fees are more effective than others, but do not appear to 
reduce the importance that investors place on other fund 
characteristics, such as performance or risk.\1145\ Other studies, 
however, have found that disclosures may be ineffective, particularly 
if the intended audience does not read the disclosure documents or does 
not understand the material presented to them. One study, for example, 
notes that as the length and complexity of the disclosure document 
increases, so does the time that it takes for investors to read and 
understand the material contained within; therefore, investors are more 
likely to prefer shorter, simpler, and more straightforward language in 
disclosures.\1146\
---------------------------------------------------------------------------

    \1144\ See Relationship Summary Adopting Release at Section IV, 
which also discusses the benefits and limitation of disclosure. See 
also Margaret Hagan, Designing 21st Century Disclosure Methods for 
Financial Decision Making, Stanford Law School Policy Lab (2016), 
available at https://law.stanford.edu/publications/designing-21st-century-disclosures-for-financial-decision-making/. One study finds 
that when fund expenses are bundled with brokerage commissions, 
reducing the transparency of various fees and costs, investors 
experience larger degrees of underperformance than when the fees are 
more transparent. See Roger M. Edelen, Richard B. Evans, & Gregory 
B. Kadlec, Disclosure and Agency Conflict: Evidence from Mutual Fund 
Commission Bundling, 103 J. Fin. Econ. 308 (2012). See AARP August 
2018 Letter.
    \1145\ See Lucy Hayes, William Lee, & Anish Thakrar, Now You See 
It: Drawing Attention to Charges in the Asset Management Industry 
(Fin. Conduct Auth., Occasional Paper No. 32, Apr. 2018), available 
at https://www.fca.org.uk/publication/occasional-papers/occasional-paper-32.pdf. See Morningstar Letter. See also Anagol et al. (2015), 
supra footnote 1075.
    \1146\ See Tamar Frankel, The Failure of Investor Protection by 
Disclosure, 81 U. Cin. L. Rev. 421 (2013). See FPC. See also Omri 
Ben-Shahar & Carl E. Schneider, The Failure of Mandated Disclosure, 
159 U. Pa. L. Rev. 647 (2011), which also questions the 
effectiveness of disclosures and finds mandated disclosures 
ineffective substitutes for more direct regulation. See AARP August 
2018 Letter; Better Markets August 2018 Letter; State Attorneys 
General Letter.
---------------------------------------------------------------------------

    Many studies have explored the effect of revealing conflicts of 
interest to consumers and note that disclosure of conflicts may produce 
undesirable behavior by the disclosing party, or that receivers of the 
information provided by disclosures may fail to appropriately account 
for the implications.\1147\ A series of studies documents that 
consumers do not account for conflicts of interest revealed through 
disclosures, and that such disclosures of conflicts can have the 
perverse effect of increasing bias and moral licensing in the provision 
of advice.\1148\ Moral licensing arises when the discloser of 
information ``take[s] an ethical action that validates [her] self-image 
as a good person'' so she feels as though she ``may well give [herself] 
permission to play fast and loose with the rules for a while.'' \1149\ 
Disclosure may also lead to a decrease in trust of biased advice 
because consumers feel pressured to satisfy the discloser's self-
interest (``panhandler effect''); \1150\ however, the panhandler effect 
can be mitigated if the disclosure is provided from an external source, 
the disclosure is not common knowledge between the discloser and the 
receiver of the information, the receiver can change his or her mind at 
a later date, and the receiver can change his or her mind in 
private.\1151\ One

[[Page 33434]]

study notes that, beyond conflicts disclosures, disclosures of actual 
bias lead to an improvement in performance of portfolios relative to 
investors who only receive conflict disclosures.\1152\
---------------------------------------------------------------------------

    \1147\ See also Relationship Summary Adopting Release.
    \1148\ See Daylian M. Cain, George Loewenstein, & Don A. Moore, 
When Sunlight Fails to Disinfect: Understanding the Perverse Effects 
of Disclosing Conflicts of Interest, 37 J. Consumer Res. 836 (2011); 
Daylian M. Cain, George Loewenstein, & Don A. Moore, The Dirt on 
Coming Clean: Perverse Effects of Disclosing Conflicts of Interest, 
34 J. Legal Stud. 1 (2005); George Loewenstein, Daylian M. Cain & 
Sunita Sah, The Limits of Transparency: Pitfalls and Potential of 
Disclosing Conflicts of Interest, 101 Am. Econ. Rev. (Papers & 
Proc.) 423 (2011). These studies also note that, although disclosure 
is intended to help financially unsophisticated consumers, 
disclosure is most likely to be beneficial to sophisticated users of 
the information. One study, however, notes that disclosure can 
reduce biased advice if the disclosure acts as a deterrent against 
entering into conflicts, and may improve trust in advisers. See 
Sunita Sah & George Loewenstein, Nothing to Declare: Mandatory and 
Voluntary Disclosure Leads Advisors to Avoid Conflicts of Interest, 
25 PSYCH. SCI. 575 (2014). See also Morningstar Letter; EPI Letter; 
Better Markets August 2018 Letter; Warren Letter; UVA Letter; AARP 
August 2018 Letter; Johnsen Letter.
    \1149\ See Robert A. Prentice, Moral Equilibrium: Stock Brokers 
and the Limits of Disclosure, 2011 Wis. L. Rev. 1059 (2011). See 
AARP August 2018 Letter; Better Markets August 2018 Letter; State 
Attorneys General Letter.
    \1150\ See Cain et al. (2011), supra footnote 1148; Sunita Sah, 
Prashant Malaviya, & Debora Thompson, Conflict of Interest 
Disclosure as an Expertise Cue: Differential Effects of Automatic 
and Deliberative Processing, 147 Organizational Behav. & Hum. 
Decision Processes 127 (2018), whereby disclosures of conflicts of 
interest act ``as a heuristic cue to infer greater trust in 
advisors' expertise.''
    \1151\ See Sunita Sah, George Loewenstein, & Daylian M. Cain, 
The Burden of Disclosure: Increased Compliance With Distrusted 
Advice, 104 J. Personality & Soc. Psychol. 289 (2013). See 
Morningstar Letter; Better Markets August 2018 Letter; EPI Letter.
    \1152\ See Christopher Tarver Robertson, Biased Advice, 60 Emory 
L.J. 653 (2011). This study also suggests that obtaining an opinion 
from an unbiased adviser ``is a much better remedy for biased advice 
than disclosure.'' See AARP August 2018 Letter.
---------------------------------------------------------------------------

    From the perspective of the investor, conflicts disclosures may 
lead to under- or over-reaction by investors. According to one study, 
investors may not know how to appropriately respond to information 
about conflicts (e.g., estimating the effects on the quality of advice 
or knowing how to search for an unbiased second opinion) and therefore 
may fail to adequately adjust their behaviors when conflicts are 
disclosed.\1153\ Alternatively, some investors may overreact to 
disclosures of conflicts of interest, and may instead forgo valuable 
investment advice.\1154\
---------------------------------------------------------------------------

    \1153\ See Angela A. Hung, Min Gong, & Jeremy Burke, Effective 
Disclosures in Financial Decisionmaking, RAND Labor and Population 
Report Prepared for the Department of Labor (2015), available at 
https://www.rand.org/content/dam/rand/pubs/research_reports/RR1200/RR1270/RAND_RR1270.pdf. See also AARP August 2018 Letter; Better 
Markets August 2018 Letter; Warren Letter. See also James M. Lacko & 
Janis K. Pappalardo, The Effect of Mortgage Broker Compensation 
Disclosures on Consumers and Competition: A Controlled Experiment, 
Federal Trade Commission, Bureau of Economics Staff Report (Feb. 
2004), available at https://www.ftc.gov/sites/default/files/documents/reports/effect-mortgage-broker-compensation-disclosures-consumers-and-competition-controlled-experiment/030123mortgagefullrpt.pdf, which documents that when mortgage 
customers receive information about mortgage broker compensation 
through disclosures, such disclosures lead to an increase in more 
expensive loans and create a bias against broker-sold loans, even 
when the broker-sold loans are the more cost effective option. See 
EPI Letter.
    \1154\ See George Loewenstein, Cass R. Sunstein, & Russell 
Golman, Disclosure: Psychology Changes Everything, 6 Ann. Rev. Econ. 
391 (2014). See IRI Letter.
---------------------------------------------------------------------------

C. Benefits and Costs

1. General
    In formulating Regulation Best Interest, the Commission has 
considered the potential benefits of establishing a best interest 
standard of conduct for broker-dealers, as well as the potential costs.
    Regulation Best Interest enhances the broker-dealer standard of 
conduct beyond existing suitability obligations, and aligns the 
standard of conduct with retail customers' reasonable expectations. 
Under Regulation Best Interest, broker-dealers and their associated 
persons will be required, among other things, to: (1) Act in the best 
interest of the retail customer at the time the recommendation is made, 
without placing the financial or other interest of the broker-dealer 
ahead of the interests of the retail customer; and (2) address 
conflicts of interest by establishing, maintaining, and enforcing 
policies and procedures reasonably designed to identify and fully and 
fairly disclose material facts about conflicts of interest, and in 
instances where we have determined that disclosure is insufficient to 
reasonably address the conflict, to mitigate or, in certain instances, 
eliminate the conflict. As a result, Regulation Best Interest should 
enhance the efficiency of recommendations that broker-dealers provide 
to retail customers, help retail customers evaluate the recommendations 
received, and improve retail customer protection when receiving 
recommendations from broker-dealers. The four component obligations of 
Regulation Best Interest's work together to enhance the current 
standard of conduct for broker-dealers and improve disclosure of 
material facts relating to the scope and terms of the relationship and 
conflicts of interest. Both on its own and together with the other new 
rules and forms we are adopting,\1155\ we anticipate that Regulation 
Best Interest will reduce the agency costs of the relationship between 
the associated persons of the broker-dealer and their retail customers, 
while preserving access to financial advice and choice in the scope of 
services and how to pay for them.
---------------------------------------------------------------------------

    \1155\ See, e.g., Relationship Summary Adopting Release.
---------------------------------------------------------------------------

    In this section, we discuss broader themes associated with the 
costs and benefits of Regulation Best Interest, including general 
comments we received on our analysis of the costs and benefits in the 
Proposing Release. Following this more general discussion, we discuss 
the specific costs and benefits associated with Regulation Best 
Interest's four component obligations.
    While the Commission has considered the potential benefits and 
costs of Regulation Best Interest, the Commission notes that generally 
it is difficult to quantify such benefits and costs with meaningful 
precision.\1156\ Where possible, the Commission has provided an 
estimate of specific costs; however, several factors make the 
quantification of many of the effects of Regulation Best Interest 
difficult. With respect to costs to broker-dealers, there is a lack of 
data on the extent to which broker-dealers with different business 
practices engage in disclosure and conflict mitigation activities to 
comply with existing requirements, and therefore how costly it would be 
to comply with the proposed requirements. Also, the final rule will 
provide broker-dealers flexibility in complying with Regulation Best 
Interest, and, as a result, there could be multiple ways in which 
broker-dealers will satisfy this obligation, although broker-dealers 
must comply with each of the elements of the obligation. In addition, 
Regulation Best Interest may affect broker-dealers differently 
depending on their business model (e.g., full service broker-dealer, 
broker-dealer that uses independent contractors, insurance-affiliated 
broker-dealer) and size. More generally, estimates of the magnitude of 
such benefits and costs depend on assumptions about (1) the extent to 
which broker-dealers currently engage in disclosure and conflict 
mitigation activities, (2) how broker-dealers currently develop 
recommendations for their customers, (3) how broker-dealers choose to 
comply with Regulation Best Interest, (4) whether and how broker-
dealers change investments and share classes offered as a result of 
Regulation Best Interest, (5) whether and how product manufacturers 
change their investment offerings as a result of Regulation Best 
Interest, (6) whether broker-dealers restrict access to brokerage 
accounts by raising minimum account sizes or adding additional 
qualification requirements, (7) whether broker-dealers try to shift 
customers to advisory accounts as a result of Regulation Best Interest, 
(8) how retail customers perceive the risk and return of their 
portfolios, (9) how likely retail investors are to act on a 
recommendation that complies with Regulation Best Interest, (10) how 
the risk and return of retail customer portfolios change as a result of 
how they act on the recommendation, and (11) how investment advisers, 
including dually registered advisers, react to the adoption of 
Regulation Best Interest and the other regulatory developments, 
including the rules we are adopting and interpretations we are issuing 
simultaneously with Regulation Best Interest. Because many of these 
factors are firm-specific and thus inherently difficult to quantify, 
even if it were possible to calculate a range of potential quantitative 
estimates, that range would be so wide as to not be informative about 
the magnitude of the

[[Page 33435]]

benefits or costs associated with Regulation Best Interest.
---------------------------------------------------------------------------

    \1156\ See supra Section III.B.3.c for discussion of the wide 
range of estimates of the potential benefits of Regulation Best 
Interest stemming from a reduction in investor harm, and discussion 
surrounding infra footnotes 1165-1182 for other issues associated 
with these estimates.
---------------------------------------------------------------------------

    Broader economic forces, beyond broker-dealer and retail customer 
behavioral responses to Regulation Best Interest, also make meaningful 
estimates of economic impacts difficult to develop. The market for 
investment advice and services is complex and vast, and as history 
demonstrates, is dynamic and affected by market-specific facts 
(including product developments and regulatory changes) as well as 
macroeconomic factors (including general economic conditions). For 
example, the introduction of indexation to the retail investment market 
and the subsequent increase in index products (and providers) and 
reduction in the costs of indexing for retail investors have had 
substantial effects on the market for retail investment advice and 
services. The more recent introduction of ETFs has had similar 
unanticipated and underestimated effects, including, in general, 
reducing investor costs and increasing tax efficiency, as well as 
increasing the array of product offerings. Developments such as the 
employer-driven shift from defined benefit plans to defined 
contribution plans also have had significant effects on the market for 
investment advice. We expect these and other factors, including factors 
not currently identified, will continue to affect the market and, 
accordingly, may change the economic effects of the rule. These sources 
of uncertainty and complexity make meaningfully quantifying many of the 
costs and benefits of the rule difficult and, particularly over long 
time periods, inherently speculative.
a. Broad Commenter Concerns With Respect to Costs and Benefits
    We received many comments regarding our analysis in the Proposing 
Release of the benefits and costs. In this section, we discuss comments 
that address broader aspects of our analysis. Comments that address 
costs and benefits of more specific components of Regulation Best 
Interest are discussed in the corresponding sections for each rule 
component that follows.
    Some commenters stated that our analysis in the Proposing Release 
did not properly incorporate current market practices into the 
baseline.\1157\ As discussed above, we have revised the discussion to 
include those practices, which may reflect guidance by SROs such as 
FINRA, requirements and obligations under state laws, practices 
implemented by broker-dealers in response to the (now vacated) DOL 
Fiduciary Rule that have not been reversed, and any practices 
implemented by broker-dealers to fulfill their obligations under 
existing federal securities laws.\1158\ While we acknowledged in the 
Proposing Release that variation in the extent to which broker-dealers 
with different business practices already engage in disclosure and 
conflict mitigation activities makes quantifying Regulation Best 
Interest's costs and benefits with meaningful precision difficult, we 
more explicitly emphasize how this variation in current market 
practices affects the costs and benefits of Regulation Best Interest in 
the discussion that follows.\1159\ In general, to the extent that 
broker-dealer practices are already aligned with the requirements of 
Regulation Best Interest, the anticipated magnitude of both the costs 
and the benefits associated with a given component of Regulation Best 
Interest will be correspondingly reduced, and vice versa.
---------------------------------------------------------------------------

    \1157\ See, e.g., CFA August 2018 Letter; CCMC Letters.
    \1158\ See supra Section III.B.2.
    \1159\ See Proposing Release at 21643.
---------------------------------------------------------------------------

    As discussed above,\1160\ commenters noted the existence of 
fiduciary standards in various states. One commenter provided an 
overview of the fiduciary obligations of state-registered investment 
advisers, ``typified by an expectation of undivided loyalty where the 
adviser acts primarily for the benefit of its clients.'' \1161\ This 
commenter also stated that ``[s]ome states also extend these fiduciary 
obligations beyond investment advisers to brokers, especially in dual-
hatted scenarios,'' and that these fiduciary obligations were extended 
even when broker-dealers handled non-discretionary accounts.\1162\ We 
recognize that there is substantial variation in the sources, scope, 
and application of state fiduciary law. And we acknowledge that such 
state-level obligations for broker-dealers mean that they may already 
engage in practices under the baseline that overlap with certain 
requirements under Regulation Best Interest. To the extent that state-
level law incorporates fiduciary principles similar to those reflected 
in Regulation Best Interest, the magnitude of the costs and benefits 
discussed below that stem from the application of those principles to 
broker-dealers will be correspondingly reduced. However, costs and 
benefits that arise from obligations under Regulation Best Interest 
that differ from obligations under state law, such as the Conflict of 
Interest Obligation, will be maintained.\1163\
---------------------------------------------------------------------------

    \1160\ See supra Section III.B.2.
    \1161\ See NASAA February 2019 Letter at 22 and footnote 40.
    \1162\ Id. at 23-24.
    \1163\ Whether Regulation Best Interest would have a preemptive 
effect on any state law would be determined in future judicial 
proceedings, and would depend on the language and operation of the 
particular state law at issue. We considered whether we could 
determine the economic impact of possible, future state-law 
preemption on retail customers, but concluded that we cannot analyze 
the economic effects of the possible preemption of state law at this 
point because the factors that will shape those judicial 
determinations are too speculative. Among the unknown factors are: 
(1) The final language in any proposed state legislation or 
regulation adopting a fiduciary or other standard for broker-
dealers; (2) whether that language would constitute the type of law, 
rule, or regulation that is expressly preempted by the securities 
law or impliedly preempted under principles applied by courts; and 
(3) whether, if there was preemption, that preclusion of state law 
would have any positive or negative effects on investors when 
compared with the economic effects of Regulation Best Interest.
---------------------------------------------------------------------------

    Some commenters suggested that certain types of costs should remain 
outside the scope of our analysis. Some stated that our analysis should 
not consider, for example, costs to broker-dealers resulting from lost 
revenues on securities they cease offering or costs associated with any 
potential increase in arbitration claims as a result of Regulation Best 
Interest, except to the extent that they are passed on to investors in 
the form of higher fees.\1164\ These commenters suggested that because 
these types of costs are a direct result of policies that make 
investors better off, they should not factor into an assessment of 
Regulation Best Interest. The Commission has an obligation to consider 
the economic effect of Regulation Best Interest on affected parties, 
including broker-dealers, even when those costs are associated with 
benefits to investors. However, in the specific discussion of each rule 
component that follows, we highlight instances where a given cost is 
directly associated with a benefit to investors.
---------------------------------------------------------------------------

    \1164\ See AARP August 2018 Letter; EPI Letter; Better Markets 
August 2018 Letter; Cetera August 2018 Letter.
---------------------------------------------------------------------------

    Commenters raised several issues related to the quantification of 
costs and benefits, or lack thereof, in the Proposing Release. They 
asserted that our analysis focused too much on Regulation Best 
Interest's costs and did not quantify any of the benefits, such as the 
reduction in investor harm.\1165\ As discussed above, some studies 
present anecdotal evidence of behavior by certain broker-dealers, such 
as recommending investments that are inferior to available 
alternatives, that is harmful to investors.\1166\ A potential

[[Page 33436]]

benefit of Regulation Best Interest is therefore a reduction in that 
harm, as asserted by commenters. However, the anecdotal evidence of 
investor harm in these studies does not lend itself to aggregation.
---------------------------------------------------------------------------

    \1165\ See AARP August 2018 Letter; Better Markets August 2018 
Letter; CFA August 2018 Letter.
    \1166\ See supra footnotes 1068 and 1075.
---------------------------------------------------------------------------

    Commenters also stated that we should have incorporated the 
approach used by the DOL RIA and the CEA to quantify aggregate investor 
harm.\1167\ While both of these analyses surveyed a broad literature on 
the relative performance of broker-sold versus direct-sold mutual 
funds, they both relied on a particular study to estimate aggregate 
investor harm, extrapolating the effect of ``excess loads'' on the 
performance of broker-sold funds to total industry-wide AUM.\1168\ We 
disagree with this approach because, as noted by commenters, we believe 
these analyses misapplied the particular study's results.\1169\ When 
the results of the study are correctly applied, the aggregate estimate 
of investor harm obtained using this approach is negligible.\1170\
---------------------------------------------------------------------------

    \1167\ See Better Markets August 2018 Letter.
    \1168\ See supra footnotes 1081 and 1099.
    \1169\ See, e.g., Lewis (2017), supra footnote 1099.
    \1170\ See id.
---------------------------------------------------------------------------

    Another commenter advocated a similar approach, claiming that risk-
adjusted returns net of fees, which calculate the excess return of an 
investment above a benchmark that matches the risk of the investment, 
are the only appropriate measure of whether a recommendation is in a 
retail customer's best interest.\1171\ While there are studies showing 
that broker-sold mutual funds underperform direct-sold funds to varying 
degrees,\1172\ we do not believe, for the reasons explained below, that 
applying estimates of this under-performance to industry-wide AUM 
produces a meaningful estimate of the aggregate investor harm 
attributable to recommendations made by broker-dealers that is 
sufficiently precise to inform our policy choices. First, as discussed 
above, these studies do not necessarily cleanly distinguish under-
performance attributable to broker-dealers from under-performance 
attributable to investment advisers.\1173\
---------------------------------------------------------------------------

    \1171\ See EPI Letter. See also Former SEC Senior Economists 
Letter, stating that risk-adjusted returns are an appropriate 
measure of investor harm.
    \1172\ See, e.g., Bergstresser et al. (2009), supra footnote 
1048; Del Guercio & Reuter (2014), supra footnote 1081.
    \1173\ See supra footnote 1097.
---------------------------------------------------------------------------

    Second, interpreting the relative underperformance of broker-sold 
funds as a measure of investor harm due to conflicts of interest 
implicitly evaluates investor harm against a benchmark that does not 
include financial advice. However, that benchmark does not necessarily 
reflect the appropriate alternative available to investors in broker-
sold funds. Extrapolating from these studies leads to the conclusion 
that investors would do better investing on their own, yet there are 
other studies showing that is not the case, at least not for all 
investors.\1174\ We further note that calculating the investor harm 
against a benchmark that includes the fees retail customers would pay 
for equivalent advice could significantly reduce the magnitude of these 
estimates.\1175\
---------------------------------------------------------------------------

    \1174\ See supra footnotes 1045-1048.
    \1175\ See also supra footnote 1103.
---------------------------------------------------------------------------

    Finally, while risk-adjusted returns may be useful in comparing the 
performance of particular mutual funds, particularly when trying to 
evaluate fund manager skill, they do not necessarily reflect the 
utility that investors achieve from their investments.\1176\ 
Heterogeneous investors value investments and the services provided by 
financial professionals differently depending on their investment 
profile and preferences, and risk-adjusted returns do not necessarily 
represent aggregate utility across all investors in a way that permits 
us to arrive at an aggregate measure of investor harm. For example, 
consumers invest in various forms of insurance products in order to 
hedge their exposure to bad outcomes (e.g., home insurance policies), 
even though the expected returns on such investments are generally 
negative. The relative underperformance of broker-sold mutual funds 
also may not capture any intangible benefits investors derive from 
receiving tailored financial advice.\1177\ Alternatively, the relative 
performance of mutual funds sold through these two channels may reflect 
other factors that are unrelated to conflicts of interest.\1178\ 
Accordingly, while we do not dispute the existence of broker-dealer 
behavior under the baseline that is harmful to investors, based on our 
analysis, including our analysis of the comments received, we continue 
to believe that quantifying that harm, and therefore quantifying the 
benefits associated with reducing it, depends on many contingent 
factors that would render any estimates insufficiently precise to 
inform our policy choices.\1179\
---------------------------------------------------------------------------

    \1176\ Even in the context of evaluating fund manager skill, 
there is debate about whether risk-adjusted returns are an 
appropriate measure of fund performance. See e.g., Vincent Glode, 
Why Mutual Funds ``Under Perform'', 99 J. Fin. Econ. 546 (2011); 
Jonathan B. Berk & Jules H. van Binsbergen, Measuring Skill in the 
Mutual Fund Industry, 118 J. Fin. Econ. 1 (2015).
    \1177\ See, e.g., Bergstresser et al. (2009), supra footnote 
1048, who note that ``[o]ne possibility is that brokers provide 
other intangible benefits, which we cannot measure'' when 
interpreting the relative performance of broker-sold versus direct-
sold mutual funds.
    \1178\ See, e.g., The DOL RIA, supra footnote 1002, at footnote 
473, noting that the relative performance of broker-sold versus 
direct-sold funds ``. . . is an imperfect measure of the impact of 
conflicts of interest; other factors, aside from conflicts of 
interest, affect the relative performance of mutual funds sold 
through the two distribution channels.''
    \1179\ See Discussion following footnote 1156 for a discussion 
of these factors. See also infra Section III.C.7, where we have 
endeavored to estimate some of the potential benefits of Regulation 
Best Interest based on many assumptions.
---------------------------------------------------------------------------

    With respect to the magnitude of the costs we assessed in the 
Proposing Release, some commenters asserted that our analysis 
underestimated the costs of complying with Regulation Best Interest, 
though only a few provided estimates of these costs.\1180\ Where 
commenters provided estimates for a specific component of Regulation 
Best Interest, particularly the Disclosure Obligation, we discuss those 
estimates when discussing that component of Regulation Best Interest 
below. Based on its experience with the DOL Rule, one commenter 
provided a broad estimate of the compliance costs associated with the 
entire package of rules we proposed, including Regulation Best Interest 
and Form CRS, indicating that the rule package would entail initial 
costs of $20 million and ongoing costs of $5 million per year for their 
firm, but that these costs would be manageable.\1181\ Another commenter 
stated that for a small broker-dealer with $500,000 in net capital, the 
compliance costs estimated in the Proposing Release could constitute 
12% of that net capital, making compliance with Regulation Best 
Interest burdensome for such broker-dealers.\1182\ We acknowledge that 
the costs of Regulation Best Interest could be more burdensome for 
small broker-dealers and discuss any corresponding competitive effects 
in Section III.D.1.
---------------------------------------------------------------------------

    \1180\ See Schwab Letter; ICI Letter; Letter from James J. 
Angel, Associate Professor of Finance, Georgetown University (Aug. 
7, 2018) (``Angel Letter''); LPL August 2018 Letter; NSCP Letter.
    \1181\ See Raymond James Letter.
    \1182\ See NSCP Letter.
---------------------------------------------------------------------------

    Although the majority of the industry studies provided by 
commenters focused on the effects of the DOL Fiduciary Rule on broker-
dealers and their customers, one industry survey provided information 
about industry beliefs about potential effects of proposed Regulation 
Best Interest.\1183\

[[Page 33437]]

The survey consisted of approximately 30 individual financial 
professionals across a mix of 15 companies providing financial advisory 
services and products, including broker-dealers and dually registered 
firms, with $23 trillion in AUM and administration and nearly 79 
million investment accounts. All of the participants surveyed stated 
that it was unlikely that they would reconsider their broker-dealer 
registration status, while nearly 40% stated that they may alter their 
investment choices and 35% could alter the services that they offer. 
With respect to the costs of Regulation Best Interest and Form CRS, 
approximately 36% of respondents stated that the implementation costs 
could be between 1% and 5% of annual profits; however, nearly 80% of 
respondents noted that costs are likely to decline over time.\1184\ We 
note that one of the cost estimates provided by a commenter above is 
consistent with this range.\1185\ One commenter suggested that for 
firms that offer access to thousands of unique securities, many of 
which likely have similar strategies (e.g., index mutual funds or 
ETFs), requiring broker-dealers to ``consider reasonably available 
alternatives offered by the broker-dealer as part of having a 
reasonable basis for making the recommendation'' would make it cost 
prohibitive for broker-dealers and financial professionals to evaluate 
the costs associated with ``every similar investment product available 
through the broker-dealer's platform.'' \1186\ Many survey 
participants, although they believed that the Commission underestimated 
the aggregate costs of Regulation Best Interest and Form CRS, agreed 
that the benefits to investors were likely to justify the costs.
---------------------------------------------------------------------------

    \1183\ See Center for Capital Markets Competitiveness, SEC 
Regulation Best Interest Rule Proposals: Request for Information 
Analysis, FTI Consulting Report Presented to the U.S. Chamber of 
Commerce (Jul. 25, 2018), available at https://www.centerforcapitalmarkets.com/wp-content/uploads/2018/08/Reg-BI-Rule-Proposal-Research_8.7.18_FTI-Updated_final.pdf. See CCMC 
Letters. Survey participants also addressed questions related to 
beliefs regarding investor protection, choices for retail customers, 
and the standard of conduct for broker-dealers.
    \1184\ One commenter stated that the ``costly'' recordkeeping 
requirements described in the Proposing Release ``are unnecessary as 
self-interest will lead firms to keep proof of compliance'' and 
should be eliminated. See Angel Letter.
    \1185\ See supra footnote 1181. Relative to this commenter's 
2018 fiscal year profits, its initial cost estimate of $20 million 
would represent approximately 2% of annual profits for this firm. 
See https://www.sec.gov/Archives/edgar/data/720005/000072000518000083/rjf-20180930x10k.htm.
    \1186\ See LPL December 2018 Letter.
---------------------------------------------------------------------------

    Other commenters stated that a number of elements of the Proposing 
Release potentially could increase litigation exposure for some broker-
dealers. For example, one commenter discussed that, because proposed 
Regulation Best Interest did not ``expressly define `financial 
incentive''' for purposes of the proposed requirement of policies and 
procedures designed to disclose and mitigate, or eliminate, conflicts 
arising from financial incentives, broker-dealers could face challenges 
to ``design and maintain effective compliance programs that 
appropriately address the conflicts inherent in their particular 
business models'' thereby potentially increasing litigation 
risks.\1187\ Another commenter indicated that, with respect to 
proprietary products, ``[s]tate courts in enforcement actions and in 
review of such actions'' may find it difficult to distinguish the best 
interest standard for broker-dealers from a fiduciary standard for 
investment advisers, and may cause certain associated persons of 
broker-dealers to ``shy away from the risks of litigation in this 
regulatory environment, causing a substantial market contraction away 
from middle class investors.'' \1188\
---------------------------------------------------------------------------

    \1187\ See Primerica Letter.
    \1188\ See Letter from Douglas M. Ommen, Iowa Insurance 
Commissioner (Aug. 6, 2018) (``Iowa Insurance Commissioner 
Letter'').
---------------------------------------------------------------------------

    In the Proposing Release, we were able to quantify costs for 
limited portions of Regulation Best Interest, particularly those 
stemming from requirements related to document creation for purposes of 
the Paperwork Reduction Act. While we have updated these estimates in 
Section IV.B, we continue to believe that it is not possible to 
meaningfully quantify the full costs and benefits of Regulation Best 
Interest because such analysis would depend on many contingent factors 
that render any estimate insufficiently precise to inform our policy 
choices.\1189\ So while we acknowledge, for example, that Regulation 
Best Interest may impose costs that are a significant portion of the 
estimate of initial and ongoing costs of $20 million and $5 million by 
the commenter cited above, we cannot anticipate the associated costs 
for all firms because of the wide variation in size and scope of 
business practices across firms as well as the many unknown factors 
associated with the principles-based nature of Regulation Best 
Interest. In discussing Regulation Best Interest's component 
obligations below, we address any estimates provided by commenters 
where we can and otherwise explain the specific factors that preclude 
quantifying the costs of Regulation Best Interest with meaningful 
precision beyond our Paperwork Reduction Act estimates.
---------------------------------------------------------------------------

    \1189\ See Discussion following footnote 1156 for a discussion 
of these factors. See also infra Section III.C.7, where we have 
endeavored to estimate some of the potential benefits of Regulation 
Best Interest based on many assumptions.
---------------------------------------------------------------------------

b. Broad Investor Protection Benefits
    As discussed above, in addition to any enhancements provided above 
and beyond current requirements and market practices, each of the 
component obligations of Regulation Best Interest share features with 
market best practices under the baseline, as shaped by FINRA's guidance 
on relevant rules or as described in its Report on Conflicts of 
Interest. Given this overlap, FINRA, in response to a congressional 
request, enumerated the ways it believes Regulation Best Interest 
enhances existing broker-dealer obligations under current FINRA 
rules.\1190\
---------------------------------------------------------------------------

    \1190\ See FINRA 2018 Letter.
---------------------------------------------------------------------------

    In addition to the enhancements that each of Regulation Best 
Interest's component obligations provide above and beyond existing 
broker-dealer obligations under the baseline, which we discuss below, 
Regulation Best Interest increases retail customer protections by 
establishing these obligations under the Exchange Act so that the 
Commission may enforce them directly and examine for compliance. 
Additionally, to the extent that market best practices may reflect some 
FINRA guidance that is not required by FINRA's rules, some broker-
dealers may not currently implement these practices. To the extent that 
broker-dealers and their associated persons do not currently implement 
existing best practices that will be codified in Regulation Best 
Interest, retail customers will benefit because it will increase the 
implementation of these best practices throughout the industry.
2. Disclosure Obligation
    As adopted, the Disclosure Obligation of Regulation Best Interest's 
requires a broker-dealer, prior to or at the time of the 
recommendation, to provide to the retail customer, in writing, full and 
fair disclosure of all material facts relating to the scope and terms 
of the relationship and all material facts relating to conflicts of 
interest that are associated with the recommendation. Regulation Best 
Interest explicitly requires disclosure of ``all material facts 
relating to the scope and terms of the relationship with the retail 
customer'' including: (i) That the broker, dealer, or such natural 
person is acting as a broker, dealer, or an associated person of a 
broker or dealer with respect to the recommendation; (ii) the material 
fees and costs that apply to the retail customer's transactions, 
holdings, and accounts; and (iii) the type and scope of

[[Page 33438]]

services provided to the retail customer, including any material 
limitations on the securities or investment strategies involving 
securities that may be recommended to the retail customer; and all 
material facts relating to conflicts of interest that are associated 
with the recommendation.
    Under the baseline, some disclosure obligations already exist, as 
do an array of market practices with respect to the disclosure of 
capacity, fees, services, and conflicts of interest.\1191\ The 
Disclosure Obligation will enhance disclosure obligations that exist 
under the baseline and bring greater alignment to market practices by 
establishing an explicit and broad disclosure requirement under the 
Exchange Act that applies to all broker-dealers when they make a 
recommendation to a retail customer. We expect this change to improve 
the quality and consistency of disclosures and thus (1) reduce the 
information asymmetry that may exist between a retail customer and her 
broker-dealer, and (2) facilitate customer comparisons of different 
broker-dealers which we expect will, in turn, increase competition 
among broker-dealers, including with respect to fees and costs, as 
discussed below.\1192\
---------------------------------------------------------------------------

    \1191\ For instance, broker-dealers are subject to a number of 
disclosure obligations under the Exchange Act when they effect 
certain customer transactions. These disclosure obligations include 
written disclosure about capacity, compensation, and third-party 
remuneration related to the transaction, and disclosures about 
whether the broker-dealer has any control, affiliation, or interest 
in the security or the issuer of the security being offered. Broker-
dealers also face liability under the antifraud provisions of the 
federal securities laws for failure to provide disclosure, such as 
disclosure of ``honest and complete information'' or any material 
adverse facts or materials conflicts of interest, including any 
economic self-interest, when recommending a security (see supra 
footnote 988). In addition, broker-dealers must comply with a number 
of SRO disclosure obligations--such as FINRA Rule 2124 (Net 
Transactions with Customers), FINRA Rule 2262 (Disclosure of Control 
Relationship with Issuer), and FINRA Rule 2269 (Disclosure of 
Participation or Interest in Primary or Secondary Distribution). 
Finally, broker-dealers may also adjust their practices consistent 
with existing SRO guidance on specific disclosures--such as FINRA 
Regulatory Notice 13-23, Brokerage and Individual Retirement Account 
Fees (July 2013) on fee disclosure. See Proposing Release at 
footnotes 175, 176, 177, and 192; supra footnotes 303 and 985-988 
for a more detailed discussion on existing disclosure practices.
    \1192\ See supra footnote 1072 for a discussion of potential 
information asymmetries between broker-dealers and retail customers.
---------------------------------------------------------------------------

    Relative to the baseline, the Disclosure Obligation will change how 
broker-dealers disclose information to their retail customers in 
several specific ways. First, under the baseline, a broker-dealer and 
its associated persons are not explicitly required to disclose that 
they are acting in a broker-dealer capacity when making a 
recommendation. We also clarify above that the use of the terms 
``adviser'' or ``advisor'' in a name or title by (i) a broker-dealer 
that is not also registered as an investment adviser, or (ii) a 
financial professional that is not also a supervised person of an 
investment adviser would presumptively violate this particular 
disclosure requirement. Second, Regulation Best Interest requires that 
any disclosure made by a broker-dealer be ``full and fair,'' meaning 
that the broker-dealer is required to provide sufficient information to 
enable a retail investor to make an informed decision with regard to 
the recommendation, even where this information is about aspects of the 
relationship between a retail customer and a broker-dealer that may 
already require disclosure, implicitly or explicitly, under the 
baseline. We expect the ``full and fair'' requirement to benefit retail 
customers in cases where it results in disclosures that are not 
currently required under broker-dealer antifraud provisions. Finally, 
Regulation Best Interest requires that broker-dealers provide these 
disclosures to retail customers in writing at or before the time of a 
recommendation. However, we are permitting oral disclosures prior to or 
at the time of a recommendation and written disclosures after a 
recommendation under the circumstances outlined in Section II.C.1, Oral 
Disclosure or Disclosure After a Recommendation.\1193\ We focus our 
discussion of both the benefits and costs of the Disclosure Obligation 
on these changes relative to the baseline.\1194\
---------------------------------------------------------------------------

    \1193\ For example, when oral disclosures are used prior to or 
at the time of a recommendation, broker-dealers must maintain a 
record of the fact that oral disclosure was provided. See supra 
footnotes 301 and 507-508 and surrounding discussion for more detail 
on when oral disclosure prior to or at the time of a recommendation 
and disclosure in writing after a recommendation are permitted.
    \1194\ See supra footnotes 1157-1159.
---------------------------------------------------------------------------

    Regulation Best Interest's Disclosure Obligation is different from 
the Proposing Release's Disclosure Obligation in two ways. First, while 
the Proposing Release required that a broker-dealer ``reasonably 
disclose'' material facts to retail customers, Regulation Best Interest 
requires that a broker-dealer provide retail customers with ``full and 
fair'' disclosure of material facts. As discussed above, this change 
from the Proposing Release does not have a substantive effect on the 
expected economic effect of the Disclosure Obligation. Specifically, in 
both the Proposing Release and Regulation Best Interest, the 
formulation of the Disclosure Obligation, as described in the release 
text, required that a broker-dealer provide sufficient information to 
enable a retail investor to make an informed decision with regard to a 
recommendation.\1195\ Therefore, we do not expect this change to affect 
our assessment of Regulation Best Interest's costs and benefits. 
Second, whereas the Proposing Release's Disclosure Obligation did not 
explicitly require a broker-dealer to disclose particular types of 
material facts relating to the scope and terms of its relationship with 
a retail customer, Regulation Best Interest explicitly requires that 
these material facts include the capacity in which the broker-dealer is 
acting, fees and costs, and the type and scope of services provided, 
including material limitations on the securities or investment 
strategies that may be recommended. We include any economic effects 
associated with this change in our discussion of Regulation Best 
Interest's benefits and costs. Finally, while we discuss the direct 
benefits and costs of the Disclosure Obligation in this section, retail 
customers, broker-dealers, investment advisers, and their financial 
professionals may experience indirect benefits or costs due to 
competitive effects caused by the Disclosure Obligation. We discuss any 
competitive effects below in Section III.D.1.
---------------------------------------------------------------------------

    \1195\ See Proposing Release at Section II.D.1.c.
---------------------------------------------------------------------------

a. Benefits
    Regulation Best Interest requires that brokers, dealers, or natural 
persons associated with a broker-dealer disclose that they are acting 
as a broker, dealer, or an associated person of a broker-dealer prior 
to or at the time of a recommendation to a retail customer. Broker-
dealers are not explicitly required to disclose this information prior 
to or at the time of a recommendation under the baseline, though they 
may disclose it to comply with other federal securities laws and SRO 
rules, or because they consider it to be a market best practice.\1196\ 
This requirement is most likely to have economic effects when retail 
customers have both brokerage and advisory accounts with the same 
financial professional, as may be the case if the financial 
professional is dually-registered. It is designed to make all

[[Page 33439]]

retail customers aware of the capacity in which their broker-dealer is 
acting when a recommendation is made, which may help the retail 
customer better evaluate the advice they receive. For instance, the 
cost to the retail customer of acting on such advice will typically 
depend on whether the advice is tied to the retail customer's brokerage 
or advisory account. In addition, understanding the capacity in which a 
financial professional is acting may provide the retail customer with 
context for, and facilitate review of, other relevant disclosures by 
the broker-dealer. Knowing that she is receiving advice from a broker-
dealer, or an associated person of a broker-dealer, may focus the 
retail customer's attention on any potential conflicts of interest 
specifically associated with receiving a recommendation from a broker-
dealer. For example, a disclosure that a firm is acting in the capacity 
of a broker-dealer may encourage a retail customer to seek additional 
information about commissions, which could give the firm or its 
financial professional an incentive to recommend transactions that may 
be inconsistent with the client's most efficient investment strategy, 
such as a buy-and-hold strategy.
---------------------------------------------------------------------------

    \1196\ For example, under the baseline, broker-dealers may 
decide that disclosing the capacity in which it is acting is 
necessary in order to meet its duty of fair dealing under the 
antifraud provisions of the federal securities laws. In addition, 
broker-dealers must disclose whether they effected the transaction 
as a principal or agent in the customer confirmation statement 
pursuant to Exchange Act Rule 10b-10, which a retail customer 
generally receives after the trade is completed.
---------------------------------------------------------------------------

    While the capacity disclosure requirement and the disclosures 
investors will receive in Form CRS will increase the likelihood that 
retail customers understand the nature of their relationship with a 
broker-dealer or financial professional, and hence how this 
relationship might affect the recommendations retail customers receive, 
some investors may form beliefs about the nature of their relationship 
with a broker-dealer or financial professional based on their use of 
particular names and titles such as ``adviser'' or ``advisor,'' as well 
as how their services are marketed. In cases where these terms are used 
by (i) a broker-dealer that is not also registered as an investment 
adviser, or (ii) a financial professional that is not also a supervised 
person of an investment adviser, some retail customers may not fully 
understand that their broker-dealer or financial professional is not 
acting in the capacity of an investment adviser, even though investors 
receive some information about the capacity their broker-dealer or 
financial professional is acting in on Form CRS or other 
disclosures.\1197\
---------------------------------------------------------------------------

    \1197\ Investors may not fully understand this capacity 
disclosure because, for example, their financial professional is not 
a supervised person of an investment adviser but works for a dual-
registrant, and they interpret Form CRS as suggesting the financial 
professional also provides both types of services. Alternatively, 
even if an investor's broker-dealer or financial professional solely 
offers services in a broker-dealer capacity, the use of the titles 
``adviser'' or ``advisor'' may leave her confused about the nature 
of the services provided, despite the capacity disclosure on Form 
CRS. See Relationship Summary Proposal at footnotes 411-412.
---------------------------------------------------------------------------

    To the extent that, despite the disclosures provided on Form CRS, 
the use of the titles ``adviser'' and ``advisor'' causes investor 
confusion about the nature of the relationship retail investors have, 
or will have, with a broker-dealer or financial professional, the 
presumption that the use of these titles by (i) a broker-dealer that is 
not also registered as an investment adviser, or (ii) a financial 
professional that is not also a supervised person of an investment 
adviser would violate the capacity disclosure requirement will 
potentially benefit investors in two ways.\1198\ First, certain 
investors may seek an advisory relationship and would be better off 
receiving advice from an investment adviser. In situations where 
confusion associated with titles might cause such an investor to 
mistakenly engage in a relationship with a broker-dealer or an 
associated person of a broker-dealer, the presumption should mitigate 
costs the investor might incur associated with receiving and, 
potentially, acting on recommendations from a broker-dealer, as well as 
costs associated with correcting this mismatch by switching to an 
investment adviser.\1199\ Second, to the extent that, as a result of 
the use of the titles ``advisor'' or ``adviser,'' any confusion might 
remain about the capacity in which a broker-dealer or its associated 
person is acting, the presumption should alleviate that confusion and 
thus increase the likelihood that retail customers focus their 
attention on any potential conflicts of interest specifically 
associated with receiving a recommendation from a broker-dealer. Any 
benefits associated with the presumption will apply for current and 
potential retail customers of the approximately 100 broker-dealers with 
retail customers that are not also investment advisers and use the 
terms ``adviser'' or ``advisor'' in their names, and for current and 
potential retail customers of the approximately 16% of all registered 
representatives that use these titles and are not dually 
registered.\1200\ These benefits will be limited to the extent that 
broker-dealers and their financial professionals choose other names or 
titles that may indicate that they provide advisory services or use 
marketing materials that hold them out as providing advisory services 
but do not trigger the presumption or preclude application of the 
solely incidental prong of the broker-dealer exception to the 
definition of investment adviser.\1201\
---------------------------------------------------------------------------

    \1198\ Several commenters generally ascribed benefits to 
restricting the usage of the terms ``adviser'' and ``advisor.'' See 
supra footnotes 326-330.
    \1199\ See Relationship Summary Proposal at footnote 674 for 
further discussion of the costs associated with a mismatch between 
an investor and their preferred type of investment advice provider.
    \1200\ Staff analysis found that 100 retail-facing broker-
dealers as of December 2018 use either ``adviser'' or ``advisor'' in 
their firm names. See Relationship Summary Proposal at footnote 685 
for more discussion of the estimate that approximately 16% of all 
registered representatives use these titles and are not dually 
registered.
    \1201\ See supra footnotes 336-340.
---------------------------------------------------------------------------

    As discussed above, under the baseline, broker-dealers may, in 
practice, already disclose information about the fees they charge, the 
type and scope of services they provide, and any conflicts of interest 
associated with their recommendations.\1202\ However, Regulation Best 
Interest's explicit requirement that broker-dealers disclose all 
material facts related to the scope and terms of their relationship 
with a retail customer and all material facts relating to conflicts of 
interest that are associated with a recommendation may provide retail 
customers with useful information that they may not currently receive, 
enabling them to make more informed investment decisions. The magnitude 
and nature of this benefit will depend on the extent to which a broker-
dealer already discloses these material facts and how broker-dealers 
choose to disclose this information. For example, if broker-dealers 
choose to disclose all material facts in one consolidated document, the 
disclosure may, depending on the facts and circumstances of the 
disclosure, be more informative to some retail customers than 
disclosures that are provided across many documents. In other cases, 
layered disclosures may allow broker-dealers to target their 
disclosures to their particular retail customer base at the relevant 
point in time, increasing

[[Page 33440]]

the likelihood that investors read these disclosures.\1203\
---------------------------------------------------------------------------

    \1202\ These disclosures may stem from implicit or explicit 
requirements under federal securities laws. For example, broker-
dealers are explicitly required to disclose certain aspects of the 
fees their retail customers pay, directly and indirectly, under 
Exchange Act Rule 10b-10 (see, e.g., 913 Study at footnotes 256-
259). In other cases, courts have found that broker-dealers may 
implicitly be required to disclose conflicts of interest or other 
material facts related to the scope and terms of their relationship 
with retail customers (see, e.g., 913 Study at footnotes 249-255). 
See also NASD Notice to Members 92-11.
    \1203\ See the discussion of layered disclosure in supra Section 
II.C.1.c. See also supra footnote 540 on the potential benefits of 
layered disclosure.
---------------------------------------------------------------------------

    While the Proposing Release's Disclosure Obligation did not 
explicitly require a broker-dealer to disclose particular types of 
material facts relating to the scope and terms of its relationship with 
a retail customer, Regulation Best Interest explicitly requires that 
these material facts include: (1) The capacity in which the broker-
dealer is acting; (2) fees and costs; and (3) the type and scope of 
services provided, including material limitations on the securities or 
investment strategies that may be recommended. We generally anticipate 
greater benefits under Regulation Best Interest than under the 
Proposing Release. Specifically, to the extent that broker-dealers may 
not have disclosed the types of information we are requiring under 
Regulation Best Interest, Regulation Best Interest should increase the 
consistency of disclosure practices across broker-dealers, which may 
make it easier for investors to compare disclosures from and services 
offered by different broker-dealers or other firms. In addition, if 
some broker-dealers would not have disclosed the specific types of 
information required under Regulation Best Interest, and retail 
customers find that information useful, Regulation Best Interest may 
facilitate more informed decisions by retail customers when they are 
deciding whether or not to open an account or use a recommendation. For 
example, disclosures about the scope and terms of services offered by a 
broker-dealer or about their fees and costs may facilitate more 
informed decisions by retail customers as to which type of account is 
appropriate for them and whether they should open an account with a 
given broker-dealer. Alternatively, disclosures about conflicts of 
interest or fees and costs may facilitate more informed decisions by 
retail customers as to whether or not they should use a recommendation 
of a securities transaction or investment strategy.
    Regulation Best Interest also explicitly requires that disclosures 
be ``full and fair,'' and thus that a broker-dealer must provide 
sufficient information to enable a retail customer to make an informed 
decision with regard to a recommendation.\1204\ Broker-dealers may 
disclose, for example, certain conflicts of interest associated with 
their recommendations under the baseline. However, under existing 
federal securities laws and SRO rules, they are not expressly required 
to provide full and fair disclosure in the manner required under 
Regulation Best Interest. As a result, existing disclosure practices 
may not be designed to specifically help retail customers make informed 
decisions about the recommendations they receive. By explicitly 
requiring that broker-dealers provide sufficient information to enable 
retail investors to make an informed decision with regard to a 
recommendation, Regulation Best Interest imposes a minimum standard on 
disclosures that may increase the consistency of disclosure practices 
across broker-dealers relative to the baseline. This may also cause 
such disclosures to be more useful to retail customers in evaluating 
the advice they receive, thereby enabling them to make more informed 
decisions about the recommendations they receive. To the extent that 
disclosure obligations under the baseline already result in broker-
dealers providing sufficient information to enable a retail customer to 
make an informed decision with regard to a recommendation, the 
magnitude of the benefits from this component of the Disclosure 
Obligation is likely to be correspondingly reduced.\1205\
---------------------------------------------------------------------------

    \1204\ See discussion at supra footnotes 463-469.
    \1205\ See supra footnote 1191 for more on disclosure 
obligations and requirements under the baseline.
---------------------------------------------------------------------------

    Regulation Best Interest's Disclosure Obligation also establishes a 
standard for the form and timing of disclosures by requiring that they 
be made in writing prior to or at the time of a recommendation. While 
broker-dealers may already disclose information on the fees they 
charge, the type and scope of services they provide, and any conflicts 
of interest associated with their recommendations under the baseline, 
federal securities laws and SRO rules may not explicitly specify the 
form and timing of such disclosures. In cases where these requirements 
are explicit, they may not require delivery at or prior to a retail 
customer's evaluation of the recommendations they receive and any 
corresponding investment decision. In contrast, while broker-dealers 
will have some flexibility regarding the form and timing of their 
disclosures under Regulation Best Interest, retail customers will 
receive standardized disclosures about the fees and costs, as well as 
any conflicts of interest, associated with a recommendation prior to or 
at the time of receiving the recommendation. The Disclosure Obligation 
should increase the consistency of disclosure practices across broker-
dealers and across different types of information relative to the 
baseline, thereby increasing the likelihood that retail customers have 
the information they need to make a more informed and efficient 
investment decision at the time they receive a recommendation.
    As noted above, we are permitting oral disclosure prior to or at 
the time of a recommendation and written disclosure after a 
recommendation has been made under the circumstances outlined in 
Section II.C.1, Oral Disclosure or Disclosure After a 
Recommendation.\1206\ Because oral disclosure is permitted in cases 
where written disclosure prior to or at the time of recommendation is 
not feasible or practical, investors may benefit by receiving 
information that otherwise may not have been available to them at the 
time they make an investment decision. In contrast, because written 
disclosure is permitted in instances where existing regulations permit 
disclosure after a recommendation, the benefits associated with the 
form and timing of disclosures under Regulation Best Interest may be 
reduced if the information in such disclosures would have been useful 
to investors in making an investment decision. However, for both oral 
disclosure prior to or at the time of a recommendation and written 
disclosure after a recommendation has been made as permitted under the 
circumstances outlined in Section II.C.1, Oral Disclosure or Disclosure 
After a Recommendation, retail customers will still receive disclosures 
in writing prior to a recommendation regarding the circumstances under 
which oral disclosure or disclosure after a recommendation will occur 
and the material facts that will be disclosed under these 
circumstances.\1207\
---------------------------------------------------------------------------

    \1206\ See supra footnote 1193.
    \1207\ See discussion following supra footnote 301.
---------------------------------------------------------------------------

    Several commenters stated that there are limits to the 
effectiveness of disclosure and cited a number of studies suggesting 
that disclosure alone is unlikely to solve the issues surrounding, for 
example, the conflicts of interest between a broker-dealer or the 
associated person of a broker-dealer and a retail customer.\1208\ 
Another commenter cited the 2008 RAND Study, concluding that investors 
do not have the education or background to understand financial 
disclosures and do not read long, formulaic documents.\1209\ Other 
commenters claimed that

[[Page 33441]]

numerous academic studies demonstrate that disclosing conflicts of 
interest does not adequately address the potential harm they cause to 
investors.\1210\ Another commenter provided studies showing that 
disclosure can encourage better behavior by broker-dealers, improving 
investor welfare.\1211\
---------------------------------------------------------------------------

    \1208\ See Morningstar Letter; EPI Letter; Better Markets August 
2018 Letter; St. John's U. Letter; Letter from Tom C.W. Lin, 
Professor of Law, Temple University Beasley School of Law (Jul. 11, 
2018) (``Lin Letter'').
    \1209\ See Galvin Letter and discussion of 2008 RAND Study.
    \1210\ See State Treasurers Letter; Better Markets August 2018 
Letter; PIABA Letter.
    \1211\ See Morningstar Letter.
---------------------------------------------------------------------------

    As discussed above, we acknowledge studies showing disclosure can 
vary in its effectiveness depending on the issue it is intended to 
address, its intended audience, and the format in which it is 
delivered.\1212\ To the extent some retail customers are not able to 
understand the information disclosed by a broker-dealer regarding the 
scope of services it provides and the conflicts of interest associated 
with the recommendations it makes, the benefits of the Disclosure 
Obligation will not directly affect those investors, and may not 
increase the efficiency of their investment decisions. However, 
Regulation Best Interest is not limited to disclosure; rather, the 
Disclosure Obligation is just one component of Regulation Best Interest 
that as a whole will enhance the efficiency of recommendations that 
broker-dealers provide to retail customers, help retail customers 
evaluate the recommendations received, and improve retail customer 
protection when receiving recommendations from broker-dealers. In 
particular, in addition to the Disclosure Obligation, both the Care 
Obligation and the Conflict of Interest Obligation, discussed below, 
are designed to promote more efficient investment decisions by imposing 
affirmative obligations on the broker-dealer that cannot be fulfilled 
through disclosure alone, regardless of whether the retail customer 
fully incorporates disclosed information into its investment decisions.
---------------------------------------------------------------------------

    \1212\ See supra Section III.B.4.c.
---------------------------------------------------------------------------

    Additionally, to the extent that the information disclosed by 
broker-dealers as a result of Regulation Best Interest increases the 
comparability of the securities and services offered by different 
broker-dealers, it may foster competition between broker-dealers that 
benefits even those retail customers who are not able to understand the 
information disclosed by broker-dealers.\1213\ For example, if an 
increase in comparability promotes competition on the basis of 
recommendation quality, it may cause broker-dealers to mitigate or 
eliminate conflicts even in cases where the Conflict of Interest 
Obligation does not expressly require policies and procedures to 
mitigate or eliminate such conflicts. Because the Disclosure Obligation 
provides broker-dealers with some flexibility as to the form and timing 
of their disclosures, the magnitude of this benefit will depend on the 
extent to which these disclosures are comparable across broker-dealers 
or to which the disclosures made by one broker-dealer draw attention to 
practices at other broker-dealers that may not be in the best interest 
of retail customers.
---------------------------------------------------------------------------

    \1213\ See Relationship Summary Adopting Release at footnote 
1035 for similar discussion of the potential benefits comparability 
can have on competition.
---------------------------------------------------------------------------

    The magnitude of the Disclosure Obligation's benefits will depend 
on a number of factors, including which facts about the scope and terms 
of their relationship with retail customers are material, the extent to 
which broker-dealers already disclose information in a manner that is 
consistent with the Disclosure Obligation under the baseline, the 
manner in which they choose to disclose this information, the extent to 
which retail customers understand such disclosures and would use them 
in making investment decisions, and the extent to which such 
disclosures would improve the efficiency of retail customers' 
investment decisions, which varies with the specific circumstances of 
each retail customer.
b. Costs
    We expect broker-dealers and their financial professionals to incur 
costs as a result of Regulation Best Interest's Disclosure Obligation, 
and retail customers may incur indirect costs as well. In this section, 
we analyze these costs in terms of how Regulation Best Interest changes 
disclosure requirements for broker-dealers relative to the baseline.
    The requirement that broker-dealers or their associated persons 
disclose the capacity in which they or their associated persons are 
acting prior to or at the time of making a recommendation may be 
fulfilled by delivering the Relationship Summary, depending on the 
facts and circumstances.\1214\ For example, a standalone broker-dealer 
may satisfy this requirement of the Disclosure Obligation by delivering 
the Relationship Summary to the retail customer, as required pursuant 
to Form CRS. In contrast, for broker-dealers who are dually registered, 
and associated persons who are either dually registered or who are not 
dually registered but only offer broker-dealer services through a firm 
that is dually registered, delivering the Relationship Summary will not 
be sufficient to disclose the capacity in which they are acting. Thus, 
while standalone broker-dealers that deliver the Relationship Summary 
generally will not incur additional costs to comply with this 
requirement of the Disclosure Obligation, dual-registrants will incur 
additional costs, which could include the creation of disclosure 
materials as well as policies and procedures to assist their associated 
persons in determining when they are acting in a broker-dealer 
capacity. However, dual-registrants and their associated persons will 
have some flexibility with respect to the form, timing, or method of 
satisfying this requirement of the Disclosure Obligation when they or 
their associated persons make recommendations acting as brokers, 
dealers, or associated persons of a broker or dealer.\1215\
---------------------------------------------------------------------------

    \1214\ See supra footnotes 320-321 and surrounding discussion.
    \1215\ See supra footnote 306.
---------------------------------------------------------------------------

    The presumption that the use of the titles ``adviser'' and 
``advisor'' would violate the capacity disclosure requirement may 
impose costs on certain broker-dealers and their financial 
professionals, investors, and other affected parties. Broker-dealers 
and their associated persons currently using names and titles 
containing the terms ``adviser'' and ``advisor'' will incur direct 
costs, including those associated with changing firm names, written 
and/or electronic marketing materials, advertisements, and personal 
communication tools that use these titles, among other items, as well 
as any costs associated with voluntary outreach to customers to inform 
them of these changes.\1216\ While commenters did not provide specific 
estimates of these costs, they described them as ``very real costs,'' 
\1217\ ``significant costs and disruption,'' \1218\ and ``burdensome 
and

[[Page 33442]]

costly.'' \1219\ To the extent that a broker-dealer's company name that 
includes ``adviser'' or ``advisor'' is recognized as a brand in the 
market and therefore represents a valuable intangible asset to the 
broker-dealer, the broker-dealer may also incur indirect costs if some 
of its ``brand value'' is lost following a company name change.\1220\ 
Additionally to the extent that investors who have a preference for 
receiving advice from a broker-dealer or an associated person of a 
broker-dealer search exclusively for such advice using the terms 
``adviser'' or ``advisor,'' they may experience a reduction in the 
choice of service providers available to them (e.g., they might only 
find dual-registrants).\1221\ Finally, organizations that award 
credentials or certifications to broker-dealers and financial 
professionals that include the terms ``adviser'' or ``advisor'' may 
lose revenues associated with a reduction in future demand for these 
credentials and certifications, or lose revenues associated with the 
maintenance of current credentials or certifications by awardees.\1222\ 
Relatedly, affected financial professionals may experience a loss 
associated with any value they currently derive from the use of these 
credentials or certifications.\1223\ Rather than incur any of the costs 
associated with changing names and titles discussed above, some broker-
dealers may choose to register as investment advisers if they determine 
it will be less costly, in which case these broker-dealers will incur 
any costs associated with dual registration. The potential costs 
associated with the presumption apply for the approximately 100 broker-
dealers, as of December 2018, with retail customers that are not also 
investment advisers and use either ``adviser'' or ``advisor'' in their 
firm names, and for the approximately 16% of all registered 
representatives that use these titles and might be affected by the 
presumption.\1224\
---------------------------------------------------------------------------

    \1216\ See e.g., HD Vest Letter (stating that ``[t]he term 
`Advisor' permeates nearly every HD Vest disclosure, representative 
agreement, selling agreement, client agreement, client 
communication, marketing piece, and website'' and noting that 
broker-dealers would need to develop compliance policies to ensure 
oversight of the names and titles used by their financial 
professionals); LPL August 2018 Letter (stating that ``legal 
entities with so-called `doing business as' (d/b/a) names containing 
the term `advisor' or `adviser'--through which many securities 
professionals operate their business practices--will be required to 
rename their businesses and incur significant costs and disruption 
in updating all marketing materials with the prior name.''); SIFMA 
August 2018 Letter; Morgan Stanley Letter.
    \1217\ See HD Vest Letter.
    \1218\ See LPL August 2018 Letter. See also NAIFA Letter (noting 
the ``significant costs to update all materials, marketing, signage, 
legally-required disclosure documents, etc. . . .''); SIFMA August 
2018 Letter (noting the ``significant costs and burdens'' that would 
be involved with ``[e]xtensive repapering.'').
    \1219\ See Morgan Stanley Letter.
    \1220\ Academic evidence suggest corporate brands are valuable 
intangible assets to firms. See, e.g., Mary E. Barth et al., Brand 
Values and Capital Market Valuation, 3 Rev. Acct. Stud. 41 (1998).
    \1221\ The extent of this potential cost depends on how likely 
it is that investors rely on the titles ``adviser'' and ``advisor'' 
in finding a broker-dealer. For example, one survey suggests that 
40-50% of investors find their financial professionals through 
personal recommendations, not via searches for these titles (see 
supra footnote 946 and discussion in Relationship Summary Adopting 
Release at Section IV.B.2.a).
    \1222\ See IWI Letter (noting that ``Title Restrictions, as 
proposed, have a potential to impact the long-term growth of two of 
the Institute's registered marks.''). This commenter did not provide 
specific data or estimates on the potential magnitude of this 
effect.
    \1223\ See NAIFA Letter. This commenter did not provide specific 
data or estimates on the potential magnitude of this effect.
    \1224\ See supra footnote 1200.
---------------------------------------------------------------------------

    The requirement that broker-dealers disclose material facts 
relating to the material fees and costs that apply to a retail 
customer's transactions, holdings, and accounts may also be partially 
fulfilled by delivering the Relationship Summary. Form CRS will require 
broker-dealers to provide retail investors a high-level summary of 
principal fees and costs, including transaction-based fees, as well as 
a narrative discussion of other fees that retail investors will pay 
directly or indirectly. However, while providing such high-level 
summaries partially complies with the Disclosure Obligation, the 
Relationship Summary is unlikely to provide retail customers with all 
of the material facts about the fees and costs that apply to a 
particular recommendation.\1225\ As a result, Regulation Best Interest 
will impose costs on broker-dealers associated with assessing whether 
facts about the fees and costs that apply to a retail customer's 
transactions, holdings, and accounts are material and delivering those 
material facts to retail customers.
---------------------------------------------------------------------------

    \1225\ See the discussion following supra footnote 368.
---------------------------------------------------------------------------

    Broker-dealers will have some flexibility in how they comply with 
this requirement, which will allow them to tailor these disclosures to 
the needs of their retail customers and to implement them in a manner 
that is as cost efficient as possible, given their business models. In 
addition, the Disclosure Obligation may be satisfied by providing 
documents that broker-dealers are already required to produce or 
voluntarily produce under the baseline, such as prospectuses, in which 
case they may only incur costs associated with determining the timing 
and method by which they deliver these disclosures.\1226\ For example, 
under the baseline, broker-dealers may currently deliver prospectuses 
to retail customers after the completion of a transaction under the 
baseline, but would need to deliver them prior to or at the time of a 
recommendation under Regulation Best Interest, unless made under the 
circumstances outlined in Section II.C.1, Oral Disclosure or Disclosure 
After a Recommendation, allowing them to rely on delivery of 
information after the fact. In cases where required disclosures are 
already produced under the baseline, broker-dealers and their 
associated persons may still incur costs associated with delivering 
these disclosures prior to or at the time of a recommendation if they 
are not delivered by that time under the baseline.
---------------------------------------------------------------------------

    \1226\ See discussion at supra footnotes 495-496.
---------------------------------------------------------------------------

    Broker-dealers may also incur costs as a result of Regulation Best 
Interest's requirement that they disclose material facts about the type 
and scope of services provided to a retail customer, including any 
material limitations on the securities or investment strategies 
involving securities that may be recommended to the retail customer. As 
discussed above, some broker-dealers may be able to fulfill their 
obligation to disclose these material facts, such as those related to 
account monitoring, account minimums, or material limitations on the 
securities or investment strategies that may be recommended, by 
complying with Form CRS or by using disclosures included in account 
opening agreements or other customer disclosures.\1227\ For these 
broker-dealers, this requirement of the Disclosure Obligation should 
not cause them to incur additional costs beyond an initial assessment 
of whether they can comply with the Disclosure Obligation using Form 
CRS or pre-existing disclosures. In cases where a broker-dealer is not 
able to disclose all material facts relating to the type and scope of 
services they provide by complying with Form CRS or in combination with 
existing disclosures, broker-dealers will incur costs associated with 
assessing which facts about the type and scope of services provided to 
retail customers are material and delivering written disclosure of 
those material facts to retail customers. As discussed above, broker-
dealers will have some flexibility in how they comply with this 
requirement, allowing them to tailor these disclosures to the needs of 
their retail customers and to their business models and to implement 
these disclosures in a cost efficient manner.
---------------------------------------------------------------------------

    \1227\ See supra footnote 1203.
---------------------------------------------------------------------------

    While the Proposing Release's Disclosure Obligation did not 
explicitly require broker-dealers or their associated persons to 
disclose particular types of material facts relating to the scope and 
terms of their relationship with a retail customer, Regulation Best 
Interest explicitly requires that these material facts include the 
capacity in which the broker-dealer or its associated person is acting; 
material fees and costs; the type and scope of services provided, 
including material limitations on the securities or investment 
strategies that may be recommended; and all material facts relating to 
conflicts of interest that are associated with a recommendation. To the 
extent that broker-dealers are not disclosing this information or are 
not

[[Page 33443]]

disclosing it by the time of a recommendation, broker-dealers may incur 
higher costs associated with disclosing these material facts under 
Regulation Best Interest compared to the baseline.
    In general, for any material facts relating to the scope and terms 
of its relationship with retail customers, a broker-dealer may have to 
determine how to disclose those facts in a manner that is ``full and 
fair,'' as required by Regulation Best Interest, which will cause it to 
incur costs. Similarly, the requirement that broker-dealers disclose 
all material facts in writing prior to or at the time of a 
recommendation may also impose costs on broker-dealers. For example, 
even if a broker-dealer currently discloses some information about its 
fees under the baseline, it may not currently disclose that information 
prior to the time of a recommendation, and may incur costs updating 
systems and processes to ensure the information is disclosed in a 
manner that complies with Regulation Best Interest's requirements, 
including any costs associated with delivery of the information to 
retail customers.
    Broker-dealers may incur costs associated with the full and fair 
disclosure of all material facts relating to conflicts of interest that 
are associated with a recommendation. As discussed below in our 
analysis of the Conflict of Interest Obligation, broker-dealers 
currently have obligations to disclose certain material conflicts of 
interest under the baseline.\1228\ To the extent that broker-dealers 
will be required to disclose material facts about conflicts of interest 
that they do not currently disclose to retail customers under the 
baseline, broker-dealers will incur costs associated with assessing 
whether facts about these conflicts are material and delivering those 
facts to retail customers. They also may incur costs associated with 
identifying particular conflicts of interest to disclose.\1229\
---------------------------------------------------------------------------

    \1228\ See infra footnote 1261. See also supra footnotes 985-
988.
    \1229\ See infra Section III.C.4 for a discussion of costs 
associated with identifying conflicts of interest as part of the 
Conflict of Interest Obligation.
---------------------------------------------------------------------------

    As discussed above, there are circumstances where broker-dealers 
and their associated persons may make oral disclosures or written 
disclosures after the time of a recommendation under the circumstances 
outlined in Section II.C.1, Oral Disclosure or Disclosure After a 
Recommendation. Where oral disclosures are made, broker-dealers and 
their associated persons may incur costs associated with subsequently 
documenting such disclosures. These costs may include the time spent 
documenting such disclosures, the development of systems and processes 
necessary to document such disclosures, training associated persons to 
use these systems and processes, and supervising the compliance by 
associated persons with this obligation. For both oral disclosures and 
written disclosures made after a recommendation, broker-dealers and 
their associated persons may incur costs associated with developing 
initial disclosures about the material facts subject to oral 
disclosures and written disclosures after a recommendation, the 
circumstances under which such disclosures will be made, as well as 
costs associated with training financial professionals to make such 
disclosures in a manner that complies with Regulation Best Interest.
    While most of the costs associated with preparing and delivering 
disclosures are likely to be incurred by broker-dealers, their 
associated persons may incur costs as well. For example, when a 
financial professional is aware that the broker-dealer's disclosure is 
insufficient to describe ``all material facts,'' the associated person 
must supplement that disclosure, and may incur costs in developing such 
disclosure on their own to ensure they are in compliance with the 
Disclosure Obligation.\1230\ The magnitude of this cost will depend on 
the extent to which the financial professional cannot rely on the 
disclosure made by the broker-dealer.
---------------------------------------------------------------------------

    \1230\ See discussion following supra footnote 307 for an 
example of a case where an associated person of a broker-dealer may 
be required to provide her own disclosures in order to comply with 
the Disclosure Obligation.
---------------------------------------------------------------------------

    As discussed above, while we are unable to quantify the full costs 
of Regulation Best Interest, including the Disclosure Obligation, we 
are able to estimate some of the costs associated with the Disclosure 
Obligation, specifically the costs related to information collection 
requirements as defined by the Paperwork Reduction Act. As discussed 
further below in Section IV.B.1, the Commission estimates that the 
preparation and delivery of standardized language, fee schedules, and 
standardized conflict disclosures that broker-dealers are required to 
provide to retail customers to comply with the Disclosure Obligation 
will impose on broker-dealers an initial aggregate burden of 6,216,125 
hours and an additional initial aggregate cost of $42.84 million as 
well as an ongoing aggregate burden of 2,101,493 hours.\1231\ Thus, the 
Disclosure Obligation will impose an estimated initial aggregate cost 
of at least $1,508.88 million and an ongoing aggregate annual cost of 
at least $499.59 million on broker-dealers.\1232\ We note

[[Page 33444]]

that these estimates assume broker-dealers are not currently producing 
and delivering documents associated with the Disclosure Obligation. To 
the extent that broker-dealers are already doing so, these estimates 
may overstate the costs associated with the information collection 
requirements as defined by the Paperwork Reduction Act.
---------------------------------------------------------------------------

    \1231\ The estimate of the initial aggregate burden is based on 
the following calculation: 5,630 hours + 7,560 hours + 40,200 hours 
+ 2,040,000 hours + 3,780 hours + 20,100 hours + 2,040,000 hours + 
3,780 hours + 15,075 hours + 2,040,000 hours = 6,216,125 hours. As 
discussed in more detail in infra Section IV.B.1, 5,630, 7,560, and 
40,200 hours are estimates of the initial aggregate burden for the 
preparation of disclosure of capacity, type, and scope, for dual-
registrants and small and large broker-dealers, respectively. 
2,040,000 hours is the estimate of the initial aggregate burden for 
the delivery of the disclosure of capacity, type, and scope to 
retail customers. 3,780 and 20,100 hours are estimates of the 
initial aggregate burden for the preparation of disclosure of fees 
for small and large broker-dealers, respectively. 2,040,000 hours is 
the estimate of the initial aggregate burden for the delivery of the 
disclosure of fees to retail customers. 3,780 and 15,075 hours are 
estimates of the initial aggregate burden for the preparation of 
disclosure of material conflicts of interest for small and large 
broker-dealers, respectively. 2,040,000 hours is the estimate of the 
initial aggregate burden for the delivery of the disclosure of 
material conflicts of interest to retail customers. The estimate of 
the initial aggregate cost is based on the following calculation: 
$2.80 million + $3.80 million + $15.00 million + $1.88 million + 
$9.99 million + $1.88 million + $7.49 million = $42.84 million. As 
discussed in more detail in supra Section V.D, $2.80 million, $3.80 
million, and $15.00 million are estimates of the initial aggregate 
cost for the preparation of disclosure of capacity, type, and scope, 
for dual-registrants and small and large broker-dealers, 
respectively. $1.88 million and $9.99 million are estimates of the 
initial aggregate cost for the preparation of disclosure of fees for 
small and large broker-dealers, respectively. $1.88 million and 
$7.49 million are estimates of the initial aggregate cost for the 
preparation of disclosure of material conflicts of interest for 
small and large broker-dealers, respectively. The estimate of the 
ongoing aggregate burden is based on the following calculation: 
3,941 hours + 3,024 hours + 40,200 hours + 408,000 hours + 1,512 
hours + 8,040 hours + 816,000 hours + 756 hours + 4,020 hours + 
816,000 hours = 2,101,493 hours. As discussed in more detail in 
supra Section V.D, 3,941, 3,024, and 40,200 hours are estimates of 
the ongoing aggregate burden for the preparation of disclosure of 
capacity, type, and scope, for dual-registrants and small and large 
broker-dealers, respectively. 408,000 hours is the estimate of the 
ongoing aggregate burden for the delivery of the disclosure of 
capacity, type, and scope to retail customers. 1,512 and 8,040 hours 
are estimates of the ongoing aggregate burden for the preparation of 
disclosure of fees for small and large broker-dealers, respectively. 
816,000 hours is the estimate of the ongoing aggregate burden for 
the delivery of the disclosure of fees to retail customers. 756 and 
4,020 hours are estimates of the ongoing aggregate burden for the 
preparation of disclosure of material conflicts of interest for 
small and large broker-dealers, respectively. 816,000 hours is the 
estimate of the ongoing aggregate burden for the delivery of the 
disclosure of material conflicts of interest to retail customers.
    \1232\ These estimates are calculated as follows: (96,125 hours 
of in-house legal counsel) x ($415.72/hour for in-house counsel) + 
(6,120,000 hours for delivery for each customer account) x ($233.02/
hour for registered representative) + (90,763 hours for outside 
legal counsel) x ($497/hour for outside legal counsel) = $1,508.88 
million, and (35,056 hours of in-house legal counsel) x ($415.72/
hour for in-house counsel) + (2,040,000 hours for delivery for each 
customer account) x ($233.02/hour for registered representative) + 
(26,437 hours for in-house compliance counsel) x ($365.39/hour for 
outside legal counsel) = $499.59 million. The hourly wages for in-
house legal and compliance counsel and registered representatives 
are obtained from SIFMA. The hourly rates for outside legal counsel 
are discussed in supra Section V.D.
---------------------------------------------------------------------------

    Several commenters stated that we underestimated the compliance 
costs of Regulation Best Interest in the Proposing Release, 
particularly with respect to the potential transaction-based nature of 
the Disclosure Obligation and the resultant record-making and 
recordkeeping requirements.\1233\ One commenter stated that if the 
Disclosure Obligation is a transaction-based requirement, its costs 
were significantly underestimated in the Proposing Release, citing an 
estimate that an earlier proposal of a point-of-sale disclosure 
requirement would cost between $1 million and $1.2 million per 
firm.\1234\ We first note that, given that there are approximately 
2,766 broker-dealers with retail-facing operations, the commenter's 
cited estimate implies initial costs of approximately $1.4 billion and 
ongoing costs of approximately $1.4 billion,\1235\ so the commenter's 
implied estimate of $1.4 billion in initial costs associated with the 
Disclosure Obligation is consistent with our estimate of initial costs 
above.\1236\ Second, we note that, as discussed in more detail above in 
Section II.C.1.d, the Disclosure Obligation only requires that certain 
disclosures be made prior to or at the time of a recommendation, and 
broker-dealers may use standardized disclosures at an earlier point 
than the time of a recommendation to the extent such disclosures 
satisfy the Disclosure Obligation. In this regard, while the 
commenter's estimate may be indicative for some firms, the cost per 
firm will vary widely depending on the scope and business model of each 
broker-dealer. Because Regulation Best Interest provides broker-dealers 
with some flexibility regarding both the form and timing of the 
Disclosure Obligation, its costs are likely to be lower than a pure 
point-of-sale requirement.\1237\
---------------------------------------------------------------------------

    \1233\ See Schwab Letter; ICI Letter; Angel Letter; Vanguard 
Letter; LPL August 2018 Letter; NSCP Letter.
    \1234\ See Schwab Letter, citing April 12, 2004 comment letter 
from George Kramer of the Securities Industry Association (``SIA''). 
This estimate is based on a point-of-sale disclosure requirement in 
proposed rule 15c2-3, for which SIA estimated that implementation 
costs would be in the order of $500,000 per firm, as would annual 
costs associated with maintaining and updated necessary systems and 
procedures. See also SIFMA August 2018 Letter at footnote 38 
referencing the same estimate.
    \1235\ These estimates are calculated as follows: (2766 retail-
facing broker-dealers) x ($500,000 per firm in initial costs) = 
$1.383 billion. Implied ongoing costs are calculated the same way.
    \1236\ See supra footnote 1232.
    \1237\ See supra footnotes 531-533 for a discussion of layered 
disclosure and footnotes 541-542 for a discussion of the Disclosure 
Obligation's requirements with respect to timing of disclosures.
---------------------------------------------------------------------------

    Beyond the estimates provided above for that are derived from 
estimates developed for purposes of the Paperwork Reduction Act in 
Section IV.B.1, the Commission is unable to fully quantify the costs of 
the Disclosure Obligation because the magnitude of these costs depend 
on firm-specific factors that are inherently difficult to quantify 
given the principles-based nature of Regulation Best Interest.\1238\ 
These factors include the extent to which current disclosure practices 
under the baseline are different from the requirements of the 
Disclosure Obligation, the manner in which broker-dealers choose to 
comply with the Disclosure Obligation given the flexibility it 
provides, how broker-dealers assess whether facts relating to the scope 
and terms of their relationship with a retail customer are material, 
how they determine whether their disclosure of such material facts is 
full and fair, or the extent to which they will satisfy the Disclosure 
Obligation's requirements by delivering the Relationship Summary or 
pre-existing documents.
---------------------------------------------------------------------------

    \1238\ See supra Section III.C.1.
---------------------------------------------------------------------------

3. Care Obligation
    Under the baseline, broker-dealers are subject to suitability 
obligations and requirements under the anti-fraud provisions of the 
federal securities laws and the Suitability Rule when making 
recommendations to retail customers. The Care Obligation incorporates 
and adds to existing suitability requirements applicable to broker-
dealers, thereby reducing the incidence of inefficient recommendations 
to retail customers.
    FINRA rules require broker-dealers making recommendations to have, 
based on a particular customer's investment profile, a reasonable basis 
to believe that the recommendation is suitable for that customer. In 
addition, FINRA guidance and Commission opinions interpret suitability 
as prohibiting a broker-dealer from placing its interests ahead of the 
customer's interest and requiring the recommendations to be consistent 
with the customer's best interest.\1239\ However, this obligation is 
not explicitly required by FINRA's rule (or its supplementary 
material). Under the baseline, a recommendation by a broker-dealer or 
its associated persons may be consistent with a retail customer's best 
interest but broker-dealers and their associated persons are not 
required to make recommendations in the best interest of these 
customers, as will be required under Regulation Best Interest. Relative 
to the baseline, the Care Obligation will change how broker-dealers and 
their associated persons make recommendations to retail customers in 
several ways, some of which differ from the Proposing Release.
---------------------------------------------------------------------------

    \1239\ See supra footnote 570 and 913 Study at footnote 270.
---------------------------------------------------------------------------

    First, the Care Obligation explicitly includes cost as a factor for 
consideration when determining whether a recommendation is in a retail 
customer's best interest. In contrast, the Proposing Release emphasized 
cost as an important factor to consider and stated that broker-dealers 
may be required to consider cost as a factor when making 
recommendations, but did not explicitly require its consideration when 
making a recommendation.\1240\ In addition, we clarify above in Section 
II.C.2 that, when determining whether a recommendation is in a retail 
customer's best interest with respect to cost or other relevant 
factors, broker-dealers and their associated persons should consider 
reasonably available alternatives. Conversely, under FINRA suitability 
obligations, broker-dealers and their associated persons are not 
required to consider reasonably available alternatives when determining 
whether a recommendation is suitable for a retail customer.\1241\
---------------------------------------------------------------------------

    \1240\ See supra footnote 572 and preceding text.
    \1241\ See id.
---------------------------------------------------------------------------

    Second, under the baseline, FINRA rules require that a broker-
dealer or associated person who has actual or de facto control over a 
customer's account must have a reasonable basis for believing that a 
series of recommended transactions, even if suitable when viewed in 
isolation, is not excessive and unsuitable for the customer when taken 
together in light of the customer's investment profile. In contrast, 
the Care Obligation requires that a broker-dealer or its associated 
person has a reasonable basis to believe that a series of recommended 
transactions is not excessive and is in that retail customer's best 
interest. This is the case at all times--when the broker-dealer or 
associated person has actual or de facto

[[Page 33445]]

control over a customer's account as well as when no control exists 
(whether actual or de facto).
    Finally, FINRA's suitability standard applies to recommendations of 
rollover decisions that involve securities transactions, but not 
necessarily in the absence of a securities transaction.\1242\ In 
addition, FINRA's suitability standard does not explicitly apply to 
recommendations of account types and implicit hold recommendations 
resulting from agreed upon account monitoring.\1243\ In contrast, 
Regulation Best Interest explicitly applies to account recommendations 
as an ``investment strategy involving securities,'' including 
recommendations of securities account types, as well as rollovers or 
transfers of assets from one account to another. In addition, under 
Regulation Best Interest, implicit hold recommendations resulting from 
agreed upon account monitoring constitute recommendations of ``any 
securities transaction or investment strategy involving securities,'' 
and are therefore within the scope of Regulation Best Interest. 
Moreover, recommendations to open an IRA or to roll over assets into an 
IRA are subject to Regulation Best Interest, including the Care 
Obligation, thereby requiring a broker-dealer or its associated persons 
to have a reasonable basis to believe that the IRA or IRA rollover is 
in the best interest of the retail customer at the time of the 
recommendation, taking into consideration the retail customer's 
investment profile and other relevant factors, as well as the potential 
risks, rewards, and costs of the IRA or IRA rollover compared to the 
retail customer's existing 401(k) or other retirement account. We focus 
our discussion of both the benefits and costs of the Care Obligation 
under Regulation Best Interest on these changes relative to the 
baseline.
---------------------------------------------------------------------------

    \1242\ See FINRA Regulatory Notice 13-45 and supra footnote 172.
    \1243\ See supra footnote 170.
---------------------------------------------------------------------------

    Regulation Best Interest's Care Obligation differs from the 
Proposing Release's Care Obligation in two ways that respond to 
commenter concerns but that we do not expect to have significant 
economic effects.\1244\ First, the general best interest standard of 
conduct from the Proposing Release is incorporated into Regulation Best 
Interest's Care Obligation, which, as adopted, also requires that a 
broker-dealer or its associated persons have a reasonable basis to 
believe that a recommendation, or series of recommendations, does not 
place the financial or other interest of the broker-dealer or its 
associated persons ahead of the interest of the particular retail 
customer. Broker-dealers and their associated persons can comply with 
Regulation Best Interest as a whole by complying with its four 
component obligations, which now explicitly include the Proposing 
Release's general best interest standard in elements of the Care 
Obligation. This change to the Care Obligation, as compared to the 
Proposing Release, is intended to emphasize the importance of 
determining that each recommendation is in the best interest of the 
retail customer and that it does not place the broker-dealer's 
interests ahead of the retail customer's interest; however, we do not 
believe there will be significant economic effects associated with this 
change from the Proposing Release.\1245\ Second, Regulation Best 
Interest, as adopted, does not explicitly require broker-dealers or 
their associated persons to exercise ``prudence'' in making 
recommendations. Instead they must exercise reasonable diligence, care, 
and skill in making such recommendations. While we removed the term 
``prudence'' to address commenter concerns that it might create legal 
confusion and uncertainty, this does not change the requirements or 
obligations under the Care Obligation as compared to the Proposing 
Release.\1246\ Therefore, we do not expect this change to have a 
significant economic effect, as compared to the Proposing Release.
---------------------------------------------------------------------------

    \1244\ See discussion at supra footnotes 147, 606, and 577-584.
    \1245\ If anything, to the extent that broker-dealers or their 
associated persons might have misunderstood the Proposing Release 
with respect to their obligation to provide recommendations that are 
in the best interest of retail customers, Regulation Best Interest, 
as adopted, emphasizes the importance of determining that each 
recommendation is in the best interest of the retail customer will 
benefit retail customers.
    \1246\ See supra footnotes 579-585 and surrounding discussion.
---------------------------------------------------------------------------

a. Benefits
    As described in the Proposing Release, the Care Obligation did not 
explicitly require broker-dealers and their associated persons to 
consider the costs associated with a recommendation when determining 
whether it was in a retail customer's best interest, though the 
Proposing Release discussed cost as a relevant factor in making this 
determination, and noted that broker-dealers might be required to 
consider cost as a factor when making recommendations under the 
baseline.\1247\ The Care Obligation under Regulation Best Interest 
includes an explicit requirement to consider the cost of a 
recommendation. If this causes broker-dealers and their associated 
persons to more carefully consider cost in relation to other factors, 
compared to the baseline, it should reduce the incidence of 
recommendations of higher cost investments from a set of reasonably 
available alternatives that achieve the retail customer's objective. If 
the explicit requirement to consider the cost of a recommendation 
encourages broker-dealers and their associated persons to more 
carefully consider cost, compared to the baseline, the final rule makes 
it less likely that a broker-dealer or its associated persons could 
have a reasonable basis to believe such investments are in the retail 
customer's best interest because it would be difficult to have such a 
belief for investments that are identical beyond their costs. 
Therefore, including cost as a required factor in Regulation Best 
Interest should enhance the efficiency of recommendations to retail 
customers relative to the baseline.\1248\
---------------------------------------------------------------------------

    \1247\ See supra footnote 572.
    \1248\ See discussion surrounding supra footnotes 563-565.
---------------------------------------------------------------------------

    As discussed above, while a ``quantitative suitability'' 
requirement applies to series of recommended transactions under the 
baseline, it only applies in cases where a broker-dealer has 
``control'' over a customer account. Relative to the baseline, broker-
dealers and their associated persons will be required to have a 
reasonable basis to believe that any series of recommended transactions 
is in the retail customer's best interest, not just series of 
recommended transactions that occur in an account they control. This 
change relative to the baseline should enhance investor protection by 
reducing the incidence of cases where a broker-dealer or its associated 
persons recommend an excessively high rate of portfolio turnover, or 
``churn,'' for accounts that they do not control. In addition, the 
discussion above regarding the potential benefits from the increased 
standard of conduct required by the Care Obligation in the context of 
individual recommendations also applies to series of recommended 
transactions. Enhancing the standard of conduct that applies to series 
of recommended transactions and reducing the incidence of 
recommendations that result in excess portfolio turnover should result 
in more efficient recommendations, benefiting retail customers. We are 
unable to specifically quantify these potential benefits because, in 
addition to the reasons cited above, we do not have and cannot 
reasonably obtain comprehensive data on how often broker-dealers, for 
accounts they do not

[[Page 33446]]

control, recommend series of transactions that result in excessive 
portfolio turnover and are therefore not in the best interest of their 
retail customers.
    Regulation Best Interest applies to account recommendations, 
including recommendations to open an IRA or to participate in an IRA 
rollover. Accordingly, these types of recommendations are subject to 
the Care Obligation (as well as the other components of Regulation Best 
Interest). Several commenters highlighted the heightened risk of harm 
associated with IRA and IRA rollover recommendations because the amount 
of assets associated with such recommendations can be a significant 
portion of a retail customer's net worth, and one commenter cited 
academic and industry studies that identify activities that are 
particularly prone to conflicts of interest, including IRA 
rollovers.\1249\ We acknowledge the heightened effect that 
recommendations to open an IRA or to participate in an IRA rollover can 
have on the financial well-being of retail customers.\1250\ While 
FINRA's suitability standard under the baseline applies to rollover 
recommendations involving securities transactions, the suitability 
standard does not necessarily apply to a rollover recommendation if 
that recommendation does not involve a securities transaction.\1251\ To 
the extent that broker-dealers and their associated persons currently 
make recommendations to open an IRA or to participate in an IRA 
rollover that do not involve securities transactions under the 
baseline, Regulation Best Interest should result in IRA and IRA 
rollover recommendations to retail customers that are more efficient 
because they will be in the retail customer's best interest regardless 
of whether or not they involve securities transactions.
---------------------------------------------------------------------------

    \1249\ See CFA August 2018 Letter; AARP August 2018 Letter; 
Morningstar Letter; CFA Institute Letter.
    \1250\ See supra footnotes 191-192. See also Fiduciary 
Benchmarks Letter.
    \1251\ See supra footnote 1242.
---------------------------------------------------------------------------

    Regulation Best Interest also applies to other account type 
recommendations. Broker-dealers may offer different types of brokerage 
accounts that include different levels of services and costs. The 
choice of account type can have a significant effect on the financial 
wellbeing of a retail customer. For example, a recommendation to open 
an advisory over a brokerage account, or vice versa, can have a 
substantial long-term effect on a retail customer's assets. This effect 
may depend on the costs the retail customer incurs through the 
particular account as well as the retail customer's investment 
profile.\1252\ Regulation Best Interest should result in 
recommendations regarding account type that are in the best interest of 
the retail customer, particularly with respect to cost, increasing the 
efficiency of the account type recommendations retail customers receive 
relative to the baseline.
---------------------------------------------------------------------------

    \1252\ See supra footnote 191.
---------------------------------------------------------------------------

    Finally, by clarifying that implicit hold recommendations resulting 
from agreed-upon account monitoring services constitute recommendations 
of ``any securities transaction or investment strategy involving 
securities,'' the Care Obligation will apply at the point in time at 
which their broker-dealer or associated person performs the agreed-upon 
monitoring, regardless of whether the broker-dealer or an associated 
person communicates any recommendation. This should increase the 
efficiency of the implicit hold recommendations retail customers 
receive relative to the baseline.
b. Costs
    We expect broker-dealers and their associated persons to incur 
costs as a result of the Care Obligation, and, to the extent broker-
dealers pass these costs on to retail customers, these customers may 
incur costs as well. In this section, we analyze these costs in terms 
of how Regulation Best Interest, as adopted, changes the required 
standard of care broker-dealers owe their retail customers relative to 
the baseline. We also highlight any changes in our assessment of these 
costs as compared to the Proposing Release. We discuss the costs of 
complying with the Care Obligation, such as those associated with 
training employees or developing policies and procedures, in Section 
III.C.5.
    To comply with the Care Obligation, some broker-dealers may stop 
offering certain securities to retail customers, or their associated 
persons may stop recommending certain securities to retail customers. 
These decisions may be based on determinations that offering or 
recommending those securities typically would not satisfy the Care 
Obligation. To the extent that they earn revenue from offering and 
recommending such securities, broker-dealers and their associated 
persons may incur costs associated with the determination to cease 
offering or recommending these products.
    Commenters stated that our analysis should not consider lost 
revenue as a cost of complying with Regulation Best Interest, except to 
the extent that the lost revenue is passed on to investors in the form 
of higher fees, because these types of costs are a direct result of 
policies that make investors better off.\1253\ As discussed above, our 
economic analysis must consider the costs Regulation Best Interest may 
impose on all affected parties, including broker-dealers. However, we 
believe that any loss of revenues associated with recommendations that 
would not satisfy the Care Obligation is compensated by the 
corresponding benefit to retail customers--namely the provision of more 
efficient recommendations by their financial professionals.\1254\ In 
addition, even if broker-dealers or their associated persons have a 
reasonable basis to believe that a certain investment could be in the 
best interest of some retail customers, they may forgo offering or 
recommending the investment if, for example, they think that it may 
increase their exposure to regulatory enforcement risk over their 
compliance with Regulation Best Interest.\1255\ This could result in 
costs to both the broker-dealer and any retail customers for whom the 
investment would be an efficient investment choice.
---------------------------------------------------------------------------

    \1253\ See supra footnote 1164.
    \1254\ See supra Section III.A.2 for a more detailed discussion 
of efficient recommendations.
    \1255\ See, e.g., Iowa Insurance Commissioner Letter.
---------------------------------------------------------------------------

    Because the Care Obligation holds broker-dealers and their 
associated persons to an enhanced standard of conduct, they may incur 
costs associated with increased legal exposure if, for example, 
Regulation Best Interest results in increased retail customer 
arbitrations or litigation. For example, one commenter stated that the 
lack of clarity in how to weight various factors associated with the 
potential risks and rewards of a recommendation could lead to arbitrary 
claims regarding other alternative recommendations that, ex-post, would 
have performed better.\1256\ Similarly, because the Care Obligation 
also requires that a series of recommended transactions be in the best 
interest of a retail customer, regardless of whether a broker-dealer or 
an associated person controls the retail customer's account, a broker-
dealer could incur the same types of costs associated with increased 
arbitration or litigation risk relative to the baseline. We cannot 
anticipate the extent to which Regulation Best Interest will increase 
retail customer claims, but many retail customer arbitrations are 
already predicated in whole or in part on facts alleging that a broker-
dealer

[[Page 33447]]

breached a fiduciary duty or its suitability obligations. Additionally, 
the clarity in the rule text and this release regarding the Care 
Obligation, as well as the other aspects of Regulation Best Interest 
that bring enhanced conduct and clarity (e.g., the policies and 
procedures requirement and that Regulation Best Interest applies only 
at the time a recommendation is made) should mitigate against an 
increase in the likelihood and cost of such claims.
---------------------------------------------------------------------------

    \1256\ See CCMC Letters.
---------------------------------------------------------------------------

    The Care Obligation explicitly requires that cost be considered as 
a factor when determining whether a recommendation is in the best 
interest of a retail customer. Several commenters stated that the 
Proposing Release's guidance emphasizing cost as a specific factor in 
the Care Obligation could create uncertainty around how the cost of a 
recommendation should be weighed with other factors.\1257\ As discussed 
above, the inclusion of cost as a factor in the Care Obligation does 
not require that the ``least expensive'' recommendation be made by a 
broker-dealer or its associated person; cost is one factor, but not the 
only relevant factor. Nonetheless, to the extent that the inclusion of 
cost as a factor in the Care Obligation increases the arbitration or 
litigation risk to which broker-dealers or their associated persons are 
exposed, this change could impose additional costs on broker-dealers.
---------------------------------------------------------------------------

    \1257\ See ICI Letter; CCMC Letters; LPL August 2018 Letter.
---------------------------------------------------------------------------

    Regulation Best Interest also expressly applies to account 
recommendations, including recommendations of securities account types, 
as well as rollovers or transfers of assets from one account to 
another. We also clarify above that implicit hold recommendations 
resulting from agreed-upon account monitoring are within the scope of 
Regulation Best Interest and are therefore subject to the Care 
Obligation. Should they choose to discontinue offering certain 
services, as a result of Regulation Best Interest, broker-dealers could 
lose revenue associated with making recommendations for account types 
(including IRAs). They may also decide to cease offering monitoring 
services on retail customer accounts. However, as we discussed above 
with respect to recommendations more generally, we believe that any 
loss of revenues associated with recommendations that would not satisfy 
the Care Obligation is compensated by the corresponding benefits to 
retail customers associated with more efficient account 
recommendations.
    The Commission is unable to fully quantify the costs that the Care 
Obligation will impose on broker-dealers, their associated persons, or 
their retail customers because the magnitude of these costs depends on 
firm-specific factors that are inherently difficult to quantify given 
the principles-based nature of Regulation Best Interest.\1258\ These 
factors include the extent to which broker-dealers and their associated 
persons currently engage in practices under the baseline that would 
satisfy the Care Obligation, either of their own volition or as a 
result of complying with other regulations; the extent to which broker-
dealers and their associated persons will cease recommending certain 
securities or investment strategies; the likelihood that retail 
customers file more arbitration or litigation claims; and the extent to 
which broker-dealers pass on any cost increases to their retail 
customers.\1259\
---------------------------------------------------------------------------

    \1258\ See also supra Section III.C.1.a.
    \1259\ See discussion following infra footnote 1329 for 
discussion of factors affecting whether broker-dealers pass on costs 
to their retail customers and the resultant competitive effects.
---------------------------------------------------------------------------

4. Conflict of Interest Obligation
    The Conflict of Interest Obligation under Regulation Best Interest 
is intended to reduce the agency costs that arise when a broker-dealer 
and its associated persons provide a recommendation to a retail 
customer by addressing the effect of the associated person's or broker-
dealer's conflicts of interest on the recommendation.
    The Conflict of Interest Obligation would require that broker-
dealers establish, maintain, and enforce written policies and 
procedures that are reasonably designed to address the effect of the 
broker-dealer's and the associated persons' conflicts of interest on a 
recommendation. At a minimum, a broker-dealer is required to address 
the effect of conflicts of interest on a recommendation. At a minimum, 
a broker-dealer is required to address the effect of an identified 
conflict on a recommendation by disclosing the material facts 
associated with that conflict and by disclosing material limitations of 
the menu of securities when the conflict stems from such limitations. 
In certain cases, a broker-dealer is required to address the effect of 
an identified conflict by either mitigating the conflict, or, in 
certain cases, by eliminating certain sales practices.
    The Conflict of Interest Obligation is intended to reduce the 
information asymmetry between a retail customer and a broker-dealer and 
its associated persons with respect to the broker-dealer's conflicts of 
interest or those of its associated persons that may have an effect on 
the recommendations provided to the retail customer. This disclosure 
may help the retail customer form a better assessment of the efficiency 
of the recommendation received. Moreover, reducing this information 
asymmetry may discourage broker-dealers from acting on incentives that 
differ from retail customer objectives.
    Similarly, by addressing the effect of certain conflicts of 
interest through mitigation, the Conflict of Interest Obligation is 
intended to reduce the effect incentives created by those conflicts may 
have on a recommendation provided to the retail customer. Depending on 
how effective the mitigation method is in reducing these incentives, 
the efficiency of the recommendation provided to the retail customer 
may increase.
    Similarly, by addressing the effect of certain conflicts of 
interest through elimination, the Conflict of Interest Obligation is 
intended to neutralize the effect of incentives created by those 
conflicts may have on a recommendation provided to the retail customer. 
In this case, the efficiency of the recommendations provided to the 
retail customer may increase.
    The conflicts of interest that the broker-dealer or its associated 
persons have, and the incentives that these conflicts create, arise 
from, among other things, the manner in which broker-dealers generate 
revenue and the manner in which broker-dealers compensate their 
associated persons with respect to their dealings with retail 
customers.
    The compensation arrangement between a broker-dealer and its 
associated persons may reflect the amount of revenues that the 
associated persons generate for the broker-dealer from activities 
performed, including providing recommendations to retail customers. 
Such arrangements between the broker-dealer and its associated persons 
may create incentives for the associated person to take actions 
consistent with maximizing the broker-dealer's objectives (e.g., 
expected profits). For instance, if an associated person's compensation 
from providing recommendations to retail customers is tied to the 
amount of revenues that the associated person generates for the broker-
dealer, the associated person may have an incentive to recommend 
securities or investment strategies that would bring more revenue to 
the broker-dealer, relative to other comparable securities or 
investment strategies. Furthermore, even if the compensation 
arrangement does not create an explicit incentive for the associated 
person, the

[[Page 33448]]

broker-dealer may direct the attention of the associated person to 
certain securities. For instance, even if the revenues that the broker-
dealer receives when its associated persons provide recommendations to 
retail customers are not passed on to the associated persons, the 
broker-dealer's receipt of compensation from some securities or their 
sponsors may lead the broker-dealer to emphasize to its associated 
persons the securities that are the source of such compensation.
    The revenues that a broker-dealer receives when a retail customer 
acts on an investment recommendation may depend on the broker-dealer's 
compensation arrangement with the product sponsor. The broker-dealer 
may receive different compensation from different product sponsors for 
distributing comparable securities or investment strategies. If the 
objectives of the broker-dealer are tied to the amount of revenues it 
receives from recommended securities or investment strategies, the 
broker-dealer may have an incentive to advise only, or predominantly, 
on securities or investment strategies that come with attractive 
compensation arrangements and less so, or not at all, on other 
comparable securities or investment strategies. Accordingly, the 
incentives created by the compensation arrangements with the product 
sponsors may cause a broker-dealer to limit the menu of securities from 
which the broker-dealer or its associated persons make recommendations.
    The conflicts of interest that can arise from the compensation 
arrangement between the broker-dealer and its associated persons, and 
from the compensation arrangement between the broker-dealer and the 
product sponsors, can create incentives that may affect the broker-
dealer's or its associated persons' recommendations to retail 
customers. In certain circumstances, a broker-dealer's conflicts of 
interest, or its associated persons' conflicts of interest, may result 
in recommendations that are not in the best interest of the retail 
customer.\1260\
---------------------------------------------------------------------------

    \1260\ See FINRA Conflicts Report.
---------------------------------------------------------------------------

    As discussed above, in Section III.B.2, broker-dealers are 
currently subject to Commission and SRO regulations and rules that 
govern their business conduct. For example, with respect to the 
provision of advice, courts have found broker-dealers liable under the 
antifraud provisions of the federal securities laws for not giving 
``honest and complete information'' or for not disclosing ``material 
adverse facts of which it is aware'' with regard to certain conflicts 
of interest, in certain circumstances.\1261\ Furthermore, broker-
dealers are generally prohibited from making an unsuitable 
recommendation to a customer.\1262\
---------------------------------------------------------------------------

    \1261\ See the Suitability Rule; see also 913 Study at 55 for a 
detailed discussion of the broker-dealers' disclosure obligations 
and liabilities under the current regulatory regime.
    \1262\ See FINRA Rule 2111.03 (Recommended Strategies).
---------------------------------------------------------------------------

    In addition, broker-dealers may be liable under the Exchange Act 
for failure to supervise their associated persons when providing advice 
to retail customers.\1263\ Broker-dealers are generally required to 
establish policies and procedures that are reasonably designed to 
prevent and detect violations of the federal securities laws and 
regulations, as well as applicable SRO rules. Broker-dealers are also 
required to establish and maintain systems for applying these 
procedures (e.g., identifying and reviewing red flags with respect to 
the recommendations provided by their associated persons).\1264\
---------------------------------------------------------------------------

    \1263\ See 913 Study at 74.
    \1264\ Id. at 75. In addition, FINRA Rule 3010 requires broker-
dealers to establish and maintain a system to supervise the 
activities of their associated persons that is reasonably designed 
to achieve compliance with the applicable securities laws and 
regulations and FINRA rules. FINRA Rule 3120 requires broker-dealers 
to have a system of supervisory control policies and procedures that 
tests and verifies supervisory procedures.
---------------------------------------------------------------------------

    As discussed above, a number of studies and papers provide evidence 
suggesting that despite the current regulatory regime and observations 
that agency costs to retail customers from broker-dealer relationships 
may be trending downward, the effect of conflicts of interest on the 
provision of advice remains a concern.\1265\ We also noted in Section 
III.A.2 above that, more generally, the conflicts of interest of the 
broker-dealer and its associated persons and the incentives that these 
conflicts create may result in agency costs for the retail customers 
that persist despite the current regulatory regime.
---------------------------------------------------------------------------

    \1265\ See supra Section III.B.3.c.
---------------------------------------------------------------------------

    The Conflict of Interest Obligation in Regulation Best Interest is 
intended to reduce the agency costs associated with the conflicts of 
interest of the broker-dealers and its associated persons when they 
provide recommendations on securities transactions and investment 
strategies to retail customers. Below we discuss the economic 
implications of different requirements of this obligation, including 
their benefits and costs relative to the current regulatory regime.
a. Overarching Obligation Related to Conflicts of Interest
    The overarching obligation of the Conflict of Interest Obligation 
states that broker-dealers must establish, maintain, and enforce 
written policies and procedures reasonably designed to identify and at 
a minimum disclose, or eliminate, all conflicts of interest associated 
with recommendations to retail customers.
    The requirement to establish written policies and procedures 
reasonably designed to identify conflicts of interest is a new 
requirement relative to the current regulatory regime. This requirement 
may impose costs on those broker-dealers that currently do not 
implement such policies and procedures voluntarily. These costs stem 
from the resources that a broker-dealer would have to expend to 
identify existing and potential conflicts of interest and to design 
policies and procedures that can reasonably identify and manage 
circumstances when a conflict of interest arises within the broker-
dealer. These circumstances would have to take into account, among 
other things, how the broker-dealer generates revenue from providing 
recommendations to retail customers and how associated persons of the 
broker-dealer are compensated for providing recommendations. In 
addition, these circumstances would have to account for the limitations 
of the menu of securities from which broker-dealers provide 
recommendations. Furthermore, broker-dealers may incur costs of 
reviewing and updating such policies and procedures as new conflicts of 
interest arise or as new circumstances develop that may cause the 
broker-dealer to identify an existing conflict of interest. The 
Commission is providing below a quantitative estimate of the cost to 
broker-dealers associated with designing and updating such policies and 
procedures under certain assumptions
    The requirement to establish policies and procedures reasonably 
designed to identify conflicts of interest may also create benefits for 
retail customers. As noted above, the policies and procedures would 
require broker-dealers to: (1) Identify existing conflicts of interest 
and new circumstances in which an existing conflict of interest may 
arise, and (2) new conflicts of interest and the circumstances in which 
they may arise. Having a process in place to identify and address the 
conflicts of interest associated with a recommendation at the time the 
recommendation is made to a retail customer would reduce the likelihood

[[Page 33449]]

that a broker-dealer may fail to disclose material facts relating to 
conflicts of interest. Thus, the process a broker-dealer develops as a 
result of complying with the Conflict of Interest Obligation may 
improve the quality of the content of the disclosure of conflicts of 
interest that may affect a recommendation. To the extent such 
disclosure helps retail customers make a better assessment of the 
efficiency of the recommendation they receive, the requirement may 
benefit the retail customers.
    The Commission continues to believe that it is not possible to 
meaningfully quantify the potential costs and benefits of the Conflict 
of Interest Obligations because such analysis would depend on many 
contingent factors that render any estimate insufficiently precise to 
inform our policy choices.\1266\ For example, such an analysis of the 
Conflict of Interest Obligation would require strong assumptions about 
the circumstances under which a broker-dealer may fail to identify a 
given conflict of interest, and also about the extent to which the 
disclosure of the conflicts of interest may enhance decision making for 
retail customers.
---------------------------------------------------------------------------

    \1266\ See discussion following supra footnote 1156 for a 
general discussion of these factors. See also infra Section III.C.7, 
where we have endeavored to quantify some of the potential benefits 
of Regulation Best Interest based on many assumptions.
---------------------------------------------------------------------------

    The requirement to establish policies and procedures reasonably 
designed to, at a minimum, disclose identified conflicts of interest 
may help a retail customer evaluate the efficiency of the 
recommendation provided by a broker-dealer and its associated persons, 
and may affect the retail customer's decision of whether, and how, to 
act on the recommendation. As noted in Section III.A.2 above, reducing 
the information asymmetry between a retail customer and a broker-dealer 
and its associated persons may help the retail customer form a better 
assessment of the efficiency of the received recommendation.
    Disclosure requirements generally are intended to reduce 
information asymmetries between transacting parties. Whether such a 
reduction is likely to occur depends largely on the effectiveness of 
the disclosure. If the disclosure provides new information, transacting 
parties may make more informed decisions than they would without this 
new information, and, from this perspective, the disclosure may be 
effective. However, disclosure can be effective even if no new 
information is provided, to the extent the form and manner in which a 
disclosure requirement reaches the transacting parties facilitates a 
more informed decision. There is extensive academic literature on the 
factors that contribute to disclosure effectiveness.\1267\ Among these 
factors, those associated with bounded rationality, including financial 
literacy, are generally important.\1268\ In particular, disclosure 
effectiveness generally increases with the level of financial literacy 
of the transacting party.\1269\ It is also possible that if a broker-
dealer's retail customers have different degrees of financial literacy, 
the potential anticipated reaction of the retail customers that are 
financially literate to the disclosure of conflicts of interest may 
cause the broker-dealer to choose to eliminate certain conflicts, 
which, in turn, would benefit the population of retail customers that 
are less financially literate. Specifically, the requirement to 
establish policies and procedures reasonably designed to, at a minimum, 
disclose identified conflicts of interest may have a deterrent effect 
on some broker-dealers to the extent that they anticipate that 
disclosing material facts about certain conflicts of interest may be 
effective in dissuading certain retail customers from seeking or 
accepting recommendations from their associated persons in the future. 
As noted above, such broker-dealers may choose to eliminate those 
conflicts instead.
---------------------------------------------------------------------------

    \1267\ See supra Section III.B.4.c for a detailed discussion of 
the academic literature on disclosure effectiveness.
    \1268\ Id.
    \1269\ Id.
---------------------------------------------------------------------------

i. Disclosing Conflicts of Interest
    The requirement under the Conflict of Interest Obligation to 
develop reasonably designed policies and procedures to, at a minimum, 
disclose identified conflicts of interest would obligate a broker-
dealer to provide information (e.g., material facts) about its 
conflicts of interest and those that its associated persons have when 
making a recommendation to a retail customer. As discussed above, this 
information may already be disclosed under the regulatory baseline and 
by broker-dealers that adopt best practices. However, it is currently 
not clear in what form and what manner this disclosure reaches the 
retail customer.\1270\ Under Regulation Best Interest, the Conflict of 
Interest Obligation is intended to require that such disclosure reach 
the retail customer more directly and in a more timely manner.\1271\ In 
addition, the material facts disclosed may increase the salience of the 
conflicts of interest to retail customers as being a potential factor 
contributing to an associated person's recommendation. Salience 
detection is a key feature of human cognition allowing individuals to 
focus their limited mental resources on a subset of the available 
information and causing them to over-weight this information in their 
decision making processes.\1272\ Limited attention among individuals 
increases the importance of focusing on salient disclosure signals. 
Research suggests that increasing signal salience is particularly 
helpful in reducing limited attention of consumers with lower education 
levels and financial literacy.\1273\ To the extent that this manner of 
disclosure and the associated increase in salience results in more 
informed decisions with respect to whether to act on a received 
recommendation, the disclosure requirement resulting from the Conflict 
of Interest Obligation will benefit retail customers.
---------------------------------------------------------------------------

    \1270\ See e.g., 913 Study.
    \1271\ Broker-dealers satisfy their current disclosure 
obligations in the account opening agreement, account statements, 
and information made public on their websites.
    \1272\ See Daniel Kahneman, Thinking, Fast and Slow (2013); 
Susan T. Fiske & Shelley E. Taylor, Social Cognition: From Brains to 
Culture (3rd ed. 2017).
    \1273\ See, e.g., Victor Stango & Jonathan Zinman, Limited and 
Varying Consumer Attention: Evidence from Shocks to the Salience of 
Bank Overdraft Fees, 27 Rev. Fin. Stud. 990 (2014).
---------------------------------------------------------------------------

    It is also possible that the disclosure of material facts about a 
broker-dealer's conflicts of interest or those of its associated 
persons related to a recommendation may not benefit the retail customer 
receiving that recommendation. As noted by one commenter, the academic 
literature on disclosure effectiveness notes that in certain 
circumstances, disclosure of financial information may induce a 
``panhandler effect'', whereby disclosure increases the pressure to 
comply with the advice if the advisee (e.g., the retail customer) feels 
obliged to satisfy the financial interest of the advice provider (e.g., 
the associated person).\1274\
---------------------------------------------------------------------------

    \1274\ See, e.g., EPI Letter at 11, noting that ``[a]s the SEC 
itself noted in its analysis of one of the proposed regulations, 
disclosure may even induce a `panhandler effect,' whereby clients 
may go through with a transaction in response to social pressure to 
meet the professional's financial interests.'' The Commenter also 
notes that generally disclosure may not incentivize a financial 
professional to change her behavior: ``The SEC also noted that 
disclosure could have an effect on the behavior of financial 
professionals through `moral licensing'--the belief that they have 
already fulfilled their moral obligations through disclosure, and 
`strategic biasing'--the desire to compensate for an anticipated 
loss of profit from disclosure.'' As discussed above, Regulation 
Best Interest recognizes that certain conflicts of interest cannot 
be reasonably addressed with disclosure alone. See also supra 
Section III.B.4.c, which discusses in more detail these effects.

---------------------------------------------------------------------------

[[Page 33450]]

ii. Elimination of Conflicts of Interest
    The policies and procedures that broker-dealers will need to 
maintain and implement to comply with the Conflict of Interest 
Obligation will also give them the option of addressing conflicts of 
interest associated with recommendations by eliminating such conflicts 
entirely, rather than just disclosing them to the retail customer. 
Depending on the effectiveness of the policies and procedures that a 
broker-dealer implements to comply with the Conflict of Interest 
Obligation, conflicts of interest that are not required to be 
eliminated and that remain may still have a significant effect on an 
associated person's recommendation. If a broker-dealer considers that 
the effect of a conflict of interest on the recommendations of its 
associated persons cannot be adequately addressed by the broker-dealer, 
as required by the Conflict of Interest Obligation (discussed further 
below), the broker-dealer may consider modifying its practices to 
eliminate that conflict. By eliminating a conflict, the broker-dealer 
would neutralize the effect of this conflict on the recommendations 
provided by the broker-dealer or its associated persons to retail 
customers. The absence of this conflict of interest when the associated 
person is considering reasonably available alternatives for a 
recommendation to a retail customer, as noted above in the discussion 
of the Care Obligation, would likely result in an increase in the 
efficiency of the customers. As discussed above in Section III.A.2, 
this outcome would be consistent with the goals of Regulation Best 
Interest by reducing the agency costs associated with an associated 
person's incentives created by these conflicts of interest, which would 
benefit the retail customer.
    Furthermore, the option to address conflicts of interest through 
elimination allows broker-dealers to reduce the compliance costs 
associated with managing conflicts of interest. For example, if a 
broker-dealer determines it is too costly to just disclose a conflict 
of interest as required under the Conflict of Interest Obligation, the 
broker-dealer could choose to eliminate the conflict. On the other 
hand, by eliminating a conflict of interest, a broker-dealer may forgo 
the potential revenues associated with that conflict of interest.
b. Mitigation of Certain Incentives to the Associated Persons
    The requirement to establish, maintain, and enforce written 
policies and procedures reasonably designed to identify and mitigate 
conflicts of interest that create an incentive for the associated 
person of the broker-dealer to place the interest of the broker-dealer 
or the associated person ahead of the interest of the retail customer 
will likely affect the relationship between the broker-dealer and its 
associated persons, the menu of securities that the broker-dealer makes 
available to its associated persons, and the recommendations that the 
broker-dealer and its associated persons provide to retail customers. 
In the employment relationship between a broker-dealer and its 
associated persons, the broker-dealer generally hires and compensates 
associated persons to perform certain services (e.g., providing 
recommendations on securities transactions and investment strategies to 
retail customers) using the broker-dealer's framework (e.g., policies 
and procedures to ensure compliance with applicable laws and rules, 
supervisory systems that monitor for potential violations of policies 
and procedures, etc.). The compensation that the associated person 
receives from the broker-dealer may reflect the level of effort that 
the broker-dealer expects the associated person to exert when 
performing a service, given the broker-dealer's infrastructure. As 
noted above, the broker-dealer may also structure the associated 
person's compensation to create incentives that are consistent with 
maximizing the broker-dealer's objectives.
    The requirement to establish, maintain, and enforce written 
policies and procedures reasonably designed to identify and mitigate 
conflicts of interest that create an incentive for the associated 
person of the broker-dealer to put the interest of the broker-dealer or 
the associated person ahead of the interest of the retail customer may 
affect the employment relationship between the broker-dealer and the 
associated person in several ways. First, the requirement may change a 
broker-dealer's existing policies and procedures that are designed to 
achieve compliance with the regulatory baseline as well as the 
supervisory systems that allow the broker-dealer to monitor for 
potential violations by the associated persons of these policies and 
procedures. To this end, broker-dealers will need to consider the 
amount of time and level of resources to devote to design and establish 
policies and procedures that seek to reduce the likelihood of an 
associated person placing its interest or the interest of the broker-
dealer ahead of the interests of a retail customer when providing 
recommendations to retail customers.
    Another way that this requirement may affect the employment 
relationship between the broker-dealer and the associated person is by 
changing the level of effort that the associated person would have to 
exert to ensure that all recommendations supplied to retail customers 
are compliant with the Conflict of Interest Obligation. As a corollary, 
this requirement may also affect the level of effort that a supervisor 
would have to exert to ensure that the recommendations supplied by its 
associated persons to a retail customer comply with the obligations of 
Regulation Best Interest.
    As discussed above in the context of the Care Obligation, an 
associated person would have to not only consider a number of factors 
when making a recommendation to a retail customer, but also ensure that 
the recommendation is in the best interest of the retail customer. The 
determination that a recommendation is in the retail customer's best 
interest may depend on the conflicts of interest that exist at the time 
the associated person makes the recommendation, and, importantly, on 
how the broker-dealer complies with the requirement to establish, 
maintain, and enforce policies and procedures reasonably designed to 
identify and mitigate or eliminate conflicts of interest that create an 
incentive for the associated person to put the interest of the broker-
dealer or the associated person ahead of the interest of the retail 
customer. It is possible that more effective policies and procedures 
may lower the level of effort an associated person would have to exert 
to have a reasonable basis to believe that recommendations are 
compliant with Regulation Best Interest, in the sense that a supervisor 
or the broker-dealer would determine whether the effect of the 
associated person's or the broker-dealer's conflicts of interest is 
reduced to the point where the incentives created by these conflicts do 
not have a negative effect on the recommendations. However, the 
potential increase in the supervisor's level of effort may substitute 
for the potential decrease in the associated person's level of effort.
    One commenter had concerns about the discussion in the Proposing 
Release about the effect of the compensation arrangements between the 
broker-dealer and the associated person on the effort exerted by the 
associated person when

[[Page 33451]]

providing a recommendation.\1275\ This commenter stated that if the 
compensation leads to lower effort, the associated person would not 
make recommendations that are in the retail customer's best interest. 
As discussed above, the Commission notes that the relationship between 
the effort exerted to make a recommendation and the efficiency of the 
recommendation is complex, and that lower effort may not necessarily be 
inconsistent with increasing the efficiency of the recommendation.
---------------------------------------------------------------------------

    \1275\ See AARP August 2018 Letter.
---------------------------------------------------------------------------

    Finally, the Conflict of Interest Obligation may affect the 
compensation arrangement between the broker-dealer and its associated 
persons. Certain compensation arrangements may create incentives for an 
associated person to place his or her interest of the interest of the 
broker-dealer ahead of the interest of the customer, and therefore 
create conflicts of interest for the broker-dealer's associated 
persons. For example, as discussed above in Section III.B.1.f, broker-
dealers commonly compensate their associated persons based on 
commissions and performance-based awards. These compensation 
arrangements create incentives for associated persons to recommend 
securities or investment strategies that generate more commissions to 
the broker-dealer and potentially themselves over other securities or 
investment strategies.
    The Conflict of Interest Obligation requires a broker-dealer to 
have policies and procedures that are reasonably designed to identify 
and disclose and mitigate, or eliminate, any conflicts of interest 
associated with recommendations that create an incentive for the 
associated person or the firm to place the interest of the associated 
person or the firm ahead of the interest of the retail customer, 
including conflicts of interest that arise from compensation 
arrangements between broker-dealers and their associated persons. 
Depending on how a broker-dealer complies with the Conflict of Interest 
Obligation, compensation arrangements between broker-dealers and their 
associated persons may change as a result of establishing these 
policies and procedures. For example, as discussed above in Section 
III.B.2.e, in response to the DOL Fiduciary Rule, which among other 
things, was designed to restrict broker-dealer activities and reduce 
the conflicts of interest of a broker-dealer and those of its 
associated persons, some broker-dealers altered the compensation for 
their associated persons. Specifically, some broker-dealers chose to 
equalize commissions and deferred sales charges charged across similar 
securities or investment strategies. Others chose to restrict or 
eliminate sales quotas, contests, special awards, and bonuses, 
including deferred bonuses as part of the recruitment efforts.\1276\ It 
is possible that some broker-dealers may choose to comply with the 
Conflict of Interest Obligation by establishing policies and procedures 
that would address conflicts using these or similar methods. It is also 
possible that some broker-dealers may rely on existing policies and 
procedures that address conflicts through methods such as compliance 
and supervisory systems that are consistent with the Conflict of 
Interest Obligation.
---------------------------------------------------------------------------

    \1276\ However, we understand that following the decision by the 
Fifth Circuit to vacate the DOL Fiduciary Rule, some broker-dealers 
may have reverted back to compensation arrangements that they had in 
place prior to the DOL Fiduciary Rule. For instance, as discussed in 
Section III.B.2.e.ii, supra, some broker-dealers reinstated their 
deferred recruiting bonuses.
---------------------------------------------------------------------------

    Some of these methods may reduce the overall compensation of the 
associated person from providing recommendations (e.g., altering 
certain bonuses). The same methods or others (e.g., altering deferred 
recruiting bonuses) may complicate a broker-dealer's hiring of new 
associated persons. However, to the extent that these methods address 
the conflicts of interest of a broker-dealer or those of its associated 
persons in an effective manner, these methods may enhance the 
efficiency of the recommendations provided by a broker-dealer and its 
associated persons, and, therefore benefit retail customers.
    In general, if a broker-dealer implements policies and procedures 
pursuant to the Conflict of Interest Obligation that may result in a 
significant reduction in the overall compensation that an associated 
person receives from providing recommendations, the associated person 
may have an incentive to register as an investment adviser, if not 
already registered as one, and provide advice mostly or only in an 
investment adviser capacity.
    To the extent broker-dealers establish, maintain, and enforce 
policies and procedures that are effective at reducing the incentives 
of an associated person to put the interest of the broker-dealer or the 
associated person ahead of the interest of the retail customer, the 
Conflict of Interest Obligation would reduce the effect of these 
conflicts on the recommendations provided by associated persons to 
retail customers. In this way, complying with the Conflict of Interest 
Obligation would increase the efficiency of the recommendations for 
retail customers, relative to the regulatory baseline. This, in turn, 
would reduce the agency costs associated with the broker-dealer's and 
its associated persons' incentives that are created by their conflicts 
of interest. Lower agency costs at these broker-dealers would benefit 
retail customers.
    One commenter noted that the size of these benefits of Regulation 
Best Interest should be quantified relative to the baseline that 
includes the current regulatory regime as well as current 
practices.\1277\ The Commission agrees with the commenter and notes 
that, as discussed in Section III.B, broker-dealers may already have 
compliance and supervisory systems in place that are effective at 
reducing to a reasonable extent the effect of an associated person's 
conflicts of interest on the recommendations provided to retail 
customers.\1278\ Therefore, for the retail customers of these broker-
dealers, the potential benefits above may be small. In contrast, for 
the retail customers of the broker-dealers that are not currently 
addressing conflicts of interest in a manner consistent with Regulation 
Best Interest, the potential benefits above may be large.
---------------------------------------------------------------------------

    \1277\ See CFA August 2018 Letter.
    \1278\ See FINRA Conflicts Report.
---------------------------------------------------------------------------

    This commenter further stated that the economic analysis in the 
Proposing Release did not provide a thorough discussion of the 
relationship between the broker-dealer and its associated persons with 
a focus on the incentives of the associated persons.\1279\ The 
Commission notes that the analysis above about the incentives of the 
associated persons expands the analysis in the Proposing Release and 
establishes a clear link between compensation and incentives.
---------------------------------------------------------------------------

    \1279\ See CFA August 2018 Letter.
---------------------------------------------------------------------------

    As noted in the economic analysis of the Proposing Release,\1280\ 
broker-dealers may also adjust their menus of securities in response to 
the requirement to establish, maintain, and enforce written policies 
and procedures reasonably designed to identify and mitigate conflicts 
of interest that create an incentive for the associated person to place 
his or her interest or the interest of the broker-dealer ahead of the 
interest of the retail customer. It is possible that some broker-
dealers may decide to expand their offerings to better comply with the 
process required pursuant to the Conflict of Interest Obligation. For 
instance, broker-dealers that currently

[[Page 33452]]

offer advice only on a limited set of securities (e.g., proprietary 
securities) would have to disclose and evaluate their menu of 
securities to ensure that their policies and procedures regarding their 
limited menus of securities and the disclosures of any conflicts 
associated with such limitations do not result in recommendations that 
place the interest of the broker-dealer or its associated persons ahead 
of the retail customer's interest.
---------------------------------------------------------------------------

    \1280\ See Proposing Release at 21658.
---------------------------------------------------------------------------

    Broker-dealers may also manage conflicts of interest by limiting 
their menu of securities on which they offer recommendations. Broker-
dealers may prefer a limited menu of securities to better mitigate the 
potential costs associated with compliance of Regulation Best Interest. 
For instance, a limited menu of securities may result in more 
homogenous product fees across comparable securities or investment 
strategies, which would help reduce the effect of certain conflicts of 
interest on the recommendations provided to retail customers. Broker-
dealers may also respond by limiting their menus of securities because 
they may have conflicts of interest due to variation in the 
compensation they receive from product sponsors, as discussed above.
    It is possible that complying with the Conflict of Interest 
Obligation in this manner may result in securities menus that limit an 
associated person's choices of investments when providing a 
recommendation to a retail customer.\1281\ However, as discussed below, 
the requirements of the Conflict of Interest Obligation and the Care 
Obligation are intended to reduce the likelihood that limitations on 
securities menus result in recommendations that are not in the best 
interest of the retail customer.\1282\
---------------------------------------------------------------------------

    \1281\ See supra Section II.C.2.
    \1282\ For example, if none of the securities on the menu would 
be in the best interest of the retail customer in a given set of 
circumstances, the associated person may not recommend any of the 
securities on the menu to the retail customer.
---------------------------------------------------------------------------

    It is also possible that broker-dealers that limit their menus of 
securities in response to the Conflict of Interest Obligation may 
eliminate securities or investment strategies that are inferior 
relative to other securities or investment strategies in terms of 
performance and costs. Recommendations based on menus of securities 
that do not contain inferior securities or investment strategies are 
more likely to be efficient for the retail customer. To the extent 
broker-dealers eliminate inferior investments from their securities 
menus as a result of complying with the Conflict of Interest 
Obligation, Regulation Best Interest would provide a benefit for the 
retail customers of these broker-dealers.
    Broker-dealers may pass on some of the compliance costs to their 
retail customers. For instance, broker-dealers may increase their fees 
on the services that they provide to retail customers as part of the 
relationship, or may adopt new fees. Alternatively, broker-dealers may 
seek to renegotiate their compensation arrangements with the product 
sponsors in the hopes of extracting greater compensation (e.g., more 
attractive revenue-sharing agreements), relative to current practices. 
The likelihood of a favorable outcome for the broker-dealers may depend 
on whether product sponsors can charge their retail customers higher 
fees. However, it is likely that product sponsors are already charging 
fees that are privately optimal (e.g., maximize their revenue net of 
costs), and thus any deviations from these fees would lead to a 
suboptimal outcome for the product sponsors. In other words, product 
sponsors may not have an incentive to increase their fees.
    A number of commenters stated that policies and procedures that 
address how broker-dealers manage conflicts of interest relating to 
limited menus of securities could impose costs on a retail customer 
when all securities on the menu have high fees or create a benefit for 
retail customers if securities with high fees are eliminated.\1283\ As 
noted in the Proposing Release and above, the Commission acknowledges 
the benefits to the retail customers of the broker-dealers that comply 
with Regulation Best Interest by eliminating inferior securities or 
investment strategies. The Commission also acknowledges the potential 
costs of limited menus of securities by expanding the Conflict of 
Interest Obligation to include requirements that would address 
specifically limited menus of securities and by providing a detailed 
analysis of the economic implications of these requirements, below.
---------------------------------------------------------------------------

    \1283\ See, e.g., CFA August 2018 Letter; AARP August 2018 
Letter; EPI Letter; Better Markets August 2018 Letter.
---------------------------------------------------------------------------

c. Material Limitations on Recommendations to Retail Customers
    The Conflict of Interest Obligation includes a requirement that 
specifically addresses material limitations on recommendations to 
retail customer (e.g., offering only proprietary or other limited range 
of securities). This provision requires broker-dealers to establish, 
maintain, and enforce written policies and procedures reasonably 
designed to identify and disclose any material limitations placed on 
securities or investment strategies that may be recommended to a retail 
investor and any conflicts of interest associated with such limitations 
in accordance with the Disclosure Obligation. It further requires such 
policies and procedures to be reasonably designed to prevent such 
limitations and associated conflicts of interest from causing the 
broker-dealer or its associated persons to make recommendations that 
place the interest of the broker-dealer or associated persons ahead of 
the interest of the retail customer.
    As noted above, broker-dealers may limit their menus of securities 
in response to certain requirements of the Conflict of Interest 
Obligation. The requirements that address limited menus of securities 
are designed to help ensure that these limitations and associated 
conflicts of interest do not create incentives for the broker-dealer or 
its associated persons to make recommendations that are not in the best 
interest of the retail customer. The second aspect of the requirement 
would seek to ensure that the menu of securities is not limited to the 
point where it restricts a broker-dealer and its associated persons 
from complying with the Care Obligation, and in particular with the 
requirement to provide recommendations that are in the customer's best 
interest.\1284\ To the extent these requirements reduce the effect of 
the limitations of the menu of securities and the associated conflicts 
of interest on the recommendations provided by a broker-dealer or its 
associated persons, the Conflict of Interest Obligation would result in 
recommendations that are more likely to be efficient, relative to the 
baseline.
---------------------------------------------------------------------------

    \1284\ Broker-dealers that offer a limited menu of securities 
may not be able to offer recommendations to certain clients. See 
also supra footnote 1282.
---------------------------------------------------------------------------

    The requirements that address limitations of the menu of securities 
may have additional implications for certain product markets, and 
ultimately, retail customers. To better understand these implications 
we focus the discussion on the market for mutual funds.
    As discussed in Section III.B.3, academic literature has noted that 
in certain product markets, such as mutual funds, the different 
distribution channels that product sponsors use to reach the retail 
customer may cause these markets to fragment. In the market for mutual 
fund products, some products are sold to retail customers only through 
broker-dealers--the so-called ``broker-sold'' distribution channel--
while other products are sold

[[Page 33453]]

directly to retail customers--the so-called ``direct-sold'' 
distribution channel.\1285\ The products that are sold through the 
broker-sold channel usually carry higher fees relative to comparable 
products that are sold through the direct-sold channel.\1286\ Higher 
fees on the broker-sold products reflect broker-dealers' compensation 
for distributing the product. In general, all transactions linked to 
the broker-sold distribution channel are triggered by a recommendation 
provided by an associated person of the broker-dealer. Most product 
sponsors currently rely on one of the two channels to distribute their 
products, but not on both.\1287\
---------------------------------------------------------------------------

    \1285\ In this discussion, the broker-sold distribution channel 
includes sales that are the result of a recommendation provided by 
the broker-dealer but may also include sales that are solicited by 
the retail customer where no advice or recommendation was provided 
by the broker-dealer (i.e., unadvised sales). The direct-sold 
distribution channel includes unadvised sales through broker-dealer 
open platforms as well as sales that the retail customer solicits 
directly from the product sponsor. Investment advisers may also 
access products through the direct-sold distribution channel.
    \1286\ See, e.g., Del Guercio & Reuter (2014).
    \1287\ See, e.g., Del Guercio & Reuter (2014), supra footnote 
1081, and Reuter (2015), supra footnote 1095.
---------------------------------------------------------------------------

    A retail customer that has an account with a broker-dealer that 
provides advice is not necessarily constrained to accessing products 
only through the broker-sold channel. A retail customer could access 
products from the direct-sold channel to transact on his or her own 
(for example, if the broker-dealer may not provide recommendations on a 
particular product).\1288\ A retail customer who has access to products 
from both distribution channels and who understands the effect of fees 
on a product's performance may prefer to access a product through the 
broker-sold channel if, for example, the combined cost of identifying 
(e.g., search costs) and accessing comparable direct-sold products 
(e.g., product fee) is higher than the total cost of the broker-sold 
product recommended by the associated person of the broker-
dealer.\1289\ As more direct-sold products enter the market,\1290\ the 
retail customer's cost of identifying \1291\ direct-sold products that 
are comparable alternatives to a broker-sold product recommended by an 
associated person of the broker-dealer may become lower.\1292\ In turn, 
the retail customer's demand for broker-sold products may 
decline.\1293\
---------------------------------------------------------------------------

    \1288\ A retail customer could also access securities through 
financial professionals that are not broker-dealers, including 
investment advisers.
    \1289\ Some broker-dealers may offer securities to retail 
customers through both distribution channels, but these broker-
dealers provide recommendations only on securities offered through 
the broker-sold channel. For example, some broker-dealers with open 
platforms may only provide recommendations on proprietary 
securities.
    \1290\ See, e.g., ICI Letter, which shows an increasing trend in 
the number of mutual funds with no 12b-1 fees over the past 10 
years. These funds are available through the direct-sold channel.
    \1291\ Broker-dealers with open platforms that allow retail 
customers to access securities on this platform without a 
recommendation from the broker-dealer and its associated persons 
generally provide extensive research and analytical tools. The 
Commission has recently adopted rule amendments that address 
research reports that broker-dealers make available to their retail 
customers. See Covered Investment Fund Research Reports, Release 33-
10580 (Nov 30, 2018); 83 FR 64180 (Dec. 13, 2018).
    \1292\ See, e.g., Ali Hortacsu & Chad Sylverson, Product 
Differentiation, Search Costs, and Competition in the Mutual Fund 
Industry: A Case Study of S&P 500 Index Funds, 119 Q. J. Econ. 403 
(2004), who estimate an investor's search costs for S&P500 index 
funds and show that, as the number of S&P500 index funds increased 
over their sample period spanning 1995 to 2000, the investor's 
search costs generally declined. The authors further show that this 
downward trend was driven by funds that are in lower end of the 
search cost distribution and that these funds were mostly no-load 
funds. These no-load funds are usually available through the direct-
sold channel.
    \1293\ However, a retail customer may value the services 
provided by a broker-dealer that extend beyond the provision of 
recommendations on securities transactions and investment strategies 
and continue to maintain an account with the broker-dealer. To 
counter the potential decline in the demand for broker-sold 
products, a broker-dealer may respond by offering more services and 
increasing the fee for the package of services or by trying to shift 
the retail customer to a potentially more profitable advisory 
account (to the extent that the broker-dealer offers this type of 
accounts).
---------------------------------------------------------------------------

    According to economic first principles, when enough retail 
customers exhibit a preference for direct-sold products over broker-
sold products, the aggregate demand for broker-sold products should 
decline. To remain competitive, product sponsors that rely on the 
broker-sold channel to distribute their products would have to lower 
the fees on their products. Lower fees on broker-sold products may 
result in lower compensation for broker-dealers and their associated 
persons from providing recommendations on these products. Lower fees on 
broker-sold products would benefit retail customers who access mutual 
fund products through the broker-sold channel.
    This market mechanism would allow retail customers' demand to 
affect how product sponsors compensate broker-dealers for recommending 
broker-sold products. While this mechanism is currently available to 
retail customers and is considered generally effective, it is not clear 
how effective this mechanism is in all aspects of the market, 
particularly in the short run.\1294\ As noted by one commenter, the 
expense ratio for domestic equity mutual funds declined from 0.86 
percent in 2007 to 0.59 percent in 2017, a 31% reduction over the ten 
year period.\1295\ This commenter further notes that this downward 
trend in expense ratios reflects, among other things, a ``long-running 
shift by investors toward lower-cost funds.'' Because the number of 
low-cost funds that enter the market over the period 2007-2017 has 
increased substantially, the assessment of this commenter would appear 
to be consistent with the market mechanism being effective in the long 
run.\1296\
---------------------------------------------------------------------------

    \1294\ Recent academic research questions the effectiveness of 
the market mechanism, at least in the short run. See. e.g., Yang 
Sun, Does Competition Protect Retail Investors? Role of Financial 
Advice (Working Paper, Apr. 2017), available at https://coller.tau.ac.il/sites/coller-english.tau.ac.il/files/media_server/Recanati/management/conferences/finance/2017/61.pdf. This research 
shows that the sudden entry of several low-cost index funds caused 
direct-sold actively managed funds with similar investment 
objectives to cut their fees by 6.4 basis points. In contrast, 
broker-sold actively managed funds with similar investment 
objectives as the new entrant funds increased their fees by 12.2 
basis points. The study further shows that while some of the fee 
increase in the broker-sold funds is accompanied by increased levels 
of active management, most of the fee increase (more than 60%) was 
passed on to broker-dealers. The author argues that the broker-sold 
actively managed funds are able to increase their fees only to the 
extent that they can signal to the market that they are not 
employing strategies that mimic index funds.
    \1295\ See ICI Letter.
    \1296\ Id. at 42.
---------------------------------------------------------------------------

    As noted above, the effectiveness of the market mechanism may 
depend on a number of factors, including the retail customer's ability 
to understand the effect of fees on the performance of a product and 
willingness to shop around for comparable products, the product 
sponsor's ability to signal how its broker-sold products stand out 
among comparable products, and the broker-dealer's menu and the 
disclosure about potential limitations of this menu.\1297\
---------------------------------------------------------------------------

    \1297\ As noted in supra footnote 1292, the effectiveness of 
this market mechanism may also depend on whether broker-dealers 
offer advisory accounts and whether these broker-dealers can 
convince retail customers to switch to an advisory account rather 
than to a self-directed account.
---------------------------------------------------------------------------

    The Conflict of Interest Obligation may improve the effectiveness 
of this market mechanism through the requirement that broker-dealers 
establish, maintain, and implement written policies and procedures 
reasonably designed to identify and disclose all material limitations 
of products that may be recommended and any associated conflicts of 
interest. This requirement would result in disclosures that, while not 
necessarily new relative to the regulatory baseline, may increase the 
salience of the limitations of product menus and the associated 
conflicts of

[[Page 33454]]

interest for the retail customers.\1298\ The added focus on these 
limitations may cause some retail customers to question whether the 
recommendations that they are receiving are taking into consideration a 
reasonable set of alternatives. Thus, this disclosure may encourage 
retail customers to shop for comparable products that they may prefer 
(e.g., based on cost factors) over the broker-sold products that are 
being recommended to them.
---------------------------------------------------------------------------

    \1298\ See supra footnote 1272 and accompanying text.
---------------------------------------------------------------------------

    As an example, a broker-dealer that is providing recommendations 
only for proprietary products would have to disclose, the material 
limitation that the products on the menu are all proprietary, and the 
material fact of the conflict of interest that the broker-dealer and 
its associated persons are being compensated for selling these 
products. As discussed above in Section II.C.3.f, there are a number of 
other potential conflicts of interest associated with proprietary 
products. While broker-dealers may disclose this information under the 
regulatory baseline, it is not clear the manner in which this 
disclosure currently reaches the retail customer.\1299\ The new 
required disclosure with respect to conflicts of interest (under the 
Disclosure Obligation) is intended to be more comprehensive and more 
specific, and is also intended to reach the retail customer more 
directly. From this perspective, the disclosure of the limitations of 
the product menu and its associated conflict of interest may better 
inform retail customers' choices and, therefore, may be more effective, 
compared to current disclosure forms of the same information. While, 
generally, the effectiveness of disclosure depends on many factors that 
are well known in the academic literature, the disclosure requirement 
of the Conflict of Interest Obligation may also depend on the range of 
material facts that the broker-dealer deems necessary to disclose in 
order to be in compliance with the obligation.\1300\
---------------------------------------------------------------------------

    \1299\ See, e.g., 913 Study.
    \1300\ See supra Section III.B.4.c for a detailed discussion of 
the academic literature on disclosure effectiveness.
---------------------------------------------------------------------------

    The Conflict of Interest Obligation addresses limited product menus 
by requiring that broker-dealers take measures through reasonably 
designed written policies and procedures to evaluate and prevent the 
limitations and the associated conflicts of interest from causing 
associated persons of the broker-dealer to make recommendations that 
are inconsistent with the requirements of Regulation Best Interest. The 
requirement seeks to address specific firm-level conflicts--namely, the 
conflicts associated with the establishment of a product menu--which 
are likely to affect recommendations made to retail customers and may 
result in recommendations that place the interest of the broker-dealer 
or its associated persons ahead of the interest of the retail customer.
    This requirement may have a direct effect on the relationship 
between broker-dealers and product sponsors. To the extent that enough 
broker-dealers decide to no longer offer recommendations on certain 
types of products that carry higher fees (i.e., exclude them from the 
menus), the aggregate demand for such products may decline. Product 
sponsors that face declining demand for some of their products may 
respond by lowering the fees on these products or by repackaging these 
products into new and more competitive products that may again draw the 
interest of the broker-dealers.
d. Elimination of Certain Sales Practices
    As part of the Conflict of Interest Obligation in Regulation Best 
Interest, broker-dealers are required to establish, maintain, and 
enforce written policies and procedures reasonably designed to identify 
and eliminate any sales contests, sales quotas, bonuses, and non-cash 
compensation that are based on the sales of specific securities or 
specific types of securities within a limited period of time. The 
Commission believes that the conflicts of interest associated with 
these practices that may create high-pressure situations for the 
associated persons of the broker-dealer to recommend a specific 
security over another cannot be reasonably addressed through disclosure 
and mitigation and should be addressed through elimination in order to 
comply with the requirements of Regulation Best Interest.\1301\
---------------------------------------------------------------------------

    \1301\ See also the discussion in Section II.C.3.g, supra.
---------------------------------------------------------------------------

    Relative to the regulatory baseline, this requirement would provide 
benefits to retail customers. Conflicts of interest that create 
incentives for the associated persons to recommend a specific security 
(or specific types of securities) over another are likely to have a 
significant effect on an associated person's recommendation, even if 
such conflicts were disclosed and mitigated via policies and procedures 
established, maintained and enforced by the broker-dealer. By 
explicitly requiring policies and procedures reasonably designed to 
eliminate sales practices that may result in such conflicts, the 
requirement should neutralize the effect of these conflicts on the 
recommendations provided by associated persons to retail customers. The 
absence of these conflicts when the associated person is considering 
reasonably available alternatives for a recommendation to a retail 
customer, as noted in the discussion of the Care Obligation, may 
increase the efficiency of the recommendation for their retail 
customers. As discussed above in Section III.A.2, this outcome is 
consistent with Regulation Best Interest reducing the agency costs 
associated with a broker-dealer's incentives or the incentives of its 
associated persons created by these conflicts of interest, which, in 
turn, would benefit the retail customer.
    The requirement to establish policies and procedures reasonably 
designed to eliminate certain sales practices may reduce the total 
compensation that a broker-dealer and its associated person receives 
from providing recommendations to retail customers. As discussed above, 
to the extent that the reduction in an associated person's total 
compensation is sufficiently large, the associated person may have an 
incentive to register as an investment adviser and provide investment 
advice only in his or her advisory capacity. Furthermore, the potential 
decline in the total compensation of an associated person of the 
broker-dealer due to this requirement may dissuade financial 
professionals from providing advice in the capacity of a broker-dealer, 
and as a result, broker-dealers may find it more difficult to hire new 
associated persons, relative to the baseline.
    In addition, the types of sales practices that this requirement is 
meant to address generally create incentives for associated persons to 
recommend certain types of securities or investment strategies over 
certain time periods over other types of securities or investment 
strategies. By requiring broker-dealers to establish policies and 
procedures reasonably designed to eliminate certain sales practices 
that create these types of incentives, broker-dealers may experience a 
reduction in the revenue stream associated with certain securities or 
investment strategies. Thus, through this requirement, Regulation Best 
Interest may impose a cost on the broker-dealers that currently rely on 
these types of practices in order to incentivize sales. On the other 
hand, retail customers who have born costs associated with such 
practices will benefit from the cessation of these sales practices.

[[Page 33455]]

    As discussed above, while we are unable to quantify the full costs 
of Regulation Best Interest, including the Conflict of Interest 
Obligation, we are able to estimate some of the costs associated with 
the Conflict of Interest Obligation, specifically the costs related to 
information collection requirements as defined by the Paperwork 
Reduction Act. As discussed further in Section IV.B.1, the Commission 
believes that broker-dealers would update their policies and procedures 
to comply with this requirement and would incur an initial aggregate 
burden of approximately 128,160 hours and an additional initial 
aggregate cost of approximately $25 million, as well as an ongoing 
aggregate annualized burden of approximately 27,900 hours, and an 
ongoing aggregate annualized cost of approximately $2.91 million.\1302\ 
Furthermore, the Commission believes that in order to identify 
conflicts of interest and determine whether the conflicts are material, 
broker-dealers would incur an initial aggregate burden of approximately 
69,150 hours and an additional initial aggregate cost of approximately 
$15.71 million as well as an ongoing aggregate annualized burden of 
approximately 27,660 hours.\1303\ Thus, we estimate the Conflict of 
Interest Obligation of proposed Regulation Best Interest would impose 
an initial aggregate cost of at least $110.73 million and an ongoing 
aggregate annual cost of at least $20.44 million on broker-
dealers.\1304\
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    \1302\ These estimates are based on the following calculations: 
120,600 hours + 7,560 hours = 128,160 hours; $10 million + $15 
million = $25 million; and 24,120 hours + 3,780 hours = 27,900 
hours. As discussed in more detail in infra Section V.D, 120,600 
hours and 7,560 hours are preliminary estimates for the initial 
aggregate burdens for large and small broker-dealers, respectively, 
$10 million and $15 million are preliminary estimates for the 
initial aggregate costs for large and small broker-dealers, 
respectively, and 24,120 hours and 3,780 hours are preliminary 
estimates for the ongoing aggregate burdens for large and small 
broker-dealers, respectively.
    \1303\ The estimate of the initial aggregate burden is based on 
the following calculations: 13,830 hours + 55,320 hours = 69,150 
hours, where, as discussed in more detail in Section V.D, 13,830 
hours and 55,320 hours are estimates for the initial aggregate 
burdens for identifying conflicts of interest and determining 
whether the conflicts are material for all broker-dealers, 
respectively.
    \1304\ These estimates are calculated as follows: (90,450 hours 
of in-house legal counsel) x ($415.72/hour for in-house counsel) + 
(27,660 hours for in-house compliance counsel) x ($365.39/hour for 
in-house compliance counsel) + (27,660 hours for identifying 
conflicts of interest) x ($229.74/hour for business line personnel) 
+ (51,540 hours for review of policies and procedures) x ($309.60/
hour for in-house compliance manager) + (50,302 hours for outside 
legal counsel) x ($497/hour for outside legal counsel) + (55,317 
hours for modifying existing technology) x ($284/hour for outside 
senior programmer) = $110.73 million, and (8,040 hours of in-house 
legal counsel) x ($415.72/hour for in-house counsel) + (21,870 hours 
for in-house compliance counsel) x ($365.39/hour for in-house 
compliance counsel) + (21,870 hours for identifying conflicts of 
interest) x ($229.74/hour for business line personnel) + (3,780 
hours for review of policies and procedures) x ($309.60/hour for 
compliance manager) + (3,783 hours for outside legal counsel) x 
($497/hour for outside legal counsel) + (3,773 hours for outside 
compliance services) x ($273/hour for outside compliance services) = 
$20.44 million. The hourly wages for in-house legal and compliance 
counsel, registered representatives, senior business analyst, 
compliance manager, and business-line personnel are obtained from 
SIFMA. The hourly rates for outside legal counsel, outside senior 
programmer, systems analyst or programmer and outside compliance 
services are discussed in infra Section V.D.
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5. Compliance Obligation
    The Compliance Obligation of Regulation Best Interest requires 
broker-dealers to establish, maintain, and enforce written policies and 
procedures reasonably designed to achieve compliance with Regulation 
Best Interest.\1305\ This obligation creates an affirmative obligation 
under the Exchange Act with respect to Regulation Best Interest as a 
whole, while providing sufficient flexibility to allow broker-dealers 
to establish compliance policies and procedures that accommodate a 
broad range of business models.\1306\
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    \1305\ These policies and procedures are in addition to the 
policies and procedures required under the Conflict of Interest 
Obligation.
    \1306\ See supra Section II.C.4.
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    The Compliance Obligation is designed to ensure that broker-dealers 
have internal controls in place to prevent violations of Regulation 
Best Interest. The policies and procedures required to comply with this 
obligation would allow the Commission to identify and address potential 
compliance deficiencies or failures (such as inadequate or inaccurate 
policies and procedures, or failure to follow the policies and 
procedures) early on, reducing the chance of retail customer 
harm.\1307\
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    \1307\ See supra Section II.C.4.
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    As discussed above in Section III.B.2.d, under the regulatory 
baseline, broker-dealers are subject to supervisory obligations that, 
among other things, require them to establish policies and procedures 
reasonably designed to prevent and detect violations of, and achieve 
compliance with, the federal securities laws and regulations,\1308\ as 
well as applicable SRO rules.\1309\ Broker-dealers would have the 
ability to update these policies and procedures to comply with the 
Compliance Obligation, rather than create new policies and procedures.
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    \1308\ See Section 15(b)(4)(E) of the Exchange Act.
    \1309\ See FINRA Rule 3110 (Supervision).
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    The obligation indirectly benefits retail customers by ensuring 
that broker-dealers have sufficient internal controls in place to 
support compliance with Regulation Best Interest.
    The obligation will impose compliance costs on broker-dealers. 
However, these costs are likely to be smaller for those broker-dealers 
that already have effective compliance systems in place, including 
effective policies and procedures.
    Broker-dealers may incur operational costs related to training 
their associated persons and developing policies and procedures to 
ensure compliance with the Care Obligation. For example, broker-dealers 
may have to provide training to their employees and other associated 
persons on how to make recommendations that do not place the interest 
of the broker-dealer or their associated persons ahead of the interest 
of the retail customer. In the Proposing Release, these training costs 
were discussed as part of a separate general best interest obligation, 
and our assessment of those costs has not changed.\1310\ Broker-dealers 
also may incur costs related to training their associated persons on 
how to determine that they have a reasonable basis to believe that a 
recommendation is in a retail customer's best interest. This may 
include training on how to evaluate the potential risks, rewards, and 
costs associated with a recommendation as well as how a retail 
customer's investment profile affects this determination. Additionally, 
broker-dealers may incur costs related to training their associated 
persons on any relevant factors specific to making recommendations 
regarding IRAs, IRA rollovers, or other account types, as well as 
implicit hold recommendations resulting from agreed-upon account 
monitoring. These training costs will be lower for broker-dealers that 
already operate in a manner that is consistent with the requirements of 
the Care Obligation and higher for those that do not. Firms may already 
comply with the requirements of the Care Obligation, to varying 
degrees, either of their own volition or because they are already 
subject to and comply with similar obligations.
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    \1310\ See Proposing Release at Section IV.C.2.a.
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    As discussed above, while we are unable to quantify the full costs 
of Regulation Best Interest, including the Compliance Obligation, we 
are able to estimate some of the costs associated with the Compliance 
Obligation, specifically the costs related to information collection 
requirements as defined by the Paperwork Reduction

[[Page 33456]]

Act. As discussed further in Section IV.B.1, the Commission believes 
that broker-dealers would update their policies and procedures to 
comply with this requirement. We estimate that broker-dealers would 
incur an initial aggregate burden of 524,404 hours and an additional 
initial aggregate cost of approximately $76.3 million, as well as an 
ongoing aggregate annualized burden of 452,524 hours, and an ongoing 
aggregate annualized cost of approximately $2.91 million.\1311\ Thus, 
the Compliance Obligation of Regulation Best Interest would impose an 
initial aggregate cost of at least $214.66 million and an ongoing 
aggregate annual cost of at least $110.86 million on broker-
dealers.\1312\
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    \1311\ These estimates are based on the following calculations: 
80,400 hours + 4,536 hours + 11,064 hours + 428,404 hours= 524,404 
hours; $6 million + $7.5 million + $62.8 million = $76.3 million; 
and 24,120 hours + 428,404 hours = 452,524 hours. As discussed in 
more detail in infra Section V.D, 80,400 hours, 4,536 hours, 11,064 
hours and 428,404 hours are estimates for the initial aggregate 
burdens for large and small broker-dealers, updating training 
module, and training, respectively. In addition, $6 million, $7.5 
million, and $62.8 million are estimates for the initial aggregate 
costs for large and small broker-dealers and updating training 
modules, respectively. Furthermore, 24,120 hours and 428,404 hours 
are estimates for the ongoing aggregate burdens for large broker-
dealers and training, respectively. Finally, $2.91 million is the 
estimate of the ongoing aggregate cost for small broker-dealers.
    \1312\ These estimates are calculated as follows: (65,832 hours 
of in-house legal counsel) x ($415.72/hour for in-house counsel) + 
(4,536 hours for in-house compliance counsel) x ($365.39/hour for 
in-house compliance counsel) + (10,050 hours for reviewing policies 
and procedures) x ($446.04/hour for in-house general counsel) + 
(15,582 hours for reviewing policies and procedures and update 
existing training systems) x ($309.60/hour for in-house compliance 
manager) + (428,404 hours for training) x ($233.02/hour for 
registered representative) + (27,163 hours for outside legal 
counsel) x ($497/hour for outside legal counsel) + (221,127 hours 
for updating training module) x ($284/hour for outside senior 
programmer or systems analyst)= $214.66 million, and (8,040 hours of 
in-house legal counsel) x ($415.72/hour for in-house counsel) + 
(8,040 hours for in-house compliance counsel) x ($365.39/hour for 
in-house compliance counsel) + (8,040 hours for updating policies 
and procedures) x ($229.74/hour for business line personnel) + 
(8,040 hours for reviewing policies and procedures) x ($309.60/hour 
for compliance manager) + (3,783 hours for outside legal counsel) x 
($497/hour for outside legal counsel) + (3,773 hours for outside 
compliance services) x ($273/hour for outside compliance services) + 
(428,404 hours of training) x ($233.02/hour for registered 
representative) = $110.86 million. The hourly wages for in-house 
legal and compliance counsel, registered representatives, senior 
business analyst, compliance manager, and business-line personnel 
are obtained from SIFMA. The hourly rates for outside legal counsel, 
outside senior programmer, systems analyst or programmer and outside 
compliance services are discussed in infra Section V.D.
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6. Record-Making and Recordkeeping
    Regulation Best Interest will also impose record-making and 
recordkeeping requirements on broker-dealers with respect to certain 
information collected from, or provided to, retail customers. The 
Commission is amending Rules 17a-3 and 17a-4 of the Exchange Act, which 
specify minimum requirements with respect to the records that broker-
dealers must make, and how long those records and other documents must 
be kept, respectively. We are amending Rule 17a-3 by adding a new 
paragraph (a)(35) that requires a record of all information collected 
from, and provided to, the retail customer pursuant to Regulation Best 
Interest, as well as the identity of each natural person who is an 
associated person of a broker or dealer, if any, responsible for the 
account. This requirement applies to each retail customer to whom a 
recommendation of any securities transaction or investment strategy 
involving securities is provided. The neglect, refusal, or inability of 
a retail customer to provide or update any information about the 
customer investment profile will, however, excuse the broker-dealer 
from obtaining that information. Rule 17a-4(e)(5) will be amended to 
require that broker-dealers retain all records of the information 
collected from or provided to each retail customer pursuant to 
Regulation Best Interest for at least six years after the earlier of 
the date the account was closed or the date on which the information 
was last replaced or updated.
    The requirement to create certain written records of information 
collected from or provided to a retail customer under the Disclosure 
Obligation will trigger a record-making obligation under paragraph 
(a)(35) of Rule 17a-3 and a recordkeeping obligation under Rule 17a-
4(e)(5) that may impose additional compliance costs on broker-dealers. 
In cases where broker-dealers choose to meet part of the Disclosure 
Obligation orally under the circumstances outlined above in Section 
II.C.1, Oral Disclosure or Disclosure After a Recommendation, the 
requirement to maintain a record of the fact that oral disclosure was 
provided to the retail customer will trigger a record-making obligation 
under paragraph (a)(35) of Rule 17a-3 and a recordkeeping obligation 
under Rule 17a-4(e)(5) that may impose additional compliance costs on 
broker-dealers. Furthermore, the Care Obligation may require creating 
new documents or modifying existing documents to reflect standardized 
questionnaires seeking customer investment profile information. These 
requirements will also trigger a record-making obligation under 
paragraph (a)(35) of Rule 17a-3 and a recordkeeping obligation under 
Rule 17a-4(e)(5) that will impose additional compliance costs on 
broker-dealers. Currently, under Rule 17a-3(a)(17), broker-dealers that 
make recommendations for accounts with a natural person as customer or 
owner are required to create, and periodically update, specified 
customer account information. However, the information collection 
requirements of Rule 17a-3(a)(17) do not cover all aspects of the 
``customer investment profile'' that broker-dealers may attempt to 
obtain to make a customer-specific suitability determination under the 
Suitability Rule.
    As noted above, the Conflict of Interest Obligation requires 
broker-dealers to establish policies and procedures that are reasonably 
designed to address conflicts of interest, including disclosing 
material facts associated with the conflicts. The disclosures will be 
made pursuant to the Disclosure Obligation and are not expected to 
trigger record-making or recordkeeping obligations outside the 
Disclosure Obligation.
    The Commission is providing estimates of the initial and ongoing 
burden hours associated with the record-making and recordkeeping 
obligations of the Disclosure, Care, and Conflict of Interest 
Obligations, under certain assumptions. These estimates are discussed 
in Section IV.B.5. Based on these burden hours estimates, the 
Commission expects that the record-making and recordkeeping obligations 
of Regulation Best Interest will impose an initial aggregate burden of 
17,684,020 hours and an additional initial aggregate cost of $375,732 
as well as an ongoing aggregate annualized burden of 5,520,800 hours on 
broker-dealers.\1313\

[[Page 33457]]

After monetizing the burden hours, the record-making and recordkeeping 
obligations will impose an initial aggregate cost of at least $4,121.73 
million and an ongoing aggregate annual cost of at least $1,736.52 
million on broker-dealers.\1314\
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    \1313\ These estimates are based on the Commission's estimates, 
discussed in Section IV.B.5, with respect to the initial and ongoing 
aggregate costs and burdens imposed on broker-dealers by the record-
making obligation of proposed Rule 17a-3(a)(35) and the 
recordkeeping obligation of the proposed amendment to Rule 17a-
4(e)(5) associated with all component obligations of Regulation Best 
Interest. The estimate of the initial aggregate burden is based on 
the following calculation: 4,020 hours + 4,080,000 hours + 
13,600,000 hours = 17,684,020 hours, where, as discussed in more 
detail in Section IV.B.5, 4,020 hours is the estimate of amending 
the account disclosure agreement by large broker-dealers, 4,080,000 
hours is the estimate of the burden associated with filling out the 
information disclosed pursuant to Regulation Best Interest in the 
account disclosure agreement, and 13,600,000 hours is the estimate 
of the burden to broker-dealers for adding new documents or 
modifying existing documents to the broker-dealer's existing 
retention system. $375,732 is the estimate of amending the account 
disclosure agreement by small broker-dealers pursuant to the record-
making obligation of Rule 17a-3(a)(35). The estimate of the ongoing 
annual burden is 3,400,00 hours + 1,060,000 hours + 1,060,000 hours 
= 5,520,800 hours where 3,400,00 hours is the estimate of complying 
with the recordkeeping obligation of the amendment to Rule 17a-
4(e)(5) and 1,060,000 hours are estimates of both the record-making 
and recordkeeping obligations associated with oral disclosure.
    \1314\ These estimates are calculated as follows: (2,010 hours 
of in-house legal counsel) x ($415.72/hour for in-house counsel) + 
(17,680,000 hours for entering and adding new or modifying existing 
documents in each customer account) x ($233.02/hour for registered 
representative) + (2,010 hours for in-house compliance counsel) x 
($365.39/hour for in-house compliance counsel) + (756 hours for 
outside legal counsel) x ($497/hour for outside legal counsel) = 
$4,121.73 million, and (3,400,000 hours for recordkeeping) x 
($365.39/hour for in-house compliance counsel) + (1,060,000 hours 
for record-making associated with oral disclosure) x ($233.02/hour 
for registered representative) + (1,060,000 hours for record-keeping 
associated with oral disclosure) x ($233.02/hour for registered 
representative) = $1,736.52 million. The hourly wages for in-house 
legal and compliance counsel and registered representatives are 
obtained from SIFMA. The hourly rates for outside legal counsel are 
discussed in infra Section IV.B.5.
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7. Approaches to Quantifying the Potential Benefits
    As discussed above, several commenters suggested that we quantify 
the existing harm to investors under the baseline and the corresponding 
benefit resulting from Regulation Best Interest. We continue to believe 
that it is not possible to quantify, with meaningful precision, either 
the existing harm or the specific benefits we expect to flow from 
Regulation Best Interest. Such an analysis, including one that would 
produce ranges, depends on many contingent factors that render any 
estimate insufficiently precise to inform our policy choices.\1315\ 
Nonetheless, the Commission has endeavored to estimate some of the 
potential benefits that may result from Regulation Best Interest using 
a variety of methodologies, which are explained below in more detail 
along with certain caveats and the principal assumptions relied on. 
Specifically, we have attempted to estimate the benefit that may result 
from a reduction in fees due to increased competition; we also consider 
the potential benefit arising from a reduction in the relative 
performance differences of broker-sold and direct-sold mutual funds.
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    \1315\ See supra footnote 1156 and subsequent text for a 
discussion of these factors. For these reasons and because we 
believe that quantification of the costs and benefits of the 
alternatives discussed in infra Section III.E would require still 
further assumptions, lead to additional imprecision, and yield less 
meaningful results, we have not included quantified estimates of the 
economic effects of these alternatives.
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    The quantification exercise below provides an estimate for some of 
the potential benefits associated with Regulation Best Interest. For 
example, as discussed in more detail below, a potential reduction in 
fees can benefit retail customers in other ways beyond reducing the 
total dollar amount paid for investment services. Furthermore, as 
discussed elsewhere in this economic analysis, the rule is expected to 
generate other benefits for retail customers that we are not able to 
meaningfully quantify.
a. Benefit to Investors Due to a Potential Reduction in Fees
    As discussed above, Regulation Best Interest may reduce the 
attractiveness of certain products to broker-dealers due to the Care 
Obligation (e.g., the emphasis on the need to consider cost, among 
other things) and the Conflict of Interest Obligation (e.g., addressing 
conflicts of interest, including product menu limitations) and/or may 
reduce retail customers' aggregate demand for certain products due to 
the Disclosure Obligation (e.g., due to a reduction in any information 
asymmetry with respect to fees). To the extent that Regulation Best 
Interest produces these effects on certain products, the affected 
product sponsors may react by lowering the fees that they charge retail 
customers on these products to be more competitive, or by repackaging 
these products into new products that are more competitively priced. 
The increased competition generated by the lower fees for affected 
products may further incentivize other product sponsors (i.e., those 
not directly affected by Regulation Best Interest) to lower their fees 
as well.\1316\ Alternatively, a product sponsor may preempt the 
potential decline in the aggregate demand for its products by lowering 
the fees before other sponsors do.
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    \1316\ A product sponsor that does not lower its fees on a given 
product may risk experiencing low retail customer aggregate demand 
or low demand from broker-dealers as a result of Regulation Best 
Interest. To stay competitive this product sponsor may have to lower 
the fees on its product.
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    For the purposes of calculation, we assume that this potential 
competition in prices results in a new long-run equilibrium in this 
product market, in which product sponsors charge fees that are close to 
or equal to their marginal costs. Lower fees translate into direct 
savings to retail customers. If a portion of fees collected from retail 
customers serves to compensate broker-dealers for selling certain 
investment products, then lowering those fees could also translate into 
less severe conflicts of interest. Thus, a reduction in fees may 
improve the efficiency of the recommendations that broker-dealers make 
to retail customers. This potential increase in the efficiency of the 
recommendations received also benefits retail customers.\1317\
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    \1317\ For purposes of this analysis, we assume that product 
sponsors respond to competitive pressures by lowering their fees. 
However, competition may affect quality in addition to price. For 
example, product sponsors may choose to offer higher quality 
products which may be costlier to produce (e.g., because they must 
hire more skilled managers or apply more costly technology) and as 
such require higher fees. Alternatively, product sponsors may lower 
fees by reducing the quality of their product (e.g., hiring fewer 
skilled managers) and, as a result, offering lower fee products that 
may produce lower average returns. Competition along both of these 
dimensions may allow retail customers to choose different 
combinations of quality and price, depending on their individual 
preferences.
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    The market for mutual fund products may illustrate the potential 
for attaining such a new long-run equilibrium as a result of Regulation 
Best Interest. We focus on mutual funds for this analysis because of 
the available data for mutual funds, but we expect the same or similar 
dynamics could apply to other financial products. As this market 
transitions toward this new long-run equilibrium, total fund expenses 
(i.e., distribution expenses and management fees) that are in excess of 
the marginal cost of distributing and operating the fund may be reduced 
in a number of ways, including by lowering fees, reliance on 
alternative distribution channels, or exiting the market in whole or in 
part (i.e., by limitations on offerings). Below we attempt to quantify 
the benefits associated with this potential long-run equilibrium in the 
market for mutual fund products as a result of such reduction in fees, 
relative to the baseline, assuming all funds reduced fees to marginal 
costs. To this end, we start with the current distribution of fees of 
funds within each Center for Research in Security Prices (CRSP) 
objective class.\1318\ We focus on funds that have reported this 
information in 2018 in CRSP. We perform the analysis using total fees 
(i.e., fund expense ratios). As an alternative, we also perform the 
analysis using the component of the total fees that are allocated 
toward distribution and

[[Page 33458]]

marketing expenses, and that we can observe, namely 12b-1 fees.\1319\
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    \1318\ Calculated based on data from the Center for Research in 
Security Prices (CRSP), University of Chicago Booth School of 
Business. Funds with different objectives may incur different 
marginal costs due to the frequency of trading in the markets that 
are reflective of the objective of the fund, advertising to reach a 
certain clientele, distribution costs, etc. The CRSP Mutual Fund 
dataset includes a breakdown of mutual funds by their objective 
types.
    \1319\ 12b-1 fees are paid out of fund assets to cover the costs 
of marketing and selling fund shares. ``Distribution fees'' include 
fees to compensate brokers and others who sell fund shares, and to 
pay for advertising and printing and mailing prospectuses to new 
investors. ``Shareholder service fees'' are fees that cover the cost 
of responding to investor inquiries and providing investors with 
information. This analysis excludes loads because, unlike 12b-1 
fees, loads cannot be separately broken out.
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    We estimate the marginal cost of distributing and operating a non-
index fund in a given CRSP objective class (i.e., strategy) as the 
minimum total fee of the funds in that class, after excluding index 
funds. Similarly, we estimate the marginal cost of operating an index 
fund in a given CRSP objective class as the minimum total fee of the 
index funds in that class. We then calculate the maximum ``excess fee'' 
for a fund (index or non-index) as the difference between the actual 
total fee of the fund and the marginal cost of the CRSP objective class 
that contains the fund. By construction, the excess fee cannot be 
negative.
    We obtain an aggregate amount of reduced fees of approximatively 
$22.2 billion for non-index funds and $1.4 billion for index funds 
annually at the new potential equilibrium.\1320\ The aggregate amount 
of saved fees across index and non-index funds becomes approximatively 
$23.6 billion. Similarly, if we focus on 12b-1 fees only, the aggregate 
amount of saved fees are $9.13 billion for non-index funds and $0.32 
billion for index funds, or $9.45 billion across both index and non-
index funds.
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    \1320\ We calculate the dollar value associated with these 
excess fees by multiplying the excess fees of a fund with total net 
assets (TNA) of the fund and then aggregating across funds. This 
amount represents the capital that would be reallocated towards more 
efficient funds and can be thought of as ``fees saved'' by retail 
customer as this product market shifts from the baseline equilibrium 
to the new equilibrium.
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    Using certain assumptions to calculate the present value of this 
potential fee reduction,\1321\ we calculate the net benefit of the new 
equilibrium as the difference between the two present values of 
declining perpetuities that pay the dollar value associated with excess 
fees under the baseline equilibrium and the new equilibrium, 
respectively, for each of the three scenarios. When using the total 
fees, we obtain an expected net benefit of $35.21 billion in the 
moderate decay scenario, $59.15 billion in the accelerated decay 
scenario, and $76.49 billion in the rapid decay scenario. Similarly, 
when using 12b-1 fees only, we obtain an expected net benefit of $14.10 
billion in moderate decay scenario, $23.69 billion in the accelerated 
decay scenario, and $30.63 billion in the rapid decay scenario.
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    \1321\ First, we note that expense ratios for equity mutual 
funds have declined at a rate of about 3% per year since 2000. This 
rate doubles to 6% if we focus on the period following FINRA's 
adoption of the Suitability Rule in 2011. We assume that under the 
current equilibrium, or ``baseline equilibrium,'' excess fees--as 
defined above--would continue to decline at the rate of 3% per year. 
This rate of decay corresponds to a half-life of approximatively 23 
years. We further assume that as the product market shifts towards 
the new equilibrium, excess fees decline at a rate that is at least 
as high as the post-2011 rate. Because Regulation Best Interest 
enhances the broker-dealer standard of conduct established by the 
Suitability Rule--particularly with respect to the disclosure, 
mitigation, or elimination of conflicts of interest, which is not 
addressed by the Suitability Rule--and the federal securities laws, 
we believe that a rate of decay that is at least as large as the one 
observed in the post-2011 period is not unreasonable. Under this 
assumption, we consider three scenarios: (1) Moderate decay at 6%; 
(2) accelerated decay at 9%; and (3) rapid decay at 12%. The half-
life for each of these scenarios is 11.5 years, 7.7 years, and 5.8 
years, respectively. Finally, we assume that the opportunity cost of 
the excess fees is equal to the expected rate of return on the 
value-weighted market portfolio, as defined in CRSP, as these fees 
encumber capital that would have otherwise been invested in 
efficient funds. To estimate the expected return on the market 
portfolio, we assume that the discount rate is the geometric average 
of the annual rate of return on the market portfolio over the period 
1927-2018, namely 9.76%.
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b. Benefits to Investors Due to a Potential Reduction in the Relative 
Underperformance of Broker-Versus Direct Sold Mutual Funds
    Another way to estimate the potential benefits of Regulation Best 
Interest is to use aspects of the approach used in the CEA Study and 
the DOL RIA, as suggested by several commenters.\1322\ Specifically, we 
rely on academic literature claiming that, to varying degrees, broker-
sold mutual funds underperform direct-sold mutual funds and assume that 
underperformance reflects agency costs associated with the conflicts of 
interest that may be present in recommendations provided by broker-
dealers. Although this literature addresses only a portion of the AUM 
affected by Regulation Best Interest, we use methods from these studies 
to estimate the monetary effect the final rule might produce by 
reducing the effect that conflicts of interest have on the 
recommendations provided by broker-dealers.
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    \1322\ See supra footnote 1167.
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    Total AUM of load and no-load long-term mutual funds in the U.S. as 
of the end of 2018 are approximately $12.4 trillion, with $10.4 
trillion attributable to no-load funds and $2.1 trillion attributable 
to load funds.\1323\ To estimate the monetary effect of potential 
conflicts of interest as they pertain to mutual funds, we use estimates 
of the difference in net returns (gross returns on a fund's performance 
less fees and other expenses associated with the fund) between broker-
sold funds and funds that are direct-sold from Reuter (2015).\1324\ We 
then apply this difference to the aggregate market capitalization of 
load funds, which we assume are sold with a recommendation from a 
broker-dealer because we cannot identify the channel through which 
mutual funds are sold or whether each sale through the broker-sold 
channel involves a recommendation. To the extent that no-load funds are 
also sold by broker-dealers, this assumption may cause us to 
underestimate the portion of mutual fund AUM that are sold with a 
recommendation from a broker-dealer.\1325\ Because the data in Reuter 
(2015) ends in 2012, for the purposes of this approach we assume that 
the relative underperformance of broker-sold funds, and hence our 
application of this underperformance to load funds as a proxy for funds 
sold with a recommendation from a broker-dealer, remains unchanged from 
2012.\1326\
---------------------------------------------------------------------------

    \1323\ See Investment Company Institute 2019 Fact Book, Figure 
6.12.
    \1324\ See Reuter (2015), supra footnote 1095. In contrast to 
the DOL RIA, we do not base our analysis on excess loads, as 
estimated in Christoffersen et al. (2013), supra footnote 1081. 
Prior commenters noted that the average excess load, by definition, 
is zero and would likely yield a much lower estimate of aggregate 
harm, than the estimate published by the CEA and include in the DOL 
RIA. See, e.g., Lewis (2017), supra footnote 1099. See also supra 
footnotes 1169 and 1170.
    \1325\ Brokers may still be compensated for selling no-load 
funds by 12b-1 fees, revenue sharing, or other arrangements.
    \1326\ See supra footnote 1102 for discussion of how trends in 
the relative performance of load funds may have changed in more 
recent years.
---------------------------------------------------------------------------

    Reuter (2015) employs a variety of methods in computing the 
difference in net returns between broker-sold and direct-sold actively 
managed funds, including different ways of computing net returns (e.g., 
net return, net return plus 12b-1 fees, net alphas, and ordinary least-
squares and weighted least-squares regression methods), different 
samples (e.g. ``non-specialized domestic equity''), and different 
weighting schemes (e.g. equally weighted or value weighted returns). 
Reuter concludes by noting that the performance difference between 
broker-sold and direct-sold actively managed mutual funds is likely to 
fall between 0.20% and 0.47%, depending whether or not 12b-1 fees are 
included in the estimation. Given that the underperformance only 
affects broker-sold funds, and applying these underperformance 
estimates to load funds, the estimated monetized underperformance of 
broker-sold funds

[[Page 33459]]

ranges from $4.1 billion per year to $9.7 billion per year.
    As discussed elsewhere in this release, we expect Regulation Best 
Interest will reduce the severity of conflicts of interest that may 
contribute to the underperformance between broker-sold and direct-sold 
mutual funds. However, the range noted above most likely overestimates 
the expected reduction in harm associated with broker-sold mutual funds 
due to Regulation Best Interest for a number of reasons. First, as 
discussed by Bergstresser et al. (2009), broker-sold funds can be sold 
by both broker-dealers and investment advisers (e.g., dually registered 
investment advisers), and the data these studies relied upon is not 
sufficiently granular to identify the fraction of broker-sold funds 
sold by each type of financial professional.\1327\ Because Regulation 
Best Interest applies to registered broker-dealers, this range would 
need to be narrowed to reflect the proportion of broker-sold funds sold 
by registered broker-dealers.
---------------------------------------------------------------------------

    \1327\ See Bergstresser et al. (2009), supra footnote 1048.
---------------------------------------------------------------------------

    Second, the estimated range fully attributes the differences 
between direct-sold funds and broker-sold funds to conflicts of 
interest between retail customers and broker-dealers. This might over-
estimate the benefits of Regulation Best Interest because there might 
be other unobservable systematic differences between investors who 
choose direct-sold funds versus those who choose to employ a financial 
professional. For example, retail customers that buy broker-sold funds 
might be willing to pay more for those funds if they receive intangible 
benefits from a broker-dealer's recommendation that are not reflected 
in the relative performance between funds sold through these two 
channels. Furthermore, not all sales in the broker-sold channel are 
triggered by recommendations provided by broker-dealers or their 
associated persons. For example, customer-directed transactions may not 
involve a recommendation at all.
    Third, measuring a fund's performance using its net return relative 
to a benchmark might not be the most accurate measure of a fund 
manager's skill or the value created by a fund to an investor.\1328\ 
Therefore, estimating investor harm assuming this definition of the 
value created by a fund might potentially overstate or understate this 
harm.
---------------------------------------------------------------------------

    \1328\ See supra footnote 1176.
---------------------------------------------------------------------------

    Taking into account these caveats,\1329\ to the extent that 
Regulation Best Interest mitigates, and in the limit, eliminates the 
adverse effects of conflicts of interest on broker-dealers' 
recommendations, we estimate that the benefits attributable to 
Regulation Best Interest could be as large as $4.1 billion per year to 
$9.7 billion per year when estimated assuming that the relative 
underperformance of broker-sold mutual funds estimated in the academic 
literature reflects conflicts of interest that will eventually be 
eliminated.
---------------------------------------------------------------------------

    \1329\ See supra footnotes 1172-1178 for further discussion of 
the limitations that apply in using the relative underperformance of 
broker-sold mutual funds as an estimate of investor harm and, 
therefore, the benefits of Regulation Best Interest.
---------------------------------------------------------------------------

    As with our other estimates of the benefits above, we assume that 
there is already a decreasing trend in the underperformance gap under 
the baseline that is consistent with the decreasing trend in mutual 
fund expense ratios of 3%, and that Regulation Best Interest will 
accelerate this trend to a decay rate under three scenarios: (1) 
Moderate decay at 6%; (2) accelerated decay at 9%; and (3) rapid decay 
at 12%. Similarly, we assume a discount rate of 9.76% as above to value 
these cash flows. Under these assumptions, the present value of the 
potential benefits of Regulation Best Interest in the mutual fund 
sector, relative to the baseline, from limiting or eliminating the 
adverse effects of conflicts of interest could be as large as 
approximately $6.8 to $16 billion in the moderate decay scenario, $11.4 
to $26.7 billion in the accelerated decay scenario, and $14.7 to $34.5 
billion in the rapid decay scenario.
    Finally, we can obtain an approximate estimate of the present value 
of the costs associated with Regulation Best Interest using the costs 
estimated in Section IV for purposes of the Paperwork Reduction Act, 
which imply aggregate initial costs of approximately $5.96 billion and 
ongoing costs of $2.37 billion. Assuming the initial costs are incurred 
one year from the rule's enactment, and using a discount rate of 9.76% 
as above, the present value of these costs is approximately $27.5 
billion. Note that this cost estimate cannot be directly compared with 
the benefit estimates above as the benefits estimates are with respect 
to mutual funds only.

D. Efficiency, Competition, and Capital Formation

    As discussed above, Regulation Best Interest is designed to address 
the agency costs that arise when an associated person of the broker-
dealer provides a recommendation to a retail customer that may not be 
fully addressed by the regulatory baseline. Regulation Best Interest is 
intended to reduce agency costs and other costs by enhancing the 
standard of conduct of broker-dealers, increasing the effectiveness of 
disclosure to allow retail customers to make a more informed decision 
with respect to the recommendation they receive and by requiring 
broker-dealers to implement policies and procedures reasonably designed 
to reduce the effect of conflicts of interest on recommendations to 
retail customers. Specifically, the Disclosure Obligation and Conflict 
of Interest Obligation require broker-dealers to disclose information 
that, while not necessarily new in all instances, will reach retail 
customers more directly and more timely than under the regulatory 
baseline. In addition, the disclosed information would raise a retail 
customer's salience of fees, scope of the relationship, conflicts of 
interest, and limitations of the menu of securities from which the 
retail customer receives recommendations as potential factors affecting 
the recommendations of a broker-dealer or its associated persons. The 
content and form of disclosure may help some retail customers make more 
informed decisions with regards to whether to act on a recommendation 
provided by an associated person of the broker-dealer. Regulation Best 
Interest may also reduce the agency costs faced by these retail 
customers.
    The Conflict of Interest Obligation also requires broker-dealers to 
implement policies and procedures to reduce the effect of conflicts of 
interest and securities menu limitations on recommendations to retail 
customers. For broker-dealers that implement more effective policies 
and procedures, the obligation may increase the efficiency of the 
recommendations for their retail customers. As a result, Regulation 
Best Interest may reduce the agency costs faced by these retail 
customers.
    The Care Obligation requires a broker-dealer and its associated 
persons to have a reasonable basis to believe that a recommendation 
provided to a retail customer is in the customer's best interest. This 
reasonable basis should include factors similar to those identified by 
the Suitability Rule of the current regulatory regime as well as 
additional factors. For example, relative to the regulatory baseline, 
the Care Obligation requires that a broker-dealer and its associated 
persons consider costs, among other factors, and establish a direct 
link between the attributes of a security or investment strategy and 
the retail customer's best interest. By

[[Page 33460]]

requiring consideration of costs and by including an explicit link 
between the investment-related factors and the best interest, the 
obligation may increase the efficiency of the recommendations for the 
retail customer. As a result, Regulation Best Interest may reduce the 
agency costs faced by these retail customers.
    Through these effects, as discussed below, Regulation Best Interest 
may have an effect on competition, capital formation, and efficiency.
1. Competition
    Regulation Best Interest may have competitive effects for the 
market for investment advice and may affect how broker-dealers compete 
with each for retail customers. As discussed in Section III.C, the 
brokerage industry currently recognizes that broker-dealers and their 
associated persons may have conflicts of interest that create 
incentives for broker-dealers or their associated persons to make 
recommendations that, while suitable for their retail customers, may 
not be in the best interest of (and may not be the most efficient 
recommendations for) such customers. As noted above in Section 
III.B.2.c, a FINRA survey suggested that broker-dealers currently 
employ different methods for managing conflicts of interest, with some 
methods being more effective than others at reducing the effect of 
conflicts of interest on recommendations. These methods generally 
depend on the size and complexity of a broker-dealer's business model. 
Against this backdrop, the cost of complying with Regulation Best 
Interest, scaled by the size and complexity of a broker-dealer's 
business activities, may be higher for broker-dealers that currently 
employ less effective methods for managing conflicts of interest.
    Relative to broker-dealers that face lower compliance costs, 
broker-dealers that face higher compliance costs may be at a 
disadvantage when competing for retail customers and may not be able to 
fully pass on these costs to their retail customers. For example, the 
presumption related to the titles ``adviser'' and ``advisor'' may 
impose higher costs on broker-dealers that use these terms in their 
names or titles, but that are not dual-registrants.\1330\ The extent to 
which broker-dealers are able to pass on costs to their retail 
customers depends on a number of factors that include the availability 
of close substitutes for the services provided by broker-dealers and 
the cost to retail customers of switching accounts to a competing 
broker-dealer, investment adviser, or other financial services 
provider. If broker-dealers are unable to pass costs through to 
customers, it is possible that some of the broker-dealers that face 
high compliance costs may decide to exit the market for investment 
advice in the capacity of a broker-dealer.
---------------------------------------------------------------------------

    \1330\ See supra footnotes 1216-1220.
---------------------------------------------------------------------------

    The potential competitive effects associated with compliance costs 
could be further exacerbated by how broker-dealers choose to comply 
with the component obligations of Regulation Best Interest. As 
discussed in Section III.C.4, broker-dealers are given flexibility when 
addressing conflicts of interest through policies and procedures. 
Because Regulation Best Interest and the component obligations are 
generally principles-based, a broker-dealer would have to determine 
what constitutes effective means of addressing a given conflict of 
interest, and how it should relate to the size and complexity of a 
broker-dealer's business model. For a broker-dealer that is dually 
registered or for a broker-dealer that is affiliated with an investment 
adviser, the overall costs of complying with Regulation Best Interest 
may encourage the broker-dealer to exit the market for providing 
investment advice in the capacity of a broker-dealer and, instead, 
provide advice only in the capacity of an investment adviser. Whereas 
broker-dealers have explicit requirements to establish written policies 
and procedures reasonably designed to disclose, mitigate or eliminate 
identified conflicts of interest that create an incentive for the 
associated persons to place their interest ahead of the retail 
customer, the fiduciary standard for investment advisers relies on full 
and fair disclosure and informed consent to address conflicts of 
interest.\1331\ Investment advisers must also adopt and implement 
written policies and procedures reasonably designed to prevent 
violations of the Advisers Act, including violations related to 
undisclosed conflicts of interest.\1332\ More generally, compliance 
costs may drive such firms to no longer offer advice in the capacity of 
a broker-dealer if firms anticipate the profitability of their broker-
dealer business under Regulation Best Interest to be lower than the 
profitability of their advisory business.
---------------------------------------------------------------------------

    \1331\ As discussed in supra Section I.C, some broker-dealer 
commenters also expressed the view that by requiring mitigation of 
financial incentives, Regulation Best Interest would require more of 
broker-dealers than what is required of investment advisers under 
their fiduciary duty, which could create a competitive issue for 
broker-dealers that could further encourage migration from the 
broker-dealer to investment adviser model and result in a loss of 
choice for retail customers. Because of this competitive issue, 
dually registered financial professionals could be incentivized to 
recommend advisory accounts through compensation.
    \1332\ See Advisers Act Rule 206(4)-7.
---------------------------------------------------------------------------

    Similar concern over costs of complying with Regulation Best 
Interest may deter some broker-dealers from entering the market for 
investment advice. Higher entry costs may have long-run competitive 
effects on prices paid by retail customers, as incumbents adjust their 
strategic behavior to reflect a lower threat of competition from new 
entrants, relative to the baseline.\1333\ Regulation Best Interest may 
also encourage competition for retail customers to the extent that the 
Disclosure Obligation increases the retail customers' salience to 
variables such as fees and conflicts of interest that would facilitate 
comparability across broker-dealers. For example, retail customers may 
form preferences over some or all of the disclosed variables, such as 
fees, securities or service offerings, and range of conflicts of 
interest, and may choose one broker-dealer over another or over an 
investment adviser based on these preferences. In turn, if firms 
anticipate that there is a possibility that retail customers may use 
the disclosed variables for comparability purposes, broker-dealers may 
compete over some or all of these variables to attract more retail 
customers. This potential competition may result in greater securities 
or service offerings, or lower fees for retail customers.
---------------------------------------------------------------------------

    \1333\ See, e.g., Mas-Colell et al. (1995).
---------------------------------------------------------------------------

    Regulation Best Interest may also affect how broker-dealers compete 
with each other when negotiating with investment sponsors for access to 
securities. The findings of the aforementioned FINRA survey suggest 
that broker-dealers may face different degrees of competition when 
negotiating with product sponsors for access to certain securities. For 
instance, the survey observed that some product sponsors rate the 
broker-dealers that are interested in distributing their securities 
based on criteria such as product expertise and experience, the quality 
of the control environment, and the strength of their sales practices. 
Broker-dealers that have higher ratings, based on these criteria may be 
given access to a broader range of securities, including more complex 
securities. In contrast, broker-dealers that have lower ratings may be 
given access to a narrower range of securities. To the extent 
Regulation Best Interest has the effect of increasing and homogenizing 
the product expertise and experience (e.g., the Care Obligation) and 
the quality of the

[[Page 33461]]

control environment (e.g., the Conflict of Interest Obligation) across 
the complying broker-dealers, the final rule may increase the 
competition across firms when negotiating with product sponsors. This 
increased competition may allow product sponsors to economize on the 
distribution costs, and may result in lower fees for retail customers.
    Regulation Best Interest may also have competitive effects for the 
market for investment advice, more generally. Regulation Best Interest 
may affect how broker-dealers compete with firms that provide advice in 
a capacity other than as a broker-dealer, such as an investment 
adviser. Under the regulatory baseline, investment advisers owe a 
fiduciary duty to their clients. Some commenters describe this standard 
of conduct as a ``higher'' standard compared to the standard of conduct 
applies to broker-dealers under the regulatory baseline.\1334\
---------------------------------------------------------------------------

    \1334\ See Letter from Ken Fisher, Fisher Investments (Jul. 31, 
2018) (``Fisher Letter''); PIABA Letter; FPC Letter; NASAA August 
2018 Letter; U. of Miami Letter; Rhoades August 2018 Letter.
---------------------------------------------------------------------------

    For some retail customers the duty owed to them by their firm or 
financial professional may be a determining factor when deciding which 
type of firm or financial professional they want to use. As previously 
noted, key elements of the standard of conduct that applies to broker-
dealers, at the time a recommendation is made, under Regulation Best 
Interest will be substantially similar to key elements of the standard 
of conduct that applies to investment advisers pursuant to their 
fiduciary duty under the Advisers Act. As such, the standard of conduct 
under Regulation Best Interest may make broker-dealers more attractive 
to certain retail customers who seek recommendations for securities 
transactions or investment strategies in a more cost effective manner, 
but worry about the duties owed to them by their financial 
professional. As a result, Regulation Best Interest may increase the 
competition between broker-dealers and investment advisers for retail 
customers interested in obtaining investment advice. In competing for 
business, broker-dealers and investment advisers may lower their fees, 
resulting in retail customers paying less for obtaining investment 
advice. To the extent that this potential lower cost causes an increase 
in the demand for investment advice in the capacity of a broker-dealer, 
this positive competitive effect may offset some of the negative 
potential competitive effects of Regulation Best Interest, such as 
higher cost of entry in the market for investment advice in the 
capacity of a broker-dealer relative to the baseline, as discussed 
above.
    The Disclosure Obligation may also encourage competition for retail 
customers across broker-dealers and investment advisers. As noted 
above, the Disclosure Obligation would require broker-dealers to make 
full and fair disclosure of all material facts relating to the scope 
and terms of the relationship with the retail customer and all material 
facts relating to conflicts of interest that are associated with a 
recommendation. Investment advisers are also required to provide full 
and fair disclosure of material facts about similar elements under the 
current regulatory regime. To the extent that the Disclosure Obligation 
raises the salience of variables that may facilitate comparison across 
broker-dealers and investment advisers, Regulation Best Interest may 
encourage competition between broker-dealers and investment advisers.
    Regulation Best Interest may also have competitive effects for 
financial professionals that offer investment advice in a capacity 
other than that of a broker-dealer (e.g., investment advisers and other 
financial professionals that are not registered with the Commission, 
such as insurance companies, banks, and trust companies). As discussed 
above in Section III.C.4, depending on the effectiveness of disclosure 
and the effectiveness of policies and procedures that address 
securities menu limitations (e.g., the Disclosure Obligation and 
Conflict of Interest Obligation), Regulation Best Interest may reduce 
the retail customers' aggregate demand for certain securities that are 
distributed by broker-dealers and securities on which broker-dealers or 
their associated persons provide recommendations. Instead, retail 
customers may access some of these or comparable securities from other 
financial professionals. For example, a retail customer may access 
certain securities offered by broker-dealers through corporate 
fiduciaries such as commercial banks or trust companies. Alternatively, 
a retail customer may open an advisory account and access securities 
that are comparable to those offered by the broker-dealer. To the 
extent that Regulation Best Interest causes a potential reduction in 
the retail customers' aggregate demand for securities offered by 
broker-dealers, retail customers' aggregate demand may increase for 
securities offered by non-broker-dealers. Regulation Best Interest may 
also affect how product sponsors compete for flows from retail 
customers. As discussed above in Section III.C.4, depending on the 
effectiveness of disclosure and the effectiveness of policies and 
procedures that address limitations of the menu of securities (e.g., 
Disclosure and Conflict of Interest Obligations), Regulation Best 
Interest may reduce the aggregate demand for certain sponsors' 
securities. To remain competitive, product sponsors that face decreased 
demand as a result of Regulation Best Interest may reprice their 
securities (e.g., by offering different share classes), lower their 
fees, or seek alternative distribution channels that are not affected 
by Regulation Best Interest. For example, product sponsors may choose 
to distribute their securities through investment advisers or through 
commercial banks to the extent that the banks can engage in limited 
broker-dealer activity, subject to certain conditions, without having 
to register as broker-dealers.\1335\ Finally, product sponsors may 
choose to distribute their securities directly to retail investors 
rather than indirectly, through broker-dealers. The potential 
competitive effect of Regulation Best Interest on product sponsors may 
manifest itself in lower product fees for retail customers.
---------------------------------------------------------------------------

    \1335\ See Exchange Act Sections 3(a)(4)(B) and 3(a)(5)(B) and 
rules thereunder (providing banks exceptions from ``broker'' and 
``dealer'' status for specified securities activities).
---------------------------------------------------------------------------

2. Capital Formation and Efficiency
    Regulation Best Interest is designed to reduce the agency and other 
costs to retail customers associated with obtaining recommendations 
from broker-dealers. As discussed above, to reduce these costs, 
Regulation Best Interest would impose obligations on broker-dealers 
that are designed to increase the efficiency of the recommendations to 
retail customers relative to the recommendations that broker-dealers 
and their associated persons provide to retail customers under the 
regulatory baseline.
    To the extent retail customers receive recommendations that are 
more efficient relative to the baseline, Regulation Best Interest would 
increase the efficiency of the portfolio allocation that a retail 
customer makes as a result of the recommendation received. As discussed 
above in Sections III.A.2 and III.C, this would occur when a retail 
customer increases the allocative efficiency of his or her portfolio 
when the recommendation leads to a reallocation of resources across 
time and market and economic conditions that generate a higher net 
benefit to the retail customer, relative to the baseline. Thus, to the 
extent that Regulation Best Interest

[[Page 33462]]

increases the efficiency of the associated persons' recommendations to 
retail customers, the final rule would have a positive effect on the 
retail customers' allocative efficiency.
    Regulation Best Interest may also increase the efficiency of the 
recommendations involving rollovers or transfers of assets from 
retirement accounts to other taxable or non-taxable accounts, relative 
to the baseline. As noted above, the incentives associated with this 
type of recommendation are particularly acute because of the size of 
the transaction and the importance to the retail customer (e.g., given 
that the amount of assets associated with such recommendations can be a 
significant portion of a retail customer's net worth). The potential 
increase in the efficiency of this type of recommendation may improve 
the allocative efficiency of assets held in retirement accounts, and 
may encourage retail customers to consider a rollover or transfer of 
assets recommendation to potentially increase the efficiency of their 
retirement asset allocation.
    Similarly, Regulation Best Interest may increase the efficiency of 
the recommendations regarding account types. As discussed above, 
currently, a dual-registrant may have an incentive to recommend the 
account type that benefits the dual-registrant at the expense of the 
retail customer. The potential increase in the efficiency of this type 
of recommendation under Regulation Best Interest relative to a similar 
recommendation that the dual-registrant may provide under the baseline 
may improve the allocative efficiency of the retail customer's assets 
held in this account.
    The possibility that Regulation Best Interest may increase the 
efficiency of the recommendations provided by the associated persons of 
the broker-dealer may enhance the attractiveness of broker-dealer 
services for those investors who currently do not invest through 
broker-dealers. Although there are costs associated with these 
requirements, the protections deriving from these requirements may 
benefit investors, issuers, and intermediaries by helping to create a 
marketplace where a higher number of retail customers invest through 
broker-dealers, relative to the current regulatory regime. If retail 
customers are more willing to participate in the securities markets 
through broker-dealers, Regulation Best Interest would have a positive 
effect on capital formation.

E. Reasonable Alternatives

    Regulation Best Interest establishes a new standard of conduct for 
broker-dealers under the Exchange Act that is intended to address the 
agency costs that retail customers face when obtaining recommendations 
of securities transactions and investment strategies from broker-
dealers and their associated persons. This new standard is intended to 
enhance investor protection, while preserving, to the extent possible, 
retail investor access (in terms of choice and cost) to differing types 
of investment services and securities. As noted above, the Commission 
considered several reasonable alternative policy choices, including (1) 
applying the fiduciary standard under the Advisers Act to broker-
dealers, and (2) adopting a ``new'' uniform fiduciary standard of 
conduct applicable to both broker-dealers and investment advisers, such 
as that recommended by the staff in the 913 Study. The Commission also 
considered adopting similar standards to those the DOL had provided 
under its fiduciary rule to broker-dealers and investment 
advisers.\1336\ We examine the effects of these primary alternatives, 
as well as several other alternatives that we considered both in the 
Proposing Release and in response to comments.
---------------------------------------------------------------------------

    \1336\ We had additionally discussed in the Proposing Release an 
alternative of a principles-based best interest standard. See 
Proposing Release at 21663. Some of the economic effects of this 
alternative would be similar to the economic effects of any of the 
fiduciary alternatives, which would also be principles-based.
---------------------------------------------------------------------------

1. Fiduciary Standard for Broker-Dealers
    As discussed in the Proposing Release and as raised by commenters, 
instead of adopting our approach in Regulation Best Interest, the 
Commission could have alternatively imposed a form of fiduciary 
standard on broker-dealers providing recommendations to retail 
customers. The Commission recognized that fiduciary standards vary 
among investment advisers, banks acting as trustees or fiduciaries, or 
ERISA plan providers, but fiduciaries are generally required to act in 
the best interest of their clients.\1337\
---------------------------------------------------------------------------

    \1337\ See Proposing Release at footnotes 328-329. For example, 
an investment adviser's fiduciary duty under the Advisers Act 
comprises a duty of care and a duty of loyalty. This combination of 
care and loyalty obligations has been characterized as requiring the 
investment adviser to act in the ``best interest'' of its client at 
all times. See Fiduciary Interpretation.
---------------------------------------------------------------------------

    Under any of the options considered, the Commission would have to 
craft a mechanism to apply a uniform standard of conduct to all 
financial professionals regardless of how they engage with their retail 
customers. This approach was advocated by certain commenters, many of 
whom asserted that it would reduce retail investor confusion as it 
would ensure that investors are provided the same standard of care and 
loyalty regardless of what type of financial professional they 
engage.\1338\ As discussed above and in detail further below we 
believe, in practice, that such uniformity would be difficult to 
implement and disruptive to pursue as a result of various factors, 
including the key differences in the ways broker-dealers and investment 
advisers engage with retail clients. Achieving such uniformity could 
require narrowing the type and scope of services permitted to be 
provided by various types of financial professionals. If we were to 
pursue such an approach, it could reduce retail customers' confusion 
with respect to the duties owed to them by the broker-dealers and 
investment advisers and could reduce potential costs to some investors 
associated with choosing a type of relationship that is not well suited 
to them, because under a uniform standard, retail customers of each 
type of financial professional would be subject to the same standard of 
conduct.
---------------------------------------------------------------------------

    \1338\ See, e.g., Better Markets Letter at 24.
---------------------------------------------------------------------------

    However, this uniformity could come at a cost to both investors and 
financial service providers. Such an approach could result in a 
standard of conduct for broker-dealers that is not appropriately 
tailored to the structure and characteristics of the broker-dealer 
model (i.e., transaction specific recommendations and compensation), 
and might not properly take into account, or build upon, existing 
obligations that apply to broker-dealers, including under FINRA 
rules.\1339\ A potential implication of this paradigm shift would be 
that broker-dealers would face significant compliance costs, at least 
in the short run, relative to the regulatory baseline. Potentially 
higher compliance costs could increase the incentive to offer 
investment advice in the capacity of investment adviser and could 
decrease the incentive to offer investment advice in the capacity of 
broker-dealer. To the extent broker-dealers act on the increased 
incentives and decide to participate in the market for investment 
advice only in the capacity of investment advisers, retail customers 
could experience an increase in the cost of obtaining investment 
advice, relative to the baseline. Furthermore, as noted above, the 
potential exit of broker-dealers from the market for investment advice 
in the broker-dealer capacity could limit how retail customers would 
access certain securities or investment strategies and how they would 
pay for investment advice, which, in turn, could increase

[[Page 33463]]

their costs of obtaining investment advice, relative to the 
baseline.\1340\ To the extent broker-dealers decide to continue to 
participate in the market for investment advice in the capacity of 
broker-dealers, they could pass on increased compliance costs, in full 
or in part, to their retail customers. As a result, retail customers 
could experience an increase in the cost of obtaining investment 
advice, relative to the baseline. The potential increase in the cost of 
accessing investment advice could push some retail customers outside 
the market for investment advice from Commission-registered broker-
dealers and investment advisers.\1341\
---------------------------------------------------------------------------

    \1339\ See also 913 Study at 139-143.
    \1340\ See supra Section III.D.1.
    \1341\ See supra Section I.A for a discussion of access to 
investment advice in the context of the DOL Fiduciary Rule.
---------------------------------------------------------------------------

    We discuss each of the three options for applying a uniform 
fiduciary standard in more detail below. We compare each of the three 
alternatives against the regulatory baseline, which is the current 
broker-dealer regulatory regime. In addition, we briefly discuss the 
differences between the standard of conduct imposed by Regulation Best 
Interest and the fiduciary standard under the Advisers Act. As 
discussed above in Section I, we believe that our approach in adopting 
Regulation Best Interest will best achieve the Commission's important 
goals of enhancing retail investor protection and decision making, 
while preserving, to the extent possible, retail investor access (in 
terms of choice and cost) to differing types of investment services and 
securities.
a. Fiduciary Standard Under the Advisers Act Applied to Broker-Dealers
    A number of commenters discussed the viability of this alternative 
and stated that it would provide superior investor protection benefits 
relative to the standard that the Commission proposed.\1342\ At the 
outset, we note that, at the time a recommendation is made, key 
elements of the standard of conduct that applies to broker-dealers 
under Regulation Best Interest will be substantially similar to key 
elements of the standard of conduct that applies to investment advisers 
pursuant to their fiduciary duty under the Advisers Act. Both standards 
of conduct require that, when making a recommendation or providing 
advice, firms and financial professionals act in the best interest of 
the retail investor and not place the financial professionals' 
interests ahead of the retail investor.\1343\ Both standards provide 
methods for addressing conflicts of interest, although the mechanics of 
those methods and their outcomes may be different,\1344\ and both 
standards require full and fair disclosure of material facts that 
affect the relationship, including costs. Both standards allow each 
type of financial professional to agree to provide account monitoring 
services to retail investor accounts, although continuous monitoring is 
embedded in the regulatory regime and market practices for investment 
advisers, whereas a broker-dealer may agree to provide account 
monitoring services only to the extent that it is solely incidental to 
the primary brokerage business.\1345\
---------------------------------------------------------------------------

    \1342\ See Betterment Letter; Warren Letter; Fein Letter; State 
Treasurers Letter; AARP August 2018 Letter; ACLI Letter; Schwab 
Letter.
    \1343\ See supra Section I.A.
    \1344\ Whereas, pursuant to Regulation Best Interest, broker-
dealers are required to (i) to establish written policies and 
procedures reasonably designed to identify and at a minimum, 
disclose, or eliminate, all conflicts of interest; and (ii) to 
establish written policies and procedures reasonably designed to 
mitigate or eliminate identified conflicts of interest, the 
fiduciary standard for investment adviser relies on full and fair 
disclosure and informed consent.
    \1345\ See Solely Incidental Interpretation. See also supra 
Section II.B.2.b.
---------------------------------------------------------------------------

    We recognize that there are certain notable differences between the 
Advisers Act fiduciary standard and the Regulation Best Interest 
standard we are adopting. In particular, the investment adviser 
fiduciary duty is generally principles-based, in keeping with the 
regulatory tradition and market practices for advisers,\1346\ whereas 
Regulation Best Interest, while also largely principles-based, 
establishes minimum, obligations that are generally more prescriptive 
than the fiduciary obligations under Advisers Act. Further, advisers 
are able to address conflicts of interest through full and fair 
disclosure and informed consent,\1347\ while broker-dealers must have 
policies and procedures that are reasonably designed to identify and 
disclose and mitigate, or eliminate, any conflicts of interest 
associated with recommendations that create an incentive for the 
broker-dealer or its associated persons to place the interest of the 
broker-dealer or its associated persons ahead of the interest of the 
retail customer. With regard to the substance of both standards, the 
investment adviser fiduciary duty generally is broader and applies to 
the entire relationship between adviser and client, including providing 
non-securities advice,\1348\ whereas Regulation Best Interest only 
applies at the time of a recommendation of any securities transaction 
or investment strategy by a broker-dealer to its retail 
customers.\1349\ Where application of the Advisers Act fiduciary 
standard to broker-dealers would impose on broker-dealers obligations 
similar to those of Regulation Best Interest, we anticipate similar 
economic effects; in contrast, where this alternative would result in 
different obligations, it would generate economic effects distinct from 
those of Regulation Best Interest.
---------------------------------------------------------------------------

    \1346\ See Fiduciary Interpretation.
    \1347\ See id.
    \1348\ For example, an investment adviser may consider both 
securities annuity products (e.g., variable annuities) and non-
securities annuity products (e.g., fixed annuities) when providing 
advice on annuity products to a client with an advisory retirement 
account.
    \1349\ However, under the current legal and regulatory regime, 
broker-dealers are subject to other rules that apply outside the 
context of a recommendation, including rules regarding how broker-
dealers market securities and services (communications with the 
public), how they execute trades (best execution), and the fees that 
they charge (fair and reasonable compensation obligations). 
Moreover, broker-dealers always a have a duty of fair dealing with 
their retail customers under SRO rules. In addition, broker-dealers 
are subject to a number of obligations that attach when a broker-
dealer makes a recommendation to a customer, as well as general and 
specific requirements aimed at addressing certain conflicts of 
interest, including requirements to eliminate, mitigate, or disclose 
certain conflicts of interest. See Proposing Release Section I.A.1.
---------------------------------------------------------------------------

i. Fiduciary Standard Under the Advisers Act Relative to the Baseline
    Relative to the regulatory baseline, the fiduciary standard of this 
alternative applied to broker-dealers could benefit retail customers in 
some circumstances by extending the obligations of all firms and 
financial professionals to act in the best interest of retail customers 
(and to not place the interest of the firm or the interest of the 
financial professionals ahead of those of the retail customers) to 
aspects of the relationship other than providing personalized 
investment advice through recommendations. For example, retail 
customers might benefit if broker-dealers were required (as advisers 
are under their current fiduciary standard) to disclose any material 
conflicts related to their execution of trades for retail customers in 
the case when the broker-dealer has not provided a recommendation 
regarding the transaction (e.g., self-directed trade). In addition, 
under the fiduciary standard that applies to investment advisers, if an 
investment adviser cannot fully and fairly disclose a material conflict 
of interest to a client such that the client could reasonably be 
expected to provide informed consent, the investment adviser would be 
expected to either eliminate the conflict or adequately mitigate (i.e., 
modify its practices to reduce) the conflict to the point where full 
and fair disclosure of the conflict to the client and informed

[[Page 33464]]

consent is possible.\1350\ To the extent that this approach of 
addressing conflicts of interest would extend to the fiduciary standard 
in this alternative, a broker-dealer would also have to eliminate or 
modify a conflict of interest to the point where full and fair 
disclosure and informed consent is possible. The potential reduction in 
the effect of conflicts of interest on recommendations and the 
potential reduction in the information asymmetry between a retail 
customer and a broker-dealer would likely increase the efficiency of 
the recommendation provided by the firm to the retail customer, 
relative to the baseline. Thus, this alternative may reduce the agency 
costs of the relationship between a broker-dealer and a retail 
customer, which would benefit retail customers, relative to the 
baseline.
---------------------------------------------------------------------------

    \1350\ See Fiduciary Interpretation.
---------------------------------------------------------------------------

    However, any such benefits would come at a cost. As an initial 
matter, the fiduciary standard under this alternative is a principles-
based regime and shaped by decades of case law specific to investment 
advisory model. In contrast, the standard of conduct that applies to 
broker-dealers under the baseline is more prescriptive, and governed by 
detailed SRO rules. Therefore, if this alternative were adopted, 
broker-dealers would face increased compliance costs resulting from 
having to conform their advice models to a regulatory regime that was 
not formed for a transaction-based model governed by detailed SRO 
rules.
    The potential increased compliance costs associated with applying 
the fiduciary standard in this alternative to broker-dealers would 
likely increase the broker-dealers' incentives to offer investment 
advice in the capacity of investment adviser and may decrease their 
incentive to continue offering investment advice in the capacity of 
broker-dealer dealer (on a transaction-by-transaction basis), relative 
to the baseline.\1351\ For example, if this alternative were to create 
situations where the compensation to a broker-dealer for providing a 
recommendation in a commission-based brokerage account would be less 
than the compensation under a fee-based advisory account and/or where 
the perceived regulatory burden for an investment adviser is lower, 
relative to the baseline, a broker-dealer's incentive to offer advice 
in the capacity of investment adviser would likely increase, relative 
to the baseline.\1352\
---------------------------------------------------------------------------

    \1351\ See Vivek Bhattacharya, Gaston Illanes, & Manisha Padi, 
Fiduciary Duty and the Market for Financial Advice (Working Paper, 
Apr. 2019) for a recent paper providing an empirical analysis on the 
effect of state-level standards of conduct on the structure of the 
market for investment advice in the context of variable annuities. 
The study finds differences in broker-dealer behavior when comparing 
states with and without a fiduciary obligation for broker-dealers. 
The states with the obligation are associated with fewer variable 
annuity sales and are also associated with some broker-dealers 
exiting the industry. Specifically, the paper observes, among other 
things, that a state-level obligation reduces the number of broker-
dealers that are not dually registered by about 16% but has no 
meaningful effect on the number of dual-registrants. The authors 
argue that this compositional shift in the number of broker-dealers 
is due to firms exiting the market. The paper also observes that a 
state-level obligation on broker-dealers may cause a compositional 
shift in the pool of variable annuities sold by broker-dealers 
toward annuities that offer a larger and more diverse set of 
investment options, which, in certain circumstances, may also 
generate higher expected returns for retail customers. The paper 
also observes that under certain circumstances a state-level 
obligation on broker-dealers may increase the quality of the 
variable annuities sold by broker-dealers. ``Quality'' is defined by 
the authors as ``the return on variable annuities assuming optimal 
allocation.'' The authors interpret these results as suggesting that 
a state-level obligation on broker-dealers may (i) cause some 
broker-dealers to exit the market, and (ii) cause a compositional 
shift in the variable annuities sold by the broker-dealers that do 
not exit the market toward annuities of higher quality as defined in 
the paper. However, the limitations of the data sample and of the 
empirical methodology make it difficult to (i) generalize these 
results to the entire market of annuities sold by broker-dealers, 
(ii) extrapolate these results to the entire universe of securities 
that broker-dealers offer advice on, (iii) extrapolate the results 
to the population of broker-dealers not captured by the data sample, 
or (iv) use the results as a basis for comparing the investor 
protections offered by state-level standards of conduct, SRO rules, 
existing federal standards of conduct, and Regulation Best Interest. 
See also supra footnote 1163 and surrounding discussion noting that 
there is substantial variation in the sources, scope, and 
application of state fiduciary law.
    \1352\ Broker-dealers that choose to deregister would eliminate 
the costs of complying with FINRA rules, which are broader than 
retail customer sales practice obligations, and submitting to FINRA 
examinations as well as compliance with other specific rules, which 
do not apply to advisers.
---------------------------------------------------------------------------

    To the extent broker-dealers act on the increased incentives and 
decide to participate in the market for investment advice only in the 
capacity of investment advisers--for example, dual-registrants may 
prefer to offer investment advice only in the capacity of investment 
adviser--retail customers may experience an increase in the cost of 
obtaining investment advice, relative to the baseline. Furthermore, as 
noted above, the potential exit of broker-dealers from the market for 
investment advice in the capacity of broker-dealer may limit how retail 
customers can access certain securities or investment strategies and 
how they can pay for investment advice, which, in turn, may further 
increase the cost of obtaining investment advice, relative to the 
baseline.\1353\ Alternatively, to the extent broker-dealers decide to 
continue to participate in the market for investment advice in the 
capacity of broker-dealers, they may pass on the increased compliance 
costs, in full or in part, to their retail customers in the form of 
higher prices for services rendered. In particular, retail customers 
may experience an increase in the cost of obtaining investment advice, 
relative to the baseline.
---------------------------------------------------------------------------

    \1353\ See supra Section III.D.1.
---------------------------------------------------------------------------

    It is also possible that the fiduciary standard of this alternative 
may result in a different menu of choices that allows retail customers 
to access investment advice in a more cost-efficient manner relative to 
the baseline. For example, if more financial professionals decide to 
participate in the market for investment advice in the capacity of 
investment advisers, competitive pressure may result in investment 
advisers providing better pricing and/or more choices of accessing 
investment advice for retail customers.
    To the extent that the cost of accessing investment advice 
increases under the fiduciary standard of this alternative, some retail 
customers may be pushed outside the market for investment advice. For 
example, currently, a retail customer that prefers to receive 
recommendations from a broker-dealer or its associated persons to 
implement a buy-and-hold strategy may find a brokerage account to be 
better suited to his or her needs compared to an advisory 
account.\1354\ Under the fiduciary standard in this alternative, this 
retail customer may have to pay more for the broker-dealer services 
that come with his or her account, including obtaining investment 
advice, relative to the baseline. If this increase in the cost for 
broker-dealer services outweighs the benefits of the potential improved 
efficiency of the recommendations provided by the

[[Page 33465]]

broker-dealer for this retail customer, as noted above, the retail 
customer may prefer to switch to a more-limited brokerage account that 
does not come with personalized investment advice (e.g., an execution-
only brokerage account).\1355\ Alternatively, and as noted by one 
commenter, the retail customer may switch to a light version of an 
advisory account that implements automated investment strategies 
tailored around a retail customer's goals.\1356\ However, this type of 
advisory account may not offer the flexibility of personalized 
investment advice to the evolving needs of the customer and may not be 
as responsive to market movements not anticipated by the automated 
investment strategies.
---------------------------------------------------------------------------

    \1354\ For example, Del Guercio & Reuter (2014), supra footnote 
1081, document (Table 1 on page 1682) that retail customers can 
access index funds through both broker-dealers (i.e., the broker-
sold channel, as discussed above) and directly from the fund sponsor 
(i.e., the direct-sold channel). Furthermore, in their sample, the 
average expense ratio for an index fund is 0.86 if sold through the 
broker-sold channel and 0.44 if sold through the direct channel. 
Assuming that a retail customer is interested in implementing a buy-
and-hold strategy using index funds that carry no loads, the cost to 
the retail customer of implementing this strategy through a broker-
dealer would be on average 86 basis points of the assets invested 
per year. In contrast, the cost to the retail customer of 
implementing the same strategy through an investment adviser would 
be on average 44 basis points plus the investment adviser's AUM-
based fee per year. Assuming that in the investment adviser's fee is 
100 basis points of AUM per year, the cost to the retail customer of 
implementing his or her strategy with an investment adviser would be 
on average 144 basis points.
    \1355\ Relative to a brokerage account that offers personalized 
investment advice, execution-only brokerage accounts may also come 
with enhanced research tools, more investment choices, and, 
potentially, other forms of impersonal advice.
    \1356\ See, e.g., CFA August 2018 Letter at 79, noting that 
``[f]or example, Vanguard charges 0.30% for its Personal Advisor 
Services, Schwab charges 0.28% for its Intelligent Advisory 
Services, and Betterment charges 0.25% for its Digital offering and 
0.40% for its Premium offering.''
---------------------------------------------------------------------------

b. Uniform Fiduciary Standard Under 913(g)
    Another alternative approach to the standard of conduct imposed by 
Regulation Best interest is a ``new'' uniform fiduciary standard of 
conduct applicable to both broker-dealers and investment advisers, such 
as that recommended by the staff in the 913 Study.\1357\ The fiduciary 
standard under this alternative would require firms ``to act in the 
best interest of the customer without regard to the financial or other 
interest of the broker, dealer, or investment adviser providing the 
advice.'' Based on the Commission staff's recommendations about ways in 
which the fiduciary standard proposed by the 913 study could be 
implemented, the fiduciary standard under this alternative could have 
imposed any or all of the following requirements: (1) Eliminate or 
disclose conflicts of interest; (2) prohibit certain conflicts of 
interest by requiring firms to mitigate conflicts through specific 
action, or to impose specific disclosure and consent requirements; and 
(3) specify the basis a broker-dealer or investment adviser has in 
making a recommendation to a retail customer by referring to and 
expanding upon broker-dealers' existing suitability requirements.
---------------------------------------------------------------------------

    \1357\ One of the staff's primary recommendations was that the 
Commission engage in rulemaking to adopt and implement a uniform 
fiduciary standard of conduct for broker-dealers and investment 
advisers when providing personalized investment advice about 
securities to retail customers. The staff's recommended standard 
would require firms ``to act in the best interest of the customer 
without regard to the financial or other interest of the broker, 
dealer, or investment adviser providing the advice.'' The staff made 
a number of specific recommendations for implementing the uniform 
fiduciary standard of conduct, including that the Commission should: 
(1) Require firms to eliminate or disclose conflicts of interest; 
(2) consider whether rulemaking would be appropriate to prohibit 
certain conflicts, to require firms to mitigate conflicts through 
specific action, or to impose specific disclosure and consent 
requirements; and (3) consider specifying uniform standards for the 
duty of care owed to retail customers, such as specifying what basis 
a broker-dealer or investment adviser should have in making a 
recommendation to a retail customer by referring to and expanding 
upon broker-dealers' existing suitability requirements. See 913 
Study.
---------------------------------------------------------------------------

    Some of the benefits of the investment advisers' fiduciary standard 
of the previous alternative would carry over to the new uniform 
standard of this alternative. In particular, relative to the baseline, 
the new fiduciary standard of this alternative applied to broker-
dealers could benefit retail customers in some circumstances by 
extending the obligations of all firms and financial professionals to 
act in the best interest of retail customers (and to not place the 
interest of the firm or those of the financial professionals ahead of 
the interest of the retail customer) to aspects of the relationship 
other than providing personalized investment advice through 
recommendations.
    In addition, the new fiduciary standard of this alternative applied 
to broker-dealers may create additional benefits for their retail 
customers, relative to the baseline. For example, requirements (1) and 
(2) may enhance the obligations under the baseline by requiring broker-
dealers to disclose conflicts of interest and to take actions to 
mitigate or eliminate certain conflicts of interest. To the extent that 
these requirements reduce of the effect of the conflicts of interest on 
the recommendation provided by a broker-dealer or its associated 
persons and reduce the information asymmetry between retail customers 
and broker-dealers, the new fiduciary standard of this alternative may 
increase, relative to the baseline, the efficiency of the 
recommendations made by broker-dealers and their associated persons. 
Furthermore, requirement (3) may enhance the existing suitability 
requirements that apply to broker-dealers and, to the extent that this 
requirement results in recommendations that are better aligned with the 
objectives of the retail customers, the new fiduciary standard of 
conduct of this alternative may further increase, relative to the 
baseline, the efficiency of the recommendations provided by broker-
dealers and their associated persons. The potential increase in the 
efficiency of the recommendations provided by broker-dealers and their 
associated persons under the new fiduciary standard of this alternative 
would benefit retail customers, relative to the baseline.
    Similarly, the new fiduciary standard of this alternative applied 
to investment advisers may create benefits for their clients, relative 
to the baseline. Requirements (1) and (2) would enhance the obligations 
of the investment advisers under the current fiduciary standard that 
applies to investment advisers by requiring investment advisers to take 
actions to mitigate or eliminate certain conflicts of interest. To the 
extent that these requirements reduce of the effect of the conflicts of 
interest on the recommendation provided by an investment adviser or its 
associated persons and reduce the information asymmetry between retail 
customers and investment advisers, the new fiduciary standard under 
this alternative may increase the efficiency of the recommendations 
made by investment advisers and their associated persons, relative to 
the baseline.
    The new fiduciary duty of this alternative may also result in 
increased competition across financial professionals for retail 
customers or clients, relative to the baseline. This potential increase 
in competition, relative to the baseline, may benefit retail customers 
of broker-dealers and clients of investment advisers in the form of 
lower prices for investment advice.
    Turning to the potential costs imposed by this alternative, we note 
that some of the costs of the investment advisers' fiduciary standard 
of the previous alternative carry over to the new fiduciary standard of 
this alternative. As noted above, this alternative would impose a new 
regulatory paradigm on broker-dealers relative to the baseline. The 
fiduciary standard of this alternative would be principles-based and 
shaped by common law. In contrast, the standard of conduct that applies 
to broker-dealers under the baseline is more prescriptive and governed 
by detailed SRO rules. A paradigm shift from the standards of conduct 
under the current baseline to the uniform standard in this alternative 
may increase compliance costs relative to the baseline.\1358\
---------------------------------------------------------------------------

    \1358\ See also 913 Study at 156-159.
---------------------------------------------------------------------------

    Furthermore, the potential increased compliance costs associated 
with applying the fiduciary standard of this alternative to broker-
dealers may increase, relative to the baseline, a broker-dealer's 
incentives to offer investment advice in the capacity of an

[[Page 33466]]

investment adviser and may decrease their incentive to offer investment 
advice in the capacity of broker-dealer. For example, if this 
alternative creates situations where the compensation to a broker-
dealer for providing a recommendation in a commission-based brokerage 
account would be less than the compensation under a fee-based advisory 
account while the perceived regulatory burden is equal to that of an 
investment adviser, a broker-dealer's incentive to offer advice in the 
capacity of investment adviser may increase, relative to the 
baseline.\1359\
---------------------------------------------------------------------------

    \1359\ See supra footnote 1351.
---------------------------------------------------------------------------

    To the extent broker-dealers act on the increased incentives and 
decide to participate in the market for investment advice only in the 
capacity of investment advisers--for example, dual-registrants may 
prefer to offer investment advice only in the capacity of investment 
adviser--retail customers may experience an increase in the cost of 
obtaining investment advice, relative to the baseline. Alternatively, 
to the extent broker-dealers decide to continue to participate in the 
market for investment advice in the capacity of broker-dealers, they 
may pass on the increased compliance costs, in full or in part, to 
their retail customers in the form of higher prices for services 
rendered, relative to the baseline. In particular, retail customers may 
experience an increase in the cost of obtaining investment advice, 
relative to the baseline.\1360\
---------------------------------------------------------------------------

    \1360\ See also 913 Study at 159-162.
---------------------------------------------------------------------------

    Similarly, the new fiduciary standard of this alternative may also 
impose additional compliance costs for investment advisers relative to 
the baseline.\1361\ For example, to the extent that investment advisers 
currently provide investment advice to their clients in a manner that 
is not fully consistent with the requirements (2) and (3), investment 
advisers may incur compliance costs in adhering to these potentially 
more stringent requirements.
---------------------------------------------------------------------------

    \1361\ See id. at 159.
---------------------------------------------------------------------------

    Investment advisers would likely pass on the potential increase in 
the costs of complying with the new fiduciary standard of this 
alternative to their clients. In turn, under the new fiduciary standard 
of this alternative, clients may experience an increase in the cost of 
obtaining investment advice, relative to the baseline.
    It is also possible that the new fiduciary standard of this 
alternative may result in a different menu of choices that allows 
retail customers and clients to access investment advice in a more 
cost-efficient manner relative to the baseline. For example, if more 
financial professionals decide to participate in the market for 
investment advice as investment advisers, competitive pressure may 
result in better pricing and/or greater choice in accessing investment 
advice for retail customers and clients that choose to use an 
investment adviser.
    However, to the extent that the cost of accessing investment advice 
increases under the new fiduciary standard of this alternative, some 
retail customers may be pushed outside the market for investment 
advice, relative to the baseline. For example, currently, a retail 
customer who prefers to receive recommendations from a broker-dealer or 
its associated persons to implement a buy-and-hold strategy may find a 
brokerage account to be better suited to his or her needs than an 
advisory account. Under the new fiduciary standard of this alternative, 
this retail customer may have to pay more for the broker-dealer 
services that come with his or her account, including obtaining 
investment advice, relative to the baseline. If, from the perspective 
of a retail customer, this increase in the cost for broker-dealer 
services outweighs the expected benefits of the potential improved 
efficiency of the recommendations provided by the broker-dealer, the 
retail customer may prefer to switch to a more limited brokerage 
account that does not come with personalized investment advice (e.g., 
an execution-only brokerage account).\1362\
---------------------------------------------------------------------------

    \1362\ Relative to a brokerage account that offers personalized 
investment advice, execution-only brokerage accounts may also come 
with enhanced research tools, more investment choices, and, 
potentially, other forms of impersonal advice.
---------------------------------------------------------------------------

    Alternatively, and as noted by one commenter, the retail customer 
may switch to an advisory account that implements automated investment 
strategies.\1363\ However, this type of advisory account may not offer 
the flexibility of personalized investment advice to the evolving needs 
of the customer, the level of contact a retail customer seeks from a 
relationship with a financial professional, and may not be as 
responsive to market movements not anticipated by the automated 
investment strategies.
---------------------------------------------------------------------------

    \1363\ See, e.g., CFA August 2018 Letter at 79, noting that 
``[f]or example, Vanguard charges 0.30% for its Personal Advisor 
Services, Schwab charges 0.28% for its Intelligent Advisory 
Services, and Betterment charges 0.25% for its Digital offering and 
0.40% for its Premium offering.''
---------------------------------------------------------------------------

    Similarly, under the new fiduciary standard of this alternative, 
clients of investment advisers may experience an increase in the cost 
of obtaining investment advice. Some of these clients may not be able 
to afford the additional cost and may be pushed outside the market for 
investment advice, relative to the baseline. As noted above, the 
options available to these clients may not offer the flexibility of 
tailored investment advice that may benefit a client with evolving 
needs.
c. Fiduciary Standard Under the DOL Rule and BIC Exemption
    A third alternative approach to addressing the agency costs 
associated with obtaining advice from broker-dealers is a fiduciary 
standard coupled with a series of disclosures and other requirements 
akin to the full complement of conditions of the DOL's BIC Exemption 
adopted in connection with the DOL Fiduciary Rule. This alternative 
would mirror the key conditions that apply to an ``adviser'' under the 
BIC Exemption.\1364\ This alternative approach would apply to broker-
dealers when providing recommendations to retail customer for all types 
of retail accounts rather than retirement accounts only. At least one 
commenter signaled support for this alternative.\1365\
---------------------------------------------------------------------------

    \1364\ For a discussion of key conditions of the BIC Exemption, 
see Section I.A.2 of the Proposing Release at 21581. As discussed 
above, the DOL Fiduciary Rule--including the BIC Exemption--was 
vacated by the United States Court of Appeals for the Fifth Circuit 
on March 15, 2018, although some firms may continue to seek comply 
with certain of its conditions under a DOL temporary enforcement 
policy. See also supra Section III.B.2.e. See also supra footnote 
32.
    \1365\ See Galvin Letter.
---------------------------------------------------------------------------

    Unlike other alternatives considered in this section, or Regulation 
Best Interest, this alternative can be analyzed, at least in part, 
based upon its previous adoption by the DOL and partial implementation. 
Because this alternative was already partly implemented, the market for 
investment advice, the securities market, and, ultimately investors 
have had an opportunity to partially adjust to it. Section III.B.2.e.ii 
summarizes the evidence about the response of firms, investors and 
product markets in response to the DOL Fiduciary Rule.
    The requirements of the standard of conduct in this alternative 
would enhance the obligations under the baseline by requiring broker-
dealers to adhere to the impartial conduct standard, which included 
requirements to act in their retail customers' best interest, disclose 
material conflicts of interest and designate a person responsible for 
addressing material conflicts of interest and monitoring the adherence 
of the associated persons of the broker-dealer to the impartial conduct 
standard. To the extent that

[[Page 33467]]

these requirements reduce the effect of the conflicts of interest on 
the recommendation provided by a broker-dealer or its associated 
persons and reduce the information asymmetry between retail customers 
and broker-dealers, the new standard of conduct in this alternative 
would increase the efficiency of the recommendations made by broker-
dealers and their associated persons, relative to the regulatory 
baseline. Furthermore, the requirement to act in the retail customers' 
best interest would enhance the existing suitability standard that 
applies to broker-dealers and, to the extent that the new standard of 
conduct of this alternative would result in recommendations that are 
better aligned with the objectives of the retail customers, this new 
standard would further increase the efficiency of the recommendations 
provided by broker-dealers and their associated persons, relative to 
the regulatory baseline. The potential increase in the efficiency of 
the recommendations provided by broker-dealers and their associated 
persons under the new standard in this alternative would benefit retail 
customers, relative to the baseline.
    This alternative may also affect product markets. As discussed 
above in Section III.B.2.ii, certain product sponsors introduced new 
products in the market for mutual funds, such as clean and T shares 
that were designed to facilitate compliance with various anticipated 
regulations, including the DOL Fiduciary Rule. In certain 
circumstances, these products may come with lower fees for retail 
customers. To the extent that this alternative would enhance this trend 
in product innovation, retail customers may benefit from this trend.
    However this alternative would also impose costs on broker-dealers 
and retail customers.
    Compliance costs would include costs associated with the contract 
provision, and the disclosure, policies and procedure, and record-
making and recordkeeping requirements. It is possible that broker-
dealers would pass on these direct compliance costs, in part or in 
full, to retail customers.
    In addition to these costs, this alternative would likely cause 
some broker-dealers to change their current practices, which, in turn, 
may impose further costs on them or their retail customers. As 
discussed above in Section III.B.2.e.ii some studies find evidence 
suggesting that firms have adjusted their practices, at least in the 
short-run, in response to the DOL fiduciary Rule. In particular, 
certain of these studies observe that in certain cases some broker-
dealers have either eliminated or reduced access to brokerage advice 
services. Other studies observe that some broker-dealers migrated 
toward fee-based advisory services or limited brokerage services (i.e., 
no provision of advice) and, in the process, offered their retail 
customers the option to shift from commission-based brokerage accounts 
to fee-based accounts, automated investment accounts or self-directed 
accounts. Some of their customers chose to not move to a fee-based 
account.
    Certain studies provide evidence suggesting that some broker-
dealers adjusted the range of their offerings.\1366\ Specifically, 
according to these studies, some of the respondents reduced or 
eliminated access to certain assets or share classes, such as certain 
mutual funds or mutual fund share classes, and or annuity securities 
offered.
---------------------------------------------------------------------------

    \1366\ See supra Section III.B.2.e.ii.
---------------------------------------------------------------------------

    Finally, there is some anecdotal evidence that suggests that 
certain firms changed the compensation structure for their associated 
persons.\1367\ Specifically, some firms equalize commissions and 
deferred sales charges across similar securities, while other firms 
banned sales quotas, contests, and certain bonuses.
---------------------------------------------------------------------------

    \1367\ See id.
---------------------------------------------------------------------------

    To the extent that the fiduciary standard in this alternative would 
result in similar responses by broker-dealers, the alternative would 
impose cost on retail customers relative to the baseline. For example, 
switching a retail customer from a commission-based brokerage account 
to a different type of account, such as fee-based advisory account, may 
leave a customer worse off in certain circumstances. For instance, a 
retail customer who is a buy-and-hold investor may overpay for the 
advice typically associated with this type of investment strategy if 
the retail customer were to shift from a brokerage account to a fee-
based account.\1368\ As another example, a retail customer would lose 
access to occasional personalized advice if he or she were to shift 
from his or her brokerage account to a self-directed account.
---------------------------------------------------------------------------

    \1368\ See supra footnote 1354.
---------------------------------------------------------------------------

    The cost to retail customers from switching to a suboptimal account 
is particularly important in the context of IRA brokerage accounts, 
because of the larger size of these accounts and the importance of 
these accounts for retail investors to meet their retirement needs. 
These costs may also be higher for IRA brokerage accounts than for 
other account types to the extent that these accounts include long-
term, buy-and-hold investments. As discussed in Section III.B.2.e.ii, 
one study provided an estimate for this potential cost.\1369\ However, 
as discussed above, the estimates provided by various studies, 
including this one, or by commenters are generally subject to 
assumptions or methodological limitations which may affect the 
inferences based on such estimates.
---------------------------------------------------------------------------

    \1369\ See SIFMA Study.
---------------------------------------------------------------------------

    In addition to the evidence discussed above, there are other 
potential economic implications of this alternative. For instance, this 
alternative may exclude from the market for investment advice those 
retail customers that have account balances that are below the account 
minimum for typical advisory accounts. The investment advisory industry 
might adjust to a lack of supply by accommodating lower account 
balances. However, because investment advisers have a fiduciary duty to 
all their clients, and because they have limited time and resources, 
there is likely a limit to how much an investment adviser can lower his 
or her account minimum to accommodate more advisory clients. Similarly, 
the product market may adjust by innovating new products to accommodate 
retail customers with account balances that are below the typical 
advisory account minimum. For example, hybrid products that implement 
automated investment strategies tailored to a retail customer's goals 
may substitute for the services of an investment adviser for customers 
with lower account balances.
2. Prescribed Format for Disclosure
    Although Regulation Best Interest specifies the required content of 
disclosure necessary to meet a broker-dealer's Disclosure Obligation, 
it does not prescribe a specific format for that disclosure. As an 
alternative, and as suggested by commenters,\1370\ we

[[Page 33468]]

considered requiring broker-dealers to use a specific form similar to, 
for example, Form ADV.
---------------------------------------------------------------------------

    \1370\ See, e.g., LPL August 2018 Letter that notes that ``all 
investors should be provided with general disclosures somewhat akin 
to those contained in Form ADV Part 2A--e.g., which set forth the 
ranges of remuneration payable to a broker-dealer in connection with 
its recommendations of different products . . . [W]e believe that 
detailed product-specific disclosures should be required prior to or 
at the time of a recommendation only in instances where the 
remuneration associated with the recommendation exceeds the 
previously disclosed range or where the recommendation implicates a 
conflict of interest that has not previously been disclosed. In all 
other cases, a broker-dealer should be permitted to satisfy its 
Disclosure Obligation by directing an investor in writing to review 
the recommended product's offering documents and providing 
hyperlinks to those documents (or providing a hyperlink to a central 
page on the broker-dealer's website that contains hyperlinks to the 
product documents), either prior to the recommendation via a general 
Form ADV Part 2A-like disclosure document or shortly thereafter via 
a trade confirmation.'' See also Morningstar Letter, noting 
``publicly available disclosures with a standard taxonomy work best 
because they empower third parties such as `fintech' and `reg-tech' 
firms to analyze and contextualize critical information and amplify 
a call to action for ordinary investors.'' See also Letter from 
Peter J. Chepucavage (May 31, 2018) (``Chepucavage Letter''), noting 
that ``[c]osts for the small bd's however can be reduced with a 
commission approved standard disclosure which would add certainty 
and ought to be considered especially for the small investor. [. . 
.] A standard disclosure document would also be useful for the small 
bd that cannot afford the legal assistance needed to evaluate this 
1,000 page proposal and draft appropriate documents. [. . .] The 
Commission should therefore reconsider the impact of its proposal on 
small investors and small bd's with the assumption that retirement 
accounts are significantly more important than regular brokerage 
accounts especially for small and elderly investors. A standard 
disclosure for small firms would reduce costs for the firms and 
their customers.''
---------------------------------------------------------------------------

    Because this alternative would still impose all the obligations of 
Regulation Best Interest, all the benefits and the costs identified in 
Regulation Best Interest would carry over to this alternative as well. 
However, by changing the way broker-dealers would meet the Disclosure 
Obligation, this alternative may create additional benefits and impose 
additional costs.
    The requirement to use a form similar to Form ADV to meet the 
Disclosure Obligation would put more structure on the disclosure of 
material facts relating to the scope and terms of the relationship with 
the retail customer and material facts relating to conflicts of 
interest that are associated with a recommendation. This added 
structure would facilitate retail customers' comparison of multiple 
broker-dealers, which would benefit retail customers. For example, the 
evidence provided by the investor testing surveys suggests that retail 
customers form preference over various variables that are being 
disclosed.\1371\ On the backdrop of this evidence, the structured 
disclosure provided by a specific form may enhance a retail customer's 
ability to select a broker-dealer in a manner consistent with his or 
her preferences. In addition, the structured disclosure provided by a 
form may allow a third party to collect the information disclosed by 
firms, process it, and present it to retail customers in a way that 
would make it easier for the retail customer to select a broker-dealer. 
To the extent the format of disclosure under this alternative would 
result in this potential outcome, the alternative would further benefit 
retail customers.
---------------------------------------------------------------------------

    \1371\ See Relationship Summary Adopting Release for a 
discussion of the evidence provided by the investor testing surveys.
---------------------------------------------------------------------------

    However, the requirement to use a form similar to Form ADV to meet 
the Disclosure Obligation may also impose costs on broker-dealers, at 
least in the short run, to the extent that this form of disclosure is 
different from the form of disclosure that firms employ currently to 
satisfy their disclosure obligations and liabilities under the 
baseline. In general it may be difficult to design a form that, while 
comprehensive in terms of capturing the diversity of business practices 
that broker-dealers employ, remains easy to understand for retail 
customers. In general, given that there is a wide variety of business 
models and practices, there is value in providing broker-dealers with 
flexibility to enable them to better tailor disclosure and information 
that their retail customers can understand and may be more likely to 
read at relevant points in time, rather than, for example, mandating a 
standardized all-inclusive (and likely lengthy) disclosure. Depending 
on the specific form that is eventually mandated, some firms may incur 
more costs than others. To the extent firms pass on those costs to 
retail customers, the alternative would impose a cost on retail 
customers.
3. Disclosure-Only
    Another potential alternative to addressing the agency costs of 
obtaining advice from broker-dealers is a disclosure-only alternative, 
which would require that broker-dealers satisfy only the Disclosure 
Obligation of Regulation Best Interest. In other words, broker-dealers 
would be required to provide the retail customer, in writing, full and 
fair disclosure of all material facts relating to the scope of the 
relationship with the retail customer and all material facts relating 
to the conflicts of interest associated with the recommendations to the 
retail customer, prior to or at the time of the recommendation. 
However, this alternative would not impose either the Care Obligation 
or the Conflict of Interest Obligation.
    As discussed in Sections III.C.2 and III.C.4, there may be 
substantial overlap between the disclosure requirements of Regulation 
Best Interest and the disclosure requirements under the regulatory 
baseline. From this perspective, relative to the regulatory baseline, 
the cost of this alternative to the broker-dealers may be small, at 
least for some broker-dealers. However, as pointed out above, a 
disclosure-only alternative is not likely to address the agency costs 
associated with obtaining advice from broker-dealers. As a result, the 
Commission believes both specific disclosure and mitigation 
requirements are needed to address those conflicts. Also, we noted 
above that sales contests, sales quotas, bonuses, and non-cash 
compensation that are based on the sales of specific securities within 
a limited period of time create high-pressure situations for associated 
persons to increase the sales of specific securities by compromising 
the best interest of their customers; the Commission does not believe 
such conflicts of interest can be reasonably mitigated, let alone 
disclosed, in a manner that adequately prevents harm to retail 
customers and, accordingly, believes that these conflicts must be 
eliminated in their entirety.
    Finally, as we discussed earlier, commenters noted that there are 
limits to the effectiveness of disclosure and cited a number of studies 
suggesting that disclosure alone is unlikely to solve the issues 
surrounding, for example, the conflicts of interest between a broker-
dealer (or their associated persons) and a retail customer.\1372\
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    \1372\ See supra footnote 1208 and accompanying text. See also 
supra Section III.B.4.c for a discussion of the literature on the 
effectiveness of disclosure.
---------------------------------------------------------------------------

IV. Paperwork Reduction Act

    Certain provisions of Regulation Best Interest and the rule 
amendments that we are adopting today contain ``collection of 
information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995 (``PRA'').\1373\ The Commission submitted 
Regulation Best Interest and the rule amendments to the Office of 
Management and Budget (``OMB'') for review and approval in accordance 
with the PRA.\1374\ The Commission's earlier PRA assessments have been 
revised to reflect the modifications to the rule and amendments from 
the Proposing Release, as well as additional information and data 
provided to the Commission by commenters. An agency may not conduct or 
sponsor, and a person is not required to respond to, a collection of 
information unless it displays a currently valid OMB control number. 
The titles and OMB control numbers for the collections of information 
are:
---------------------------------------------------------------------------

    \1373\ 44 U.S.C. 3501 et seq.
    \1374\ See 44 U.S.C. 3507(d); 5 CFR 1320.11.
    \1375\ See 17 CFR 240.17a-3. The addition of paragraph (a)(35) 
to Rule 17a-3 would amend the existing PRA for Rule 17a-3.
    \1376\ See 17 CFR 240.17a-4. The amendment to Rule 17a-4(e)(5) 
would amend the existing PRA for Rule 17a-4.

[[Page 33469]]



------------------------------------------------------------------------
                                                            OMB control
             Rule                      Rule title               No.
------------------------------------------------------------------------
Rule 15l-1....................  Regulation Best Interest
Rule 17a-3....................  Records to be made by          3235-0033
                                 certain exchange
                                 members, brokers and
                                 dealers \1375\.
Rule 17a-4....................  Records to be preserved        3235-0279
                                 by certain exchange
                                 members, brokers and
                                 dealers \1376\.
------------------------------------------------------------------------

    Regulation Best Interest enhances the broker-dealer standard of 
conduct beyond existing suitability obligations, and aligns the 
standard of conduct with retail customers' reasonable expectations by 
requiring broker-dealers, among other things, to: (1) Comply with 
specific obligations to make recommendations that are in the best 
interest of the retail customer, and that do not place the broker-
dealer's interests ahead of the interests of the retail customer; and 
(2) address conflicts of interest by fully and fairly disclosing 
material facts about conflicts of interest, and in instances where we 
believe disclosure is insufficient to reasonably address the conflict, 
establish, maintain and enforce policies and procedures reasonably 
designed to mitigate or, in certain instances, eliminate the conflict. 
Generally, in crafting Regulation Best Interest, we aimed to provide 
broker-dealers flexibility in determining how to satisfy the component 
obligations. For purposes of this analysis, we have made assumptions 
regarding how a broker-dealer would comply with the obligations of 
Regulation Best Interest, as well as the amendments under Rule 17a-
3(a)(35) and Rule 17a-4(e)(5).
    In the Proposing Release, we requested comment on the matters 
discussed in the PRA, including our estimates for the new and recurring 
burdens and associated costs described in connection with Regulation 
Best Interest and the amendments under Rule 17a-3(a)(35) and Rule 17a-
4(e)(5).\1377\ In particular, we sought comment on estimates as to: (1) 
The number of natural persons who are associated persons; (2) the 
number of broker-dealers that make securities-related recommendations 
to retail customers; (3) the number of natural persons who are 
associated persons that make securities-related recommendations to 
retail customers; and (4) any other costs or burdens \1378\ associated 
with proposed Regulation Best Interest that had not been identified in 
the Proposing Release.
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    \1377\ The Proposing Release proposed to add new paragraph 
(a)(25) of Rule 17a-3. As noted above, we are adopting the provision 
substantially as proposed but redesignating it as new paragraph 
(a)(35) of Rule 17a-3. See supra footnote 820 and accompanying text.
    \1378\ Throughout the PRA analysis in the Proposing Release, the 
burdens on in-house personnel were measured in terms of burden 
hours, and external costs were expressed in dollar terms.
---------------------------------------------------------------------------

    As discussed in Sections I, II, and III, we received comments that 
addressed whether we could minimize the burden of the proposed 
collections of information. We received several comments suggesting 
that our estimated burdens and costs for the rule as a whole were too 
low.\1379\ In addition, the Commission received some comments 
specifically addressing the costs to smaller broker-dealers.\1380\ 
Also, as discussed in the Economic Analysis section above, we received 
comments regarding the potential costs and burdens of proposed 
Regulation Best Interest on broker-dealers.\1381\ In response, we have 
modified several substantive requirements to the rule by, among other 
things, providing more specificity in the rule text in the Disclosure 
and Conflict of Interest Obligations, which we believe will mitigate 
some of these burdens and costs relative to the Proposing 
Release.\1382\ At the same time, certain modifications, such as 
maintaining a written record of oral disclosure, resulted in new 
burdens and costs, relative to those addressed in the Proposing 
Release, which are reflected below.
---------------------------------------------------------------------------

    \1379\ See, e.g., NSCP Letter; see also CCMC Letters (costs to 
implement the proposal were underestimated and greater than 40% of 
firms surveyed anticipate having to spend a moderate or substantial 
amount to implement Regulation Best Interest and Form CRS); Raymond 
James Letter (noting the significant implementation costs of 
Regulation Best Interest and Form CRS for the industry); SIFMA 
August 2018 Letter (stating that implementation costs of Regulation 
Best Interest and Form CRS would be significant).
    \1380\ See, e.g., Chepucavage Letter (finding that the estimates 
in the proposal are severely understated unless they are excluding 
time needed for review of the proposal and final rule and suggesting 
the Commission reconsider the impact on small investors and small 
broker-dealers); NSCP Letter (requesting the Commission to consider 
the financial and operational impacts of the proposed rule, 
particularly on small firms, and to minimize those impacts, given 
that small firms do not have compliance departments adequate to deal 
with increasing regulatory demands). See also, e.g., Iowa Insurance 
Commissioner Letter; Letter from David S. Addington, National 
Federation of Independent Business (May 30, 2018) (``NFIB Letter'').
    \1381\ See supra Section III.
    \1382\ Throughout this PRA analysis, the burdens on in-house 
personnel are measured in terms of burden hours, and external costs 
are expressed in dollar terms.
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A. Respondents Subject to Regulation Best Interest and Amendments to 
Rule 17a-3(a)(35) and Rule 17a-4(e)(5)

1. Broker-Dealers
    Regulation Best Interest imposes a best interest obligation on a 
broker-dealer when making recommendations of any securities transaction 
or investment strategy involving securities to retail customers. Except 
where noted, we have assumed that a dually registered firm, already 
subject to the Advisers Act, would be subject to new, distinct burdens 
under Regulation Best Interest.
    As of December 31, 2018, 3,764 broker-dealers were registered with 
the Commission, either as standalone broker-dealers or as dually 
registered entities.\1383\ Based on data obtained from Form BR, the 
Commission believes that approximately 73.5% of this population, or 
2,766 broker-dealers, have retail customers and therefore would be 
subject to Regulation Best Interest and the amendments under Rules 17a-
3(a)(35) and 17a-4(e)(5).\1384\ Further, based on FOCUS Report 
data,\1385\ the Commission estimates that as of December 31, 2018, 
approximately 985 broker-dealers may be deemed small entities under the 
Regulatory Flexibility Act.\1386\ Of these,

[[Page 33470]]

approximately 756 have retail business.\1387\ Therefore, we estimate 
that 2,010 broker-dealers would qualify as large broker-dealers with 
retail customers for purposes of this analysis.\1388\
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    \1383\ The Commission estimated the number of respondents in the 
Proposing Release as of December 31, 2017. The Commission is 
updating its estimated number of broker-dealers to reflect the 
number of broker-dealers registered with the Commission as of 
December 31, 2018.
    \1384\ As of December 31, 2018, 3,764 broker-dealers filed Form 
BD. Retail sales by broker-dealers were obtained from Form BR. As 
discussed above in Section III.B.1.a, the number of broker-dealers 
that serve retail customers (i.e., 2,766) likely overstates the 
number of broker-dealers that will be subject to Regulation Best 
Interest, because not all broker-dealers that serve retail investors 
provide recommendations to retail investors. We do not have reliable 
data to determine the precise number of broker-dealers that provide 
recommendations, and as a result, we have assumed, for purposes of 
this analysis that 2,766 broker-dealers will be subject to 
Regulation Best Interest.
    \1385\ FOCUS Reports, or ``Financial and Operational Combined 
Uniform Single'' Reports, are monthly, quarterly, and annual reports 
that broker-dealers are generally required to file with the 
Commission and/or SROs pursuant to Exchange Act Rule 17a-5. See 17 
CFR 240.17a-5.
    \1386\ See infra Section V for an explanation of which brokers-
dealers, subject to Regulation Best Interest, are ``small 
entities,'' for purposes of the Regulatory Flexibility Act analysis.
     The Commission's estimate is obtained from Form BD filings. 
Although Form BD filings are updated on a more frequent basis than 
annually, FOCUS data, which also informs this baseline with respect 
to broker-dealers, is only sparsely updated throughout the year. 
Moreover, instead, broker-dealers tend to make their most complete 
updates in the fourth calendar quarter of each year. Therefore, in 
order to minimize discrepancies in the broker-dealer data between 
Form BD and FOCUS data, we have normalized all of the data to the 
most recently complete FOCUS data, which is for December 2018.
    \1387\ Id.
    \1388\ This calculation was made as follows: (2,766 total retail 
broker-dealers)-(756 total small retail broker-dealers) = 2,010 
large retail broker-dealers.
---------------------------------------------------------------------------

2. Natural Persons Who Are Associated Persons of Broker-Dealers
    As with broker-dealers, Regulation Best Interest imposes a best 
interest obligation on natural persons who are associated persons of 
broker-dealers when making recommendations of any securities 
transaction or investment strategy involving securities to retail 
customers.
    The Commission believes that approximately 428,404 natural persons 
would qualify as retail-facing, registered representatives at 
standalone broker-dealers or dually registered firms,\1389\ and would 
therefore be subject to Regulation Best Interest.\1390\
---------------------------------------------------------------------------

    \1389\ See supra Section III.B.1 at Table 5. This estimate is 
based on the following calculation: (504,005 total licensed 
representatives (including representatives of investment advisers)) 
x (15% (the percentage of total licensed representatives who are 
standalone investment adviser representatives)) = approximately 
75,601 representatives at standalone investment advisers. To isolate 
the number of representatives at standalone broker-dealers and 
dually registered firms, we have subtracted 75,601 from 504,005, for 
a total of 428,404 retail-facing, licensed representatives at 
standalone broker-dealers or dually registered firms.
    \1390\ Unless otherwise noted, for purposes of the PRA, we use 
the term ``registered representatives'' to refer to associated 
persons of broker-dealers who are registered, have series 6 or 7 
licenses, and are retail-facing, and we use the term ``dually 
registered representatives of broker-dealers'' to refer to 
registered representatives who are dually registered and are 
associated persons of a standalone broker-dealer (who may be 
associated with an unaffiliated investment adviser) or a dually 
registered broker-dealer.
---------------------------------------------------------------------------

B. Summary of Collections of Information

    Regulation Best Interest requires broker-dealers and their 
associated persons \1391\ when making a recommendation of any 
securities transaction or investment strategy involving securities to a 
retail customer to act in the best interest of the retail customer at 
the time the recommendation is made, without placing the financial or 
other interest of the broker-dealer ahead of the interest of the retail 
customer. As discussed above, Regulation Best Interest specifically 
provides that this best interest obligation shall be satisfied if the 
broker-dealer complies with the specific Disclosure, Care, Conflict of 
Interest, and Compliance Obligations.
---------------------------------------------------------------------------

    \1391\ However, in certain instances, as described more fully 
below, the Commission assumes that broker-dealers will undertake 
certain Disclosure Obligations on behalf of their registered 
representatives. See, e.g., infra footnote 1396.
---------------------------------------------------------------------------

    Rule 17a-3 requires a broker-dealer to make and keep current 
certain records. The Commission is amending this rule by adding new 
paragraph (a)(35) to impose new record-making obligations on broker-
dealers subject to Regulation Best Interest. Rule 17a-4 requires a 
broker-dealer to preserve certain records if it makes or receives them. 
The Commission is amending Rule 17a-4(e)(5) to impose new record 
retention obligations on broker-dealers subject to Regulation Best 
Interest.
    The obligations arising under Regulation Best Interest and the 
amendments under Rule 17a-3(a)(35) and Rule 17a-4(e)(5) would give rise 
to distinct collections of information and associated costs and burdens 
for broker-dealers subject to the rules. The collections of information 
associated with Regulation Best Interest and rule amendments are 
described below.
1. Disclosure Obligation
    The Disclosure Obligation under Regulation Best Interest requires a 
broker, dealer, or natural person who is an associated person of a 
broker or dealer, prior to or at the time of recommending a securities 
transaction or strategy involving securities to a retail customer, to 
provide the retail customer, in writing, full and fair disclosure of: 
(1) All material facts relating to the scope and terms of the 
relationship with the retail customer, including (a) that the broker, 
dealer, or such natural person is acting as a broker, dealer, or an 
associated person of a broker or dealer with respect to the 
recommendation, (b) the fees and costs that apply to the retail 
customer's transactions, holdings, and accounts, and (c) the type and 
scope of services provided to the retail customer, including any 
material limitations on the securities or investment strategies 
involving securities that may be recommended to the retail customer; 
and (2) all material facts relating to conflicts of interest that are 
associated with the recommendation. The Commission believes that 
requiring broker-dealers to disclose to a retail customer, in writing, 
all material facts relating to the scope and terms of the relationship 
with the retail customer would facilitate the retail customer's 
understanding of the nature of his or her account, the broker-dealer's 
fees and costs, as well as the nature of services that the broker-
dealer provides, as well as any limitations to those services. It would 
also provide retail customers with information to better understand the 
differences among certain financial service providers, such as broker-
dealers, investment advisers, and dually registered firms and dually 
registered financial professionals. In addition, the obligation to 
disclose all material facts relating to conflicts of interest that are 
associated with a recommendation would raise retail customers' 
awareness of the potential effects of conflicts of interest, and 
increase the likelihood that broker-dealers would make recommendations 
that are in the retail customer's best interest.
    We are explicitly requiring in the rule text of Regulation Best 
Interest, items that the Proposing Release had only provided as 
examples of ``material facts relating to the scope and terms of the 
relationship with the retail customer'' that must be disclosed, namely: 
(1) That the broker, dealer or such natural person is acting as a 
broker, dealer or an associated person of a broker-dealer with respect 
to the recommendation; (2) the material fees and costs that apply to 
the retail customer's transactions, holdings, and accounts; and (3) the 
type and scope of services provided to the retail customer, including: 
any material limitations on the securities or investment strategies 
involving securities that may be recommended to the retail customer. We 
generally believe the proposed burdens and costs identified in the 
Proposing Release were accurate but have updated estimates to reflect 
changes in the number of broker-dealers and costs of certain services 
since the last estimate. The collections of information associated with 
the Disclosure Obligation, as well as the associated record-making and 
recordkeeping obligations are addressed below.
a. Obligation To Provide to the Retail Customer Full and Fair 
Disclosure, in Writing, of all Material Facts Relating to the Scope and 
Terms of the Relationship With the Retail Customer
    The Commission assumes for purposes of this analysis that broker-
dealers would meet the obligation to disclose to the retail customer, 
in writing, the material facts related to the scope and terms of the 
relationship with the retail customer through a

[[Page 33471]]

combination of delivery of the Relationship Summary, creating account 
disclosures to include standardized language related to capacity and 
type and scope of services, and the development of fee schedules.
(1) Disclosure of Capacity
    As discussed above, the Commission believes that a standalone 
broker-dealer would be able to satisfy its obligation to disclose that 
it is acting in a broker-dealer capacity by providing the retail 
customer with the Relationship Summary in the manner prescribed by the 
rules and guidance in the Relationship Summary Adopting Release.\1392\
---------------------------------------------------------------------------

    \1392\ See Relationship Summary Adopting Release.
---------------------------------------------------------------------------

    We assume, for purposes of this PRA analysis, that a dually 
registered broker-dealer would satisfy its obligation to disclose it is 
acting in a broker-dealer capacity by creating an account disclosure 
with standardized language, and by providing it to the retail customer 
at the beginning of the relationship. The account disclosure would set 
forth when the broker-dealer would be acting in a broker-dealer 
capacity, and the method the broker-dealer planned to use to clarify 
its capacity at the time of the recommendation. We understand that many 
broker-dealers already include such information in account disclosures.
(2) Disclosure of Fees and Costs and Type and Scope of Services, 
Including Any Material Limitations on the Securities or Investment 
Strategies That may be Recommended
    While many broker-dealers provide fee information to retail 
customers in a fee schedule, the Commission believes that to comply 
with the Disclosure Obligation broker-dealers will either amend their 
existing schedules or develop a new standardized fee schedule to 
disclose the fees and costs applicable to retail customers' 
transactions, holdings, and accounts. This fee schedule would be 
delivered to retail customers at the beginning of a relationship. If, 
at the time the recommendation is made, the disclosure made to the 
retail customer is not current or does not contain all material facts 
regarding the fees and costs of the particular recommendation, the 
broker-dealer would need to deliver an amended fee schedule or provide 
an oral update, under the circumstances outlined in Section II.C.1.
    With respect to disclosure of the type and scope of services 
provided by the broker-dealer, including any material limitations on 
the securities or investment strategies that may be recommended to the 
retail customer, we assume for purposes of this PRA analysis that a 
broker-dealer would satisfy the Disclosure Obligation by including this 
information in the account disclosure provided to the retail customer 
at the beginning of the relationship, as described above. The broker-
dealer would need to deliver an amended account disclosure to the 
retail customer in the case of any material changes made to the type 
and scope of services or provide an oral update, under the 
circumstances outlined in Section II.C.1.
b. Obligation To Provide to the Retail Customer Full and Fair 
Disclosure, in Writing, of All Material Facts Relating to Conflicts of 
Interest That are Associated With the Recommendation
    Regulation Best Interest requires a broker-dealer to provide the 
retail customer, in writing, full and fair disclosure of all material 
facts relating to conflicts of interest that are associated with a 
recommendation.
    As discussed above, we assume that broker-dealers will satisfy the 
obligation to disclose all material facts relating to conflicts of 
interest through the use of: (1) A standardized, written disclosure 
document provided to all retail customers and (2) supplemental 
disclosure provided to certain retail customers for recommendations of 
specific products.
    We assume for purposes of this analysis that delivery of written 
disclosure will occur at the beginning of a relationship, such as 
together with the account opening agreement. For existing retail 
customers, the disclosure will need to occur ``prior to or at the 
time'' of a recommendation. Subsequent disclosures may be delivered or 
the broker-dealer may provide an oral update, under the circumstances 
outlined in Section II.C.1, in the event of a material change or if the 
broker-dealer determines additional disclosure is needed for certain 
types of products.
    The corresponding estimated total annual reporting costs and 
burdens are addressed below.\1393\
---------------------------------------------------------------------------

    \1393\ The costs and burdens arising from the obligation to 
identify all material conflicts of interest that are associated with 
the recommendation are addressed below, in the context of the 
Conflict of Interest Obligation, in Section V.B.1.
---------------------------------------------------------------------------

c. Estimated Costs and Burdens
(1) Disclosure of Capacity, Type and Scope of Services
    Standalone broker-dealers will satisfy the obligation to disclose 
the capacity in which they are acting through the delivery to retail 
customers of the Relationship Summary, in accordance with the rules and 
guidance set forth in the Relationship Summary Adopting Release. 
Additionally, although we understand that many dual-registrants and 
standalone broker-dealers, as a matter of best practice, already 
disclose the capacity in which they are acting as well as the and type 
and scope of services they offer to retail customers, for purposes of 
this analysis, we assume that dual-registrants would create new account 
disclosure related to capacity and all broker-dealers would create or 
update account disclosure related to type and scope of services 
specifically for purposes of compliance with Regulation Best Interest. 
The Commission assumes that broker-dealers would provide the account 
disclosure to each retail customer account, regardless of whether the 
retail customer has multiple accounts with the broker-dealer.
    While the Commission recognizes that the Disclosure Obligation 
applies to the broker-dealer entity and its associated persons, we do 
not expect associated persons to incur any initial or ongoing burdens 
with respect to the scope and terms of the relationship, as we assume 
for purposes of this analysis that this information would be addressed 
by the broker-dealer entity's account disclosure.\1394\ With regard to 
disclosure of the capacity in which the associated person is acting, 
the Commission believes that dually registered representatives of 
broker-dealers will incur initial and ongoing burdens.\1395\
---------------------------------------------------------------------------

    \1394\ A broker-dealer or an associated person may satisfy the 
Disclosure Obligation by using oral disclosure if it has previously 
provided written disclosure to the retail customer beforehand as 
well as the method it planned to use to clarify the disclosure at 
the time of the recommendation. In addition, a record of the fact of 
such oral disclosure having been made must be created and retained. 
We assume that any disclosure required of a registered 
representative will be made orally, and that any ongoing costs and 
burdens will be associated with the record-making memorializing the 
fact of the oral disclosure. See Section IV.B.5 (discussing the 
costs and burdens associated with record-making).
    \1395\ See supra Section IV.B.5 (discussing the costs and 
burdens associated with record-making).
---------------------------------------------------------------------------

    Following is a discussion of the estimated initial and ongoing 
burdens and costs.
i. Initial Costs and Burdens
    Because, as noted above, standalone broker-dealers will satisfy the 
obligation to disclose the capacity in which they are acting through 
the delivery to retail customers of the Relationship Summary, we 
estimate zero burden hours for standalone broker-dealers to disclose 
the capacity in which they are acting.

[[Page 33472]]

We estimate that a dually registered firm will incur an initial 
internal burden of 10 hours for in-house counsel and in-house 
compliance \1396\ to draft language regarding the capacity in which 
they are acting for inclusion in the standardized account disclosure 
that is delivered to the retail customer.\1397\
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    \1396\ The ten hour estimate includes five hours for in-house 
counsel to draft and review the standardized language, and five 
hours for consultation and review of compliance personnel.
    \1397\ As discussed above, the following estimates include the 
costs and burdens that broker-dealers would incur in drafting 
standardized account disclosure language related to the scope and 
terms of the relationship on behalf of their dually registered 
representatives. For purposes of this analysis, the Commission 
assumes that broker-dealers will undertake these tasks on behalf of 
their registered representatives. See Section IV.B.5 (discussing the 
costs and burdens associated with record-making).
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    In addition, we estimate that dual-registrants will incur an 
estimated external cost of $4,970 for the assistance of outside counsel 
in the preparation and review of standardized language regarding 
capacity.\1398\ For the estimated 563 dually registered firms with 
retail business,\1399\ we project an aggregate initial burden of 5,630 
hours,\1400\ and $2.8 million in aggregate initial costs relating to 
disclosure of the capacity in which they are acting.\1401\
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    \1398\ Data from the Securities Industry Financial Markets 
Association's Management & Professional Earnings in the Securities 
Industry 2013 (``SIFMA Management and Professional Earnings 
Report''), modified by Commission staff to account for an 1,800-hour 
work-year and inflation, and multiplied by 5.35 (professionals) or 
2.93 (office) to account for bonuses, firm size, employee benefits, 
and overhead, suggests that costs for this position is $497 per 
hour. The SIFMA Management and Professional Earnings Report was 
updated in 2019 to reflect inflation. The numbers in the report are 
higher than the numbers we used in the Proposing Release. This 
estimate is based on the following calculation: (10 hours for 
outside counsel review/drafting) x ($497/hour for outside counsel 
services) = $4,970 in initial outside counsel costs.
    \1399\ See supra Section III.B.1.a, at Table 1, Panel B. The 
number of dually registered broker-dealers includes broker-dealers 
that are also Commission- and state-licensed investment advisers.
    \1400\ This estimate is based on the following calculation: (563 
dually registered retail firms) x (10 hours) = 5,630 initial 
aggregate burden hours.
    \1401\ This estimate is based on the following calculation: (563 
dually registered retail firms) x ($4,970 in external cost per firm) 
= $2.8 million in aggregate initial costs.
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    Similarly, to comply with Regulation Best Interest, we believe that 
broker-dealers \1402\ will draft standardized language for inclusion in 
the account disclosure to provide the retail customer with more 
specific information regarding the type and scope of services that they 
provide. We expect that the associated costs and burdens will differ 
between small and large broker-dealers, as large broker-dealers 
generally offer more products and services and therefore will need to 
evaluate a larger number of products and services.
---------------------------------------------------------------------------

    \1402\ In the Proposing Release, we inadvertently referred to 
``standalone broker-dealers'' in this discussion, but our subsequent 
references and estimates reflected our intent to capture initial 
costs and burdens relating to disclosure of type and scope of 
services on all broker-dealers (distinguishing between small and 
large).
---------------------------------------------------------------------------

    Given these assumptions, we estimate that a small broker-dealer 
will incur an internal initial burden of 10 hours for in-house counsel 
and in-house compliance to draft this standardized language.\1403\ In 
addition, a small broker-dealer will incur an estimated external cost 
of $4,970 for the assistance of outside counsel in the preparation and 
review of this standardized language.\1404\ For the estimated 756 small 
broker-dealers,\1405\ we project an aggregate initial burden of 7,560 
hours,\1406\ and aggregate initial costs of $3.8 million.\1407\
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    \1403\ The 10-hour estimate includes 5 hours for in-house 
counsel to draft and review the standardized language, and 5 hours 
for consultation and review by in-house compliance.
    \1404\ This estimate is based on the following calculation: (10 
hours for outside counsel review/drafting) x ($497/hour for outside 
counsel services) = $4,970 in initial outside counsel costs.
    \1405\ See supra footnote 1384 and accompanying text.
    \1406\ This estimate is based on the following calculation: (756 
small broker-dealers) x (10 hours per small broker-dealer) = 7,560 
initial aggregate burden hours.
    \1407\ This estimate is based on the following calculation: (756 
small broker-dealers) x ($4,970 in external cost per small broker-
dealer) = $3.8 million in aggregate initial outside counsel costs.
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    Given the broader array of products and services offered, we 
estimate that a large broker-dealer will incur an internal burden of 
twenty hours to draft this standardized language.\1408\ A large broker-
dealer will also incur an estimated cost of $7,470 for the assistance 
of outside counsel in the preparation and review of this standardized 
language.\1409\ For the estimated 2,010 large retail broker-dealers, we 
estimate an aggregate initial burden of 40,200 hours \1410\ and $15 
million in aggregate initial costs.\1411\
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    \1408\ The 20-hour estimate includes 10 hours for in-house 
counsel to draft and review the standardized language, and 10 hours 
for consultation and review by in-house compliance.
    \1409\ This estimate is based on the following calculation: (15 
hours for outside counsel review/drafting) x ($497/hour for outside 
counsel services) = $7,455 in initial outside counsel costs.
    \1410\ This estimate is based on the following calculation: 
(2,010 large broker-dealers) x (20 burden hours) = 40,200 aggregate 
initial burden hours.
    \1411\ This estimate is based on the following calculation: 
(2,010 large broker-dealers) x ($7,455 initial outside counsel 
costs) = $15 million in aggregate initial costs.
---------------------------------------------------------------------------

    We estimate that all broker-dealers will each incur approximately 
0.02 burden hours \1412\ for delivery of the account disclosure 
document.\1413\ Based on FOCUS data, we estimate that the 2,766 broker-
dealers that report retail activity have approximately 139 million 
customer accounts, and that approximately 73.5%, or 102 million, of 
those accounts belong to retail customers.\1414\ We therefore estimate 
that broker-dealers will have an aggregate initial burden of 2,040,000 
hours, or approximately 738 hours \1415\ per broker-dealer for the 
first year after Regulation Best Interest is in effect.\1416\
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    \1412\ This is the same estimate the Commission makes in the 
Relationship Summary Adopting Release. It is also the same estimate 
the Commission made in the Amendments to Form ADV Adopting Release, 
and for which we received no comment. See Amendments to Form ADV, 17 
CFR parts 275 and 279 at 49259. We expect that delivery requirements 
will be performed by a general clerk. The general clerk's time is 
included in the initial burden estimate.
    \1413\ As noted above, for new retail customers, we expect 
delivery to occur at the beginning of the relationship; for existing 
customers, we expect delivery to occur prior to or at the time of a 
recommendation.
    \1414\ We have revised our estimates from the Proposing Release 
to reflect the updated FOCUS Report data. Therefore, the 2,766 
broker-dealers (including dual-registrants) with retail customers 
report 139 million customer accounts. See Section III.B.1.a, at 
Table 1, Panel B. Assuming the amount of retail customer accounts is 
proportionate to the percentage of broker-dealers that have retail 
customers, or 73.5% of broker-dealers, then the number of retail 
customer accounts would be 73.5% of 139 million accounts = 102 
million retail customer accounts. This number likely overstates the 
number of deliveries to be made due to the double-counting of 
deliveries to be made by dual-registrants to a certain extent, and 
the fact that one customer may own more than one account.
    \1415\ These estimates are based on the following calculations: 
(0.02 hours per customer account x (102 million retail customer 
accounts) = 2,040,000 aggregate burden hours. Conversely, (2,040,000 
hours)/(2,766 broker-dealers) = approximately 738 burden hours per 
broker-dealer for the first year after Regulation Best Interest is 
in effect.
    \1416\ We estimate that broker-dealers will not incur any 
incremental postage costs because we assume that they will make such 
deliveries with another mailing the broker-dealer was already 
delivering to retail customers.
---------------------------------------------------------------------------

    We estimate a total initial aggregate burden for all broker-dealers 
to develop and deliver to retail customers account disclosures relating 
to capacity and type and scope of services of 2,093,390 burden 
hours.\1417\ We estimate a total initial aggregate cost of $21.6 
million.\1418\
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    \1417\ This estimate is based on the following calculation: 
(5,630 aggregate initial burden hours for dual-registrants) + (7,560 
aggregate initial burden hours for small broker-dealers) + (40,200 
burden hours for large broker-dealers) + (2,040,000 aggregate 
initial burden hours for all broker-dealers to deliver the account 
disclosures) = 2,093,390 total aggregate initial burden hours.
    \1418\ This estimate is based on the following calculation: 
($2.8 million in initial aggregate costs for dual-registrants) + 
($3.8 million in initial aggregate costs for small broker-dealers) + 
($15 million in initial aggregate costs for large broker-dealers) = 
$21.6 million in total initial aggregate costs.

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[[Page 33473]]

ii. Ongoing Costs and Burdens
    For purposes of this analysis, we assume that broker-dealers will 
review and amend the standardized language in the account disclosure, 
on average, once a year.\1419\ Further, we assume that broker-dealers 
will not incur outside costs in connection with updating account 
disclosures, as in-house personnel will be more knowledgeable about 
changes in capacity, and the type and scope of services offered by the 
broker-dealer. Additionally, with respect to standalone broker-dealers, 
because they will meet their obligation to disclose capacity by 
delivering the Relationship Summary, and will be subject to 
requirements to amend the Relationship Summary consistent with Form 
CRS, we estimate zero burden hours annually for ongoing costs relating 
to disclosure of capacity under the Disclosure Obligation.
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    \1419\ We believe this annual timeframe is consistent with other 
obligations imposed on broker-dealers. For example, FINRA rules set 
an annual supervisory review as a minimum threshold for broker-
dealers, for example, in FINRA Rules 3110 (requiring an annual 
review of the businesses in which the broker-dealer engages), 3120 
(requiring an annual report detailing a broker-dealer's system of 
supervisory controls, including compliance efforts in the areas of 
antifraud and sales practices); and 3130 (requiring each broker-
dealer's CEO or equivalent officer to certify annually to the 
reasonable design of the policies and procedures for compliance with 
relevant regulatory requirements).
---------------------------------------------------------------------------

    We estimate that each dually registered broker-dealer will incur 
approximately five burden hours annually for in-house compliance and 
business-line personnel to review changes in the dual-registrant's 
capacity,\1420\ and another two burden hours annually for in-house 
counsel to amend the account disclosure to disclose material changes to 
the dual-registrant's capacity, for a total of seven burden hours. The 
estimated ongoing aggregate burden to amend dual-registrants' account 
disclosures to reflect changes in capacity is therefore 3,941 hours per 
year.\1421\
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    \1420\ In the Proposing Release, we referred to capacity and 
type and scope of services, however, we captured the ongoing costs 
and burdens relating to disclosure of type and scope of services in 
the paragraphs that followed, where we inadvertently referred to 
``small standalone broker-dealers'' and ``large standalone broker-
dealers,'' but where our calculations reflected the burdens on all 
``small broker-dealers'' and all ``large broker-dealers.'' See 
Proposing Release, footnotes 600-601. We believe it is appropriate 
to distinguish between standalone and dually registered broker-
dealers in assessing the costs and burdens relating to disclosure of 
capacity, and to distinguish between small and large firms in 
assessing the costs and burdens relating to disclosure of type and 
scope of services, as reflected in this section.
    \1421\ This estimate is based on the following calculation: (7 
burden hours per dually registered firm per year) x (563 dually 
registered broker-dealers) = 3,941 ongoing aggregate burden hours 
per year.
---------------------------------------------------------------------------

    With respect to small broker-dealers, we estimate an internal 
burden of two hours for in-house compliance and business-line personnel 
to review and update changes in types or scope of services, and another 
two burden hours annually for in-house counsel to amend the account 
disclosure to disclose material changes to type and scope of services--
for a total of four burden hours. The estimated ongoing aggregate 
burden for small broker-dealers to amend account disclosures to reflect 
changes in type and scope of services is therefore 3,024 hours per 
year.\1422\
---------------------------------------------------------------------------

    \1422\ This estimate is based on the following calculation: (4 
burden hours per broker-dealer per year) x (756 small broker-
dealers) = 3,024 ongoing aggregate burden hours per year.
---------------------------------------------------------------------------

    We estimate that large broker-dealers would incur ten burden hours 
annually for in-house compliance and business-line personnel to review 
and update changes the type and scope of services, and another ten 
burden hours annually for in-house counsel to amend the account 
disclosure to disclose material changes to the type and scope of 
services, for a total of twenty burden hours. We therefore believe the 
ongoing, aggregate burden is 40,200 hours per year for large broker-
dealers.\1423\
---------------------------------------------------------------------------

    \1423\ This estimate is based on the following calculation: (20 
burden hours per broker-dealer per year) x (2,010 large broker-
dealers) = 40,200 ongoing aggregate burden hours per year.
---------------------------------------------------------------------------

    With respect to delivery of the amended account agreements in the 
event of material changes to the capacity disclosure or disclosure 
related to type and scope of services, we estimate that this would take 
place among 20% of a broker-dealer's retail customer accounts annually. 
We therefore estimate broker-dealers to incur a total annual aggregate 
burden of 408,000 hours, or 148 hours per year per broker-dealer.\1424\
---------------------------------------------------------------------------

    \1424\ (20%) x (102 million retail customer accounts) x (.02 
hours for delivery to each customer account) = 408,000 aggregate 
burden hours. Conversely, 408,000 aggregate burden hours/2,766 
broker-dealers = 148 burden hours per year per broker-dealer.
---------------------------------------------------------------------------

    The total ongoing aggregate burden for all broker-dealers to 
review, amend, and deliver updated account disclosures to reflect 
changes in capacity, type and scope of services would be 455,165 burden 
hours per year.\1425\
---------------------------------------------------------------------------

    \1425\ This estimate is based on the following calculation: 
(3,941 ongoing aggregate burden hours for dually registered broker-
dealers) + (3,024 ongoing aggregate burden hours for small broker-
dealers) + (40,200 ongoing aggregate burden hours for large broker-
dealers) + (408,000 ongoing aggregate burden hours for delivery of 
amended account disclosures) = 455,165 total ongoing aggregate 
burden hours per year.
---------------------------------------------------------------------------

    The Commission acknowledges that the types of services and product 
offerings vary greatly by broker-dealer, and therefore the costs and 
burdens associated with updating the account disclosure might also 
vary.
(2) Disclosure of Fees and Costs
    The Commission assumes for purposes of this analysis that a broker-
dealer will disclose its fees and costs through a standardized fee 
schedule, delivered to the retail customer at the beginning of the 
relationship, or, for existing retail customers, prior to or at the 
time of a recommendation and, as discussed below, will amend such fee 
schedules in the event of material changes. Although we understand that 
many broker-dealers already provide fee schedules to retail customers, 
we are assuming for purposes of this analysis that a fee schedule would 
be created specifically for purposes of compliance with Regulation Best 
Interest.\1426\ While the Commission recognizes that the fee disclosure 
included in Disclosure Obligation applies to the broker-dealer entity 
and its associated persons, we do not expect any burdens or costs on 
associated persons related to the fees and costs as this information 
would be addressed in the broker-dealer entity's fee schedule.
---------------------------------------------------------------------------

    \1426\ Our estimates may be higher than actual, since firms may 
be able to use or simply update existing disclosures depending on 
the facts and circumstances.
---------------------------------------------------------------------------

i. Initial Costs and Burdens
    We assume that, for purposes of this analysis, the associated costs 
and burdens will differ between small and large broker-dealers, as 
large broker-dealers generally offer more products and services and 
therefore will need to evaluate a wider range of fees in their fee 
schedules. As stated above, while we anticipate that many broker-
dealers may already create fee schedules, we believe that small broker-
dealers will initially spend five hours for in-house compliance and 
large broker-dealers will spend ten hours for in-house compliance to 
internally create a new fee schedule in consideration of the 
requirements of Regulation Best Interest. We additionally estimate a 
one-time external cost of $2,485 for small broker-dealers \1427\ and 
$4,970 for larger broker-dealers for outside counsel to review the fee 
schedule.\1428\ We therefore estimate the initial aggregate burden for 
small broker-dealers to be 3,780 burden

[[Page 33474]]

hours,\1429\ and the initial aggregate cost to be $1.88 million.\1430\ 
We estimate the aggregate burden for large broker-dealers to be 20,100 
burden hours,\1431\ and the aggregate cost to be $9.99 million.\1432\
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    \1427\ This cost estimate is based on the following calculation: 
(5 hours of review) x ($497/hour for outside counsel services) = 
$2,485 outside counsel costs.
    \1428\ This cost estimate is based on the following calculation: 
(10 hours of review) x ($497/hour for outside counsel services) = 
$4,970 outside counsel costs.
    \1429\ This estimate is based on the following calculation: (5 
burden hours of review per small broker-dealer) x (756 small broker-
dealers) = 3,780 aggregate initial burden hours.
    \1430\ This estimate is based on the following calculation: 
($2,485 for outside counsel costs per small broker-dealer) x (756 
small broker-dealers) = $1.88 million in aggregate initial outside 
costs.
    \1431\ This estimate is based on the following calculation: (10 
burden hours of review per large broker-dealer) x (2,010 large 
broker-dealers) = 20,100 aggregate initial burden hours.
    \1432\ This estimate is based on the following calculation: 
($4,970 for outside counsel costs per large broker-dealer) x (2,010 
large broker-dealers) = $9.99 million in aggregate initial costs.
---------------------------------------------------------------------------

    Similar to delivery of the account disclosure regarding capacity 
and type and scope of services, we estimate the burden for broker-
dealers to make the initial delivery of the fee schedule to new retail 
customers, at the beginning of the relationship, and existing retail 
customers, prior to or at the time of a recommendation, will require 
approximately 0.02 hours to deliver to each retail customer.\1433\ As 
stated above, we estimate that the 2,766 broker-dealers that report 
retail activity have approximately 139 million customer accounts, and 
that approximately 73.5%, or 102 million, of those accounts belong to 
retail customers.\1434\ We therefore estimate that broker-dealers will 
have an aggregate initial burden of 2,040,000 hours, or approximately 
738 hours per broker-dealer for the first year after Regulation Best 
Interest is in effect.\1435\
---------------------------------------------------------------------------

    \1433\ See supra footnote 1411.
    \1434\ See supra footnote 1412.
    \1435\ This estimate is based on the following calculation: (102 
million retail customer accounts) x (.02 hours for delivery to each 
customer account) = 2,040,000 aggregate burden hours. Conversely, 
(2,040,000 aggregate burden hours)/(2,766 broker-dealers) = 738 
burden hours per broker-dealer for the first year after Regulation 
Best Interest is in effect.
---------------------------------------------------------------------------

    The total aggregate initial burden for broker-dealers is therefore 
estimated at 2,063,880 \1436\ hours, and the total aggregate initial 
cost is estimated at $11.87 million.\1437\
---------------------------------------------------------------------------

    \1436\ This estimate is based on the following calculations: 
(3,780 aggregate burden hours for small broker-dealers) + (20,100 
burden hours for large broker-dealers) + (2,040,000 burden hours for 
delivery) = 2,063,880 total aggregate initial burden hours.
    \1437\ This estimate is based on the following calculation: 
($1.88 million for small broker-dealer costs) + ($9.99 million large 
broker-dealer costs) = $11.87 million in total initial aggregate 
costs.
---------------------------------------------------------------------------

ii. Ongoing Costs and Burdens
    For purposes of this PRA analysis, we assume that broker-dealers 
will review and amend the fee schedule on average, once a year. With 
respect to small broker-dealers, we estimate that reviewing and 
updating the fee schedule will require approximately two hours for in-
house compliance per year, and for large broker-dealers, we estimate 
that the recurring, annual burden to review and update the fee schedule 
will be four hours for in-house compliance for each large broker-
dealer. Based on these estimates, we estimate the recurring, aggregate, 
annualized burden will be 1,512 hours for small broker-dealers \1438\ 
and 8,040 hours for large broker-dealers.\1439\ We do not anticipate 
that small or large broker-dealers will incur outside legal, 
compliance, or consulting fees in connection with updating their 
standardized fee schedule since in-house personnel would be more 
knowledgeable about these facts, and we therefore do not expect 
external costs associated with updating the fee schedule.
---------------------------------------------------------------------------

    \1438\ This estimate is based on the following calculation: (2 
burden hours per broker-dealer) x (756 small broker-dealers) = 1,512 
aggregate burden hours per broker-dealer per year.
    \1439\ This estimate is based on the following calculation: (4 
burden hours per broker-dealer) x (2,010 large broker-dealers) = 
8,040 aggregate burden hours per broker-dealer per year.
---------------------------------------------------------------------------

    With respect to delivery of the amended fee schedule in the event 
of a material change, we estimate that this would take place among 40% 
of a broker-dealer's retail customer accounts annually, and that 
broker-dealers will require approximately 0.02 hours to deliver the 
amended fee schedule to each retail customer.\1440\ We therefore 
estimate broker-dealers would incur a total annual aggregate burden of 
816,000 hours, or 295 hours per broker-dealer.\1441\
---------------------------------------------------------------------------

    \1440\ See supra footnote 1411.
    \1441\ This estimate is based on the following calculation: (40% 
of 102 million retail customer accounts) x (.02 hours) = 816,000 
aggregate burden hours. Conversely, (816,000 aggregate burden 
hours)/(2,766 broker-dealers) = 295 burden hours per broker-dealer 
per year.
---------------------------------------------------------------------------

    The total ongoing aggregate burden for all broker-dealers to 
review, amend, and deliver updated account disclosures to reflect 
changes in fees and costs would be 825,552 burden hours per year.\1442\
---------------------------------------------------------------------------

    \1442\ This estimate is based on the following calculation: 
(1,512 ongoing aggregate burden hours for small broker-dealers) + 
(8,040 ongoing aggregate burden hours for large broker-dealers) + 
(816,000 ongoing aggregate burden hours for delivery of amended 
account disclosures) = 825,552 total ongoing aggregate burden hours 
per year.
---------------------------------------------------------------------------

    The Commission acknowledges that the type of fee schedule may vary 
greatly by broker-dealer, and therefore that the costs or burdens 
associated with updating the standardized fee schedule might similarly 
vary.
(3) Disclosure of All Material Facts Relating to Conflicts of Interest 
Associated With the Recommendation
    Regulation Best Interest requires broker-dealers to provide a 
retail customer, in writing, full and fair disclosure of all material 
facts relating to conflicts of interest that are associated with the 
recommendation. Because the Disclosure Obligation applies to both the 
broker-dealer entity and its associated persons, the Commission expects 
that the broker-dealer entity and its associated persons will incur 
initial and ongoing burdens. However, as with the disclosure of the 
capacity in which they are acting and type and scope of services, we 
assume for purposes of this analysis that the broker-dealer entities 
will incur the costs and burdens of disclosing material conflicts of 
interest on behalf of their associated persons.\1443\
---------------------------------------------------------------------------

    \1443\ See Section IV.B.5 (discussing the costs and burdens 
associated with record-making, including for associated persons of a 
broker-dealer).
---------------------------------------------------------------------------

i. Initial Costs and Burdens
    The Disclosure Obligation provides broker-dealers with the 
flexibility to choose the form and manner of conflict disclosure. 
However, we believe that many or most broker-dealers will develop a 
standardized conflict disclosure document and deliver it to their 
retail customers.\1444\ We also assume for purposes of this PRA 
analysis that broker-dealers will update and deliver the standardized 
conflict disclosure document yearly on an ongoing basis, following the 
broker-dealer's annual conflicts review process.
---------------------------------------------------------------------------

    \1444\ As noted above, we assume that delivery for new customers 
will occur at the beginning of the relationship, and that delivery 
for existing customers will occur prior to or at the time a 
recommendation is made.
---------------------------------------------------------------------------

    For purposes of this PRA analysis, we assume that a standardized 
conflict disclosure document will be developed by in-house counsel and 
reviewed by outside counsel. For small broker-dealers, we estimate it 
will take in-house counsel, on average, five burden hours to create the 
standardized conflict disclosure document and outside counsel five 
hours to review and revise the document. We estimate that the initial 
aggregate burden for the development of a standardized disclosure 
document, based on an estimated 756 small broker-dealers, will be 3,780 
burden hours.\1445\ We additionally estimate an initial cost of

[[Page 33475]]

$2,485 per small broker-dealer,\1446\ and an aggregate initial cost of 
$1.88 million for all small broker-dealers.\1447\
---------------------------------------------------------------------------

    \1445\ This estimate is based on the following calculation: (5 
hours) x (756 small broker-dealers) = 3,780 aggregate initial burden 
hours.
    \1446\ This estimate is based on the following calculation: 
($497/hour) x (5 hours) = $2,485 in initial costs.
    \1447\ This estimate is based on the following calculation: 
($497/hour x 5 hours) x (756 small broker-dealers) = $1.88 million 
in aggregate initial costs.
---------------------------------------------------------------------------

    We expect the development and review of the standardized conflict 
disclosure document to take longer for large broker-dealers because, as 
discussed above, we believe large broker-dealers generally offer more 
products and services and employ more individuals, and therefore will 
need to disclose a larger number of conflicts. We estimate that for 
large broker-dealers, it will take 7.5 burden hours for in-house 
counsel to create the standardized conflict disclosure document, and 
outside counsel will take another 7.5 hours to review and revise the 
disclosure document. As a result, we estimate the initial aggregate 
burden, based on an estimated 2,010 large broker-dealers, to be 
approximately 15,075 burden hours.\1448\ We additionally estimate 
initial costs of $3,728 per broker-dealer,\1449\ and an aggregate 
initial cost for large broker-dealers of approximately $7.49 
million.\1450\
---------------------------------------------------------------------------

    \1448\ This estimate is based on the following calculation: (7.5 
hours x 2,010 large broker-dealers) = 15,075 aggregate initial 
burden hours.
    \1449\ This estimate is based on the following calculation: 
($497/hour) x (7.5 hours) = $3,728 in initial costs per broker-
dealer.
    \1450\ This estimate is based on the following calculation: 
($497/hour) x (7.5 hours) x 2,010 large broker-dealers) = $7.49 
million in aggregate costs.
---------------------------------------------------------------------------

    We assume that broker-dealers will deliver the standardized 
conflict disclosure document to new retail customers at the inception 
of the relationship, and to existing retail customers prior to or at 
the time of a recommendation. We estimate that broker-dealers will 
require approximately 0.02 hours to deliver the standardized conflict 
disclosure document to each retail customer.\1451\ We therefore 
estimate that broker-dealers will incur an aggregate initial burden of 
2,040,000 hours, or approximately 738 hours per broker-dealer for 
delivery of the standardized conflict disclosure document the first 
year after Regulation Best Interest is in effect.\1452\
---------------------------------------------------------------------------

    \1451\ See supra footnote 1411. For purposes of this PRA 
analysis, we have assumed any initial disclosures made by the 
broker-dealer related to material conflicts of interest will be 
delivered together.
    \1452\ These estimates are based on the following calculations: 
(0.02 hours per customer account x 102 million retail customer 
accounts) = 2,040,000 aggregate initial burden hours. Conversely, 
(2,040,000 hours)/(2,766 broker-dealers) = 738 burden hours per 
broker-dealer.
---------------------------------------------------------------------------

    The total aggregate initial burden for broker-dealers is therefore 
estimated at 2,058,855 \1453\ hours, and the total aggregate initial 
cost is estimated at $9.37 million.\1454\
---------------------------------------------------------------------------

    \1453\ This estimate is based on the following calculations: 
(3,780 aggregate burden hours for small broker-dealers) + (15,075 
burden hours for large broker-dealers) + (2,040,000 burden hours for 
delivery) = 2,058,855 total aggregate initial burden hours.
    \1454\ This estimate is based on the following calculation: 
($1.88 million for small broker-dealer costs) + ($7.49 million large 
broker-dealer costs) = $9.37 million in total aggregate initial 
costs.
---------------------------------------------------------------------------

ii. Ongoing Costs and Burdens
    We believe that broker-dealers will incur ongoing annual burdens 
and costs to update the disclosure document to include newly identified 
conflicts. We assume for purposes of this analysis that broker-dealers 
will update their conflict disclosure document annually, after 
conducting an annual conflicts review. We estimate that the conflicts 
disclosures will be updated internally by both small and large broker-
dealers.
    We estimate that in-house counsel at a small broker-dealer will 
require approximately one hour per year to update the standardized 
conflict disclosure document, for an ongoing aggregate, annual burden 
of approximately 756 hours.\1455\ For large broker-dealers, we estimate 
that the ongoing, aggregate annual burden would be two hours for each 
broker-dealer: One hour for in-house compliance and one hour for in-
house counsel for legal personnel. We therefore estimate the ongoing, 
aggregate burden for large broker-dealers to be approximately 4,020 
burden hours.\1456\ We do not anticipate that small or large broker-
dealers will incur outside legal, compliance, or consulting fees in 
connection with updating their standardized conflict disclosure 
document, since in-house personnel would presumably be more 
knowledgeable about conflicts of interest.
---------------------------------------------------------------------------

    \1455\ This estimate is based on the following calculation: (1 
hour per broker-dealer) x (756 small broker-dealers) = 756 aggregate 
burden hours per year.
    \1456\ This estimate is based on the following calculation: (2 
hours per broker-dealer) x (2,010 large broker-dealers) = 4,020 
aggregate burden hours per year.
---------------------------------------------------------------------------

    With respect to ongoing delivery of the updated conflict disclosure 
document, we estimate that this will take place among 40% of a broker-
dealer's retail customer accounts annually, and that broker-dealers 
will require approximately 0.02 hours to deliver the updated conflict 
disclosure document to each retail customer.\1457\ We therefore 
estimate that broker-dealers will incur an ongoing, aggregate annual 
burden of 816,000 hours, or 295 burden hours per broker-dealer.\1458\ 
The total aggregate ongoing burden for broker-dealers is therefore 
estimated at 820,776 hours.\1459\
---------------------------------------------------------------------------

    \1457\ See supra footnote 1411. The Commission estimates that 
broker-dealers will update their disclosures of fees and costs and 
material facts relating to conflicts of interest that are associated 
with their recommendation more frequently than disclosure related to 
capacity or type and scope of services.
    \1458\ This estimate is based on the following calculation: (40% 
of 102 million retail customer accounts) x (.02 hours) = 816,000 
aggregate burden hours per year. Conversely, (816,000 aggregate 
burden hours)/(2,766 broker-dealers) = 295 hours per broker-dealer 
per year.
    \1459\ This estimate is based on the following calculations: 
(756 aggregate burden hours for small broker-dealers) + (4,020 
aggregate burden hours for large broker-dealers) + (816,000 
aggregate burden hours for delivery) = 820,776 total aggregate 
ongoing burden hours.
---------------------------------------------------------------------------

    Based on the calculation describe above, we estimate that broker-
dealers will incur an aggregate total initial burden of 6,216,125 hours 
\1460\ and a total initial cost of $42.84 million,\1461\ as well as an 
aggregate total ongoing annual burden of 2,101,493 hours \1462\ to 
comply with the Disclosure Obligation.
---------------------------------------------------------------------------

    \1460\ This estimate is based on the following calculation: 
(2,093,390 aggregate initial burden hours for initial compliance 
with disclosure of capacity and type and scope of services) + 
(2,063,880 aggregate initial burden hours for initial compliance 
with disclosure of fees and costs) + (2,058,855 aggregate initial 
burden hours for initial compliance with disclosure of all material 
facts regarding disclosure of conflicts of interest associated with 
the recommendation) = 6,216,125 total aggregate initial burden hours 
for compliance with the Disclosure Obligation.
    \1461\ This estimate is based on the following calculation: 
($21.6 million aggregate initial cost for compliance with disclosure 
of capacity and type and scope of services) + ($11.87 million 
aggregate initial cost for compliance with disclosure of fees and 
costs) + ($9.37 aggregate initial cost for compliance with 
disclosure of all material facts regarding disclosure of conflicts 
of interest associated with the recommendation) = $42.84 million 
total aggregate initial cost for compliance with the Disclosure 
Obligation.
    \1462\ This estimate is based on the following calculation: 
(455,165 aggregate annual burden hours for ongoing compliance with 
disclosure of capacity and type and scope of services) + (825,552 
aggregate annual burden hours for ongoing compliance with disclosure 
of fees and costs) + (820,776 aggregate annual burden hours for 
ongoing compliance with disclosure of all material facts regarding 
disclosure of conflicts of interest associated with the 
recommendation) = 2,101,493 total aggregate burden hours per year 
for ongoing compliance with the Disclosure Obligation.
---------------------------------------------------------------------------

2. Care Obligation
    The Care Obligation requires a broker-dealer to have a reasonable 
basis to believe, based on its understanding of the potential risks, 
rewards, and costs of the recommended security or investment strategy 
involving securities,

[[Page 33476]]

and in light of the retail customer's investment profile, that the 
recommendation is in the best interest of the particular retail 
customer and does not place the broker-dealer's interest ahead of the 
retail customer's interest. However, any PRA burdens or costs 
associated with the Care Obligation are duplicative of costs associated 
with other obligations in Regulation Best Interest, including the 
Disclosure Obligation and the Record-Making Obligation under Rule 17a-
3(a)(35) and Recordkeeping Obligation under Rule 17a-4(e)(5).
3. Conflict of Interest Obligation
    The Conflict of Interest Obligation creates an overarching 
obligation to require broker-dealers \1463\ to establish written 
policies and procedures reasonably designed to identify and at a 
minimum disclose, pursuant to the Disclosure Obligation, or eliminate 
all conflicts of interest associated with a recommendation. More 
specifically, broker-dealers are specifically required to establish, 
maintain, and enforce written policies and procedures reasonably 
designed to: (i) Identify and mitigate any conflicts of interest 
associated with recommendations that create an incentive for a natural 
person who is an associated person of a broker or dealer to place the 
interest of the broker or dealer, or such natural person making the 
recommendation, ahead of the interest of the retail customer; (ii) (A) 
identify and disclose any material limitations placed on the securities 
or investment strategies involving securities that may be recommended 
to a retail customer and any conflicts of interest associated with such 
limitations, in accordance with the Disclosure Obligation, and (B) 
prevent such limitations and associated conflicts of interest from 
causing the broker, dealer, or a natural person who is an associated 
person of the broker or dealer to make recommendations that place the 
interest of the broker, dealer, or such natural person ahead of the 
interest of the retail customer; and (iii) identify and eliminate sales 
contests, bonuses, and non-cash compensation that are based on the 
sales of specific securities or specific types of securities within a 
limited period of time.\1464\
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    \1463\ As discussed above, the Conflict of Interest Obligation 
and Compliance Obligation apply solely to the broker or dealer 
entity, and not to the associated persons of a broker or dealer.
    \1464\ Rule 15l-1 under the Exchange Act.
---------------------------------------------------------------------------

    Written policies and procedures developed pursuant to the Conflict 
of Interest Obligation of Regulation Best Interest would help a broker-
dealer to develop a process reasonably designed for its business, for 
identifying conflicts of interest, and then determining whether to 
eliminate, or disclose and/or mitigate the conflict and the appropriate 
means of eliminating, disclosing and/or mitigating the conflict. In 
addition, establishing and maintaining written policies and procedures 
would generally (1) assist a broker-dealer in supervising its 
associated persons and assessing compliance with the Conflict of 
Interest Obligation; and (2) assist the Commission and SRO staff in 
connection with examinations and investigations.\1465\
---------------------------------------------------------------------------

    \1465\ See Section II.C.3.a.
     Any written policies and procedures developed pursuant to 
Regulation Best Interest would be required to be retained pursuant 
to Exchange Act Rule 17a-4(e)(7), which requires broker-dealers to 
retain compliance, supervisory, and procedures manuals (and any 
updates, modifications, and revisions thereto) describing the 
policies and procedures of the broker-dealer with respect to 
compliance with applicable laws and rules, and supervision of the 
activities of each associated, for a specified period of time. The 
record retention requirements of Rule 17a-4(e)(7) include any 
written policies and procedures that broker-dealers may produce 
pursuant to the Conflict of Interest Obligation of Regulation Best 
Interest.
---------------------------------------------------------------------------

    In light of the modifications to several substantive requirements 
of the rule relative to the Proposing Release, including the Conflict 
of Interest Obligation, as discussed in more detail above, we believe 
these changes will allow broker-dealers' to more easily incorporate the 
requirements of Regulation Best Interest into existing supervisory and 
compliance systems and streamline compliance with Regulation Best 
Interest.\1466\ Therefore, we generally believe our proposed burdens 
and costs are accurate but have updated estimates to reflect changes in 
the number of broker-dealers and costs of certain services since the 
last estimate in the Proposing Release.
---------------------------------------------------------------------------

    \1466\ See Section II.C.3.
---------------------------------------------------------------------------

    Following is a detailed discussion of the estimated costs and 
burdens associated with the Conflict of Interest Obligation.
a. Written Policies and Procedures
i. Initial Costs and Burdens
    We believe that most broker-dealers have policies and procedures in 
place to address conflicts of interest, but do not necessarily have 
written policies and procedures regarding the identification and 
management of conflicts as required by Regulation Best Interest. To 
comply with the Conflict of Interest Obligation, we believe that 
broker-dealers would utilize a combination of in-house and outside 
legal and compliance counsel to update existing policies and 
procedures.\1467\ We assume that, for purposes of this analysis, the 
associated costs and burdens would differ between small and large 
broker-dealers, as large broker-dealers generally offer more products 
and services and therefore would need to evaluate and address a greater 
number of potential conflicts of interest. As discussed above, we 
estimate that 2,010 broker-dealers would qualify as large broker-
dealers for purposes of this analysis and 756 would qualify as small 
broker-dealers that have retail business.\1468\
---------------------------------------------------------------------------

    \1467\ See footnote 1381 and accompanying text.
    \1468\ See footnote 1387 and accompanying text.
---------------------------------------------------------------------------

    In the Proposing Release, we estimated that a large broker-dealer 
would incur a one-time internal burden of 60 hours for in-house legal 
and in-house compliance counsel to update existing policies and 
procedures to comply with Regulation Best Interest.\1469\ We also 
estimated a cost of $4,720 for outside counsel to review updated 
policies and procedures on behalf of a large broker-dealer, with an 
aggregate initial burden of 123,300 burden hours and aggregate initial 
cost of $9.70 million for large broker-dealers.\1470\
---------------------------------------------------------------------------

    \1469\ See Proposing Release at 21666.
    \1470\ Id.
---------------------------------------------------------------------------

    In the Proposing Release, we assumed that small broker-dealers 
would primarily rely on outside counsel to update existing policies and 
procedures, as small broker-dealers generally have fewer in-house legal 
and compliance personnel. Given that smaller broker-dealers generally 
have fewer conflicts of interest, we estimated that 40 hours of outside 
legal counsel services would be required, for a one-time cost of 
$18,800 per small broker-dealer, and an aggregate cost of $15.1 million 
for all small broker-dealers, and we also expected that in-house 
compliance personnel would require 10 hours to review and approve the 
updated policies and procedures, for an aggregate burden of 8,020 
hours.\1471\ Therefore, we estimated the total initial aggregate burden 
to be 131,320 hours and the total initial aggregate cost to be $24.8 
million.\1472\
---------------------------------------------------------------------------

    \1471\ Id.
    \1472\ Id.
---------------------------------------------------------------------------

    We believe our estimates are generally accurate in light of the 
increased specificity in Regulation Best Interest as to how a broker-
dealer must address specified conflicts of interest but due to changes 
in the number of broker-dealers and cost estimates for certain 
services, we are revising our burden and cost estimates.\1473\
---------------------------------------------------------------------------

    \1473\ We have revised our cost estimates to reflect the updated 
SIFMA Management and Professional Earnings Report which was updated 
in 2019 to reflect inflation. Therefore, the hourly rates used here 
for certain services, for example, outside legal counsel and outside 
compliance costs, are higher than the numbers in the Proposing 
Release.

---------------------------------------------------------------------------

[[Page 33477]]

    For purposes of Regulation Best Interest as adopted, we estimate 
that a large broker-dealer would incur an initial burden of 50 hours 
for in-house counsel and in-house compliance to update existing 
policies and procedures to comply with Regulation Best Interest and an 
initial burden of 5 hours for general counsel and 5 hours for a Chief 
Compliance Officer to review and approve the updated policies and 
procedures, for a total of 60 burden hours.\1474\ We also estimate ten 
hours of outside counsel services will be required at a cost of $4,970 
to review updated policies and procedures on behalf of a large broker-
dealer.\1475\ We therefore estimate the aggregate initial burden for 
large broker-dealers to be of 120,600 burden hours \1476\ and initial 
aggregate cost of approximately $10.0 million for large broker-
dealers.\1477\
---------------------------------------------------------------------------

    \1474\ This estimate is based on the following calculation: (50 
hours of review for in-house counsel and in-house compliance 
counsel) + (5 hours of review for general counsel) + (5 hours of 
review for Chief Compliance Officer) = 60 initial burden hours per 
large broker-dealer.
    \1475\ Data from the SIFMA Management and Professional Earnings 
Report suggests that the average hourly rate for legal services is 
$497/hour. This cost estimate is therefore based on the following 
calculation: (10 hours of review) x ($497/hour for outside counsel 
services) = $4,970 in outside counsel costs per large broker-dealer.
    \1476\ This estimate is based on the following calculation: (60 
burden hours of review per large broker-dealer) x (2,010 large 
broker-dealers) = 120,600 aggregate burden hours for large broker-
dealers.
    \1477\ This estimate is based on the following calculation: 
($4,970 for outside counsel costs per large broker-dealer) x (2,010 
large broker-dealers) = approximately $10.0 million in outside 
counsel costs for large broker-dealers.
---------------------------------------------------------------------------

    For small broker-dealers, we believe that they would primarily rely 
on outside counsel to update existing policies and procedures, as small 
broker-dealers generally have fewer in-house legal and compliance 
personnel. Given that smaller broker-dealers generally have fewer 
conflicts of interest, we estimate that 40 hours of outside legal 
counsel would be required to update existing policies and procedures, 
for a one-time cost of $19,880 per small broker-dealer,\1478\ and an 
aggregate cost of $15.0 million for all small broker-dealers.\1479\ We 
also expect that in-house compliance would require 10 hours to review 
and approve the updated policies and procedures, for an aggregate 
burden of 7,560 hours.\1480\ Therefore, we estimate the total initial 
aggregate burden to be 128,160 hours \1481\ and the total initial 
aggregate cost to be approximately $25.0 million.\1482\
---------------------------------------------------------------------------

    \1478\ This cost estimate is based on the following calculation: 
(40 hours of review) x ($497/hour for outside counsel services) = 
$19,880 in outside counsel costs per small broker-dealer.
    \1479\ This cost estimate is based on the following calculation: 
($19,880 for outside attorney costs per small broker-dealer) x (756 
small broker-dealers) = approximately $15.0 million in outside 
counsel costs for small broker-dealers.
    \1480\ This estimate is based on the following calculation: (10 
burden hours) x (756 small broker-dealers) = 7,560 aggregate burden 
hours.
    \1481\ This estimate is based on the following calculation: 
(120,600 aggregate burden hours for large broker-dealers) + (7,560 
aggregate burden hours for small broker-dealers) = 128,160 total 
aggregate burden hours.
    \1482\ This estimate is based on the following calculation: ($10 
million in aggregate costs for large broker-dealers) + ($15.0 
million in aggregate costs for small broker-dealers) = $25.0 million 
total aggregate costs.
---------------------------------------------------------------------------

ii. Ongoing Costs and Burdens
    For purposes of this analysis, we assume that small and large 
broker-dealers would review and update policies and procedures on an 
annual basis to accommodate the addition of, for example, new products 
or services, new business lines, and/or new personnel. We also assume 
that broker-dealers would review and update their policies and 
procedures for compliance with the Conflict of Interest Obligation on 
an annual basis, and in-house personnel would perform the review and 
make any updates.
    In the Proposing Release, we estimated that large broker-dealers 
would incur an annual internal burden of 12 hours to review and update 
existing policies and procedures to identify new conflicts for an 
ongoing, aggregate burden of 24,660 hours with no ongoing costs as they 
would rely on internal personnel.\1483\ We assumed small broker-dealers 
would rely on outside legal counsel and compliance consultants to 
review and update policies and procedures, with final review and 
approval from in-house compliance \1484\ with an aggregate, annual 
ongoing cost of $3.08 million per year.\1485\ In addition to these 
costs, we believed that small broker-dealers would incur an internal an 
ongoing, aggregate burden of 28,670 hours. While the Commission 
believes our time estimates from the Proposing Release are generally 
accurate, we have revised our burdens and estimates to account for 
changes in both the number of broker-dealers and external costs of 
services.
---------------------------------------------------------------------------

    \1483\ Proposing Release at 21667.
    \1484\ Id.
    \1485\ Id.
---------------------------------------------------------------------------

    We estimate that large broker-dealers, which generally have more 
numerous and complex products and services, as well as and higher rates 
of hiring and turnover would incur an annual internal burden of 12 
hours to review and update existing policies and procedures: Four hours 
for in-house counsel, four hours for in-house compliance, and four 
hours for business-line personnel to identify new conflicts. We 
therefore estimate an ongoing, aggregate burden for large broker-
dealers of approximately 24,120 hours.\1486\ Because we assume that 
large broker-dealers would rely on internal personnel to update 
policies and procedures on an ongoing basis, we do not believe large 
broker-dealers would incur ongoing external costs.
---------------------------------------------------------------------------

    \1486\ This estimate is based on the following calculation: (12 
burden hours per large broker-dealer) x (2,010 large broker-dealers) 
= 24,120 aggregate ongoing burden hours.
---------------------------------------------------------------------------

    We assume for purposes of this analysis that small broker-dealers, 
generally have fewer and less complex products and lower rates of 
hiring. We also assume they would primarily rely on outside legal 
counsel and outside compliance consultants for review and update of 
their policies and procedures, with final review and approval from an 
in-house compliance manager. We estimate that outside legal counsel 
would require approximately five hours per year to update policies and 
procedures, for an annual cost of $2,485 for each small broker-
dealer.\1487\ The projected aggregate, annual ongoing cost for outside 
legal counsel to update policies and procedures for small broker-
dealers would be $1.88 million per year.\1488\ In addition, we expect 
that small broker-dealers would require five hours of outside 
compliance services per year to update their policies and procedures, 
for an ongoing cost of $1,365 per year,\1489\ and an aggregate ongoing 
cost of $1.03 million.\1490\ The total aggregate, ongoing cost for 
small

[[Page 33478]]

broker-dealers is therefore projected at $2.91 million per year.\1491\
---------------------------------------------------------------------------

    \1487\ This estimate is based on the following calculation: (5 
hours per small broker-dealer) x ($497/hour for outside counsel 
services) = $2,485 in outside counsel costs.
    \1488\ This estimate is based on the following calculation: 
($2,485 in outside counsel costs per small broker-dealer) x (756 
small broker-dealers) = $1.88 million in aggregate, ongoing outside 
legal costs per year.
    \1489\ We believe that performance of this function will most 
likely be equally allocated between a senior compliance examiner and 
a compliance manager. Data from the SIFMA Management and 
Professional Earnings Report suggests that costs for these positions 
are $237 and $309 per hour, respectively for an average of $273 per 
hour. This cost estimate is based on the following calculation: (5 
hours of review) x ($273/hour for outside compliance services) = 
$1,365 in outside compliance service costs.
    \1490\ This estimate is based on the following calculation: 
($1,365 in outside compliance costs per small broker-dealer) x (756 
small broker-dealers) = $1.03 million in aggregate, ongoing outside 
compliance costs per year.
    \1491\ This estimate is based on the following calculation: 
($1.88 million for outside legal counsel costs) + ($1.03 million for 
outside compliance costs) = $2.91 million total aggregate ongoing 
costs per year.
---------------------------------------------------------------------------

    In addition to the costs described above, we additionally believe 
small broker-dealers would incur an internal burden of approximately 5 
hours for an in-house compliance manager to review and approve the 
updated policies and procedures per year. The ongoing, aggregate burden 
for small broker-dealers would be 3,780 hours for in-house compliance 
manager review.\1492\
---------------------------------------------------------------------------

    \1492\ This estimate is based on the following calculation: (5 
hours compliance manager review per small broker-dealer) x (756 
small broker-dealers) = 3,780 aggregate ongoing burden hours per 
year.
---------------------------------------------------------------------------

    We therefore estimate the total ongoing aggregate ongoing burden to 
be 27,900 hours per year \1493\ and the total ongoing aggregate cost to 
be $2.91 million per year.\1494\
---------------------------------------------------------------------------

    \1493\ This estimate is based on the following calculation: 
(24,120 aggregate ongoing burden hours for large broker-dealers) + 
(3,780 aggregate ongoing burden hours for small broker-dealers) = 
27,900 total aggregate ongoing burden hours per year.
    \1494\ This estimate is based on the following calculation: 
($2.91 million per year in total aggregate ongoing costs for small 
broker-dealers) + ($0 projected ongoing costs for large broker-
dealers) = $2.91 million per year in total aggregate ongoing costs.
---------------------------------------------------------------------------

    The Commission acknowledges that policies and procedures may vary 
greatly by broker-dealer, given the differences in size and the 
complexity of broker-dealer business models. Accordingly, we expect 
that the need to update policies and procedures might also vary 
greatly.
b. Identification and Management of Conflicts of Interest
    With respect to identifying and determining whether a conflict of 
interest exists in connection with a recommendation and whether it 
needs to be addressed through disclosure, mitigation and/or 
elimination, a broker-dealer would first need to establish mechanisms 
to proactively and systematically identify conflicts of interest in its 
business on an ongoing or periodic basis.\1495\ For purposes of this 
analysis, we assume that most broker-dealers already have an existing 
technological infrastructure in place, and we assume it would need to 
be modified to comply with the Conflict of Interest Obligation.
---------------------------------------------------------------------------

    \1495\ See supra Section III.C.3.
---------------------------------------------------------------------------

i. Initial Costs and Burdens
    As stated in the Proposing Release, we believed that costs and 
burdens may vary greatly depending on the size of the broker-dealer, 
but we expected that modification of a broker-dealer's existing 
technology would initially require the retention of an outside 
programmer as well as coordination between the programmer and the 
broker-dealer's in-house compliance manager. The costs and burdens for 
this process were estimated to be $15.43 million and 14,285 burden 
hours.\1496\ In addition to these costs and burdens, we expected that a 
broker-dealer would spend time to determine whether the conflict of 
interest identified were material and would have required an additional 
14,285 burden hours for all broker-dealers for an aggregate burden of 
28,570 hours for identification of conflicts of interest.\1497\
---------------------------------------------------------------------------

    \1496\ Proposing Release at 21667.
    \1497\ Id.
---------------------------------------------------------------------------

    As stated above, we believe the process would be largely the same 
as set forth in the Proposing Release but have revised our estimates 
and costs below to account for changes in the number of broker-dealers 
and external costs as well as to account for some changes to the 
structure of the Conflict of Interest Obligation.
    To comply with the Conflict of Interest Obligation, we expect that 
broker-dealers will modify existing technology through the work of an 
outside programmer which would require, on average, an estimated 20 
hours, for an estimated cost per broker-dealer of $5,680.\1498\ We 
additionally continue to estimate (as was set forth in the Proposing 
Release) that coordination between the programmer and the broker-
dealer's compliance manager would involve five burden hours.\1499\ The 
aggregate initial costs and burdens for the modification of existing 
technology to identify conflicts of interest would therefore be $15.71 
million,\1500\ and 13,830 burden hours.\1501\
---------------------------------------------------------------------------

    \1498\ Data from the SIFMA Management and Professional Earnings 
Report suggests that the average hourly rate for technology services 
in the securities industry is $284. This cost estimate is based on 
the following calculation: (20 hours of review) x ($284/hour for 
technology services) = $5,680.
    \1499\
    \1500\ This cost estimate is based on the following calculation: 
($5,680 in outside programmer costs per broker-dealer) x (2,766 
broker-dealers) = $15.71 million in aggregate outside programmer 
costs.
    \1501\ This burden estimate is based on the following 
calculation: (5 burden hours for in-house compliance manager) x 
(2,766 broker-dealers) = 13,830 aggregate burden hours.
---------------------------------------------------------------------------

    As a result of the changes made to the rule text of the Conflict of 
Interest Obligation, we believe that broker-dealers would incur burdens 
to: (1) Identify conflicts of interest and determine whether the 
conflict involves an incentive to an associated person to place the 
interest of the broker-dealer or natural person making the 
recommendation ahead of the interest of the retail customer, a material 
limitation on the product menu, or a sales practice that is based on 
the sales of specific securities or specific types of securities within 
a limited period of time and (2) determine whether and how the conflict 
would be disclosed, disclosed and mitigated, or eliminated in 
accordance with the Conflict of Interest Obligation. In order to 
complete this process, we believe a broker-dealer, on average, would 
require approximately 20 hours \1502\ of review per broker-
dealer,\1503\ for an aggregate of 55,320 burden hours for all broker-
dealers.\1504\ We therefore estimate the total initial aggregate burden 
for identification and management of conflicts of interest is 69,150 
hours.\1505\
---------------------------------------------------------------------------

    \1502\ In light of the changes made to the rule text of the 
Conflict of Interest Obligation and the comments received, we have 
increased our estimate to 20 burden hours per broker-dealer.
    \1503\ This burden estimate consists of 10 hours for review by 
business line personnel, and 10 hours for review by in-house 
compliance manager.
    \1504\ This burden estimate is based on the following 
calculation: (20 burden hours) x (2,766 broker-dealers) = 55,320 
aggregate burden hours.
    \1505\ This burden estimate is based on the following 
calculation: (13,830 burden hours for modification of technology) + 
(55,320 burden hours for evaluation of managing conflicts) = 69,150 
total aggregate burden hours.
---------------------------------------------------------------------------

ii. Ongoing Costs and Burdens
    To maintain compliance with the Conflict of Interest Obligation, we 
assume for purposes of this analysis that a broker-dealer would seek to 
identify additional conflicts of interest as its business evolves. As 
noted above, the Commission recognizes that broker-dealers vary in the 
types of services and product offerings and therefore vary in the types 
of conflicts of interest that exist within and across broker-
dealers.\1506\
---------------------------------------------------------------------------

    \1506\ See supra Section II.C.3.
---------------------------------------------------------------------------

    However, for purposes of the PRA analysis in the Proposing Release, 
we assumed that broker-dealers would, at a minimum, engage in a 
material conflicts identification process on an annual basis, and we 
estimated that in the aggregate broker-dealers would spend 
approximately 28,570 hours each to complete this process per 
year.\1507\ Similar to the Proposing Release, we believe that for 
purposes of this analysis, broker-dealers would, through the help of 
the business line and compliance personnel, spend on average 10 hours 
\1508\ to perform an annual

[[Page 33479]]

conflicts review using the modified technology infrastructure.\1509\ 
Therefore, the Commission estimates that the aggregate ongoing burden 
for an annual conflicts review, based on an estimated 2,766 retail 
broker-dealers, would be approximately 27,660 burden hours per 
year.\1510\ Because we assume that broker-dealers would use in-house 
personnel to identify and evaluate new, potential conflicts, we 
continue to believe they would not incur additional ongoing external 
costs.
---------------------------------------------------------------------------

    \1507\ See Proposing Release at 21668.
    \1508\ This burden estimate consists of five hours for review by 
business line personnel, and five hours for review by an in-house 
compliance manager.
    \1509\ FINRA rules set an annual supervisory review as a minimum 
threshold for broker-dealers. See, e.g., FINRA Rules 3110 (requiring 
an annual review of the businesses in which the broker-dealer 
engages); 3120 (requiring an annual report detailing a broker-
dealer's system of supervisory controls, including compliance 
efforts in the areas of antifraud and sales practices); and 3130 
(requiring each broker-dealer's CEO or equivalent officer to certify 
annually to the reasonable design of the policies and procedures for 
compliance with relevant regulatory requirements).
    \1510\ This estimate is based on the following calculation: (10 
hours per retail broker-dealer) x (2,766 retail broker-dealers) = 
27,660 aggregate burden hours per year.
---------------------------------------------------------------------------

c. Training
    As discussed in the Proposing Release, we expect that broker-
dealers would develop training programs to comply with Regulation Best 
Interest, including the Conflict of Interest Obligation. However, we 
believe that any burdens and costs associated with a training program 
would fall under the new Compliance Obligation as it would be developed 
to comply with Regulation Best Interest as a whole, including each of 
the component obligations.
    In total, to comply with the Conflict of Interest Obligation, the 
Commission estimates that the total initial burdens and costs to be 
197,310 hours \1511\ and $40.71 million,\1512\ and the total ongoing 
burdens and costs to be 55,560 hours \1513\ per year and $2.91 million 
per year.\1514\
---------------------------------------------------------------------------

    \1511\ This estimate is based on the following calculation: 
(128,160 initial burden hours for policies and procedures) + (69,150 
initial burden hours for identification and management of conflicts 
of interest) = 197,310 initial burden hours to comply with the 
Conflict of Interest Obligation.
    \1512\ This estimate is based on the following calculation: 
($25.0 million initial costs for policies and procedures) + ($15.71 
million initial costs for identification and management of conflicts 
of interest) = $40.71 million initial total costs to comply with the 
Conflict of Interest Obligation.
    \1513\ This estimate is based on the following calculation: 
(27,900 ongoing burden hours for policies and procedures) + (27,660 
ongoing burden hours for identification and management of conflicts 
of interest) = 55,560 aggregate ongoing burden hours per year to 
comply with Conflict of Interest Obligation.
    \1514\ This estimate is based on the following calculation: 
($2.91 million ongoing costs for policies and procedures) + ($0 
ongoing costs for identification and management of conflicts of 
interest) = $2.91 million aggregate ongoing total costs per year to 
comply with the Conflict of Interest Obligation.
---------------------------------------------------------------------------

4. Compliance Obligation
    As discussed above, in response to comments that we should require 
policies and procedures to comply with Regulation Best Interest as a 
whole, we are adopting the Compliance Obligation.\1515\ The Compliance 
Obligation requires that the broker-dealer \1516\ establish, maintain 
and enforce written policies and procedures reasonably designed to 
achieve compliance with Regulation Best Interest. This Compliance 
Obligation creates an explicit obligation under the Exchange Act with 
respect to Regulation Best Interest as a whole. Similar to the policies 
and procedures requirement of the Conflict of Interest Obligation, 
broker-dealers will have flexibility to design policies and procedures 
that are reasonable for the scope, size and risks associated with the 
operations of the firm and the types of business in which the broker-
dealer engages. Because we did not include the Compliance Obligation in 
the Proposing Release, we did not previously include costs and burdens 
associated with the Compliance Obligation, but we have provided a 
detailed explanation of these costs and burdens below.\1517\
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    \1515\ Section II.C.4.
    \1516\ See supra footnote 1462 and accompanying text.
    \1517\ We note that any burdens and costs to comply with the 
Conflict of Interest Obligation are included in the estimates in 
Section IV.B.3 above.
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a. Written Policies and Procedures
i. Initial Costs and Burdens
    While the Compliance Obligation creates an explicit requirement 
under the Exchange Act, we believe that broker-dealers would likely 
establish policies and procedures to comply with Regulation Best 
Interest pursuant to Section 15(b)(4)(E) and SRO rules by adjusting 
their current systems of supervision and compliance, as opposed to 
creating new systems. While broker-dealers must already have policies 
and procedures in place to address other Commission and SRO rules, they 
would need to update their systems of supervision and compliance to 
account for Regulation Best Interest.
    To comply with the Compliance Obligation, we believe that broker-
dealers would employ a combination of in-house and outside legal and 
compliance counsel to update existing policies and procedures to 
account for the Disclosure and Care Obligations.\1518\ We assume that, 
for purposes of this analysis, the associated costs and burdens would 
differ between small and large broker-dealers, as large broker-dealers 
generally offer more products and services and employ more individuals 
and therefore would need to evaluate and update a greater number of 
systems. As discussed above, we estimate that 2,010 broker-dealers 
would qualify as large broker-dealers for purposes of this analysis and 
756 would qualify as small broker-dealers that have retail 
business.\1519\
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    \1518\ Id.
    \1519\ See supra footnote 1387 and accompanying text.
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    For purposes of this analysis we estimate that a large broker-
dealer would incur a one-time average internal burden of 30 hours for 
in-house legal personnel and in-house compliance counsel to update 
existing policies and procedures to comply with the Compliance 
Obligation and a one-time burden of five hours for general counsel and 
five hours for a Chief Compliance Officer to review and approve the 
updated policies and procedures, for a total of 40 burden hours.\1520\ 
We also estimate six hours of outside counsel services a cost of $2,982 
for outside counsel to review updated policies and procedures on behalf 
of a large broker-dealer.\1521\ We therefore estimate the aggregate 
burden for large broker-dealers to be of 80,400 burden hours \1522\ and 
aggregate cost of $6.0 million for large broker-dealers.\1523\
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    \1520\ This estimate is based on the following calculation: (30 
hours of review for in-house legal and in-house compliance) + (5 
hours of review for general counsel) + (5 hours of review for Chief 
Compliance Officer) = 40 burden hours.
    \1521\ Data from the SIFMA Management and Professional Earnings 
Report suggests that the average hourly rate for legal services is 
$497/hour. This cost estimate is therefore based on the following 
calculation: (6 hours of review) x ($497/hour for outside counsel 
services) = $2,982 in outside counsel costs.
    \1522\ This estimate is based on the following calculation: (40 
burden hours of review per large broker-dealer) x (2,010 large 
broker-dealers) = 80,400 aggregate burden hours.
    \1523\ This estimate is based on the following calculation: 
($2,982 for outside counsel costs per large broker-dealer) x (2,010 
large broker-dealers) = $6.0 million in outside counsel costs.
---------------------------------------------------------------------------

    For small broker-dealers, we believe that they would primarily rely 
on outside counsel to update existing policies and procedures, as small 
broker-dealers generally have fewer in-house legal and compliance 
personnel. We estimate that only 20 hours of outside legal counsel 
services would be required, for a one-time cost of $9,940 per small 
broker-dealer,\1524\ and an aggregate cost of $7.5 million for all

[[Page 33480]]

small broker-dealers.\1525\ We also expect that in-house compliance 
personnel would require 6 hours to review and approve the updated 
policies and procedures, for an aggregate burden of 4,536 hours.\1526\ 
Therefore, we estimate the total initial aggregate burden to be 84,936 
hours \1527\ and the total initial aggregate cost to be $13.5 
million.\1528\
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    \1524\ This cost estimate is based on the following calculation: 
(20 hours of review) x ($497/hour for outside counsel services) = 
$9,940 in outside counsel costs.
    \1525\ This cost estimate is based on the following calculation: 
($9,940 for outside counsel costs per small broker-dealer) x (756 
small broker-dealers) = $7.5 million in outside counsel costs.
    \1526\ This estimate is based on the following calculation: (6 
burden hours) x (756 small broker-dealers) = 4,536 initial aggregate 
burden hours.
    \1527\ This estimate is based on the following calculation: 
(80,400 aggregate burden hours for large broker-dealers) + (4,536 
aggregate burden hours for small broker-dealers) = 84,936 total 
initial aggregate burden hours.
    \1528\ This estimate is based on the following calculation: ($6 
million in aggregate costs for large broker-dealers) + ($7.5 million 
in aggregate costs for small broker-dealers) = $13.5 million total 
initial aggregate costs.
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ii. Ongoing Costs and Burdens
    For purposes of this analysis, we assume that small and large 
broker-dealers would review and update policies and procedures on a 
periodic basis to accommodate the addition of, among other things, new 
products or services, new business lines, and/or new personnel. We also 
assume that broker-dealers would review and update their policies and 
procedures for compliance with Regulation Best Interest on an annual 
basis, and for purposes of this analysis, we assume they would perform 
the review and update using in-house personnel. Under the Compliance 
Obligation, we do not believe that broker-dealers would incur any costs 
or burdens associated with compliance with the Conflict of Interest 
Obligation, as those are included in the discussion above, but would 
for ongoing compliance with the Disclosure and Care Obligations.
    For large broker-dealers with more numerous and complex products 
and services, as well as higher rates of hiring and turnover, we 
estimate that each broker-dealer would annually incur an internal 
burden of 12 hours to review and update existing policies and 
procedures: four hours for legal personnel, four hours for compliance 
personnel, and four hours for business-line personnel. We therefore 
estimate an ongoing, aggregate burden for large broker-dealers of 
approximately 24,120 hours per year.\1529\
---------------------------------------------------------------------------

    \1529\ This estimate is based on the following calculation: (12 
burden hours per large broker-dealer) x (2,010 large broker-dealers) 
= 24,120 aggregate ongoing burden hours per year.
---------------------------------------------------------------------------

    We assume for purposes of this analysis that small broker-dealers, 
who generally have fewer and less complex products, and lower rates of 
hiring and turnover, would mostly rely on outside legal counsel and 
compliance consultants for review and update of their policies and 
procedures, with final review and approval from an in-house compliance 
manager. We estimate that outside counsel would require approximately 
five hours per year to update policies and procedures, for an annual 
cost of $2,485 for each small broker-dealer.\1530\ The projected 
aggregate, annual ongoing cost for outside legal counsel to update 
policies and procedures for small broker-dealers would be $1.88 
million.\1531\ In addition, we expect that small broker-dealers would 
require five hours of outside compliance services per year to update 
their policies and procedures, for an ongoing cost of $1,365 per 
year,\1532\ and an aggregate ongoing cost of $1.03 million.\1533\ The 
Commission estimates the total aggregate, ongoing cost for small 
broker-dealers is therefore $2.91 million per year.\1534\
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    \1530\ Data from the SIFMA Management and Professional Earnings 
Report suggests that the average hourly rate for legal services is 
$497/hour. This estimate is therefore based on the following 
calculation: (5 hours per small broker-dealer) x ($497/hour for 
outside counsel services) = $2,485 in outside counsel costs per 
year.
    \1531\ This estimate is based on the following calculation: 
($2,485 in outside counsel costs per small broker-dealer) x (756 
small broker-dealers) = $1.88 million in aggregate, ongoing legal 
costs per year.
    \1532\ We believe that performance of this function will most 
likely be equally allocated between a senior compliance examiner and 
a compliance manager. Data from the SIFMA Management and 
Professional Earnings Report suggests that costs for these positions 
are $237 and $309 per hour, respectively for an average of $273 per 
hour. This estimate is therefore based on the following calculation: 
(5 hours per small broker-dealer) x ($273/hour for outside counsel 
services) = $1,365 in outside compliance service costs per year.
    \1533\ This estimate is based on the following calculation: 
($1,365 in outside compliance costs per small broker-dealer) x (756 
small broker-dealers) = $1.03 million in aggregate, ongoing outside 
compliance costs per year.
    \1534\ This estimate is based on the following calculation: 
($1.88 million for outside legal counsel costs) + ($1.03 million for 
outside compliance costs) = $2.91 million total aggregate ongoing 
costs per year.
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b. Training
    Pursuant to the Compliance Obligation's requirement to ``maintain 
and enforce'' written policies and procedures, we additionally believe 
broker-dealers will develop training programs that promote compliance 
with Regulation Best Interest. We believe that a training program would 
cover compliance with Regulation Best Interest as a whole and would 
therefore cover the Disclosure, Care and Conflict of Interest 
Obligations. The initial and ongoing costs and burdens associated with 
such a training program are estimated below.
i. Initial Costs and Burdens
    We believe that broker-dealers would likely use a computerized 
training model to train their associated persons regarding the policies 
and procedures pertaining to Regulation Best Interest. We estimate that 
a broker-dealer would retain an outside systems analyst, outside 
programmer, and an outside programmer analyst to create the training 
module, at 20 hours, 40 hours, and 20 hours, respectively. The total 
cost to develop the training module would be approximately 
$20,920,\1535\ for an aggregate initial cost of $62.8 million.\1536\
---------------------------------------------------------------------------

    \1535\ Data from the SIFMA Management and Professional Earnings 
Report suggests that the average hourly rate in the securities 
industry is $263 for a systems analyst, $271 for a programmer, and 
$241 for a programmer analyst.. This cost estimate is based on the 
following calculation: ((20 hours for a systems analyst) x ($263/
hour)) + ((40 hours of labor for a programmer) x ($271/hour)) + ((20 
hours of labor for a programmer analyst) x ($241/hour)) = $20,920 in 
external technology costs per broker-dealer.
    \1536\ This estimate is based on the following calculation: 
(2,766 broker-dealers) x ($20,920in external technology costs per 
broker-dealer) = $57.9 million in aggregate costs for technology 
services.
---------------------------------------------------------------------------

    Additionally, we expect that the training module would require the 
approval of the Chief Compliance Officer, as well as in-house counsel, 
each of whom would require approximately 2 hours to review and approve 
the training module. The initial aggregate burden for broker-dealers is 
therefore estimated at 11,064 burden hours.\1537\
---------------------------------------------------------------------------

    \1537\ This estimate is based on the following calculation: 
(2,766 broker-dealers) x (4 burden hours per broker-dealer) = 11,064 
burden hours.
---------------------------------------------------------------------------

    In addition, broker-dealers would incur an initial cost for 
associated persons to undergo training through the training module. We 
estimate the training time at one hour per associated person, for an 
aggregate burden of 428,404 burden hours, or an initial burden of 154.9 
hours per broker-dealer.\1538\ We estimate the total initial aggregate 
burden to approve the training module and implement the training 
program would be 439,486 burden hours.\1539\
---------------------------------------------------------------------------

    \1538\ This estimate is based on the following calculation: (1 
burden hour) x (428,404 registered representatives at standalone or 
dually registered broker-dealers) = 428,404 aggregate burden hours. 
Conversely, (428,404 aggregate burden hours)/(2,766 retail broker-
dealers) = 154.9 initial burden hours per broker-dealer per year.
    \1539\ This estimate is based on the following calculation: 
(428,404 burden hours for training of registered representatives) + 
(11,064 burden hours to approve training program) = 439,468 total 
aggregate burden hours per year.

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[[Page 33481]]

ii. Ongoing Costs and Burdens
    We believe that, as a matter of best practice, broker-dealers would 
likely require registered representatives to repeat the training module 
for Regulation Best Interest on an annual basis. The ongoing aggregate 
cost for the one-hour training would be 428,404 burden hours per year, 
or 154.9 burden hours per broker-dealer per year.\1540\
---------------------------------------------------------------------------

    \1540\ This estimate is based on the following calculation: (1 
burden hour) x (428,404 registered representatives at standalone or 
dually registered broker-dealers) = 428,404 burden hours. 
Conversely, (428,404 aggregate burden hours) / (2,766 retail broker-
dealers) = 154.9 initial burden hours per broker-dealer.
---------------------------------------------------------------------------

    In total, to comply with the Compliance Obligation, the Commission 
estimates the total initial burdens and costs to be 524,414 hours 
\1541\ and $71.4 million,\1542\ and the total ongoing burdens and costs 
to be 463,588 hours \1543\ and $2.91 million.\1544\
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    \1541\ This estimate is based on the following calculation: 
(84,946 initial burden hours for policies and procedures) + (439,468 
initial burden hours training) = 524,414 initial burden hours to 
comply with the Compliance Obligation.
    \1542\ This estimate is based on the following calculation: 
($13.5 million initial costs for policies and procedures) + ($57.9 
million initial costs for training) = $71.4 million initial total 
costs to comply with the Compliance Obligation.
    \1543\ This estimate is based on the following calculation: 
(24,120 ongoing burden hours for policies and procedures) + (439,468 
ongoing burden hours for training) = 463,588 ongoing burden hours to 
comply with Compliance Obligation.
    \1544\ This estimate is based on the following calculation: 
($2.91 million ongoing costs for policies and procedures) + ($0 
million ongoing costs for training) = $2.91 million ongoing costs to 
comply with the Compliance Obligation.
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5. Record-Making and Recordkeeping Obligations
    The record-making and recordkeeping obligations will impose record-
making and recordkeeping requirements on broker-dealers with respect to 
certain information collected from, or provided to, retail customers. 
Specifically, the Commission is amending Rules 17a-3 and 17a-4 of the 
Exchange Act, which set forth minimum requirements with respect to the 
records that broker-dealers must make, and how long those records and 
other documents must be kept, respectively. Records made and retained 
in accordance with the amendments to Rule 17a-3(a)(35) and 17a-4(e)(5) 
will (1) assist a broker-dealer in supervising and assessing internal 
compliance with Regulation Best Interest; and (2) assist the Commission 
and SRO staff in connection with examinations and investigations.
    Due to changes in the number of broker-dealers and costs estimated 
for certain services, we are revising our estimates from those in the 
Proposing Release. However, while we understand commenters' concerns 
that the estimates are lower than what would actually be required to 
comply with Regulation Best Interest, we believe the estimates are 
generally accurate in light of the increased specificity in Regulation 
Best Interest on how to comply with the component obligations, 
including the Disclosure Obligation.\1545\ The record-making and 
recordkeeping costs and burdens associated with the amendments to Rule 
17a-3(a)(35) and Rule 17a-4(e)(5) are addressed below.
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    \1545\ See, e.g., Raymond James Letter; CCMC Letters; SIFMA 
August 2018 Letter.
---------------------------------------------------------------------------

a. Record-Making Obligation
    We are amending Rule 17a-3 by adding a new paragraph (a)(35) that 
requires a record of all information collected from, and provided to, 
the retail customer pursuant to Regulation Best Interest, as well as 
the identity of each natural person who is an associated person of a 
broker or dealer, if any, responsible for the account.\1546\ This 
requirement applies with respect to each retail customer to whom a 
recommendation of any securities transaction or investment strategy 
involving securities is provided. The neglect, refusal, or inability of 
a retail customer to provide or update any such information will, 
however, excuse the broker-dealer from obtaining that information.
---------------------------------------------------------------------------

    \1546\ As indicated in the Proposing Release, we understand that 
broker-dealers likely make such records in the ordinary course of 
their business pursuant to Exchange Act Rules 17a-3(a)(6) and (7). 
We continue to believe, for purposes of compliance with Rule 17a-
3(a)(35), that broker-dealers would need to create a record, or 
modify an existing record, to identify the associated person, if 
any, responsible for the account in the context of Regulation Best 
Interest. See Proposing Release at 21673.
---------------------------------------------------------------------------

    We indicated in the Proposing Release, and we continue to believe 
that broker-dealers currently make records of relevant customer 
investment profile information, and we therefore assume that no 
additional record-making obligations would arise as a result of broker-
dealers' or their registered representatives' collection of information 
from retail customers.\1547\ In addition, we continue to believe that 
broker-dealers likely make records of the ``identity of each natural 
person who is an associated person, if any, responsible for the 
account.'' However, we are assuming, for purposes of compliance with 
Rule 17a-3(a)(35), that broker-dealers will need to create a record, or 
modify an existing record, to identify the associated person, if any, 
responsible for the account in the context of Regulation Best Interest. 
In addition, in cases where broker-dealers choose to meet part of the 
Disclosure Obligation orally under the circumstances outlined in 
Section II.C.1, Oral Disclosure or Disclosure After a Recommendation, 
we believe the requirement to maintain a record of the fact that oral 
disclosure was provided to the retail customer will trigger a record-
making obligation under paragraph (a)(35) of Rule 17a-3 and a 
recordkeeping obligation under paragraph (e)(5) of Rule 17a-4 that may 
impose additional compliance costs and burdens on broker-dealers.
---------------------------------------------------------------------------

    \1547\ The PRA burdens and costs arising from the requirement 
that a record be made of all information provided to the retail 
customer are accounted for in Regulation Best Interest and the 
Relationship Summary Adopting Release. With respect to the 
requirement that a record be made of all information from the retail 
customer, we believe that Rule 17a-3(a)(35) will not impose any new 
substantive burdens on broker-dealers. As discussed above, we 
continue to believe that the obligation to exercise reasonable 
diligence, care, and skill will not require a broker-dealer to 
collect additional information from the retail customer beyond that 
currently collected in the ordinary course of business even though a 
broker-dealer's analysis of that information and any resulting 
recommendations will need to adhere to the enhanced best interest 
standard of Regulation Best Interest. See supra Section II.C.2.
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i. Initial Costs and Burdens
    In the Proposing Release, we assumed that broker-dealers would 
satisfy the record-making requirement of the proposed amendment to Rule 
17a-3(a)(25) by amending an existing account disclosure document to 
include the ``identity of each natural person who is an associated 
person, if any, responsible for the account.'' We estimated that the 
inclusion of this information in an account disclosure document would 
require an approximate total aggregate initial burden of 3,808,000 
hours, or approximately 1,333 hours per broker-dealer for the first 
year after Regulation Best Interest is in effect.\1548\
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    \1548\ These estimates were based on the following calculations: 
(0.04 hours per customer account) x (95.2 million retail customer 
accounts) = 3,808,000 aggregate burden hours. Conversely, (3,808,000 
aggregate burden hours)/(2,857 broker-dealers) = 1,333 hours per 
broker dealer for the first year after Regulation Best Interest is 
in effect. See Proposing Release at 21673.
---------------------------------------------------------------------------

    As discussed above, we continue to believe that broker-dealers will 
satisfy the record-making requirements of the amendment to Rule 17a-
3(a)(35) by amending an existing account disclosure document to include 
the ``identity of each natural person who is an associated person, if 
any, responsible for the account.'' We believe that the inclusion of 
this information in an account disclosure document will require, on 
average, approximately 1

[[Page 33482]]

hour per year for outside legal counsel at small broker-dealers, at an 
updated average rate of $497/hour, for an average annual cost of $497 
for each small broker-dealer to update an account disclosure document. 
The projected aggregate initial cost for small broker-dealers is 
therefore estimated to be $375,732 per year.\1549\ For broker-dealers 
that are not small entities, we estimate that the initial burden will 
be 2 hours for each broker-dealer: 1 hour for compliance personnel and 
1 hour for legal personnel. We therefore estimate the aggregate initial 
burden for broker-dealers that are not small entities to be 
approximately 4,020 burden hours.\1550\ Finally, we estimate it will 
require an additional 0.04 hours for the registered representative 
responsible for the information (or other clerical personnel) to fill 
out that information in the account disclosure document, for an 
approximate total aggregate initial burden of 4,080,000 hours, or 
approximately 1,475 hours per broker-dealer for the first year after 
Regulation Best Interest is in effect.\1551\ Because we have already 
included the costs and burdens associated with the creation of a record 
to memorialize an oral disclosure, and the delivery of the amended 
account disclosure document discussed above, they are not included in 
this section of the analysis.\1552\
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    \1549\ This estimate is based on the following calculation: (1 
hour per small broker-dealer) x (756 small broker-dealers) x ($497/
hour) = $375,732 in aggregate costs per year.
    \1550\ This estimate is based on the following calculation: (2 
burden hours per broker-dealer) x (2,010 large broker-dealers) = 
4,020 aggregate burden hours per year.
    \1551\ These estimates are based on the following calculations: 
(0.04 hours per customer account) x (102 million retail customer 
accounts) = 4,080,000 aggregate burden hours. Conversely, (4,080,000 
burden hours)/(2,766 broker-dealers) = 1,475 hours per broker-dealer 
for the first year after Regulation Best Interest is in effect.
    \1552\ See supra Section IV.B.1.
---------------------------------------------------------------------------

    The total aggregate initial burden for broker-dealers is therefore 
estimated at 4,084,020 hours,\1553\ and the total aggregate initial 
cost is estimated at $375,732.\1554\
---------------------------------------------------------------------------

    \1553\ This estimate is based on the following calculation: (0 
aggregate burden hours for small broker-dealers) + (4,020 burden 
hours for large broker-dealers) + (4,080,000 burden hours for 
personnel to fill out information in the account disclosure 
document) = 4,080,000 initial burden hours.
    \1554\ This estimate is based on the following calculation: 
($375,732 for small broker-dealer costs) + ($0 for large broker-
dealer costs) = ($375,732 in total aggregate initial costs).
---------------------------------------------------------------------------

ii. Ongoing Costs and Burdens
    We do not believe that the identity of the registered 
representative responsible for the retail customer's account will 
change. Accordingly, we continue to believe that there are no ongoing 
costs and burdens associated with this record-making requirement of the 
amendment to Rule 17a-3(a)(35).
    With respect to memorializing oral disclosures in cases where 
broker-dealers choose to meet part of the Disclosure Obligation orally 
under the circumstances outlined in Section II.C.1, Oral Disclosure or 
Disclosure After a Recommendation, we estimate that this would take 
place among 52% of a broker-dealer's retail customer accounts (and thus 
52% of a registered representative's retail customer accounts) 
annually.\1555\ We therefore estimate broker-dealers to incur a total 
annual aggregate burden of 1.06 million hours, or 383.5 burden hours 
per year per broker-dealer.\1556\
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    \1555\ We believe (and our experience indicates) that broker-
dealers will use oral disclosure rarely, and primarily when making 
disclosures regarding a change in capacity. We do not have reliable 
data to determine the precise number of retail customers that have 
both a brokerage and an advisory account with a dually registered 
associated person. As indicated above, approximately 52% of 
registered representatives were dually registered as investment 
adviser representatives at the end of 2018. See supra footnote 945 
and accompanying text. As a result, we have assumed for purposes of 
this analysis that this will take place among 52% of all retail 
customer accounts at broker-dealers annually. This estimate is 
likely over inclusive, as it includes all retail customer accounts 
at all broker-dealers (as opposed to only retail customer accounts 
where the retail customer has both a brokerage and advisory account 
with a dually registered financial professional), and under 
inclusive, as it assumes that such an oral disclosure will happen 
annually (as opposed to multiple times a year).
    \1556\ (52%) x (102 million retail customer accounts) x (0.02 
hours for recording each oral disclosure relating to a retail 
customer's account) = 1,060,800 aggregate burden hours. Conversely, 
1,060,800 aggregate burden hours/2,766 broker-dealers = 383.5 burden 
hours per broker-dealer per year.
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b. Recordkeeping Obligation
    We are amending Rule 17a-4(e)(5) to require that broker-dealers 
retain all records of the information collected from or provided to 
each retail customer pursuant to Regulation Best Interest for at least 
six years after the earlier of the date the account was closed or the 
date on which the information was last replaced or updated. We assume 
that, for purposes of this analysis, the following records would likely 
be retained pursuant to amended Rule 17a-3(a)(35): (1) Existing account 
disclosure documents; (2) comprehensive fee schedules; (3) disclosures 
identifying material conflicts; and (4) memorialized oral disclosures 
under the circumstances outlined in Section II.C.1, Oral Disclosure or 
Disclosure After a Recommendation.\1557\
---------------------------------------------------------------------------

    \1557\ In the Proposing Release, we identified four records that 
would likely need to be retained pursuant to amended Rule 17a-
3(a)(25) (now reflected as Rule 17a-3(a)(35)): (1) A standardized 
Relationship Summary document; (2) existing account disclosure 
documents; (3) a comprehensive fee schedule; and (4) disclosures 
identifying material conflicts. However, in calculating the 
estimated burden for broker-dealers to add new documents or modify 
existing documents to the broker-dealer's existing retention system, 
we erroneously assumed a broker-dealer would upload or file five 
account documents, as opposed to the four account documents 
identified in the Proposing Release. See Proposing Release at 21673-
21674. In addition, while the burden for broker-dealers to retain a 
standardized relationship summary was included in the Regulation 
Best Interest Proposing Release, it is excluded here because its 
associated burden is reflected in the Relationship Summary Proposal 
and Relationship Summary Adopting Release.
---------------------------------------------------------------------------

i. Initial Costs and Burdens
    We believe that, to reduce costs and for ease of compliance, 
broker-dealers will utilize their existing recordkeeping systems in 
order to retain the forgoing records made pursuant to Regulation Best 
Interest, and as required to be kept under the amendment to Rule 17a-
4(e)(5). As noted above, broker-dealers currently are subject to 
recordkeeping obligations pursuant to Rule 17a-4, which require, for 
example, broker-dealers to ``preserve for a period of not less than six 
years, the first two years in an easily accessible place, all records 
required to be made pursuant to'' Rule 17a-3(a)(1), (a)(2), (a)(3), 
(a)(5), (a)(21), (a)(22), and analogous records created pursuant to 
paragraph 17a-3(f). Thus, for example, broker-dealers are already 
required to maintain documents such as account blotters and ledgers for 
six years.
    We continue to believe that broker-dealers will utilize their 
existing recordkeeping systems to include any additional or amended 
records required by Regulation Best Interest or pursuant to the 
amendment to Rule 17a-4(e)(5), and would similarly utilize their 
existing recordkeeping systems to account for any differences in the 
retention period. Thus, where broker-dealers currently retain documents 
on an electronic database to satisfy existing Rule 17a-4 or otherwise, 
we continue to expect broker-dealers to maintain any additional 
documents required by Regulation Best Interest or the amendment to Rule 
17a-4(e)(5) by the same means. Likewise, where broker-dealers maintain 
documents required by existing Rule 17a-4 by paper, we would expect 
broker-dealers to continue to do so.
    Based on our belief that broker-dealers will rely on existing 
infrastructures to satisfy the recordkeeping obligations of Regulation 
Best Interest and the amendment to Rule 17-a(4)(e)(5), we believe the 
burden for broker-dealers to add new documents or

[[Page 33483]]

modify existing documents to the broker-dealer's existing retention 
system will be approximately 13.6 million burden hours for all broker-
dealers, assuming a broker-dealer will need to upload or file each of 
the four account documents discussed above for each retail customer 
account.\1558\ We do not believe there will be additional substantive 
internal or external costs relating to the uploading or filing of the 
documents. In addition, because we have already included the costs and 
burdens associated with the delivery of the amended account opening 
agreement and other documents above, we do not include them in this 
section of the analysis.
---------------------------------------------------------------------------

    \1558\ This estimate is based on the following calculation: (4 
documents per customer account) x (102 million retail customer 
accounts) x (2 minutes per document)/60 minutes = 13,600,000 
aggregate burden hours. As indicated above, the following records 
would likely need to be retained: (1) Existing account disclosure 
documents; (2) comprehensive fee schedules; (3) disclosures 
identifying material conflicts; and (4) memorialized oral 
disclosures under the circumstances outlined in Section II.C.1, 
Disclosure Obligation, Oral Disclosure or Disclosure After a 
Recommendation.
---------------------------------------------------------------------------

ii. Ongoing Costs and Burdens
    We estimate that the approximate ongoing burden associated with the 
recordkeeping requirement of the amendment to Rule 17a-4(e)(5) is 4.46 
million burden hours per year.\1559\ We do not believe that the ongoing 
costs associated with ensuring compliance with the retention schedule 
would change from the current costs of ensuring compliance with 
existing Rule 17a-4 and as outlined above.
---------------------------------------------------------------------------

    \1559\ This estimate is based on the percentage of account 
records we expect would be updated each year as described in Section 
IV.B.1, supra, and the following calculation: (40% of fee schedules 
x 102 million retail customer accounts) x (2 minutes per document) + 
(40% of conflict disclosure forms x 102 million retail customer 
accounts) x (2 minutes per document) + (20% of account opening 
documents x 102 million retail customer accounts) x (2 minutes per 
document) = 204 million minutes/60 minutes = 3.4 million aggregate 
ongoing burden hours. In addition, with respect to ongoing 
memorialization of the updated oral disclosures, we estimate that 
this will take place among 52% of a broker-dealer's retail customer 
accounts annually. We therefore estimate that broker-dealers will 
incur an aggregate ongoing burden of 1.06 million hours per year 
(calculated as follows: (52% of updated oral disclosures x 102 
million retail customer accounts) x (1.2 minutes per document) = 
63.6 million minutes/60 minutes = 1.06 million aggregate ongoing 
burden hours); or 383.5 burden hours per broker-dealer (1.06 million 
hours/2,766 broker-dealers = 383.5). 3.4 million burden hours per 
year + 1.06 million burden hours per year = 4,460,000 total 
aggregate ongoing burden hours per year.
---------------------------------------------------------------------------

V. Final Regulatory Flexibility Act Analysis

    The Commission has prepared this Final Regulatory Flexibility 
Analysis (``FRFA'') in accordance with the provisions of the Regulatory 
Flexibility Act (``RFA'') \1560\ relating to Regulation Best Interest. 
An Initial Regulatory Flexibility Analysis (``IRFA'') was prepared in 
accordance with the RFA and included in the Proposing Release.\1561\
---------------------------------------------------------------------------

    \1560\ 5 U.S.C. 603.
    \1561\ See Proposing Release, supra footnote 7, at Section VII.
---------------------------------------------------------------------------

A. Need for and Objectives of the Rule

    Broker-dealers play an important role in helping Americans organize 
their financial lives, accumulate and manage retirement savings, and 
invest toward other important long-term goals, such as buying a house 
or funding a child's college education.
    As discussed in Section I, concerns exist regarding: (1) The 
potential harm to retail customers resulting from broker-dealer 
recommendations provided in the presence of conflicts of interest and 
(2) the insufficiency of existing broker-dealer regulatory requirements 
to address these conflicts when broker-dealers make recommendations to 
retail customers. More specifically, there are concerns that existing 
requirements do not require a broker-dealer's recommendations to be in 
the retail customer's best interest.
    As a result, we are adopting Regulation Best Interest, which 
creates an enhanced standard of conduct applicable to broker-dealers at 
the time they recommend to a retail customer a securities transaction 
or investment strategy involving securities. This includes 
recommendations of account types and rollovers or transfers of assets 
and also covers implicit hold recommendations, resulting from agreed-
upon account monitoring. When making a recommendation, a broker-dealer 
must act in the retail customer's best interest and cannot place its 
own interests ahead of the customer's interests. This General 
Obligation is satisfied only if the broker-dealer complies with four 
specified component obligations: (1) Disclosure Obligation, (2) Care 
Obligation, (3) Conflict of Interest Obligation, and (4) Compliance 
Obligation. In addition, the Commission is amending Rules 17a-3 and 
17a-4 of the Exchange Act, which set forth minimum requirements with 
respect to the records that broker-dealers must make, and how long 
those records and other documents must be kept, respectively.
    First, as described in Section II.C.1, under the Disclosure 
Obligation, before or at the time of making a recommendation, a broker-
dealer must disclose, in writing,\1562\ material facts about the scope 
and terms of its relationship with the customer. This includes a 
disclosure that the broker-dealer or associated person is acting in a 
broker-dealer capacity; the material fees and costs the customer will 
incur; and the type and scope of the services to be provided, including 
any material limitations on the recommendations that could be made to 
the retail customer. Moreover, the broker-dealer must disclose all 
material facts relating to conflicts of interest associated with the 
recommendation that might incline a broker-dealer to make a 
recommendation that is not disinterested, including, for example, 
proprietary products, payments from third parties, and compensation 
arrangements.
---------------------------------------------------------------------------

    \1562\ As discussed above, there are circumstances where broker-
dealers and their associated persons may make oral disclosures or 
written disclosures after the time of a recommendation under the 
circumstances outlined in Section II.C.1, Disclosure Obligation, 
Oral Disclosure or Disclosure After a Recommendation.
---------------------------------------------------------------------------

    Second, as described in Section II.C.2, under the Care Obligation, 
a broker-dealer must exercise reasonable diligence, care, and skill 
when making a recommendation to a retail customer. The broker-dealer 
must understand potential risks, rewards, and costs associated with the 
recommendation. The broker-dealer must then consider those risks, 
rewards, and costs in light of the retail customer's investment profile 
and have a reasonable basis to believe that the recommendation is in 
the customer's best interest and does not place the broker-dealer's 
interest ahead of the retail customer's interest. When recommending a 
series of transactions, the broker-dealer must have a reasonable basis 
to believe that the transactions taken together are not excessive, even 
if each is in the retail customer's best interest when viewed in 
isolation.
    Third, as described in Section II.C.3, under the Conflict of 
Interest Obligation, a broker-dealer must establish, maintain, and 
enforce reasonably designed written policies and procedures addressing 
conflicts of interest associated with its recommendations to retail 
customers. These policies and procedures must be reasonably designed to 
identify all such conflicts and at a minimum disclose or eliminate 
them. Additionally, the policies and procedures must be reasonably 
designed to mitigate conflicts of interests that create an incentive 
for an associated person of the broker-dealer to place its interests or 
the

[[Page 33484]]

interest of the firm ahead of the retail customer's interest. Moreover, 
when a broker-dealer places material limitations on recommendations 
that may be made to a retail customer (e.g., offering only proprietary 
or other limited range of products), the policies and procedures must 
be reasonably designed to disclose the limitations and associated 
conflicts and to prevent the limitations from causing the associated 
person or broker-dealer to place the associated person's or broker-
dealer's interests ahead of the customer's interest. Finally, the 
policies and procedures must be reasonably designed to identify and 
eliminate sales contests, sales quotas, bonuses, and non-cash 
compensation that are based on the sale of specific securities or 
specific types of securities within a limited period of time.
    Fourth, as described in Section II.C.4, under the Compliance 
Obligation, a broker-dealer must also establish, maintain, and enforce 
written policies and procedures reasonably designed to achieve 
compliance with Regulation Best Interest as a whole. Thus, a broker-
dealer's policies and procedures must address not only conflicts of 
interest but also compliance with its Disclosure and Care Obligations 
under Regulation Best Interest.
    The enhancements contained in Regulation Best Interest will improve 
investor protection by enhancing the quality of broker-dealer 
recommendations to retail customers and reducing the potential harm to 
retail customers that may be caused by conflicts of interest. 
Regulation Best Interest will complement the related rules, 
interpretations, and guidance that the Commission is concurrently 
issuing.\1563\ Individually and collectively, these actions are 
designed to help retail customers better understand and compare the 
services offered by broker-dealers and investment advisers and make an 
informed choice of the relationship best suited to their needs and 
circumstances, provide clarity with respect to the standards of conduct 
applicable to investment advisers and broker-dealers, and foster 
greater consistency in the level of protections provided by each 
regime, particularly at the point in time that a recommendation is 
made.
---------------------------------------------------------------------------

    \1563\ See Relationship Summary Adopting Release; Fiduciary 
Interpretation; Solely Incidental Interpretation.
---------------------------------------------------------------------------

    All of these requirements are discussed in detail in Section II 
above. The costs and burdens of these requirements on small broker-
dealers are discussed below as well as above in our Economic Analysis 
and PRA Analysis, that discuss the costs and burdens on all broker-
dealers.

B. Significant Issues Raised by Public Comments

    The Commission is sensitive to the burdens that the new rule may 
have on small entities. In the Proposing Release, we requested comment 
on matters discussed in the IRFA. In particular, we sought comments on 
the number of small entities that may be affected by proposed 
Regulation Best Interest, and whether proposed Regulation Best Interest 
would have an effect on small entities that had not been considered. We 
requested that commenters describe the nature of any impact on small 
entities and provide empirical data to support the extent of such 
impact. We also requested comment on the proposed compliance burdens 
and the effects these burdens would have on smaller entities.
    As discussed in the Economic Analysis and PRA Analysis above, we 
received comments regarding the potential costs and burdens of the 
proposal on broker-dealers, including those that are small 
entities.\1564\ Additionally, the Commission received some comments 
specifically addressing the costs to smaller broker-dealers.
---------------------------------------------------------------------------

    \1564\ See supra Sections III and IV.
---------------------------------------------------------------------------

    One commenter stated that for a small firm with $500,000 in net 
capital, a compliance cost of $60,000 \1565\ could constitute 12% of 
that net capital, making compliance with the rule burdensome for such 
firms and potentially forcing many small firms to hire additional 
compliance personnel.\1566\ Another commenter raised concerns that 
replacing the term ``suitable'' with ``best interest'' could create 
legal risk and cause smaller and mid-sized professional firms to leave 
the market.\1567\ As noted above in Section III, we acknowledge that 
the costs of the rule could be more burdensome for small firms and 
discuss any corresponding competitive effects in Section III.D.1.\1568\ 
Further, as described above, we acknowledge the requests by commenters 
for further clarity on what it means to ``act in the best interest'' of 
the retail customer, and particularly what it means to make a 
recommendation in a retail customer's ``best interest'' under the Care 
Obligation. Consequently, in Section II.A, and in the detailed 
discussion of each of the Disclosure, Care, Conflict of Interest, and 
Compliance Obligations in Section II.C, we have provided further 
clarity on how a broker-dealer can comply with Regulation Best 
Interest. However, with respect to the comment concerning the term 
``suitable,'' we are adopting a ``best interest'' standard as 
proposed--which enhances the broker-dealer standard of conduct beyond 
existing suitability obligations--in light of our goal to enhance 
retail investor protection and decision making.
---------------------------------------------------------------------------

    \1565\ See NSCP Letter (``Consider the estimated $60,000 in 
additional compliance costs referenced in the Release which would 
represent 12% of net capital of a $500,000 firm.'')
    \1566\ See id (``Several small firms estimate that they incur 
approximately $80,000 in compliance costs to meet basic ongoing 
regulatory requirements. Notably, this amount does not include 
expenses associated with new rules, regulatory changes, regulatory 
exams or running a compliance department. In isolation, it may seem 
that this single proposal by one regulatory agency would have 
manageable marginal impact on costs. But in fact, it would be one of 
many changes (and importantly, a major change) that smaller firms 
must address. Many small firms do not have large Compliance 
Departments adequate to shoulder these ever increasing regulatory 
demands. In fact, many small firm Compliance Departments are 
comprised of just one or two persons.''). See also, generally, NFIB 
Letter (``America's small and independent businesses in the 
financial industry cannot afford the army of lawyers and clerks 
needed to comply with the welter of complex rules issued or proposed 
by the U.S. Department of Labor (DOL) (Reference 1 above), the U.S. 
Securities and Exchange Commission (SEC) (Reference 2 above), and 
the several states to govern the duties of financial businesses 
toward their retail customers.'')
    \1567\ See Iowa Insurance Commissioner Letter (``Striking 
``suitability,'' and its history and legal precedence, will usher in 
an age of legal and marketing confusion. Additionally, smaller and 
mid-sized professional firms, to avoid the risks of this confusion 
and the resulting litigation, will leave the market, and the larger 
firms will remain, increasing market concentration. A decision to 
replace the term ``suitable'' in the text of traditional suitability 
rules with the phrase ``best interest'' will disrupt the market, 
decrease competition, increase the price of services out of the 
reach of thousands of middle class Americans, and significantly 
reduce consumer options for selecting valuable professional 
services.'') But see NAIFA Letter (``NAIFA supports a best interest 
standard of conduct for securities-licensed firms and individuals, 
and we appreciate the SEC's considerable efforts to establish such a 
standard without imposing unduly prescriptive or burdensome 
implementation or compliance requirements. The SEC's general 
approach, we believe, will preserve choices for consumers at all 
income levels and account sizes--and should not unnecessarily 
increase costs for consumers or businesses.'')
    \1568\ See also infra Section V.E., noting that we believe that 
Regulation Best Interest will result in multiple investor protection 
benefits, and these benefits should apply to retail customers of 
smaller entities as well as retail customers of large broker-
dealers.
---------------------------------------------------------------------------

    Another commenter stated that costs for small broker-dealers could 
be reduced if the Commission approved a standard disclosure, which 
would add certainty and reduce costs for small firms and their 
customers.\1569\ We

[[Page 33485]]

considered, as an alternative to the Disclosure Obligation, mandating a 
standardized disclosure.\1570\ However, as described in Section II.C.1, 
after careful consideration of the comments concerning the proposed 
Disclosure Obligation, we have decided not to require any standard 
written disclosures under Regulation Best Interest at this time. We 
recognize the wide variety of business models and practices and we 
continue to believe it is important to provide broker-dealers with 
flexibility to enable them to better tailor disclosure and information 
that their retail customers can understand and may be more likely to 
read at relevant points in time, rather than, for example, mandating a 
standardized all-inclusive (and likely lengthy) disclosure.
---------------------------------------------------------------------------

    \1569\ See Chepucavage Letter (``Costs for the small bd's 
however can be reduced with a commission approved standard 
disclosure which would add certainty and ought to be considered 
especially for the small investor. [. . .] A standard disclosure 
document would also be useful for the small bd that cannot afford 
the legal assistance needed to evaluate this 1,000 page proposal and 
draft appropriate documents. [. . .] The Commission should therefore 
reconsider the impact of its proposal on small investors and small 
bd's with the assumption that retirement accounts are significantly 
more important than regular brokerage accounts especially for small 
and elderly investors. A standard disclosure for small firms would 
reduce costs for the firms and their customers.'')
    \1570\ See supra Section III.E and infra Section V.E.
---------------------------------------------------------------------------

    The vast majority of commenters supported the Commission's 
rulemaking efforts to address the standards of conduct that apply to 
broker-dealers when making recommendations, but nearly all commenters 
suggested modifications to proposed Regulation Best Interest. These 
suggestions touch on almost every aspect of the proposal, as summarized 
in Section I.C above and as discussed in more detail, along with 
explanations of modifications made in light of the comments, throughout 
the release.

C. Small Entities Subject to the Rule

    For purposes of a Commission rulemaking in connection with the RFA, 
a broker-dealer will be deemed a small entity if it: (i) Had total 
capital (net worth plus subordinated liabilities) of less than $500,000 
on the date in the prior fiscal year as of which its audited financial 
statements were prepared pursuant to Rule 17a-5(d) under the Exchange 
Act,\1571\ or, if not required to file such statements, had total 
capital (net worth plus subordinated liabilities) of less than $500,000 
on the last business day of the preceding fiscal year (or in the time 
that it has been in business, if shorter); and (ii) is not affiliated 
with any person (other than a natural person) that is not a small 
business or small organization.\1572\
---------------------------------------------------------------------------

    \1571\ 17 CFR 240.17a-5(d).
    \1572\ See 17 CFR 240.0-10(c).
---------------------------------------------------------------------------

    As discussed in Section IV above, the Commission estimates that as 
of December 31, 2018, approximately 2,766 retail broker-dealers will be 
subject to Regulation Best Interest and the amendments to Rules 17a-3 
and 17a-4.\1573\ Based on FOCUS Report data,\1574\ the Commission 
estimated that as of December 31, 2018, approximately 756 of those 
retail broker-dealers might be deemed small entities for purposes of 
this analysis.\1575\ For purposes of this RFA analysis, we refer to 
broker-dealers that might be deemed small entities under the RFA as 
``small entities,'' and we continue to use the term ``broker-dealers'' 
to refer to broker-dealers generally, as the term is used elsewhere in 
this release.\1576\ Of these 756 small entities, the Commission 
estimates that 623 are standalone broker-dealers and 133 are dually 
registered as investment advisers.\1577\
---------------------------------------------------------------------------

    \1573\ As noted above, this estimate likely overstates the 
number that would be impacted by Regulation Best Interest. See supra 
Section III.C.1.a.
    \1574\ See supra footnote 1384.
    \1575\ See supra footnote 1386.
    \1576\ Consistent with the PRA, unless otherwise notes, we use 
the terms ``registered representative'' and ``dually registered 
representative of a broker-dealer'' herein.
    \1577\ These estimate are based on FOCUS Report Data, see supra 
footnote 1384
---------------------------------------------------------------------------

D. Projected Reporting, Recordkeeping, and Other Compliance 
Requirements

    The new requirements impose certain reporting and compliance 
requirements on certain broker-dealers, including those that are small 
entities. The new requirements are summarized in this FRFA (Section 
V.A. above). All of these requirements are also discussed in detail, in 
Section II above, and these requirements as well as the costs and 
burdens on broker-dealers, including those that are small entities, are 
discussed above in Sections III and IV (the Economic Analysis and PRA 
Analysis) and below.
1. Disclosure Obligation
    The Disclosure Obligation under Regulation Best Interest requires a 
broker-dealer or its associated persons, prior to or at the time of 
recommending a securities transaction or strategy involving securities 
to a retail customer, to provide the retail customer, in writing, full 
and fair disclosure of: (1) All material facts relating to the scope 
and terms of the relationship with the retail customer, including: (a) 
That the broker, dealer, or such natural person is acting as a broker, 
dealer, or an associated person of a broker or dealer with respect to 
the recommendation, (b) the fees and costs that apply to the retail 
customer's transactions, holdings, and accounts, and (c) the type and 
scope of services provided to the retail customer, including any 
material limitations on the securities or investment strategies 
involving securities that may be recommended to the retail customer; 
and (2) all material facts relating to conflicts of interest that are 
associated with the recommendation. The estimated costs and burdens 
incurred by small entities in relation to this Disclosure Obligation 
are discussed in detail below.\1578\
---------------------------------------------------------------------------

    \1578\ For a discussion of additional costs and burdens as well 
as monetized burdens, related to the Disclosure Obligation, see 
supra Section III.C.2.b.
---------------------------------------------------------------------------

a. Obligation To Provide to the Retail Customer Full and Fair 
Disclosure, in Writing, of All Material Facts Relating to the Scope and 
Terms of the Relationship With the Retail Customer
    The Commission assumes for purposes of this analysis that small 
entities would meet the obligation to disclose to the retail customer, 
in writing, the material facts related to the scope and terms of the 
relationship with the retail customer through a combination of delivery 
of the Relationship Summary,\1579\ creating account disclosures to 
include standardized language related to the capacity in which they are 
acting and type and scope of services, and the development of fee 
schedules.
---------------------------------------------------------------------------

    \1579\ See Exchange Act Rule 17a-14 and Relationship Summary 
Adopting Release, supra footnote 12.
---------------------------------------------------------------------------

b. Estimated Costs and Burdens
    In addition to the costs described below, additional costs 
associated with Regulation Best Interest are described above in Section 
III.C.\1580\
---------------------------------------------------------------------------

    \1580\ See Sections III.C.2.b, III.C.3.b, III.C.4, III.C.5, and 
III.C.6.
---------------------------------------------------------------------------

(1) Disclosure of Capacity, Type and Scope of Services
    As explained above, standalone broker-dealers that are small 
entities will satisfy the obligation to disclose the capacity in which 
they acting through the delivery to the retail customer of the 
Relationship Summary, and accordingly, we estimate zero burden hours 
for standalone broker-dealers that are small entities to disclose the 
capacity in which they are acting.
    We estimate that a dually registered firm that is a small entity 
will incur an initial internal burden of 10 hours for in-house counsel 
and in-house compliance to draft language regarding the capacity in 
which it is acting for inclusion in the standardized account disclosure 
that is delivered to the retail customer.\1581\ In addition, we 
estimate

[[Page 33486]]

that dual-registrants that are small entities will incur an estimated 
external cost of $4,970 for the assistance of outside counsel in the 
preparation and review of standardized language regarding 
capacity.\1582\ For the estimated 133 dually registered broker-dealers 
that are small entities, we project an aggregate initial burden of 
1,330 hours,\1583\ and $661,010 in aggregate initial costs for drafting 
language regarding capacity.\1584\
---------------------------------------------------------------------------

    \1581\ See supra footnotes 1395-1396.
    \1582\ See supra footnote 1397.
    \1583\ See supra footnote 1395. This estimate is based on the 
following calculation: (133 dually registered retail firms that are 
small entities) x (10 hours) = 1,330 initial aggregate burden 
hours.) The professional skills associated with the estimated burden 
hours are specified in Section IV above.
    \1584\ This estimate is based on the following calculation: (133 
dually registered retail firms that are small entities) x ($4,970 in 
external cost per firm) = $661,010 in aggregate initial costs.
---------------------------------------------------------------------------

    Similarly, to comply with Regulation Best Interest, we believe that 
small entities will draft standardized language for inclusion in the 
account disclosure to provide the retail customer with more specific 
information regarding the type and scope of services that they provide. 
We estimate that a small entity will incur an internal initial burden 
of 10 hours for in-house counsel and in-house compliance to draft this 
standardized language.\1585\ In addition, a small entity will incur an 
estimated external cost of $4,970 for the assistance of outside counsel 
in the preparation and review of this standardized language.\1586\ For 
the estimated 756 small entities,\1587\ we project an aggregate initial 
burden of 7,560 hours,\1588\ and aggregate initial costs of $3.8 
million for drafting language regarding type and scope of 
services.\1589\
---------------------------------------------------------------------------

    \1585\ See supra footnote 1402.
    \1586\ See supra footnote 1403.
    \1587\ See supra footnote 1385 and accompanying text.
    \1588\ See supra footnote 1405.
    \1589\ See supra footnote 1406.
---------------------------------------------------------------------------

    We estimate that small entities will each incur approximately 0.02 
burden hours \1590\ for delivery of the account disclosure 
document.\1591\ Based on FOCUS data, we believe that the 756 small 
entities have a total of 5,281 customer accounts, and that 
approximately all of those accounts belong to retail customers.\1592\ 
We therefore estimate that small entities will have an aggregate 
initial burden of 106 hours, or approximately 0.14 hours \1593\ per 
small entity for the first year after Regulation Best Interest is in 
effect for delivery of the account disclosure document.\1594\
---------------------------------------------------------------------------

    \1590\ See supra footnote 1411.
    \1591\ See supra footnote 1412.
    \1592\ This estimate may overstate the number of retail customer 
accounts at small entities and/or may overstate the number of 
deliveries to be made due to the double-counting of deliveries to be 
made by dual-registrants to a certain extent, and the fact that one 
customer may own more than one account.
    \1593\ These estimates are based on the following calculations: 
(0.02 hours per customer account x (5,281 retail customer accounts) 
= 106 aggregate burden hours. Conversely, (106 hours) / (756 small 
entities) = approximately 0.14 burden hours per small entity for the 
first year after Regulation Best Interest is in effect.
    \1594\ See supra footnote 1415.
---------------------------------------------------------------------------

    We therefore estimate a total initial aggregate burden for small 
entities to develop and deliver to retail customers account disclosures 
relating to the capacity in which they are acting and type and scope of 
services of 7,666 burden hours.\1595\
---------------------------------------------------------------------------

    \1595\ This estimate is based on the following calculation: 
(1,330 aggregate initial burden hours for dually registered broker-
dealers that are small entities) + (6,230 aggregate initial burden 
hours for standalone broker-dealers that are small entities) + (106 
aggregate initial burden hours for small entities to deliver the 
account disclosures) = 7,666 total aggregate initial burden hours.
---------------------------------------------------------------------------

    In terms of ongoing costs, we estimate that each dually registered 
broker-dealer that is a small entity will incur approximately 5 burden 
hours annually for in-house compliance and business-line personnel to 
review changes in the dual-registrant's capacity, and another 2 burden 
hours annually for in-house counsel to amend the account disclosure to 
disclose material changes to the dual-registrant's capacity, for a 
total of 7 burden hours. The estimated ongoing aggregate burden to 
amend account disclosures of dual-registrants that are small entities 
to reflect changes in capacity is therefore 931 hours per year.\1596\
---------------------------------------------------------------------------

    \1596\ This estimate is based on the following calculation: (7 
burden hours per dually registered firm per year) x 133 dually 
registered broker-dealers that are small entities) = 931 ongoing 
aggregate burden hours per year.
---------------------------------------------------------------------------

    With respect to small entities, we estimate an internal burden of 2 
hours for in-house compliance and business-line personnel to review and 
update changes in types or scope of services,\1597\ and another 2 
burden hours annually for in-house counsel to amend the account 
disclosure to disclose material changes to type and scope of services--
for a total of 4 burden hours per year. The estimated ongoing aggregate 
burden for standalone broker-dealers that are small entities to amend 
account disclosures to reflect changes in type and scope of services is 
therefore 2,492 hours per year.\1598\
---------------------------------------------------------------------------

    \1597\ As noted above, we estimate zero burden hours annually 
for standalone broker-dealers that are small entities relating to 
disclosure of capacity under the Disclosure Obligation. See supra 
Section IV.B.1.a.ii.
    \1598\ This estimate is based on the following calculation: (4 
burden hours per small entity per year) x (623 standalone broker-
dealers that are small entities) = 2,492 ongoing aggregate burden 
hours per year.
---------------------------------------------------------------------------

    With respect to delivery of the amended account agreements in the 
event of material changes to the capacity disclosure or disclosure 
related to type and scope of services, we estimate that this would take 
place among 20% of a small entity's retail customer accounts annually. 
We therefore estimate small entities to incur a total annual aggregate 
burden of 21 hours, or 0.03 hours per small entity per year.\1599\
---------------------------------------------------------------------------

    \1599\ (20%) x (5,281 retail customer accounts) x (0.02 hours 
for delivery to each customer account) = 21 aggregate burden hours 
per year. Conversely, 21 aggregate burden hours/756 small entities = 
0.03 burden hours per small entity per year.
---------------------------------------------------------------------------

    The total ongoing aggregate burden for small entities to review, 
amend, and deliver updated account disclosures to reflect changes in 
capacity, type and scope of services would be 3,444 burden hours per 
year.\1600\
---------------------------------------------------------------------------

    \1600\ This estimate is based on the following calculation: (931 
ongoing aggregate burden hours for dually registered broker-dealers 
that are small entities) + (2,492 ongoing aggregate burden hours for 
standalone broker-dealers that are small entities) + (21 ongoing 
aggregate burden hours for delivery of amended account disclosures) 
= 3,444 total ongoing aggregate burden hours per year.
---------------------------------------------------------------------------

    The Commission acknowledges that the types of services and product 
offerings vary greatly by broker-dealer, and therefore the costs or 
burdens associated with updating the account disclosure might also 
vary.
(2) Disclosure of Fees and Costs
    As stated above, while we anticipate that many small entities may 
already create fee schedules, we believe that small entities will 
initially spend 5 hours to internally create a new fee schedule in 
consideration of the requirements of Regulation Best Interest. We 
additionally estimate a one-time external cost of $2,485 for small 
entities.\1601\ We therefore estimate the initial aggregate burden for 
small entities to be 3,780 burden hours,\1602\ and the initial 
aggregate cost to be $1.88 million.\1603\
---------------------------------------------------------------------------

    \1601\ See supra footnote 1426.
    \1602\ See supra footnote 1428.
    \1603\ See supra footnote 1429.
---------------------------------------------------------------------------

    Similar to delivery of the account disclosure regarding capacity 
and type and scope of services, we estimate the burden for small 
entities to make the initial delivery of the fee schedule to new retail 
customers, at the inception of the relationship, and existing retail 
customers, prior to or at the time of a recommendation, will require 
approximately 0.02 hours to deliver to each retail customer.\1604\ We 
therefore estimate that small entities will have an aggregate initial 
burden of 106 hours, or

[[Page 33487]]

approximately 0.14 hours per small entity for the first year after 
Regulation Best Interest is in effect.\1605\
---------------------------------------------------------------------------

    \1604\ See supra footnote 1411.
    \1605\ This estimate is based on the following calculation: 
(5,281 retail customer accounts) x (0.02 hours for delivery to each 
customer account) = 106 aggregate burden hours. Conversely, (106 
aggregate burden hours) / (756 small entities) = 0.14 burden hours 
per small entity for the first year after Regulation Best Interest 
is in effect.
---------------------------------------------------------------------------

    With respect to small entities, we estimate that reviewing and 
updating the fee schedule will require approximately 2 hours per year. 
Based on these estimates, we estimate the recurring, aggregate, 
annualized burden will be 1,512 hours for small entities.\1606\ We do 
not anticipate that small entities will incur outside legal, 
compliance, or consulting fees in connection with updating their 
standardized fee schedule since in-house personnel would be more 
knowledgeable about these facts, and we therefore do not expect 
external costs associated with updating the fee schedule.
---------------------------------------------------------------------------

    \1606\ See supra footnote 1437.
---------------------------------------------------------------------------

    With respect to delivery of the amended fee schedule in the event 
of a material change, we estimate that this would take place among 40% 
of a small entity's retail customer accounts annually, and that small 
entities will require approximately 0.02 hours to deliver the amended 
fee schedule to each retail customer. We therefore estimate small 
entities would incur a total annual aggregate burden of 42 hours, or 
0.06 hours per small entity.\1607\
---------------------------------------------------------------------------

    \1607\ This estimate is based on the following calculation: (40% 
of 5,281 retail customer accounts) x (0.02 hours) = 42 aggregate 
burden hours. Conversely, (42 aggregate burden hours)/(756 small 
entities) = 0.06 burden hours per small entity per year.
---------------------------------------------------------------------------

    The Commission acknowledges that the type of fee schedule may vary 
greatly by small entity and therefore that the costs or burdens 
associated with updating the standardized fee schedule might similarly 
vary.
(3) Disclosure of All Material Facts Relating to Conflicts of Interest 
Associated With the Recommendation
    We believe that many or most small entities will develop a 
standardized conflict disclosure document and deliver it to their 
retail customers.\1608\ For small entities, we estimate it will take 
in-house counsel, on average, 5 burden hours to create the standardized 
conflict disclosure document and outside counsel 5 hours to review and 
revise the document. We estimate that the initial aggregate burden for 
the development of a standardized disclosure document, based on an 
estimated 756 small entities, will be 3,780 burden hours.\1609\ We 
additionally estimate an initial cost of $2,485 per small entity,\1610\ 
and an aggregate initial cost of $1.88 million for all small broker-
dealers.\1611\
---------------------------------------------------------------------------

    \1608\ See supra footnote 1443.
    \1609\ See supra footnote 1444.
    \1610\ See supra footnote 1445.
    \1611\ See supra footnote 1446.
---------------------------------------------------------------------------

    We assume that small entities will deliver the standardized 
conflict disclosure document to new retail customers at the inception 
of the relationship, and to existing retail customers prior to or at 
the time of a recommendation. We estimate that small entities will 
require approximately 0.02 hours to deliver the standardized conflict 
disclosure document to each retail customer.\1612\ We therefore 
estimate that small entities will incur an aggregate initial burden of 
106 hours, or approximately 0.14 hours per small entity for delivery of 
the standardized conflict disclosure document the first year after 
Regulation Best Interest is in effect.\1613\ Accordingly, the total 
aggregate initial burden for small entities is estimated at 3,886 
hours,\1614\ and the total aggregate initial cost is estimated at $1.88 
million.\1615\
---------------------------------------------------------------------------

    \1612\ See supra footnote 1411. For purposes of this analysis, 
we have assumed any initial disclosures made by the small entities 
related to material conflicts of interest will be delivered 
together.
    \1613\ These estimates are based on the following calculations: 
(0.02 hours per customer account x 5,281 retail customer accounts) = 
106 aggregate burden hours. Conversely, (106 hours)/(756 small 
entities) = 0.14 burden hours per small entity for the first year 
after Regulation Best Interest is in effect.
    \1614\ This estimate is based on the following calculation: 
(3,780 aggregate initial burden hours for the development of a 
standardized conflict disclosure document) + (106 burden hours for 
delivery of the standardized conflict disclosure document) = 3,886 
aggregate initial burden hours.
    \1615\ See supra footnote 1429.
---------------------------------------------------------------------------

    We believe that small entities will incur ongoing annual burdens 
and costs to update the disclosure document to include newly identified 
conflicts. We estimate that in-house counsel at a small entity will 
require approximately 1 hour per year to update the standardized 
conflict disclosure document, for an ongoing aggregate burden of 
approximately 756 hours per year.\1616\ We do not anticipate that small 
entities will incur outside legal, compliance, or consulting fees in 
connection with updating their standardized conflict disclosure 
document, since in-house personnel would presumably be more 
knowledgeable about conflicts of interest.
---------------------------------------------------------------------------

    \1616\ See supra footnote 1453.
---------------------------------------------------------------------------

    With respect to ongoing delivery of the updated conflict disclosure 
document, we estimate that this will take place among 40% of a small 
entity's retail customer accounts annually, and that small entities 
will require approximately 0.02 hours to deliver the updated conflict 
disclosure document to each retail customer.\1617\ We therefore 
estimate that small entities will incur an aggregate ongoing burden of 
42 hours, or 0.06 burden hours per small entity per year.\1618\
---------------------------------------------------------------------------

    \1617\ See supra footnote 1455.
    \1618\ This estimate is based on the following calculation: (40% 
of 5,281 retail customer accounts) x (0.02 hours) = 42 aggregate 
burden hours. Conversely, (42 aggregate burden hours per year)/(756 
small entities) = 0.06 hours per small entity per year.
---------------------------------------------------------------------------

2. Care Obligation
    As discussed above in Section IV.B.2, we believe that any burdens 
or costs associated with the Care Obligation are accounted for in other 
obligations under Regulation Best Interest, including the Disclosure 
Obligation and the Record-making Obligation under Rule 17a-3(a)(35) and 
Recordkeeping Obligation under Rule 17a-4(e)(5). Other costs applicable 
to broker-dealers, including small entities, associated with the Care 
Obligation are discussed above in Section III.C.3.b.
3. Conflict of Interest Obligation
    As described more fully above in Section IV.B.3, the Conflict of 
Interest Obligation would generally include the obligation to: (1) 
Update written policies and procedures to comply with Regulation Best 
Interest and (2) establish mechanisms to proactively and systematically 
identify and manage conflicts of interest in its business on an ongoing 
or periodic basis.\1619\
---------------------------------------------------------------------------

    \1619\ See supra Section IV.B.3. For a discussion of additional 
costs and burdens, as well as monetized burdens, related to the 
Conflict of Interest Obligation, see supra Section III.C.4.
---------------------------------------------------------------------------

a. Written Policies and Procedures
i. Initial Costs and Burdens
    To initially comply with this obligation, we believe that small 
entities would primarily rely on outside counsel to update existing 
policies and procedures, as small broker-dealers generally have fewer 
in-house legal and compliance personnel. We estimate that 40 hours of 
outside legal counsel services would be required, for a one-time 
initial cost of $19,880 per small entity,\1620\ and an aggregate 
initial cost of $15.0 million for all small entities.\1621\ We also 
expect that in-

[[Page 33488]]

house compliance would require 10 hours to review and approve the 
updated policies and procedures, for an initial aggregate burden of 
7,560 hours.\1622\ Therefore, we estimate the total initial aggregate 
burden for small entities to be 128,160 hours \1623\ and the total 
initial aggregate cost to be $25.0 million.\1624\
---------------------------------------------------------------------------

    \1620\ See supra footnote 1477.
    \1621\ See supra footnote 1478.
    \1622\ See supra footnote 1479.
    \1623\ See supra footnote 1480.
    \1624\ See supra footnote 1481.
---------------------------------------------------------------------------

    We believe that the related ongoing costs for small entities 
(relating to outside counsel reviewing and updating policies and 
procedures on a periodic basis) would be $2,485 annually for each small 
entity,\1625\ and the projected aggregate, annual ongoing cost for 
small entities (relating to outside legal counsel) would be $1.88 
million.\1626\ In addition, we expect that small entities would require 
five hours of outside compliance services per year to update their 
policies and procedures, for an ongoing cost of $1,365 per year per 
small entity,\1627\ and an aggregate ongoing cost of $1.03 million per 
year.\1628\ The total aggregate, ongoing cost for small entities is 
therefore projected at $2.91 million per year.\1629\
---------------------------------------------------------------------------

    \1625\ See supra footnote 1486.
    \1626\ See supra footnote 1487.
    \1627\ See supra footnote 1488.
    \1628\ See supra footnote 1489.
    \1629\ See supra footnote 1490.
---------------------------------------------------------------------------

    In addition to the costs described above, we additionally believe 
small broker-dealers would incur an internal burden of approximately 
five hours for an in-house compliance manager to review and approve the 
updated policies and procedures per year. The ongoing, aggregate burden 
for small broker-dealers would be 3,780 hours for in-house compliance 
manager review per year.\1630\
---------------------------------------------------------------------------

    \1630\ See supra footnote 1491.
---------------------------------------------------------------------------

b. Identification and Management of Conflicts of Interest
    To comply with Regulation Best Interest, we expect that small 
entities would modify existing technology through an outside programmer 
which would require, on average, an estimated 20 hours, for an 
estimated initial cost per small entity of $5,680.\1631\ We 
additionally continue to project that coordination between the 
programmer and the small entity's compliance manager would involve five 
initial burden hours. The aggregate initial costs and burdens for small 
entities for the modification of existing technology to identify 
conflicts of interest would therefore be $4.29 million,\1632\ and 3,780 
burden hours.\1633\
---------------------------------------------------------------------------

    \1631\ See supra footnote 1497.
    \1632\ This cost estimate is based on the following calculation: 
($5,680 in outside programmer costs per broker-dealer) x (756 small 
entities) = $4.29 million in aggregate initial outside programmer 
costs.
    \1633\ This burden estimate is based on the following 
calculation: (5 burden hours) x (756 small entities) = 3,780 
aggregate initial burden hours.
---------------------------------------------------------------------------

    As a result of the changes made to the rule text of the Conflict of 
Interest Obligation of Regulation Best Interest, we believe that small 
entities would incur burdens to determine how to manage the conflict of 
interest. We believe that small entities would require approximately 20 
hours per small entity,\1634\ for an aggregate of 15,120 initial burden 
hours for all small entities.\1635\ The total initial aggregate burden 
for small entities for identification and management of conflicts of 
interest is therefore 18,900 initial burden hours.\1636\
---------------------------------------------------------------------------

    \1634\ See supra footnotes 1501 and 1502.
    \1635\ This burden estimate is based on the following 
calculation: (20 burden hours) x (756 small entities) = 15,120 
aggregate initial burden hours.
    \1636\ This burden estimate is based on the following 
calculation: (3,780 burden hours for modification of technology) + 
(15,120 burden hours for evaluation of managing conflicts) = 18,900 
total aggregate initial burden hours.
---------------------------------------------------------------------------

    To maintain compliance with the Conflict of Interest Obligation, we 
believe that for purposes of this analysis, small entities would, 
through the help of the business line and compliance personnel, spend 
on average 10 hours \1637\ to perform an annual conflicts review using 
the modified technology infrastructure.\1638\ Therefore, the aggregate 
ongoing burden for an annual conflicts review, based on an estimated 
756 small entities, would be approximately 7,560 burden hours per 
year.\1639\ Because we assume that small entities would use in-house 
personnel to identify and evaluate new, potential conflicts, we 
continue to believe they would not incur additional ongoing costs.
---------------------------------------------------------------------------

    \1637\ See supra footnote 1507.
    \1638\ See supra footnote 1508.
    \1639\ This estimate is based on the following calculation: (10 
hours of labor per small entity per year) x (756 small entities) = 
7,560 aggregate burden hours per year.
---------------------------------------------------------------------------

c. Training
    As discussed in the Proposing Release, we expect that small 
entities would develop training programs to comply with Regulation Best 
Interest, including the Conflict of Interest Obligation. However, we 
believe that any burdens and costs associated with a training program 
would fall under the new Compliance Obligation as it would be developed 
to comply with the rule as a whole, including each of the component 
obligations.
    In total, to comply with the Conflict of Interest Obligation, the 
Commission estimates that the total initial burdens and costs for small 
entities to be 135,720 hours \1640\ and $29.29 million \1641\ and the 
total ongoing burdens and costs for small entities to be 11,340 hours 
\1642\ and $2.91 million.\1643\
---------------------------------------------------------------------------

    \1640\ This estimate is based on the following calculation: 
(128,160 burden hours for written policies and procedures) + (7,560 
burden hours for identification and management of conflicts of 
interest) = 135,720 hours.
    \1641\ This estimate is based on the following calculation: ($25 
million initial aggregate costs relating to written policies and 
procedures) + ($4.29 million initial aggregate costs for 
modification of existing technology to identify conflicts of 
interest) = $29.29 million initial aggregate costs.
    \1642\ This estimate is based on the following calculation: 
(3,780 burden hours for reviewing and approving the updated policies 
and procedures) + (7,560 burden hours for annual conflicts review) = 
11,340 initial aggregate burden hours.
    \1643\ See supra footnote 1629.
---------------------------------------------------------------------------

4. Compliance Obligation
    As discussed above, in response to comments that we should require 
policies and procedures to comply with the rule as a whole, we are 
adopting the Compliance Obligation.\1644\ Because we did not include 
the Compliance Obligation in the Proposing Release, we did not include 
costs and burdens associated with the Compliance Obligation, but have 
provided a detailed explanation in Section IV.B.4 above, and a summary 
below.
---------------------------------------------------------------------------

    \1644\ Section II.C.4.
---------------------------------------------------------------------------

    To comply with the Compliance Obligation, we believe that small 
entities would primarily rely on outside counsel to update existing 
policies and procedures, and that 20 hours of outside legal counsel 
services would be required, for a one-time cost of $9,940 per small 
entity,\1645\ and an aggregate initial cost of $7.5 million for all 
small entities.\1646\ We also expect that in-house compliance personnel 
would require 6 hours to review and approve the updated policies and 
procedures, for an aggregate initial burden of 4,536 hours.\1647\
---------------------------------------------------------------------------

    \1645\ See supra footnote 1523.
    \1646\ See supra footnote 1524.
    \1647\ See supra footnote 1525.
---------------------------------------------------------------------------

    In terms of ongoing costs, we assume for purposes of this analysis 
that small entities would mostly rely on outside legal counsel and 
compliance consultants for review and update of their policies and 
procedures, with final review and approval from an in-house compliance 
manager. We estimate that outside counsel would require approximately 
five hours per year to update policies and procedures, for an

[[Page 33489]]

annual cost of $2,485 for each small entity.\1648\ The projected 
aggregate, annual ongoing cost for outside legal counsel to update 
policies and procedures for small entities would be $1.88 million per 
year.\1649\ In addition, we expect that a small entity would require 
five hours of outside compliance services per year to update its 
policies and procedures, for an ongoing cost of $1,365 per year,\1650\ 
and an aggregate ongoing cost of $1.03 million per year.\1651\ The 
total aggregate, ongoing cost for small entities is therefore projected 
at $2.91 million per year.\1652\
---------------------------------------------------------------------------

    \1648\ See supra footnote 1529.
    \1649\ See supra footnote 1530.
    \1650\ See supra footnote 1531.
    \1651\ See supra footnote 1532.
    \1652\ See supra footnote 1533.
---------------------------------------------------------------------------

a. Training
    Pursuant to the obligation to ``maintain and enforce'' written 
policies and procedures, we additionally believe small entities will 
develop training programs that promote compliance with Regulation Best 
Interest.
    We estimate that a small entity would retain an outside systems 
analyst, outside programmer, and an outside programmer analyst to 
create a training module, at 20 hours, 40 hours, and 20 hours, 
respectively. The total cost to develop the training module would be 
approximately $20,920 per small entity,\1653\ for an aggregate initial 
cost to small entities of $17.18 million.\1654\
---------------------------------------------------------------------------

    \1653\ See supra footnote 1534.
    \1654\ This estimate is based on the following calculation: (756 
small entities) x ($20,920 initial costs per broker-dealer) = $15.81 
million in aggregate initial costs for technology services.
---------------------------------------------------------------------------

    Additionally, we expect that the training module would require the 
approval of the Chief Compliance Officer, as well as in-house counsel, 
each of whom would require approximately 2 hours to review and approve 
the training module. The initial aggregate burden for small entities is 
therefore estimated at 3,024 initial burden hours.\1655\
---------------------------------------------------------------------------

    \1655\ This estimate is based on the following calculation: (756 
small entities) x (4 initial burden hours per small entity) = 3,024 
initial burden hours.
---------------------------------------------------------------------------

    In addition, small entities would incur an initial cost for 
registered representatives to undergo training through the training 
module. We estimate the training time at one hour per associated 
person, for an aggregate initial burden of 5,094 burden hours, or an 
initial burden of 6.7 hours per small entity.\1656\ The total aggregate 
burden to approve the training module and implement the training 
program would be 8,118 initial burden hours.\1657\
---------------------------------------------------------------------------

    \1656\ This estimate is based on the following calculation: (1 
burden hour) x (5,094 registered representatives at small entities) 
= 5,094 aggregate initial burden hours. Conversely, (5,094 aggregate 
burden hours)/(756 small entities) = 6.7 initial burden hours per 
broker-dealer.
    \1657\ This estimate is based on the following calculation: 
(5,094 burden hours for training of registered representatives) + 
(3,024 burden hours to approve training program) = 8,118 total 
aggregate initial burden hours.
---------------------------------------------------------------------------

    For purposes of this analysis, we assume that small entities would 
likely require registered representatives to repeat the training module 
for Regulation Best Interest on an annual basis. The ongoing aggregate 
cost for the one-hour training would be 5,094 burden hours per year, or 
6.7 burden hours per small entity per year.\1658\
---------------------------------------------------------------------------

    \1658\ See supra footnote 1656.
---------------------------------------------------------------------------

    In total, for small entities to comply with the Compliance 
Obligation, the Commission estimates the total initial burdens and 
costs to be 12,654 hours \1659\ and $23.31 million,\1660\ and the total 
ongoing burdens and costs to be 5,094 hours \1661\ and $2.91 
million.\1662\
---------------------------------------------------------------------------

    \1659\ This estimate is based on the following calculation: 
(4,536 initial burden hours for policies and procedures) + (8,118 
initial burden hours training) = 12,654 initial burden hours to 
comply with Compliance Obligation.
    \1660\ This estimate is based on the following calculation: 
($7.5 million initial costs for policies and procedures) + ($15.81 
million initial costs for training) = $23.31 million initial total 
costs to comply with Compliance Obligation.
    \1661\ This estimate is based on the following calculation: (0 
ongoing burden hours for policies and procedures) + (5,094 ongoing 
burden hours for training) = 5,094 ongoing burden hours to comply 
with Compliance Obligation.
    \1662\ This estimate is based on the following calculation: 
($2.91 million ongoing costs for policies and procedures) + ($0 
ongoing costs for training) = $2.91 million ongoing total costs to 
comply with Compliance Obligation.
---------------------------------------------------------------------------

5. Record-Making and Recordkeeping Obligations
    The record-making and recordkeeping obligations will impose record-
making and recordkeeping requirements on broker-dealers with respect to 
certain information collected from, or provided to, retail customers.
a. Record-Making Obligation
    As discussed above, we continue to believe that small entities will 
satisfy the record-making requirements of the amendment to Rule 17a-
3(a)(35) by amending an existing account disclosure document to include 
certain information.\1663\ We believe that the inclusion of this 
information in an account disclosure document will require, on average, 
approximately 1 hour per year for outside counsel at small entities, at 
an updated average rate of $497/hour, for an annual cost of $497 for 
each small entity to update an account disclosure document. The 
projected initial, aggregate cost for small entities is therefore 
estimated to be $375,732.\1664\ Finally, we estimate it will require an 
additional 0.04 hours for the registered representative responsible for 
the information (or other clerical personnel) to fill out that 
information in the account disclosure document, for an approximate 
total aggregate initial burden of 211 hours, or approximately 0.28 
hours per small entity for the first year after the rule is in 
effect.\1665\
---------------------------------------------------------------------------

    \1663\ See supra Section IV.B.5.a.i.
    \1664\ See supra footnote 1548.
    \1665\ These estimates are based on the following calculations: 
(0.04 hours per customer account) x (5,281 retail customer accounts 
at small entities) = 211 aggregate initial burden hours. Conversely, 
(211 burden hours)/(756 small entities) = 0.28 initial burden hours 
per broker-dealer.
---------------------------------------------------------------------------

    Because we have already included the costs and burdens associated 
with the creation of a record to memorialize an oral disclosure, and 
the delivery of the amended account disclosure document in Section 
V.D.1., we need not include them in this section of the analysis.
    We do not believe that the identity of the registered 
representative responsible for the retail customer's account will 
change. Accordingly, we continue believe that there are no ongoing 
costs and burdens associated with this record-making requirement of the 
amendment to Rule 17a-3(a)(35). With respect to memorializing oral 
disclosures, we estimate that this would take place among 52% of a 
small entity's retail customers (and thus 52% of a registered 
representative's retail customer accounts) annually.\1666\ We therefore 
estimate that small entities will incur a total annual aggregate 
ongoing burden of 55 hours or 0.07 hours per small entity per 
year.\1667\
---------------------------------------------------------------------------

    \1666\ See supra footnote 1554.
    \1667\ (52%) x (5,281 retail customer accounts at small 
entities) x (0.02 hours for recording each oral disclosure relating 
to a retail customer's account) = 55 aggregate burden hours per 
year. Conversely, 55 aggregate burden hours/756 small entities = 
0.07 ongoing burden hours per small entity per year.
---------------------------------------------------------------------------

b. Recordkeeping Obligation
    For purposes of this analysis, we assume the following records 
would likely be retained pursuant to amended Rule 17a-3(a)(35): (1) 
Existing account disclosure documents; (2) comprehensive fee schedules; 
(3) disclosures identifying material conflicts; and (4) memorialized 
oral disclosures under the circumstances outlined in Section II.C.1, 
Oral Disclosure or Disclosure After a Recommendation.
    Based on our belief that small entities will rely on existing 
infrastructures to satisfy the recordkeeping obligations of Regulation 
Best Interest and the amendment to Rule 17-a(4)(e)(5), we

[[Page 33490]]

believe the burden for small entities to add new documents or modify 
existing documents to the small entity's existing retention system will 
be approximately 704 burden hours for small entities, assuming a small 
entity will need to upload or file each of the four account documents 
discussed above for each retail customer account.\1668\ We do not 
believe there will be additional internal or external costs relating to 
the uploading or filing of the documents. In addition, because we have 
already included the costs and burdens associated with the delivery of 
the amended account opening agreement and other documents in Section 
V.D.1 above, we do not include them in this section of the analysis.
---------------------------------------------------------------------------

    \1668\ This estimate is based on the following calculation: (4 
documents per customer account) x (5,281 retail customer accounts at 
small entities) x (2 minutes per document)/60 minutes = 704 
aggregate burden hours.
---------------------------------------------------------------------------

    We estimate that the approximate ongoing burden associated with the 
recordkeeping requirement of the amendment to Rule 17a-4(e)(5) is 231 
burden hours per year.\1669\ We do not believe that the ongoing costs 
associated with ensuring compliance with the retention schedule would 
change from the current costs of ensuring compliance with existing Rule 
17a-4 and as outlined above.
---------------------------------------------------------------------------

    \1669\ This estimate is based on the percentage of account 
records we expect would be updated each year as described in Section 
IV.B.1, supra, and the following calculation: ((40% of fee schedules 
x 5,281 retail customer accounts at small entities) x (2 minutes per 
document) + (40% of conflict disclosure forms x 5,281 retail 
customer accounts at small entities) x (2 minutes per document) + 
(20% of account opening documents x 5,281 retail customer accounts 
at small entities) x (2 minutes per document)) = 10,560 minutes/60 
minutes = 176 aggregate ongoing burden hours. In addition, with 
respect to ongoing memorialization of the updated oral disclosures, 
we estimate that this will take place among 52% of a small entity's 
retail customer accounts annually. We therefore estimate that small 
entities will incur an aggregate ongoing burden of 55 hours, or 0.07 
burden hours per broker-dealer (calculated as follows: (52% of 
updated oral disclosures x 5,281 retail customer accounts at small 
entities) x (1.2 minutes per document) = 3,295 minutes/60 minutes = 
55 aggregate ongoing burden hours (or 55 aggregate burden hours/756 
small entities = 0.07 burden hours per small entity)). 176 hours + 
55 hours = 231 total aggregate ongoing burden hours.
---------------------------------------------------------------------------

E. Agency Action To Minimize Effect on Small Entities

    The RFA directs the Commission to consider significant alternatives 
that would accomplish the stated objective, while minimizing any 
significant adverse impact on small entities. As described in the 
Proposing Release we considered the following alternatives for small 
entities in relation to the new requirements: (1) The establishment of 
differing compliance or reporting requirements or timetables that take 
into account the resources available to small entities; (2) the 
clarification, consolidation, or simplification of compliance and 
reporting requirements for small entities; (3) the use of performance 
rather than design standards; and (4) an exemption from coverage of the 
new requirements, or any part thereof, for such small entities.
    Regarding the first alternative, the Commission does not believe 
that we could effectively achieve our stated objectives by establishing 
different requirements applicable to broker-dealers of different sizes. 
We considered adopting tiered compliance dates so that smaller broker-
dealers would have had more time to comply. However, as discussed in 
Section II.E above, we believe the operational capability needed to 
develop processes to comply with Regulation Best Interest is 
sufficiently established by firms of all sizes and resources. The 
Commission has determined, in light of the importance of the 
protections afforded by Regulation Best Interest to retail customers, 
that a Compliance Date of one year after the Effective Date is an 
appropriate timeframe for firms to conduct the requisite operational 
changes to their systems to establish internal processes to comply with 
Regulation Best Interest. Further, as discussed above in Section III, 
each of the component obligations in Regulation Best Interest shares 
features with existing market best practices, as shaped by FINRA's 
guidance on relevant rules or as described in its Report on Conflicts 
of Interest.\1670\ To the extent that broker-dealer (and small entity) 
practices are already aligned with the requirements of Regulation Best 
Interest, the anticipated magnitude of the costs associated with a 
given component of the rule will be correspondingly reduced.\1671\
---------------------------------------------------------------------------

    \1670\ See supra Section III.C.1.b.
    \1671\ See supra text following footnote 1159.
---------------------------------------------------------------------------

    As discussed above, we believe that Regulation Best Interest will 
result in important investor protection benefits, and these benefits 
apply to retail customers of smaller entities as well as retail 
customers of large broker-dealers. For example, a primary objective of 
this rulemaking is to enhance the quality of recommendations provided 
by broker-dealers to retail customers, by establishing under the 
Exchange Act a ``best interest'' obligation. We do not believe that the 
interest of investors who are retail customers would be served by 
establishing differing compliance or reporting requirements or 
timetables for broker-dealers that are small entities under Regulation 
Best Interest and the amendments to Rules 17a-3 and 17a-4(e)(5).
    Moreover, we continue to believe that providing an exemption or 
different requirements for small entities would be inconsistent with 
our goal of facilitating more consistent regulation, in recognition of 
the importance for both investors and broker-dealers of having the 
applicable standards for brokerage recommendations be clear, 
understandable, and as consistent as possible across a brokerage 
relationship (i.e., whether for retirement or non-retirement purposes) 
and better aligned with other advice relationships (e.g., a 
relationship with an investment adviser). Further, as discussed above, 
broker-dealers are subject to regulation under the Exchange Act and the 
rules of each SRO of which the broker-dealer is a member, including a 
number of obligations that attach when a broker-dealer makes a 
recommendation to a customer, as well as general and specific 
requirements aimed at addressing certain conflicts of interest. We note 
that these existing requirements do not generally distinguish between 
small entities and other broker-dealers.
    For the same reasons as described in the Proposing Release, we 
still do not believe that additional clarification, consolidation, or 
simplification of compliance and reporting requirements would be 
appropriate for small entities. We note, however, in crafting 
Regulation Best Interest, we generally aimed to provide broker-dealers 
flexibility in determining how to satisfy the component obligations. We 
continue to believe that this flexibility reflects a general 
performance-based approach, rather than design-based approach.
    As discussed in the Economic Analysis in Section III.E above, the 
Commission also considered a number of alternatives as they affect all 
firms, including small entities. Specifically, the Commission 
considered three different options for imposing a fiduciary standard on 
broker-dealers: (1) Applying the fiduciary standard under the Advisers 
Act to broker-dealers; (2) adopting a ``new'' uniform fiduciary 
standard of conduct applicable to both broker-dealers and investment 
advisers, such as that recommended by the staff in the 913 Study, and, 
or (3) adopting similar standards to what the DOL had provided under 
its fiduciary rule to broker-dealers and investment advisers. The 
Commission further considered requiring broker-dealers to use a 
specific form for disclosure, similar to, for example, Form ADV Part II 
in lieu of the flexible approach of the Disclosure Obligation, or in 
the alternative, developing a disclosure-only standard,

[[Page 33491]]

which would require that broker-dealers satisfy only the Disclosure 
Obligation of the final rule.
    We acknowledge certain commenters urged the Commission to take 
additional or different regulatory actions than the approach we have 
adopted, including the alternatives discussed above. We do not believe 
that any rulemaking governing retail investor-advice relationships can 
solve for every issue presented. After careful consideration of the 
comments and additional information we have received, we believe that 
Regulation Best Interest, as modified, appropriately balances the 
concerns of the various commenters in a way that will best achieve the 
Commission's important goals of enhancing retail investor protection 
and decision making, while preserving, to the extent possible, retail 
investor access (in terms of choice and cost) to differing types of 
investment services and products.

VI. Statutory Authority and Text of the Rule

    Pursuant to Dodd-Frank Wall Street Reform and Consumer Protection 
Act Section 913(f), Public Law 111-203, 124 Stat. 1376, 1827 (2010), 
and Exchange Act sections 3, 10, 15, 15(c)(6), 15(l), 17, 23 and 36 
thereof, 15 U.S.C. 78c, 78j, 78o, 78o(c)(6), 78o(l), 78q, 78w and 78mm, 
the Commission is adopting Sec.  240.15l-1 and adopting amendments to 
Sec.  240.17a-3 by adding new paragraph (a)(25), and to revise Sec.  
240.17a-4(e)(5) of Title 17 of the Code of Federal Regulations in the 
manner set forth below.

List of Subjects in 17 CFR Part 240

    Brokers, Reporting and recordkeeping requirements, Securities.

Text of the Rule

    In accordance with the foregoing, Title 17, Chapter II of the Code 
of Federal Regulations is amended as follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

0
1. The authority citation for part 240 is amended by adding sectional 
authorities for section 240.15l-1 to read as follows:

    Authority:  15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f, 
78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4, 
78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20, 
80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, 7201 et seq.; and 
8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350; and 
Pub. L. 111-203, 939A, 124 Stat. 1887 (2010); and secs. 503 and 602, 
Pub. L. 112-106, 126 Stat. 326 (2012), unless otherwise noted.
* * * * *
    Section 240.15l-1 is also issued under Pub. L. 111-203, sec. 
913, 124 Stat. 1376, 1827 (2010).
* * * * *

0
2. Add Sec.  240.15l-1 to read as follows:


Sec.  240.15l-1   Regulation Best Interest.

    (a) Best interest obligation. (1) A broker, dealer, or a natural 
person who is an associated person of a broker or dealer, when making a 
recommendation of any securities transaction or investment strategy 
involving securities (including account recommendations) to a retail 
customer, shall act in the best interest of the retail customer at the 
time the recommendation is made, without placing the financial or other 
interest of the broker, dealer, or natural person who is an associated 
person of a broker or dealer making the recommendation ahead of the 
interest of the retail customer.
    (2) The best interest obligation in paragraph (a)(1) of this 
section shall be satisfied if:
    (i) Disclosure obligation. The broker, dealer, or natural person 
who is an associated person of a broker or dealer, prior to or at the 
time of the recommendation, provides the retail customer, in writing, 
full and fair disclosure of:
    (A) All material facts relating to the scope and terms of the 
relationship with the retail customer, including:
    (1) That the broker, dealer, or such natural person is acting as a 
broker, dealer, or an associated person of a broker or dealer with 
respect to the recommendation;
    (2) The material fees and costs that apply to the retail customer's 
transactions, holdings, and accounts; and
    (3) The type and scope of services provided to the retail customer, 
including any material limitations on the securities or investment 
strategies involving securities that may be recommended to the retail 
customer; and
    (B) All material facts relating to conflicts of interest that are 
associated with the recommendation.
    (ii) Care obligation. The broker, dealer, or natural person who is 
an associated person of a broker or dealer, in making the 
recommendation, exercises reasonable diligence, care, and skill to:
    (A) Understand the potential risks, rewards, and costs associated 
with the recommendation, and have a reasonable basis to believe that 
the recommendation could be in the best interest of at least some 
retail customers;
    (B) Have a reasonable basis to believe that the recommendation is 
in the best interest of a particular retail customer based on that 
retail customer's investment profile and the potential risks, rewards, 
and costs associated with the recommendation and does not place the 
financial or other interest of the broker, dealer, or such natural 
person ahead of the interest of the retail customer;
    (C) Have a reasonable basis to believe that a series of recommended 
transactions, even if in the retail customer's best interest when 
viewed in isolation, is not excessive and is in the retail customer's 
best interest when taken together in light of the retail customer's 
investment profile and does not place the financial or other interest 
of the broker, dealer, or such natural person making the series of 
recommendations ahead of the interest of the retail customer.
    (iii) Conflict of interest obligation. The broker or dealer 
establishes, maintains, and enforces written policies and procedures 
reasonably designed to:
    (A) Identify and at a minimum disclose, in accordance with 
paragraph (a)(2)(i) of this section, or eliminate, all conflicts of 
interest associated with such recommendations;
    (B) Identify and mitigate any conflicts of interest associated with 
such recommendations that create an incentive for a natural person who 
is an associated person of a broker or dealer to place the interest of 
the broker, dealer, or such natural person ahead of the interest of the 
retail customer;
    (C)(1) Identify and disclose any material limitations placed on the 
securities or investment strategies involving securities that may be 
recommended to a retail customer and any conflicts of interest 
associated with such limitations, in accordance with subparagraph 
(a)(2)(i), and
    (2) Prevent such limitations and associated conflicts of interest 
from causing the broker, dealer, or a natural person who is an 
associated person of the broker or dealer to make recommendations that 
place the interest of the broker, dealer, or such natural person ahead 
of the interest of the retail customer; and
    (D) Identify and eliminate any sales contests, sales quotas, 
bonuses, and non-cash compensation that are based on the sales of 
specific securities or specific types of securities within a limited 
period of time.
    (iv) Compliance obligation. In addition to the policies and 
procedures

[[Page 33492]]

required by paragraph (a)(2)(iii) of this section, the broker or dealer 
establishes, maintains, and enforces written policies and procedures 
reasonably designed to achieve compliance with Regulation Best 
Interest.
    (b) Definitions. Unless otherwise provided, all terms used in this 
rule shall have the same meaning as in the Securities Exchange Act of 
1934. In addition, the following definitions shall apply for purposes 
of this section:
    (1) Retail customer means a natural person, or the legal 
representative of such natural person, who:
    (i) Receives a recommendation of any securities transaction or 
investment strategy involving securities from a broker, dealer, or a 
natural person who is an associated person of a broker or dealer; and
    (ii) Uses the recommendation primarily for personal, family, or 
household purposes.
    (2) Retail customer investment profile includes, but is not limited 
to, the retail customer's age, other investments, financial situation 
and needs, tax status, investment objectives, investment experience, 
investment time horizon, liquidity needs, risk tolerance, and any other 
information the retail customer may disclose to the broker, dealer, or 
a natural person who is an associated person of a broker or dealer in 
connection with a recommendation.
    (3) Conflict of interest means an interest that might incline a 
broker, dealer, or a natural person who is an associated person of a 
broker or dealer --consciously or unconsciously--to make a 
recommendation that is not disinterested.

0
3. Amend Sec.  240.17a-3 by adding reserved paragraphs (a)(24) through 
(34) and paragraph (a)(35) to read as follows:


Sec.  240.17a-3  Records to be made by certain exchange members, 
brokers and dealers.

    (a) * * *
    (24)-(34) [Reserved].
    (35) For each retail customer to whom a recommendation of any 
securities transaction or investment strategy involving securities is 
or will be provided:
    (i) A record of all information collected from and provided to the 
retail customer pursuant to Sec.  240.15l-1, as well as the identity of 
each natural person who is an associated person, if any, responsible 
for the account.
    (ii) For purposes of this paragraph (a)(35), the neglect, refusal, 
or inability of the retail customer to provide or update any 
information described in paragraph (a)(35)(i) of this section shall 
excuse the broker, dealer, or associated person from obtaining that 
required information.
* * * * *

0
4. Amend Sec.  240.17a-4 by revising paragraph (e)(5) to read as 
follows:


Sec.  240.17a-4  Records to be preserved by certain exchange members, 
brokers and dealers.

* * * * *
    (e) * * *
    (5) All account record information required pursuant to Sec.  
240.17a-3(a)(17) and all records required pursuant to Sec.  240.17a-
3(a)(35), in each case until at least six years after the earlier of 
the date the account was closed or the date on which the information 
was collected, provided, replaced, or updated.
* * * * *

    By the Commission.

    Dated: June 5, 2019.
Vanessa Countryman,
Acting Secretary.
[FR Doc. 2019-12164 Filed 7-11-19; 8:45 am]
 BILLING CODE 8011-01-P

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