The fiduciary standard, aimed at ensuring that financial advisors prioritize the best interests of their clients, has been a subject of reform and debate in the financial sector. Although the Department of Labor's fiduciary rule has been set aside, industry professionals, regulators, and lawmakers remain committed to implementing a comprehensive fiduciary standard. This article examines the ongoing efforts to reform the fiduciary standard, focusing on the Securities and Exchange Commission's Regulation Best Interest (Reg BI), the role of FINRA, state-level legislation, and the significance of the fiduciary standard in protecting investors.

Regulation Best Interest and Its Challenges

The Securities and Exchange Commission's Regulation Best Interest (Reg BI) has emerged as a leading contender for a broad-based fiduciary standard applicable to all securities transactions. Unlike the suitability standard, Reg BI requires broker-dealers and registered investment advisors to prioritize the best interests of their clients. However, the lack of a clear definition for "best interest" has raised concerns and prompted calls for further clarification.

Critics argue that the current definition of "retail customer" may limit the scope of the best interest standard, potentially excluding business accounts and some retirement plans. The SEC's comment period, which attracted over 3,800 comments, provided an opportunity for stakeholders to voice concerns and propose revisions to enhance the regulation's effectiveness.

The Role of FINRA and Interpretation of Reg BI

The Financial Industry Regulatory Authority (FINRA) plays a significant role in interpreting and enforcing Reg BI. Drawing from its suitability standards, FINRA will be instrumental in providing guidance on the implementation of the new regulation. Notably, FINRA's 2013 Report on Conflicts of Interest offers valuable insights into how the organization may approach Reg BI.

Democrats' Influence and Potential Legislative Impact

The potential influence of Democrats in Congress, particularly if they secure majorities, may shape the interpretation and application of Reg BI. Some Democratic lawmakers argue that the SEC's proposed rule is ambiguous and favor a uniform fiduciary standard for all retail investment advice. The involvement of Democrats could draw attention to the perceived weaknesses of Reg BI and potentially lead to revisions or more stringent enforcement.

Additional DOL Guidance and State-Level Legislation

While the Department of Labor's fiduciary rule was vacated, financial institutions can still rely on the Best Interest Contract exemption. The DOL is expected to provide further guidance on fiduciary responsibilities, although the timing and nature of this guidance remain uncertain.

Several states have taken the initiative to enact their own fiduciary standards. Nevada, Connecticut, and other states have passed or considered legislation that expands fiduciary requirements. Some states have imposed fiduciary standards on broker-dealers through court decisions, signaling a potential wave of state-level actions to protect investors.

Summary

The Fiduciary Standard stipulates that an advisor must place the client’s best interests first.

The best way to understand the fiduciary standard is to think in terms of another standard, called the suitability standard. The suitability standard says that a broker/advisor need only recommend investment products that are “suitable” for the client - but those investments do not necessarily have to be in the client’s best interests.

An example would be a broker recommending a proprietary bond fund for a client looking for a fixed income solution. The bond fund is certainly suitable, so the broker is not breaking any rules, but he/she is only recommending that particular one because they earn a commission from its sale.

In this way, the broker may not be acting in the best interests of the client, since there may be better, less expensive bond funds available in the investment universe. The fiduciary standard says that the advisor must go out and try to find the best possible solution - in this case, the best, most effective bond fund - for the client’s portfolio.

In this way, the advisor must act in the best interests of the client, even if it means not earning a handsome commission. The advisor must do his/her best to make sure investment advice is made using accurate & complete information (analysis is thorough & accurate as possible).

There is little question that the fiduciary standard better protects individual & institutional investors, than the suitability standard.

What is the Suitability Standard?
What is Due Diligence?