Fiduciary Standard vs Regulation BI

By: Brian Tullio

In early 2018, the Securities and Exchange Commission (“SEC”) issued a set of proposals, known as Regulation Best Interest (“Regulation BI”), in an effort to lift the standard of conduct applicable to broker-dealers.  Despite thousands of public comment letters, rule revisions, and a lawsuit against its implementation (which is still pending), compliance for this new regulation took effect June 30, 2020. 

So, what exactly is Regulation BI?  Under the regulation, broker-dealers will have a general obligation to “act in the best interest of a retail customer when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer” and such broker-dealers “may not put financial interest ahead of the interests of a retail customer when making recommendations.”

Although there is a lot to unpack in that statement, you may soon hear that broker-dealers act in your “best interest.”  Given this upcoming change, I thought it worthwhile to explain the fiduciary standard applicable to registered investment advisors, like Fairway.

“Fiduciary” is an important term in the financial and legal worlds that can be used to define critical relationships and responsibilities.  The fiduciary standard often describes persons or organizations that act on behalf of another person to manage assets in some form or fashion.  This standard can apply to a wide range of relationships such as financial advisors, accountants, attorneys, bankers, or corporate board members.  Since the usage is so pervasive, I am often asked what the term “fiduciary” means.  Ironically, given its importance, there is no clear, unified definition.

For registered investment advisors regulated by the SEC, like Fairway, a combination of pivotal Supreme Court cases, the Investment Advisers Act of 1940, and formal SEC interpretations give color to the definition of the fiduciary standard.  Generally, the standard encompasses both a duty of care and a duty of loyalty that are owed by the advisor to a client.  

The duty of care has three requirements: 1) to provide advice in the best interests of the client, made through a reasonable understanding of the client’s objectives, 2) to seek the best execution of a client’s transactions and trades, and 3) to provide advice and monitoring over the course of a relationship.

Similarly, the duty of loyalty requires that an advisor not place their own interests ahead of its clients’ interests.  This can involve disclosure of both potential conflicts of interest and any material facts relating to the advisory relationship.

Another layer to this equation is the CFP® certification.  This professional designation is voluntarily obtained by Fairway advisors after meeting extensive training and experience requirements, and holds advisors to the CFP® Board’s Code of Ethics and Standards of Conduct and a corresponding fiduciary standard.  To fulfill this standard, a CFP® professional is obligated to act according to three core duties:

Duty of Care

  • Act with the care, skill, prudence, and diligence that a prudent professional would exercise in light of the client’s particular goals, risk tolerance, objectives and personal circumstances.

Duty of Loyalty

  • Place the interests of the Client above the interests of the CFP® professional and the CFP® professional’s firm.
  • Avoid conflicts of interest, or fully disclose material conflicts of interest to the Client, obtain the Client’s informed consent, and properly manage the conflict.
  • Act without regard to the financial or other interests of the CFP® professional, the CFP® professional’s firm, or any individual or entity other than the Client, which means that a CFP® professional acting under a conflict of interest continues to have a duty to act in the best interests of the Client and place the Client’s interests above the CFP® professional’s.

Duty to Follow Client Instructions

  • Comply with all objectives, policies restrictions and other terms of the engagement and all reasonable and lawful directions of the client.

These duties culminate to impose a “fiduciary at all times” obligation that is applicable whenever a client engages a CFP® professional for services, whether that involves financial planning or non-financial planning advice.  Unlike Regulation BI, which only applies at the time a recommendation is made to a client, a CFP® professional must always uphold the fiduciary standard throughout the client relationship. 

Further, and equally as important, Regulation BI is limited to recommendations involving securities transactions and investment strategies for securities.  Conversely, the CFP® Code and Standards extends beyond only securities to cover all financial assets.  For example, the CFP® Code and Standards would apply to recommendations involving tax strategy or insurance transactions, whereas Regulation BI would not.

In devising Regulation BI, the SEC declined to impose a complete application of the existing fiduciary standard to broker-dealers.  In this regard, Regulation BI seems to fall short.  This decision creates several nuanced differences between the two standards, some of which are not discussed here. At the end of the day, if I were to place myself in the shoes of a client, I would want my advisor to act as my fiduciary – not just at the time of a recommendation, but continuously, and for all aspects of my financial well-being. 

Ultimately, the desire to provide sound, unbiased advice to clients drove Fairway to organize as a registered investment advisor, and to voluntarily pursue professional designations, such as the CFP® certification.  Although you may begin hearing the phrase “best interest” in the financial world more often, it is important to note the differences between standards, an advisor’s credentials, and the services an advisor’s firm offers.

Important Disclosure