How financial professionals, who are dually registered as advisers and brokers, guide clients on account selection and use titles to describe themselves under a new broker advice standard appears to be causing confusion in the industry.
Two new questions were added on Aug. 4 in the “care obligation” of the FAQs that centered on how dually registered advisers work with clients.
One of the questions asked whether a dual registrant can recommend that a client move assets from a brokerage account that has transactions-based compensation to an advisory account where the client will be charged an asset-based fee.
SEC staff said the answer is “it depends” on the potential risks, rewards and costs associated with the asset transfer.
“For example, where a retail customer holds class A mutual fund shares, the sale of such shares could generate a taxable event, and could result in the forfeit of certain benefits, such as rights of accumulation or rights of exchange,” the FAQ states. “In addition, class A shares typically charge a front-end sales load, but tend to have a lower 12b-1 fee and annual expenses than certain other mutual fund share classes. You should understand these potential risks, rewards, and costs when weighing whether a recommendation to roll over or transfer class A mutual fund shares is in the best interest of the retail customer.”
Under Reg BI, which was implemented on June 30, the SEC continues to regulate investment advisers and brokers separately. Advisers adhere to the fiduciary duty required by the Investment Advisers Act. Brokers are now governed by Reg BI, which the SEC says offers more investor protection than their previous suitability standard.
Another of the recently added FAQs centered on a dual registrant meeting a potential customer for the first time. Should the adviser act as a broker or adviser in helping the customer choose an account type?
“Where a dually-registered financial professional may not yet know and has not clearly disclosed the capacity in which he or she is acting to a potential retail customer, in the staff’s view, the financial professional should assume that both Regulation Best Interest and the Investment Advisers Act would apply, and the account recommendation generally should be evaluated under both Regulation Best Interest and the Investment Advisers Act,” the FAQs state.
It’s a Solomonic answer that might not clear up confusion.
“If I don’t know what I am, I have to comply with everything,” said Kurt Wolfe, a securities compliance lawyer at Troutman Pepper. “If you’re not quite sure in what capacity you’re acting, you must act in the best interests of the retail investor without placing your own interests ahead of the investors’ interests. That’s the basic expectation from the SEC.”
The SEC also added on Aug. 4 four new questions under the “disclosure obligation” that center on when financial professionals can use the title “adviser” or “advisor.” Again, most of the queries focused on dual registrants.
The SEC staff said someone working as only as a broker in a firm that’s registered both as advisory and brokerage can use firm marketing materials describing their associates generally as “financial advisors.”
But the broker would have to be more specific when making an investment recommendation to a client.
“For example, in a situation where such firm materials are used by a financial professional who is not also a supervised person of an investment adviser, additional disclosures would be necessary to identify the capacity in which the financial professional is acting when making the recommendation,” the FAQ states.
The update of the FAQs shows the SEC has noticed — either through exams or other observations — that the industry is still struggling with Reg BI compliance, Wolfe said.
The agency also recently issued a statement about compliance shortcomings related to a new disclosure document, Form CRS.
“It says the SEC is trying to help firms get it right,” he said. “They’re not playing a gotcha game.”
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