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SECURITIES AND EXCHANGE professional ahead of the interests of the and Quantification, and Broad Economic COMMISSION retail investor. Considerations 1. Introduction and Primary Goals of the DATES: 17 CFR Part 240 Effective date: This rule is effective Regulation 2. Broad Economic Considerations [Release No. 34–86031; File No. S7–07–18] September 10, 2019. 3. Comments on Market Failure of the Compliance date: The compliance Principal-Agent Relationship and RIN 3235–AM35 date is discussed in Section II.E of this Quantification; Comments That the final release. Broker-Dealer, Commission-Based Model Regulation Best Interest: The Broker- FOR FURTHER INFORMATION CONTACT: Should Be Severely Restricted or Dealer Standard of Conduct Lourdes Gonzalez, Assistant Chief Eliminated B. Economic Baseline AGENCY: Securities and Exchange Counsel—Office of Sales Practices; Emily Westerberg Russell, Senior 1. Providers of Financial Services Commission. 2. Regulatory Baseline and Current Market ACTION: Final rule. Special Counsel; Alicia Goldin, Senior Practices Special Counsel; John J. Fahey, Branch 3. Investment Advice and Evidence of SUMMARY: The Securities and Exchange Chief; Daniel Fisher, Branch Chief; Potential Investor Harm Commission (the ‘‘Commission’’) is Bradford Bartels, Special Counsel; and 4. Trust, Financial Literacy, and the adopting a new rule under the Geeta Dhingra, Special Counsel, Office Effectiveness of Disclosure Securities Exchange Act of 1934 of Chief Counsel, Division of Trading C. Benefits and Costs (‘‘Exchange Act’’), establishing a and Markets, at (202) 551–5550, 1. General standard of conduct for broker-dealers Securities and Exchange Commission, 2. Disclosure Obligation 100 F Street NE, Washington, DC 3. Care Obligation and natural persons who are associated 4. Conflict of Interest Obligation persons of a broker-dealer (unless 20549–8549. 5. Compliance Obligation otherwise indicated, together referred to SUPPLEMENTARY INFORMATION: The 6. Record-Making and Recordkeeping as ‘‘broker-dealer’’) when they make a Commission is adopting new rule 17 7. Approaches To Quantifying the Potential recommendation to a retail customer of CFR 240.15l–1 under the Exchange Act Benefits any securities transaction or investment to establish a standard of conduct for D. Efficiency, Competition, and Capital strategy involving securities broker-dealers and natural persons who Formation (‘‘Regulation Best Interest’’). Regulation are associated persons of a broker-dealer 1. Competition Best Interest enhances the broker-dealer when they make a recommendation to a 2. Capital Formation and Efficiency E. Reasonable Alternatives standard of conduct beyond existing retail customer of any securities 1. Fiduciary Standard for Broker-Dealers suitability obligations, and aligns the transaction or investment strategy 2. Prescribed Format for Disclosure standard of conduct with retail involving securities. The Commission is 3. Disclosure-Only customers’ reasonable expectations by also adopting amendments to rules 17 IV. Paperwork Reduction Act requiring broker-dealers, among other CFR 240.17a–3 and 17 CFR 240.17a–4 to A. Respondents Subject to Regulation Best things, to: Act in the best interest of the establish new record-making and Interest and Amendments to Rule 17a– retail customer at the time the recordkeeping requirements for broker- 3(a)(35) and Rule 17a–4(e)(5) recommendation is made, without dealers with respect to certain 1. Broker-Dealers placing the financial or other interest of information collected from or provided 2. Natural Persons Who Are Associated Persons of Broker-Dealers the broker-dealer ahead of the interests to retail customers. B. Summary of Collections of Information of the retail customer; and address Table of Contents 1. Disclosure Obligation conflicts of interest by establishing, 2. Care Obligation maintaining, and enforcing policies and I. Introduction 3. Conflict of Interest Obligation procedures reasonably designed to A. Background 4. Compliance Obligation identify and fully and fairly disclose B. Overview of Regulation Best Interest 5. Record-Making and Recordkeeping material facts about conflicts of interest, C. Overview of Modifications to the Obligations Proposed Rule Text and Guidance V. Final Regulatory Flexibility Act Analysis and in instances where we have Provided determined that disclosure is A. Need for and Objectives of the Rule D. Overview of Key Enhancements B. Significant Issues Raised by Public insufficient to reasonably address the II. Discussion of Regulation Best Interest Comments conflict, to mitigate or, in certain A. General Obligation C. Small Entities Subject to the Rule instances, eliminate the conflict. The 1. Commission’s Approach D. Projected Reporting, Recordkeeping, and standard of conduct established by 2. General Obligation To ‘‘Act in Best Other Compliance Requirements Regulation Best Interest cannot be Interest’’ 1. Disclosure Obligation satisfied through disclosure alone. The B. Key Terms and Scope of Best Interest 2. Care Obligation standard of conduct draws from key Obligation 3. Conflict of Interest Obligation 1. Natural Person Who Is an Associated 4. Compliance Obligation principles underlying fiduciary Person obligations, including those that apply 5. Record-Making and Recordkeeping 2. Recommendation of Any Securities Obligations to investment advisers under the Transaction or Investment Strategy E. Agency Action To Minimize Effect on Investment Advisers Act of 1940 Involving Securities Small Entities (‘‘Advisers Act’’). Importantly, 3. Retail Customer VI. Statutory Authority and Text of the Rule regardless of whether a retail investor C. Component Obligations chooses a broker-dealer or an 1. Disclosure Obligation I. Introduction investment adviser (or both), the retail 2. Care Obligation We are adopting a new rule 15l–1 investor will be entitled to a 3. Conflict of Interest Obligation under the Exchange Act (‘‘Regulation 4. Compliance Obligation recommendation (from a broker-dealer) D. Record-Making and Recordkeeping Best Interest’’) that will improve or advice (from an investment adviser) E. Compliance Date investor protection by: (1) Enhancing that is in the best interest of the retail III. Economic Analysis the obligations that apply when a investor and that does not place the A. Introduction and Primary Goals of the broker-dealer makes a recommendation interests of the firm or the financial Regulation, Comments on Market Failure to a retail customer and natural persons

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who are associated persons of a broker- provide a wide range of services to a an incentive to a broker-dealer to seek dealer (‘‘associated persons’’) (unless large variety of clients, from retail to increase its own compensation or otherwise indicated, together referred to clients with limited assets and other financial interests at the expense as ‘‘broker-dealer’’) and (2) reducing the investment knowledge and experience of the customer to whom it is making potential harm to retail customers from to institutional clients with very large investment recommendations. conflicts of interest that may affect the portfolios and substantial knowledge, Notwithstanding these inherent recommendation. Regulation Best experience, and analytical resources.3 conflicts of interest in the broker-dealer- Interest enhances the broker-dealer As a general matter, broker-dealers customer relationship, there is broad standard of conduct beyond existing and investment advisers have different acknowledgment of the benefits of, and suitability obligations, and aligns the types of relationships with investors, support for, the continuing existence of standard of conduct with retail offer different services, and have the broker-dealer business model, customers’ reasonable expectations by different compensation models when including a commission or other requiring broker-dealers, among other providing investment recommendations transaction-based compensation things, to: (1) Act in the best interest of or investment advisory services to structure, as an option for retail the retail customer at the time the customers. Broker-dealers typically customers seeking investment recommendation is made, without provide transaction-specific recommendations.7 For example, retail placing the financial or other interest of recommendations and receive customers that intend to buy and hold the broker-dealer ahead of the interests compensation on a transaction-by- a long-term investment may find that of the retail customer; and (2) address transaction basis (such as commissions) paying a one-time commission to a conflicts of interest by establishing, (‘‘transaction-based’’ compensation or broker-dealer recommending such an maintaining, and enforcing policies and model). A broker-dealer’s investment is more cost effective than procedures reasonably designed to recommendations may include paying an ongoing advisory fee to an identify and fully and fairly disclose recommending transactions where the investment adviser merely to hold the material facts about conflicts of interest, broker-dealer is buying securities from same investment. Retail customers with and in instances where we have or selling securities to retail customers limited investment assets may benefit determined that disclosure is on a principal basis or recommending from broker-dealer recommendations insufficient to reasonably address the proprietary products.4 Investment when they do not qualify for advisory conflict, to mitigate or, in certain advisers, on the other hand, typically accounts because they do not meet the instances, eliminate the conflict. provide ongoing, regular advice and account minimums often imposed by Regulation Best Interest establishes a services in the context of broad investment advisers. Other retail standard of conduct under the Exchange investment portfolio management, and customers who hold a variety of Act that cannot be satisfied through are compensated based on the value of investments, or prefer differing levels of disclosure alone. assets under management (‘‘AUM’’), a services (e.g., both episodic fixed fee or other arrangement (‘‘fee- recommendations from a broker-dealer A. Background based’’ compensation or model).5 This and continuous advisory services Broker-dealers play an important role variety is important because it presents including discretionary asset in helping Americans organize their investors with choices regarding the management from an investment finances, accumulate and manage types of relationships they can have, the adviser), may benefit from having access retirement savings, and invest toward services they can receive, and how they to both brokerage and advisory other important long-term goals, such as can pay for those services. It is also accounts. Nevertheless, concerns exist buying a house or funding a child’s common for a firm to provide both regarding (1) the potential harm to retail college education. Broker-dealers offer a broker-dealer and investment adviser customers resulting from broker-dealer wide variety of brokerage (i.e., agency) services. recommendations provided where services and dealer (i.e., principal) Like many principal-agent conflicts of interest exist and (2) the services and products to both retail and relationships—including the investment insufficiency of existing broker-dealer institutional customers.1 Specifically, adviser-client relationship—the regulatory requirements to address these the brokerage services provided to retail relationship between a broker-dealer conflicts when broker-dealers make customers range from execution-only and a customer has inherent conflicts of recommendations to retail customers.8 services to providing personalized interest, including those resulting from More specifically, there are concerns investment advice in the form of a transaction-based (e.g., commission) that existing requirements do not recommendations of securities compensation structure and other require a broker-dealer’s transactions or investment strategies broker-dealer compensation.6 These and recommendations to be in the retail involving securities to customers.2 other conflicts of interest may provide customer’s best interest.9 Investment advisers play a similarly B. Overview of Regulation Best Interest important, though distinct, role. As 3 See Commission Interpretation Regarding Standard of Conduct for Investment Advisers, On April 18, 2018, we proposed described in the Fiduciary Advisers Act Release No. 5248 (June 5, 2019) Interpretation, investment advisers enhancements to the standard of (‘‘Fiduciary Interpretation’’). conduct that applies when broker- 4 See Proposing Release at 21574–21575; see also 1 See Regulation Best Interest, Release No. 34– 913 Study. dealers make recommendations to retail 83062 (Apr. 18, 2018) [83 FR 21574] (May 9, 2018) 5 See 913 Study. customers.10 Specifically, the proposal (‘‘Proposing Release’’) at 21574–75; see also Staff of 6 The investment adviser-client relationship also would have established an express best the U.S. Securities and Exchange Commission, has inherent conflicts of interest, including those interest obligation that would require all Study on Investment Advisers and Broker-Dealers resulting from an asset-based compensation broker-dealers and associated persons, As Required by Section 913 of the Dodd-Frank Wall structure that may provide an incentive for an Street Reform and Consumer Protection Act (Jan. investment adviser to encourage its client to invest 2011) (‘‘913 Study’’) at 8–12, available at more money through an adviser in order increase 7 See Proposing Release at 21579. www.sec.gov/news/studies/2011/913studyfinal.pdf its AUM at the expense of the client. See Fiduciary 8 Id. at 21577–21579. (discussing the range of brokerage and dealer Interpretation at footnotes 53–72 and accompanying 9 Id. See also Section I.C, Overview of services provided by broker-dealers). text for a discussion of how investment advisers Modifications to the Proposed Rule Text and 2 See Proposing Release at 21574–21575; see also satisfy their fiduciary duty when conflicts of Guidance Provided. 913 Study. interest are present. 10 Proposing Release at 21575.

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

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First, under the Disclosure conflicts and at a minimum disclose or the point in time that a recommendation Obligation,17 before or at the time of the eliminate them. Importantly, the is made.22 recommendation, a broker-dealer must policies and procedures must be At the time a recommendation is disclose, in writing, all material facts reasonably designed to mitigate made, key elements of the Regulation about the scope and terms of its conflicts of interests that create an Best Interest standard of conduct that relationship with the customer. This incentive for an associated person of the applies to broker-dealers will be similar includes a disclosure that the firm or broker-dealer to place its interests or the to key elements of the fiduciary representative is acting in a broker- interest of the firm ahead of the retail standard for investment advisers.23 dealer capacity; the material fees and customer’s interest. Moreover, when a Importantly, regardless of whether a costs the customer will incur; and the broker-dealer places material limitations retail investor chooses a broker-dealer or type and scope of the services to be on recommendations that may be made an investment adviser (or both), the provided, including any material to a retail customer (e.g., offering only retail investor will be entitled to a limitations on the recommendations proprietary or other limited range of recommendation (from a broker-dealer) that could be made to the retail products), the policies and procedures or advice (from an investment adviser) customer. Moreover, the broker-dealer must be reasonably designed to disclose that is in the best interest of the retail must disclose all material facts relating the limitations and associated conflicts investor and that does not place the to conflicts of interest associated with and to prevent the limitations from interests of the firm or the financial the recommendation that might incline causing the associated person or broker- professional ahead of the interests of the a broker-dealer to make a dealer from placing the associated retail investor. recommendation that is not person’s or broker-dealer’s interests There are also key differences disinterested, including, for example, ahead of the customer’s interest. Finally, between Regulation Best Interest and conflicts associated with proprietary the policies and procedures must be the Advisers Act fiduciary standard that products, payments from third parties, reasonably designed to identify and reflect the distinction between the and compensation arrangements. eliminate sales contests, sales quotas, services and relationships typically Second, under the Care Obligation,18 bonuses, and non-cash compensation offered under the two business models. a broker-dealer must exercise reasonable that are based on the sale of specific For example, an investment adviser’s diligence, care, and skill when making securities or specific types of securities fiduciary duty generally includes a duty a recommendation to a retail customer. to provide ongoing advice and within a limited period of time. 24 The broker-dealer must understand Fourth, under the Compliance monitoring, while Regulation Best potential risks, rewards, and costs Obligation,20 a broker-dealer must also Interest imposes no such duty and associated with the recommendation. establish, maintain, and enforce written instead requires that a broker-dealer act The broker-dealer must then consider policies and procedures reasonably in the retail customer’s best interest at the time a recommendation is made. In those risks, rewards, and costs in light designed to achieve compliance with addition, the new obligations applicable of the customer’s investment profile and Regulation Best Interest as a whole. to broker-dealers under Regulation Best have a reasonable basis to believe that Thus, a broker-dealer’s policies and Interest are more prescriptive than the the recommendation is in the procedures must address not only obligations applicable to investment customer’s best interest and does not conflicts of interest but also compliance advisers under the Advisers Act place the broker-dealer’s interest ahead with its Disclosure and Care Obligations fiduciary duty and reflect the of the retail customer’s interest. A under Regulation Best Interest. characteristics of the generally broker-dealer should consider The enhancements contained in applicable broker-dealer business reasonable alternatives, if any, offered Regulation Best Interest are designed to model.25 by the broker-dealer in determining improve investor protection by The Commission has been studying whether it has a reasonable basis for enhancing the quality of broker-dealer and carefully considering the issues making the recommendation. Whether a recommendations to retail customers related to the standard of conduct for broker-dealer has complied with the and reducing the potential harm to retail broker-dealers for many years, which Care Obligation will be evaluated as of customers that may be caused by led to the development of Regulation the time of the recommendation (and conflicts of interest. Regulation Best Best Interest.26 In designing Regulation not in hindsight). When recommending Interest will complement the related Best Interest, we considered a number of a series of transactions, the broker- rules, interpretations, and guidance that options to enhance investor protection, dealer must have a reasonable basis to the Commission is concurrently while preserving, to the extent possible, believe that the transactions taken issuing.21 Individually and collectively, retail investor access (in terms of choice together are not excessive, even if each these actions are designed to help retail and cost) to differing types of is in the customer’s best interest when customers better understand and investment services and products. There viewed in isolation. compare the services offered by broker- Third, under the Conflict of Interest dealers and investment advisers and 22 We believe each rule and interpretation stands Obligation,19 a broker-dealer must make an informed choice of the on its own and enhances the effectiveness of establish, maintain, and enforce relationship best suited to their needs existing rules, and is reinforced by the other rules reasonably designed written policies and interpretations being adopted and circumstances, provide clarity with contemporaneously. and procedures addressing conflicts of respect to the standards of conduct 23 Specifically, an investment adviser’s fiduciary interest associated with its applicable to investment advisers and duty under the Advisers Act comprises a duty of recommendations to retail customers. broker-dealers, and foster greater care and a duty of loyalty. This combination of care These policies and procedures must be and loyalty obligations has been characterized as consistency in the level of protections requiring the investment adviser to act in the ‘‘best reasonably designed to identify all such provided by each regime, particularly at interest’’ of its client at all times. See Fiduciary Interpretation. 17 See generally Section II.C.1, Disclosure 20 See generally Section II.C.4, Compliance 24 See Fiduciary Interpretation, Section II.B.3 Obligation. Obligation. (Duty to Provide Advice and Monitoring over the 18 See generally Section II.C.2, Care Obligation. 21 See Relationship Summary Adopting Release; Course of the Relationship). 19 See generally Section II.C.3, Conflict of Interest Fiduciary Interpretation; Solely Incidental 25 See, e.g., Sections II.A and III.E. Obligation. Interpretation. 26 Proposing Release at 21579–21583.

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were several options, including, among obtaining investment in retail investor access to brokerage others: (1) Applying the fiduciary recommendations.31 services,33 and we believe that the standard under the Advisers Act to We have also declined to craft a new available alternative services were broker-dealers; (2) adopting a ‘‘new’’ uniform standard that would apply higher priced in many circumstances.34 uniform fiduciary standard of conduct equally and without differentiation to Moreover, because key elements of the that would apply equally to both broker- both broker-dealers and investment standard of conduct that Regulation Best dealers and investment advisers, such as advisers. Adopting a ‘‘one size fits all’’ Interest applies to broker-dealers at the that recommended by the staff in the approach would risk reducing investor time that a recommendation is made to 913 Study; 27 and (3) the path we choice and access to existing products, a retail customer will be substantially ultimately chose, adopting a new services, service providers, and payment similar to key elements of the standard standard of conduct specifically for options, and would increase costs for of conduct that applies to investment broker-dealers, which draws from key firms and for retail investors in both advisers pursuant to their fiduciary duty principles underlying fiduciary broker-dealer and investment adviser under the Advisers Act, we do not obligations, including those that apply relationships. Moreover, applying a new believe that applying the existing to investment advisers under the uniform standard to advisers would fiduciary standard under the Advisers Advisers Act.28 The standard also mean jettisoning to some extent the Act to broker-dealers or adopting a new provides specific requirements to fiduciary standard under the Advisers uniform fiduciary standard of conduct address certain aspects of the Act that has worked well for retail applicable to both broker-dealers and relationships between broker-dealers clients and our markets and is backed investment advisers would provide any and their retail customers, including by decades of regulatory and judicial greater investor protection (or, in any certain conflicts related to precedent. case, that any benefits would justify the compensation of associated persons.29 Our concerns about the ramifications costs imposed on retail investors in We have declined to subject broker- for investor access, choice, and cost terms of reduced access to services, dealers to a wholesale and complete from adopting either of these products, and payment options, and application of the existing fiduciary approaches are not theoretical. With the increased costs for such services and standard under the Advisers Act adoption of the now vacated products). because it is not appropriately tailored Department of Labor (‘‘DOL’’) Fiduciary We acknowledge certain commenters 32 to the structure and characteristics of Rule, there was a significant reduction urged the Commission to take additional the broker-dealer business model (i.e., 31 See, e.g., Section 913 Study. at 143–159 for the interest; charging only reasonable compensation; transaction-specific recommendations study’s consideration of the potential costs, and avoiding misleading statements about fees and and compensation), and would not expenses, and impacts of various regulatory conflicts of interest) (‘‘Impartial Conduct properly take into account, and build changes related to the provision of personalized Standards’’). See generally id. See also Proposing upon, existing obligations that apply to investment advice to retail investors. See also Release at 21580–21582. 33 broker-dealers, including under FINRA Section II.A.1, Commission’s Approach. While the full effects of the DOL Fiduciary Rule 32 were not realized as it was vacated during the 30 As discussed in more detail in the Proposing rules. Moreover, we believe (and our Release, on April 8, 2016, the DOL adopted a new, transition period, a number of industry studies experience indicates), that this approach expanded definition of ‘‘fiduciary’’ that treats indicated that, as a result of the DOL Fiduciary would significantly reduce retail persons who provide investment advice or Rule, industry participants had already or were planning to alter services and products available to investor access to differing types of recommendations for a fee or other compensation with respect to assets of a plan subject to the retail customers. For example, of the 21 members investment services and products, Employee Retirement Income Security Act of 1974 of the Securities Industry and Financial Markets reduce retail investor choice in how to (‘‘ERISA’’) (an ‘‘ERISA plan’’) or individual Association (‘‘SIFMA’’) that participated in the retirement account (‘‘IRA’’) as fiduciaries in a wider SIFMA Study, 53% eliminated or reduced access to pay for those products and services, and brokerage advice services and 67% migrated away increase costs for retail investors of array of advice relationships than under the previous regulation and issued certain related from open choice to fee-based or limited brokerage prohibited transaction exemptions (‘‘PTEs’’) services. See SIFMA & Deloitte, The DOL Fiduciary 27 Rule: A Study on How Financial Institutions Have One of the staff’s primary recommendations (together, the ‘‘DOL Fiduciary Rule’’). The rule was Responded and the Resulting Impacts on was that the Commission engage in rulemaking to subsequently vacated in toto by the United States Retirement Investors (Aug. 9, 2017), available at adopt and implement a uniform fiduciary standard Court of Appeals for the Fifth Circuit. See Chamber https://www.sifma.org/wp-content/uploads/2017/ of conduct for broker-dealers and investment of Commerce v. U.S. Dep’t of Labor, 885 F.3d 360 08/Deloitte-White-Paper-on-the-DOL-Fiduciary- advisers when providing personalized investment (5th Cir. 2018). advice about securities to retail customers. The Rule-August-2017.pdf (‘‘SIFMA Study’’). Other We understand that in the absence of a PTE, studies also saw shifts from commission-based staff’s recommended standard would require firms broker-dealers that would be considered to be a ‘‘to act in the best interest of the customer without accounts to fee-based accounts. See infra footnote ‘‘fiduciary’’ for purposes of ERISA and the Internal 1009. In addition, an industry study found that regard to the financial or other interest of the Revenue Code (the ‘‘Code’’) would be prohibited broker, dealer or investment adviser providing the some customers were shifted from commission- from engaging in purchases and sales of certain based brokerage accounts to self-directed accounts, advice.’’ The staff made a number of specific investments for their own account (i.e., engaging in while the same study observed that 29% of their recommendations for implementing the uniform principal transactions) and would be prohibited survey participants expected to move clients, fiduciary standard of conduct, including that the from receiving common forms of broker-dealer particularly those with low account balances, to Commission should: (1) Require firms to eliminate compensation (notably, transaction-based robo-advisors. See infra footnote 1010. or disclose conflicts of interest; (2) consider compensation). See DOL, Best Interest Contract 34 whether rulemaking would be appropriate to It was widely reported that a number of firms Exemption, 81 FR 21002 (Apr. 8, 2016) (‘‘BIC responded to the DOL Fiduciary Rule by either prohibit certain conflicts, to require firms to Exemption Release’’). To avoid this result, the DOL requiring customers to enter into more expensive mitigate conflicts through specific action, or to published, among other PTEs, the Best Interest advice relationships or by passing through higher impose specific disclosure and consent Contract Exemption (‘‘BIC Exemption’’), which compliance costs to customers, which altered many requirements; and (3) consider specifying uniform would have provided conditional relief for an retail customer relationships with their financial standards for the duty of care owed to retail ‘‘adviser,’’ as that term is used in the context of the professionals. See infra footnote 1007. From the customers, such as specifying what basis a broker- BIC Exemption, and the adviser’s firm, to receive SIFMA Study, for those firms whose retail dealer or investment adviser should have in making common forms of ‘‘conflicted’’ compensation, such customers faced eliminated or reduced brokerage a recommendation to a retail customer by referring as commissions and third-party payments (such as advice services, 63% of firms had customers that to and expanding upon broker-dealers’ existing revenue sharing), provided that the adviser’s firm chose to move to self-directed accounts rather than suitability requirements. See generally 913 Study. met certain conditions. See id. Generally, the BIC fee-based accounts and cited the customers’ reasons 28 See supra footnote 23. Exemption and other PTEs required that, among as ‘‘not wanting to move to a fee-based model, not 29 In addition to these alternatives, we also other things, the advice be provided pursuant to a in the best interest to move to a fee-based model, considered several other reasonable alternatives. written contract that commits the firm and the did not meet account minimums, or wanted to See Section III.E. adviser to adhere to standards of impartial conduct, maintain positions in certain asset classes 30 See also 913 Study at 139–143. including providing advice in the investor’s best prohibited by the fee-based models.’’

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or different regulatory actions than the scope of the proposed rule, including: the standard is or should be a safe approach we have adopted, including whether the standard should be a harbor; 42 what should be considered a the alternatives discussed above. We do fiduciary standard; 38 whether the recommendation, including whether not believe that any rulemaking standard should apply to both Regulation Best Interest should apply to governing retail investor-advice investment advisers and broker- recommendations to roll over or transfer relationships can solve for every issue dealers; 39 whether the standard should assets or take plan distributions, and to presented. After careful consideration of be principles-based or more recommendations of particular account the comments and additional prescriptive; 40 whether the standard types (i.e., brokerage or advisory); 43 information we have received,35 we should define ‘‘best interest;’’ 41 whether whether Regulation Best Interest should believe that Regulation Best Interest, as apply to account monitoring services modified, appropriately balances the 38 See, e.g., Letter from Jon Stein, Founder and provided by a broker-dealer, or impose concerns of the various commenters in CEO, Benjamin T. Alden, General Counsel, and a continuing duty; 44 and whether Seth Rosenbloom, Associate General Counsel, a way that will best achieve the Betterment (Aug. 7, 2018) (‘‘Betterment Letter’’); Regulation Best Interest’s protections Commission’s important goals of Letter from Kurt N. Schacht, Managing Director, should apply to a broader or narrower enhancing retail investor protection and James Allen, Head, Capital Markets Policy, and set of ‘‘retail customers.’’ 45 Linda L. Rittenhouse, Director, Capital Markets, decision making, while preserving, to CFA Institute (Aug. 7, 2018) (‘‘CFA Institute Letter; NAIFA Letter; CCMC Letters; Letter from the extent possible, retail investor Letter’’); Letter from Jill I. Gross, Associate Dean for Aron Szapiro, Director of Policy Research, Academic Affairs, Professor of Law, Elisabeth Haub access (in terms of choice and cost) to Morningstar (Aug. 7, 2018) (‘‘Morningstar Letter’’); School of Law, Pace University (Mar. 11, 2019) differing types of investment services Letter from David Kowach, Head of Wells Fargo (‘‘Pace March 2019 Letter’’); Letter from Sharon 36 Advisors, Wells Fargo (Aug. 7, 2018) (‘‘Wells Fargo and products. Cheever, Senior Vice President and General Letter’’). The Commission’s staff will offer Counsel, Pacific Life Insurance Company (Aug. 3, 42 firms significant assistance and support 2018) (‘‘Pacific Life August 2018 Letter’’); Letter See, e.g., CFA August 2018 Letter; Letter from Anthony Chereso, President & CEO, Institute for during the transition period and from Melanie Fein, Fein Law Offices (Jun. 6, 2018) (‘‘Fein Letter’’); Letter from Elizabeth Warren, U.S. Portfolio Alternatives (‘‘IPA’’) (Aug. 7, 2018) (‘‘IPA thereafter with the aim of helping to Senator (Aug. 3, 2018) (‘‘Warren Letter’’); Letter Letter’’); Letter from Heather Slavkin Corzo, AFL– ensure that the investor protections and from Dean P. McDermott, McDermott Investment CIO et al. (Apr. 26, 2019) (‘‘AFL–CIO April 2019 other benefits of the final rule are Advisors (Jul. 7, 2018) (‘‘McDermott Letter’’); Letter Letter’’). 43 See, e.g., Letter from Jason Bortz, Senior implemented in an efficient and from Brian Hamburger, President and CEO, MarketCounsel (Aug. 7, 2018) (‘‘MarketCounsel Counsel, Capital Research and Management effective manner. Further, we will Letter’’). Company (Aug. 7, 2018) (‘‘Capital Group Letter’’); continue to monitor the effectiveness of 39 See, e.g., AARP August 2018 Letter; Letter from Letter from Andrew Stoltmann, President, Public Regulation Best Interest in achieving the Americans for Financial Reform et al. (Aug. 7, 2018) Investors Arbitration Bar Association (‘‘PIABA’’) (Aug. 7, 2018) (‘‘PIABA Letter’’); SIFMA August Commission’s goals. (‘‘Americans for Financial Reform Letter’’); Letter from Robert J. Moore, Chief Executive Officer, 2018 Letter; NASAA Letter; Letter from Robert K. C. Overview of Modifications to the Cetera Financial Group (‘‘Cetera’’) (Aug. 7, 2018) Shaw, President, Individual Markets, Great-West (‘‘Cetera August 2018 Letter’’); Letter from L.A. Financial (Aug. 7, 2018) (‘‘Great-West Letter’’); Proposed Rule Text and Guidance Schnase, Individual Investor and Attorney at Law NAIFA Letter; Transamerica August 2018 Letter; Provided (Jul. 30, 2018) (‘‘Schnase Letter’’); Pacific Life Letter from Tim Rouse, Executive Director, The August 2018 Letter; Pace March 2019 Letter; SPARK Institute (Aug. 7, 2018) (‘‘SPARK Letter’’); The vast majority of commenters MarketCounsel Letter; Letter from Dennis M. Letter from Robin C. Swope, Director, Global supported the Commission’s rulemaking Kelleher, President and CEO, Stephen Hall, Legal Product Governance & Support, Invesco (Aug. 7, efforts to address the standards of Director and Securities Specialist, Lev Bagramian, 2018) (‘‘Invesco Letter’’); Letter from R. Keith Overly, President, National Association of conduct that apply to broker-dealers Senior Securities Policy Advisor, Better Markets (Aug. 7, 2018) (‘‘Better Markets August 2018 Government Defined Contribution Administrators when making recommendations, but Letter’’); Letter from Attorneys General of New (‘‘NAGDCA’’) (Aug. 7, 2018) (‘‘NAGDCA Letter’’); nearly all commenters suggested York, California, Connecticut, Delaware, Hawaii, Letter from Kevin R. Keller, Chief Executive Officer, Illinois, Maine, Maryland, Massachusetts, CFP Board, et al., Financial Planning Coalition modifications to proposed Regulation (‘‘FPC’’) (Aug. 7, 2018) (‘‘FPC Letter’’); Letter from Best Interest.37 These suggestions touch Minnesota, New Mexico, Oregon, Pennsylvania, Rhode Island, Vermont, Washington, and the Dennis Simmons, Executive Director, Committee on on almost every aspect of the proposal, District of Columbia (Aug. 7, 2018) (‘‘State Investment of Employee Benefit Assets, Committee as discussed in more detail below. A Attorneys General Letter’’). on Investment of Employee Benefit Assets variety of commenters offered 40 See, e.g., SIFMA August 2018 Letter; Letter (‘‘CIEBA’’) (Aug. 6, 2018) (‘‘CIEBA Letter’’). 44 See, e.g., SIFMA August 2018 Letter; Letter suggestions on the overall structure and from Mortimer J. Buckley, President and Chief Executive Officer, Vanguard (Aug. 7, 2018) from Lisa D. Crossley, Executive Director, National (‘‘Vanguard Letter’’); Letter from Chris Lewis, Society of Compliance Professionals (‘‘NSCP’’) 35 See supra footnotes 11–13 and accompanying General Counsel, Edward Jones (Aug. 7, 2018) (Aug. 7, 2018) (‘‘NSCP Letter’’); PIABA Letter; FPC text. (‘‘Edward Jones Letter’’); Letter from Joseph E. Letter; Better Markets August 2018 Letter; Letter 36 If any of the provisions of these rules, or the Sweeney, President, Advice & Wealth Management from Karen L. Barr, President and CEO, Investment application thereof to any person or circumstance, Products and Service Delivery, Ameriprise Adviser Association (‘‘IAA’’) (Aug. 6, 2018) (‘‘IAA is held to be invalid, such invalidity shall not affect Financial (Aug. 6, 2018) (‘‘Ameriprise Letter’’); August 2018 Letter’’). other provisions or application of such provisions Letter from Sheila Kearney Davidson, Executive We also received comments addressing when a to other persons or circumstances that can be given Vice President, Chief Legal Officer & General broker-dealer’s advisory services are ‘‘solely effect without the invalid provision or application. Counsel, New York Life Insurance Company (‘‘NY incidental to the conduct of his business as a broker 37 See, e.g., Letter from David Certner, Legislative Life’’) (Aug. 7, 2018) (‘‘NY Life Letter’’); Letter from or dealer’’ under the ‘‘broker-dealer exclusion’’ from Counsel and Legislative Policy Director, AARP Keith Gillies, NAIFA President, National the definition of investment adviser—and thus from (Aug. 7, 2018) (‘‘AARP August 2018 Letter’’); Letter Association of Insurance and Financial Advisors the application of the Advisers Act—provided in from Christopher Gilkerson, Senior Vice President (‘‘NAIFA’’) (Aug. 2, 2018) (‘‘NAIFA Letter’’); Letters Section 202(a)(11)(C) of the Advisers Act. We have and General Counsel, and Tara Tune, Director and from Tom Quaadman, Executive Vice President, addressed these comments in the context of the Corporate Counsel, Charles Schwab & Co., Inc. Center for Capital Markets Competitiveness, U.S. Solely Incidental Interpretation. (Aug. 6, 2018) (‘‘Schwab Letter’’); Letter from Chamber of Commerce (‘‘CCMC’’) (Aug. 7, 2018) 45 See, e.g., Letter from Carl B. Wilkerson, Vice Barbara Roper, Director of Investor Protection, and (supplemented by letter dated Sep. 5, 2018) President and Chief Counsel, American Council of Micah Hauptman, Financial Services Counsel, (‘‘CCMC Letters’’); Letter from Dave Paulsen, Life Insurers (‘‘ACLI’’) (Aug. 3, 2018) (‘‘ACLI Consumer Federation of America (‘‘CFA’’) (Aug. 7, Executive Vice President, Chief Distribution Officer, Letter’’); Letter from Brian H. Graff, Executive 2018) (‘‘CFA August 2018 Letter’’); Letter from Transamerica (Aug. 7, 2018) (‘‘Transamerica August Director and CEO, Craig P. Hoffman, General Joseph Borg, President, North American Securities 2018 Letter’’). Counsel, Dough Fisher, Director of Retirement Administrators Association, Inc. (‘‘NASAA’’) (Aug. 41 See, e.g., Letter from Seth A. Miller, General Policy, and Joseph A. Caruso, Government Affairs 23, 2018) (‘‘NASAA August 2018 Letter’’); Letter Counsel, Senior Vice President, Chief Risk Officer, Counsel, American Retirement Association from Kenneth E. Bentsen, Jr., President and Chief Cambridge (Aug. 7, 2018) (‘‘Cambridge Letter’’); (‘‘ARA’’) (Aug. 3, 2018) (‘‘ARA August 2018 Executive Officer, SIFMA (Aug. 7, 2018) (‘‘SIFMA SIFMA August 2018 Letter; Vanguard Letter; Letter’’); Letter from Anne Tennant, Managing August 2018 Letter’’). Edward Jones Letter; Ameriprise Letter; NY Life Continued

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In addition, most commenters from particular, several commenters With respect to the Conflict of Interest both industry and consumer advocate recommended that the Commission Obligation, many commenters groups requested modifications to each require broker-dealers provide ‘‘full and questioned the distinction between of the Disclosure, Care, and Conflict of fair’’ disclosure.47 financial incentives that would have to Interest Obligations, and also called for Regarding the Care Obligation, be mitigated and other conflicts that more specific examples of conduct that commenters from certain investor would only need to be disclosed, and would—or would not—satisfy these groups supported incorporating a recommended generally that the obligations. With respect to the ‘‘prudence’’ standard,48 while a number distinction be eliminated.53 In addition, Disclosure Obligation, most commenters of industry commenters expressed some commenters suggested that the generally sought greater clarity or made concern about including this standard.49 obligation to establish policies and suggestions regarding what material Numerous commenters requested procedures to mitigate conflicts should facts and material conflicts would need further clarity on what would be apply to material conflicts at the level to be disclosed, the form and manner required to meet the Care Obligation, of the natural person who is an (e.g., written versus oral, individualized including what factors a broker-dealer associated person (as opposed to the versus standardized, and the use of should consider in developing a retail firm).54 Commenters also asked for more electronic and/or layered) and the customer’s investment profile and when clarity and examples of what conflicts timing and frequency of the disclosure making a recommendation, and in must be mitigated versus eliminated and (e.g., whether the disclosure should be particular the role of cost and other more guidance on appropriate prior to, at the time of, or could be after relevant factors when making a mitigation methods.55 Some a recommendation), as well as whether recommendation, and also asked for commenters also expressed the view the Disclosure Obligation could be more specific examples of how to weigh that by requiring mitigation of financial satisfied by complying with other costs against other factors when making incentives, proposed Regulation Best existing disclosure requirements.46 In a recommendation.50 A majority of the Interest would require more of broker- IAC and other commenters requested dealers than what is required of Director and General Counsel, Morgan Stanley clarification on how to consider investment advisers under their (Aug. 7, 2018) (‘‘Morgan Stanley Letter’’); CCMC ‘‘reasonably available alternatives’’ fiduciary duty, which could create a Letters; Letter from Thomas Roberts, Groom Law Group (Aug. 7, 2018) (‘‘Groom Letter’’); Letter from when making a recommendation and competitive disadvantage for broker- Catherine J. Weatherford, President and CEO, suggested clarifying the scope of the dealers that could further encourage Insured Retirement Institute (‘‘IRI’’) (Aug. 7, 2018) inquiry into potential reasonably migration from the broker-dealer to (‘‘IRI Letter’’); NSCP Letter; Letter from Raymond J. available alternatives when a broker- investment adviser business model and Manista, Executive Vice President, Chief Legal Officer and Secretary, Northwestern Mutual (Aug. dealer offers a limited product menu result in a loss of retail investor access 7, 2018) (‘‘Northwestern Mutual Letter’’); State versus when the broker-dealer has an (in terms of choice and cost) to differing Attorneys General Letter; Letter from Mari-Anne ‘‘open architecture’’ model.51 Several types of investment services and Pisarri, Pickard Djinis and Pisarri LLP (Aug. 14, industry commenters made products.56 2018) (‘‘Pickard Letter’’); SIFMA August 2018 Letter; Invesco Letter; Letter from Tom Clark, recommendations regarding the In addition, a number of commenters Managing Director, Sean Murphy, Vice President, application of proposed Regulation Best agreed with the Commission’s statement Blackrock (Aug. 7, 2018) (‘‘Blackrock Letter’’). Interest to recommendations of specific that it was not intended to create a 46 See, e.g., Ameriprise Letter; Great-West Letter; categories of securities, such as variable private right of action, but many Letter from Ram Subramaniam, Head of Brokerage annuities or leveraged exchange-traded requested that the Commission and Investment Solutions, David Forman, Chief 52 Legal Officer, Fidelity Investments (Aug. 7, 2018) products. explicitly state in the final rule that (‘‘Fidelity Letter’’); Morgan Stanley Letter; CCMC Regulation Best Interest does not confer Letters; Letter from Bret C. Hester, Senior Managing 47 See, e.g., CFA August 2018 Letter; Better a private right of action.57 One Director, Head of Regulatory Affairs, Teachers Markets August 2018 Letter; Pace Letter. Insurance and Annuity Association of America 48 See, e.g., AARP August 2018 Letter; CFA Halloran, VP Managing Director, Business (‘‘TIAA’’) (Aug. 7, 2018) (‘‘TIAA Letter’’); Letter August 2018 Letter; FPC Letter. from James Sonne, Assistant Vice President, Federal Development, Transamerica (Nov. 9, 2018) 49 See, e.g., Letter from Karen L. Sukin, Executive (‘‘Transamerica November 2018 Letter’’). Government Relations, Mass Mutual (Feb. 19, 2019) Vice President, Deputy General Counsel, Primerica (‘‘Mass Mutual Letter’’); Letter from Edmund F. 53 See, e.g., CFA August 2018 Letter; SIFMA (Aug. 7, 2018) (‘‘Primerica Letter’’); Transamerica August 2018 Letter; Primerica Letter; Letter from Murphy III, President, Empower Retirement (Aug. August 2018 Letter; IPA Letter; Cetera August 2018 2, 2018) (‘‘Empower Retirement Letter’’); IRI Letter; Jeff Hartney, Executive Director, Bank Insurance Letter. and Securities Association (‘‘BISA’’) (Aug. 7, 2018) Letter from Paul Schott Stevens, President and CEO, 50 Investment Company Institute (‘‘ICI’’) (Aug. 7, 2018) See, e.g., Letter from Felice R. Foundos, (‘‘BISA Letter’’); Committee of Annuity Insurers (‘‘ICI Letter’’); SIFMA August 2018 Letter; Edward Partner, Chapman and Cutler (Aug. 6, 2018) Letter; IPA Letter; CFA Institute Letter; Morgan Jones Letter; Letter from Michelle Bryan (‘‘Chapman Letter’’); Vanguard Letter; ICI Letter; Stanley Letter; CCMC Letters. Oroschakoff, Chief Legal Officer, LPL Financial Morgan Stanley Letter; Wells Fargo Letter; 54 See, e.g., Primerica Letter; TIAA Letter; ICI (Aug. 7, 2018) (‘‘LPL August 2018 Letter’’); NASAA Primerica Letter; Great-West Letter; NASAA August Letter; Letter from Craig D. Pfeiffer, President and August 2018 Letter; AARP August 2018 Letter; 2018 Letter; Cambridge Letter; Blackrock Letter. CEO, Money Management Institute (Aug. 7, 2018) 51 PIABA Letter; Letter from Ann M. Kappler, Senior See, e.g., IAC 2018 Recommendation; Fidelity (‘‘Money Management Institute Letter’’). Vice President, Deputy General Counsel, Prudential Letter; ICI Letter; SIFMA August 2018 Letter; 55 See, e.g., AALU Letter; CFA August 2018 Financial (Aug. 7, 2018) (‘‘Prudential Letter’’), CFA Prudential Letter; LPL August 2018 Letter; Letter; Letter from Quinn Curtis, Professor of Law, Institute Letter; State Attorneys General Letter; CFA Morningstar Letter. See also AFL–CIO April 2019 University of Virginia School of Law (‘‘UVA’’), August 2018 Letter; Letter from Jason Chandler, Letter (stating that the rule ‘‘must make clear that (Aug. 3, 2018) (‘‘UVA Letter’’); Primerica Letter; Group Managing Director, Co-Head Investment brokers are required to recommend the investments Committee of Annuity Insurers Letter; Cetera Platforms and Solutions, and Michael Crowl, Group they reasonably believe are the best match for the August 2018 Letter; Wells Fargo Letter; NASAA Managing Director, General Counsel, UBS (Aug. 7, investor from among the reasonably available August 2018 Letter; Morningstar Letter. 2018) (‘‘UBS Letter’’), Letter from William F. investment options’’). 56 See, e.g., Letter from Craig S. Tyle, Executive Galvin, Secretary of the Commonwealth of 52 See, e.g., Letter from Brian Winikoff, Senior Vice President and General Counsel, Franklin Massachusetts (Aug. 7, 2018) (‘‘Galvin Letter’’); Executive Director and Head of U.S. Life, Templeton Investments, (Aug. 6, 2018) (‘‘Franklin Letter from David T. Bellaire, Executive Vice Retirement and Wealth Management, AXA (Aug. 7, Templeton Letter’’); Primerica Letter; LPL August President & General Counsel, Financial Services 2018) (‘‘AXA Letter’’); Letter from Clifford Kirsch, 2018 Letter; CCMC Letters; UBS Letter; ICI Letter; Institute (‘‘FSI’’) (Aug. 7, 2018) (‘‘FSI August 2018 Susan Krawczyk, Eversheds Sutherland, Committee Letter from Christopher A. Iacovella, Chief Letter’’); Mass Mutual Letter; Schwab Letter; Letter of Annuity Insurers (Aug. 7, 2018) (‘‘Committee of Executive Officer, American Securities Association from Michael F. Anderson, Senior Vice President Annuity Insurers Letter’’); Pacific Life August 2018 (‘‘ASA’’) (Aug. 7, 2018) (‘‘ASA Letter’’); Schwab and Chief Legal Officer, CUNA Mutual (Aug. 7, Letter; Letter from Angela Brickl, General Counsel, Letter. 2018) (‘‘CUNA Letter’’); Transamerica August 2018 Rafferty Asset Management (‘‘Direxion’’) (Aug. 7, 57 See, e.g., Letter from Paul C. Reilly, Chairman Letter. 2018) (‘‘Direxion Letter’’); Letter from Mark F. and CEO, Raymond James Financial (Aug. 7, 2018)

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commenter requested that the customer’’ to include any natural which a dual-registrant provides advice Commission elaborate and make clear person who receives a recommendation and receives compensation that subjects the remedies available to investors from the broker-dealer for the natural it to the Advisers Act.65 when broker-dealers violate Regulation person’s own account (but not an We are also clarifying the relationship Best Interest and emphasize that account for a business that he or she between the General Obligation and the scienter is not required to establish a works for), including individual plan specific component obligations, and in violation of Regulation Best Interest.58 participants.62 We are interpreting particular, what it means to ‘‘act in the Finally, numerous commenters urged ‘‘legal representative of such natural best interest’’ of the retail customer. As the Commission to coordinate with person’’ to include the nonprofessional is the case with the fiduciary duty other regulators, in particular the DOL 59 legal representatives of such a natural applicable to investment advisers under and state securities and insurance person (e.g., nonprofessional trustee the Advisers Act, we are not expressly regulators,60 and several commenters who represents the assets of a natural defining in the rule text the term ‘‘best opined that the Commission should person). interest,’’ and instead are providing in preempt (or avoid preempting) state • Implicit Hold Recommendations: Regulation Best Interest and through law.61 While broker-dealers will not be interpretations, what ‘‘acting in the best After carefully reviewing the required to monitor accounts, in interest’’ means.66 Whether a broker- comments on the proposed rule, we instances where a broker-dealer agrees dealer has acted in the retail customer’s have determined to retain its overall to provide the retail customer with best interest in compliance with structure and scope. However, we have specified account monitoring services, it Regulation Best Interest will turn on an modified the proposed rule in a number is our view that such an agreement will objective assessment of the facts and of respects and are also providing result in buy, sell or hold circumstances of how the specific additional interpretations and guidance recommendations subject to Regulation components of Regulation Best to address and clarify issues raised by Best Interest, even when the Interest—including its Disclosure, Care, commenters. Summarized below are the recommendation to hold is implicit.63 Conflict of Interest, and Compliance key modifications from the proposal, as • Recommendations of account types, Obligations—are satisfied at the time well as the interpretations and guidance including recommendations to roll over that the recommendation is made (and provided. or transfer assets from one type of not in hindsight). In response to • Retail Customer Definition: We are account to another: We are modifying commenters, we are addressing, among modifying the definition of ‘‘retail Regulation Best Interest to expressly other things, what the General apply to account recommendations Obligation does and does not require (‘‘Raymond James Letter’’); NAIFA Letter; ASA including, among others, (for example, that it does not impose a Letter; CCMC Letters; UBS Letter; LPL August 2018 recommendations to roll over or transfer continuing duty beyond a particular Letter; Cambridge Letter. Contra Letter from Elise Sanguinetti, President, American Association for assets in a workplace retirement plan recommendation), providing specific Justice (Aug. 6, 2018) (‘‘American Association for account to an IRA, recommendations to examples of what would violate Justice Letter’’). open a particular securities account Regulation Best Interest, and its 58 NASAA August 2018 Letter. (such as brokerage or advisory), and application to certain scenarios, 59 See, e.g., ICI Letter; Franklin Templeton Letter; recommendations to take a plan Morningstar Letter; Wells Fargo Letter; Edward particularly in the context of satisfying Jones Letter; IRI Letter; Letter from Cynthia Lo distribution for the purpose of opening the Care Obligation. Bessette, Executive Vice President and General a securities account.64 We are also We are also modifying and clarifying Counsel, Letter from Oppenheimer Funds (Aug. 7, providing guidance under the Care the component obligations that a broker- 2018) (‘‘Oppenheimer Letter’’); Vanguard Letter. Obligation on what factors a broker- dealer would be required to satisfy in 60 See, e.g., CCMC Letters; Letter from Robert Reynolds, President and CEO, Putnam Investments dealer generally should consider when order to meet the General Obligation: (Aug. 7, 2018) (‘‘Putnam Letter’’); Letter from Will making such recommendations. Disclosure Obligation. We are refining H. Fuller, Executive Vice President, President, • Dual-Registrants: We are providing the treatment of conflicts of interest by: Annuity Solutions, Lincoln Financial Group (Nov. additional guidance on how dual- (1) Defining in the rule text a ‘‘conflict 13, 2018) (‘‘Lincoln Financial Letter’’); Cetera registrants can comply with Regulation of interest’’ for purposes of Regulation August 2018 Letter; Great-West Letter; Letter from Marc Cadin, Chief Operating Officer, Association of Best Interest, and confirming that Best Interest (as opposed to interpreting Advanced Life Underwriting (‘‘AALU’’) (Aug. 7, Regulation Best Interest does not apply the phrase ‘‘material conflict of interest’’ 2018) (‘‘AALU Letter’’); IRI Letter; Pacific Life to advice provided by a broker-dealer as in the Proposing Release) as an August 2018 Letter; Vanguard Letter; Fidelity that is dually registered as an interest that might incline a broker- Letter; Letter from Andrew J. Bowden, Senior Vice President and General Counsel, Jackson National investment adviser (‘‘dual-registrant’’) dealer—consciously or unconsciously— Life Insurance Company (Aug. 7, 2018) (‘‘Jackson when acting in the capacity of an to make a recommendation that is not National Letter’’); Invesco Letter; Lincoln Letter; investment adviser, and that a dual- disinterested; and (2) revising the CUNA Mutual Letter; Great-West Letter. registrant is an investment adviser Disclosure Obligation to require 61 See, e.g., Cetera August 2018 Letter; ICI Letter; Franklin Templeton Letter; Putnam Investments solely with respect to accounts for disclosure of ‘‘material facts’’ regarding Letter; but see NASAA August 2018 Letter; PIABA conflicts of interest associated with the Letter; Letter from Teresa J. Verges, Director, 62 As discussed in Section II.B.3.a, Retail recommendation.67 Similar to the Investor Rights Clinic, University of Miami School Customer, Focus on Natural Persons and Legal proposal, all such conflicts of interest of Law (Aug. 2, 2018) (‘‘U. of Miami Letter’’); Letter Representatives of Natural Persons, to the extent a from Kayla Martin, Legal Intern, Christine Lazaro, plan representative who decides service will be covered by Regulation Best Director and Professor Clinical Legal Education, arrangements for a workplace retirement plan is a Securities Arbitration Clinic, St. John’s University sole proprietor or other self-employed individual 65 See Section II.B.3.d, Retail Customers, School of Law (Aug. 7, 2018) (‘‘St. John’s U. who will participate in the plan, the plan Treatment of Dual-Registrants. Letter’’); Letter from Kevin M. Carroll, Managing representative will be a retail customer to the extent 66 In the investment adviser context, an Director & Associate General Counsel, SIFMA (Mar. that the sole proprietor or self-employed individual investment adviser’s fiduciary duty under the 29, 2019) (‘‘SIFMA March 2019 Letter’’); Letter from receives recommendations directly from a broker- Advisers Act comprises a duty of care and a duty Michael Pieciak, NASAA President and dealer primarily for personal, family or household of loyalty. This combination of care and loyalty Commissioner, Vermont Department of Regulation, purposes. obligations has been characterized as requiring the NASAA (Apr. 25, 2019); Letter from Tom 63 See Section II.B.2.b, Interpretation of Any investment adviser to act in the ‘‘best interest’’ of Quaadman, Executive Vice President, CCMC (May Securities Transaction or Investment Strategy its client at all times. See Fiduciary Interpretation. 16, 2019) (‘‘CCMC May 2019 Letter’’); AFL–CIO Involving Securities. 67 See Section II.C.1.b, Disclosure Obligation, April 2019 Letter. 64 See id. Material Facts Regarding Conflicts of Interest.

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Interest (e.g., subject to the Conflict of financial or other interest of the broker- and procedures to identify and at a Interest Obligation), however, only dealer ahead of the interest of the retail minimum disclose (pursuant to the ‘‘material facts’’ regarding these customer.73 Nevertheless, we emphasize Disclosure Obligation), or eliminate, all conflicts would be required to be that while cost must be considered, it conflicts of interest associated with the disclosed under the Disclosure should never be the only consideration. recommendation; 74 and (2) setting forth Obligation. Cost is only one of many important explicit requirements to establish Furthermore, we are modifying the factors to be considered regarding the written policies and procedures Disclosure Obligation to explicitly recommendation and that the standard reasonably designed to mitigate or require broker-dealers to provide ‘‘full does not necessarily require the ‘‘lowest eliminate certain identified conflicts of and fair’’ disclosure of material facts, cost option.’’ Relatedly, we are interest, specifically: rather than requiring broker-dealers to emphasizing the need to consider costs • Mitigation of Associated Person ‘‘reasonably disclose’’ such information. in light of other factors and the retail Conflicts of Interest. We are revising the We are providing the Commission’s customer’s investment profile. proposal’s mitigation requirement to: (1) view regarding what it means to provide We are also providing additional Eliminate the distinction between ‘‘full and fair’’ disclosure to retail guidance on what it means to make a financial incentives and all other customers, including the level of recommendation in a retail customer’s conflicts of interest; and (2) focus on specificity of disclosure required, and ‘‘best interest.’’ As in the Proposing mitigating conflicts of interest the form and manner and timing and Release, determining whether a broker- associated with recommendations that frequency of such disclosure.68 We are dealer’s recommendation satisfies the create an incentive for the associated explicitly requiring the disclosure of Care Obligation will be an objective person of the broker-dealer to place the material facts relating to the scope and evaluation turning on the facts and interest of the firm or the associated terms of the relationship that were circumstances of the particular person ahead of the interest of the retail specifically identified in the proposal recommendation and the particular customer.75 We are providing further (i.e., capacity, material fees and charges, retail customer. We recognize that a guidance regarding the types of 69 and type and scope of services). In facts and circumstances evaluation of a incentives covered by this revised connection with disclosure recommendation makes it difficult to obligation, in particular focusing on requirements regarding the type and draw bright lines around whether a compensation or employment related scope of services, we are also clarifying particular recommendation will meet incentives and other incentives that at a minimum, a broker-dealer the Care Obligation. Accordingly, we provided to the associated person needs to disclose whether or not focus on how a broker-dealer could (whether by the broker-dealer or third- account monitoring services will be establish a reasonable basis to believe parties). We are also confirming, provided (and if so, the scope and that a recommendation is in the best clarifying and expanding on the frequency of those services), account interest of its retail customer and does proposal’s guidance on potential minimums, and any material limitations not place the broker-dealer’s interest mitigation methods to further promote on the securities or investment ahead of the retail customer’s interest, compliance with this obligation. strategies involving securities that may and the circumstances under which a • Address Any Material Limitations be recommended to the retail broker-dealer could not establish such a 70 on Recommendations to Retail customer. Also we conclude that the reasonable belief. Customers. To address the conflicts of We are clarifying that an evaluation of basis for a broker-dealer’s interest presented when broker-dealers recommendations as a general matter reasonably available alternatives does place any material limitations on the (i.e., what might commonly be not require an evaluation of every securities or investment strategies described as the firm’s investment possible alternative (including those involving securities that may be approach, philosophy, or strategy) and offered outside the firm) nor require recommended to a retail customer (i.e., the risks associated with a broker- broker-dealers to recommend one ‘‘best’’ only make recommendations of dealer’s recommendations in product, and what this evaluation will proprietary or other limited range of standardized (as opposed to require in certain contexts (such as a products), we are requiring broker- individualized) terms are material facts firm with open architecture). dealers to establish, maintain and relating to the scope and terms of the Furthermore, we clarify that, when a enforce written policies and procedures relationship that should be disclosed.71 broker-dealer materially limits its reasonably designed to: (1) Identify and Below, we outline a method to address product offerings to certain proprietary disclose any material limitations placed oral disclosure and written disclosure or other limited menus of products, it on the securities or investment provided after the fact.72 must still comply with the Care strategies involving securities that may Care Obligation. We are adopting the Obligation—even if it has disclosed and be recommended and any associated Care Obligation largely as proposed; taken steps to prevent the limitation conflicts of interest; and (2) prevent the however, we are expressly requiring that from placing the interests of the broker- limitations and associated conflicts of a broker-dealer understand and consider dealer ahead of the retail customer, as the potential costs associated with its required by the Disclosure and Conflict 74 This obligation achieves greater consistency recommendation, and have a reasonable of Interest Obligation—and thus could with the treatment of conflicts under the Advisers basis to believe that the not use its limited menu to justify Act. As discussed in the Fiduciary Interpretation, recommendation does not place the recommending a product that does not in seeking to meet its duty of loyalty, an adviser satisfy the obligation to act in a retail must make full and fair disclosure to its clients of all material facts relating to the advisory 68 See Section II.C.1.c, Disclosure Obligation, Full customer’s best interest. relationship. An adviser must eliminate or at least and Fair Disclosure. Conflict of Interest Obligation. We are expose through full and fair disclosure all conflicts 69 See Section II.C.1.a, Disclosure Obligation, revising the Conflict of Interest of interest which might incline an investment Material Facts Regarding Scope and Terms of the Obligation by: (1) Similar to the adviser—consciously or unconsciously—to render Relationship. proposal, establishing an overarching advice which was not disinterested. See Fiduciary 70 Id. Interpretation. 71 Id. obligation to establish written policies 75 See generally Section II.C.3.e, Conflict of 72 See Section II.C.1, Disclosure Obligation, Oral Interest Obligation, Mitigation of Certain Incentives Disclosure or Disclosure After a Recommendation. 73 See generally Section II.C.2, Care Obligation. to Associated Persons.

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interest from causing the broker-dealer Exchange Act, along with any rules the recommendations resulting from agreed- or their associated persons to make Commission may adopt thereunder, and upon account monitoring services recommendations that place the interest any other applicable provisions of the (including implicit hold of the broker-dealer or associated person federal securities laws and related rules recommendations); and, applying the ahead of the interest of the retail and regulations.80 Care Obligation to a series of customer (for example, a broker-dealer Scienter will not be required to recommended transactions (currently could establish product review establish a violation of Regulation Best referred to as ‘‘quantitative suitability’’) processes or establish procedures Interest. We note that the preemptive irrespective of whether a broker-dealer effect of Regulation Best Interest on any addressing which retail customers exercises actual or de facto control over 76 state law governing the relationship would qualify for the product menu). a customer’s account; • Elimination of Certain Conflicts. We between regulated entities and their • are requiring broker-dealers to establish customers would be determined in requiring broker-dealers to written policies and procedures future judicial proceedings based on the establish, maintain, and enforce written reasonably designed to identify and specific language and effect of that state policies and procedures reasonably eliminate any sales contests, sales law. We believe that Regulation Best designed to mitigate (and in some cases, quotas, bonuses, and non-cash Interest, Form CRS, and the related eliminate) certain identified conflicts of compensation that are based on the sale rules, interpretations and guidance that interest that create incentives to make of specific securities or the sale of the Commission is concurrently issuing recommendations that are not in the specific types of securities within a will serve as focal points for promoting retail customer’s best interest; these new limited period of time.77 By explicitly clarity, establishing greater consistency requirements are a significant and focusing on policies and procedures to in the level of retail customer critical enhancement as existing eliminate these incentives, it does not protections provided, and easing requirements under the federal mean that all other incentives are compliance across the regulatory securities laws largely center upon landscape and the spectrum of presumptively compliant with conflict disclosure rather than conflict investment professionals and products. Regulation Best Interest. Rather, such mitigation; other incentives and practices that are In addition, under Section 29(a) of the • requiring disclosure under the not explicitly prohibited are permitted Exchange Act, a broker-dealer will not provided that the broker-dealer be able to waive compliance with Disclosure Obligation of the material establishes reasonably designed policies Regulation Best Interest, nor can a retail facts relating to the scope of terms of a and procedures to disclose and mitigate customer agree to waive her protections broker-dealer’s relationship with the the incentive created to the under Regulation Best Interest. retail customer and the conflicts of representative, and the broker-dealer Furthermore, we do not believe interest associated with a broker- Regulation Best Interest creates any new and its associated persons comply with dealer’s recommendations, which will private right of action or right of the Care Obligation and the Disclosure foster retail customers’ understanding of rescission, nor do we intend such a Obligation. their relationship with the broker-dealer result. General Compliance Obligation. We and help them to evaluate the are establishing a new, general D. Overview of Key Enhancements recommendations received; and ‘‘Compliance Obligation’’ to require With these modifications and • requiring broker-dealers to broker-dealers to establish policies and clarifications, Regulation Best Interest is establish, maintain and enforce written procedures to achieve compliance with designed to improve investor protection policies and procedures reasonably 78 Regulation Best Interest in its entirety. by: designed to achieve compliance with Books and Records. In addition to • Requiring broker-dealers to have a Regulation as a whole, which will adopting Regulation Best Interest, we reasonable basis to believe that further promote broker-dealer are also adopting the record-making and recommendations are in the retail compliance with Regulation Best recordkeeping requirements largely as customer’s best interest, which Interest. proposed, with certain explanations and enhances existing suitability obligations clarifications regarding the scope of by: Requiring compliance not only with Through these new requirements, we these requirements and the extent to the explicit Care Obligation, but also believe that Regulation Best Interest will which new obligations have been with Disclosure, Conflict of Interest, and improve investor protection by created.79 Compliance Obligations; expressly enhancing the quality of broker-dealer Interaction with Other Standards, requiring consideration of cost in recommendations to retail customers Waivers and Private Right of Action. evaluating a recommendation as part of and reducing the potential harm to retail Compliance with Regulation Best the Care Obligation; expressing our customers that may be caused by Interest will not alter a broker-dealer’s views regarding the consideration of conflicted brokerage recommendations. obligations under the general antifraud reasonably available alternatives when We also believe Regulation Best Interest provisions of the federal securities laws. making a recommendation as part of the achieves these enhancements in a Regulation Best Interest applies in Care Obligation; applying Regulation manner that is workable for the addition to any obligations under the Best Interest to recommendations of transaction-based relationship offered account types and rollovers and to any by broker-dealers, thus preserving, to 76 See generally Section II.C.3.f, Conflict of the extent possible, retail investor Interest Obligation, Mitigation of Material 80 For example, any transaction or series of Limitations on Recommendations to Retail transactions, whether or not subject to the access (in terms of choice and cost) to Customers. provisions of Regulation Best Interest, remain different types of quality investment 77 See generally Section II.C.3.g, Conflict of subject to the antifraud and anti-manipulation services and products. As discussed Interest Obligation, Elimination of Certain Conflicts provisions of the securities laws, including, without above, Regulation Best Interest will of Interest. limitation, Section 17(a) of the Securities Act of 78 See generally Section II.C.4, Compliance 1933 (‘‘Securities Act’’) [15 U.S.C. 77q(a)] and complement Form CRS and related Obligation. Sections 9, 10(b), and 15(c) of the Exchange Act [15 rules, interpretations, and guidance that 79 See generally Section II.D, Record-Making and U.S.C. 78i, 78j(b), and 78o(c)] and the rules the Commission is concurrently issuing. Recordkeeping. thereunder.

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II. Discussion of Regulation Best supported a broker-dealer specific the staff’s Section 913 Study; 94 or a Interest standard of conduct.85 Several of these uniform standard similar to the DOL commenters supported the standard as reflected in the BIC A. General Obligation Commission’s approach as proposed, Exemption; 95 harmonized requirements As in the Proposing Release, with certain modifications to the and guidance for broker-dealers and Regulation Best Interest is set forth in specific component obligations investment advisers offering services to two subparagraphs: (1) An overarching discussed below.86 Some commenters retail customers; 96 or a new uniform provision setting forth a general best urged the Commission to change the best interest standard, with common interest obligation (‘‘General standard from what the commenters core elements.97 Obligation’’); and (2) a second provision called ‘‘suitability-plus’’ to what the In this vein, a number of commenters requiring compliance with specific commenters called a ‘‘true best interest suggested specific revisions to the text obligations in order to satisfy the standard,’’ including the avoidance of of the General Obligation to clarify what overarching standard (discussed below certain conflicts,87 and urged the the standard requires with respect to in Section II.C).81 Specifically, as in the Commission to change the name of broker-dealer conflicts of interest, Proposing Release, the General Regulation Best Interest unless it including that the Commission change Obligation requires that a broker-dealer required firms to always be responsible the proposed ‘‘without placing the ‘‘shall act in the best interest of the for acting in the retail customer’s best financial or other interest [of the broker- retail customer at the time the interest (as opposed to at the time of the dealer] ahead’’ language to a standard recommendation is made, without recommendation).88 Other commenters that requires a recommendation be placing the financial or other interest of advocated for the adoption of a broker- made ‘‘without regard to’’ a broker- [the broker-dealer] . . . ahead of the dealer standard modeled after FINRA dealer’s interest 98 and/or requires the interest of the retail customer.’’ 82 suitability rules,89 and some suggested broker-dealer to ‘‘place the customer’s Most commenters, including a that the Commission create a safe harbor interest first’’ or ahead of its own.99 majority of the IAC, expressed opinions from liability for compliance with These commenters stated that changing on this approach, and in particular on Regulation Best Interest.90 the proposed language to a ‘‘without the General Obligation, including By contrast, other commenters regard to’’ and/or ‘‘place the customer’s whether the obligation should be a recommended that the Commission interest first’’ phrasing would result in ‘‘fiduciary’’ standard, whether it should adopt a uniform standard of conduct for a stronger standard, whereas the be a uniform standard for broker-dealers investment advisers and broker-dealers, proposed phrasing would allow a and investment advisers,83 and whether in varying forms.91 Commenters broker-dealer to act in its own interests the standard should be more principles- expressed differing views on the form of as long as the broker-dealer does not put based or more prescriptive (in such a uniform standard of conduct, its interests ahead of its customers’ particular, whether to define ‘‘best including that the Commission should interest.100 These commenters stated interest’’).84 adopt: a fiduciary standard for broker- that broker-dealers must put aside their The views of commenters on the dealers similar to, or no less stringent own interest when determining what is approach to an enhanced standard of than, the fiduciary duty under the best for the retail customer, that broker- 92 conduct for broker-dealers varied Advisers Act; a uniform fiduciary dealers must ensure that conflicts do not widely. A number of commenters standard as articulated in Section 913(g) taint recommendations.101 93 of the Dodd-Frank Act and/or Some commenters challenged the 81 See Proposing Release at 21585 et seq. consistent with the recommendations of Commission’s concern that the ‘‘without 82 See Paragraph (a)(1) of Regulation Best Interest. regard to’’ language ‘‘could be 83 See IAC 2018 Recommendation; Letter from 85 See, e.g., SIFMA August 2018 Letter; Cetera inappropriately construed to require a Rob Foregger, Co-Founder, NextCapital (Aug. 7, August 2018 Letter; Vanguard Letter; Edward Jones 2018) (‘‘NextCapital Letter’’) (recommending that Letter; Ameriprise Letter; NY Life Letter; NAIFA broker-dealer to eliminate all of its the Commission adopt a uniform fiduciary standard Letter; CCMC Letters; Penn Mutual Letter; conflicts,’’ arguing that their position is of conduct applicable to both broker-dealers and Cambridge Letter; PIABA Letter; Letter from Ronald supported by the plain meaning of the investment advisers); Letter from Sharon Cheever, J. Kruszewski, Chairman and Chief Executive language and the context of 913(g) Senior Vice President and General Counsel, Pacific Officer, Stifel Financial (Aug. 7, 2018) (‘‘Stifel Life Insurance Company (May 28, 2019) (‘‘Pacific Letter’’); Financial Engines Letter. (which explicitly recognizes conflicts in Life May 2019 Letter’’) (recommending that the 86 See, e.g., SIFMA August 2018 Letter; Vanguard certain areas), and the interpretations by Commission adopt a single ‘best interest’ standard Letter; Edward Jones Letter; Ameriprise Letter; NY others (such as the DOL) who have used of care for all financial professionals). Life Letter; NAIFA Letter; CCMC Letters; Penn it.102 Highlighting what commenters See also Letter from R. Scott Henderson, Bank of Mutual Letter; Cambridge Letter; PIABA Letter. 87 viewed as inconsistencies in the America (Aug. 7, 2018) (‘‘Bank of America Letter’’); See, e.g., CFA Institute Letter. Letter from Christopher Jones, Chief Investment 88 See, e.g., Letter from Jean-Luc Bourdon, CPA/ Proposing Release’s interpretation of the Officer, Financial Engines (Aug. 6, 2018) PFS, Chair, Personal Financial Planning Legislative proposed ‘‘without placing . . . ahead’’ (‘‘Financial Engines Letter’’); State Attorneys and Regulatory Task Force, and Charles R. Kowal, phrasing, such as statements that the Chair, Personal Financial Planning Executive General Letter; Letter from Jill I. Gross, Associate obligation would require broker-dealers Dean, Academic Affairs, Elisabeth Haub School of Committee, AICPA (Aug. 7, 2018) (‘‘AICPA Letter’’); Law, Pace University (Mar. 11, 2019) (‘‘Gross Betterment August 2018 Letter; NASAA August to ‘‘put aside their interests’’ when Letter’’). Relatedly, one commenter expressed 2018 Letter. 89 concern that a court or arbitration panel would See, e.g., National Society of Compliance 94 See, e.g., ACLI Letter; Schwab Letter. Professionals Letter; Cetera August 2018 Letter. determine that Regulation Best Interest would 95 See, e.g., Galvin Letter. See supra footnote 32. 90 See Cambridge Letter; BISA Letter; IPA Letter. control, rather than existing case law, which would 96 See, e.g., AARP August 2018 Letter. apply a fiduciary duty in certain circumstances. See 91 See, e.g., Betterment Letter; AARP August 2018 97 See, e.g., Pacific Life August 2018 Letter. Gross Letter. See also AFL–CIO April 2019 Letter. Letter; AFR Letter; Galvin Letter; State Attorneys 98 See, e.g., CFA August 2018 Letter; FPC Letter; 84 See, e.g., Ameriprise Letter; Cambridge Letter; General Letter. PACE Letter; Better Markets August 2018 Letter. CCMC Letters; Edward Jones Letter; NAIFA Letter; 92 See, e.g., Betterment Letter; Warren Letter; Fein 99 Morningstar Letter; NY Life Letter; Letter from Letter; Letter from Joseph M. Torsella, Pennsylvania See, e.g., Invesco Letter; Schwab Letter; Better Kevin T. Reynolds, Senior Vice President, Penn State Treasurer, et al. (Aug. 7, 2018) (‘‘State Markets August 2018 Letter; CFA Institute Letter. Mutual Life Insurance Company (Aug. 1, 2018) Treasurers Letter’’); AARP August 2018 Letter. 100 See, e.g., CFA August 2018 Letter; FPC Letter; (‘‘Penn Mutual Letter’’); SIFMA August 2018 Letter; 93 See, e.g., FPC Letter; Letter from Maxine Pace Letter. Vanguard Letter; Letter from Kent. A Mason, Davis Waters, Ranking Member, Committee on Financial 101 See, e.g., CFA August 2018 Letter. & Harman LLP (Jul. 20, 2018) (‘‘Davis Harman Services, U.S. House of Representatives, et al. (Sep. 102 See, e.g., CFA August 2018 Letter; Waters Letter’’). 12, 2018) (‘‘Waters Letter’’); Fein Letter. Letter.

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making a recommendation versus others A common theme across many and-circumstances or ‘‘totality of the suggesting that a broker-dealer’s comments was the need for additional circumstances approach’’ for interests cannot ‘‘predominantly guidance on what ‘‘best interest’’ means, determining compliance with the ‘‘best motivate’’ or be the ‘‘sole basis’’ for the with some commenters recommending interest’’ standard.118 A majority of the recommendation, some commenters that the Commission codify its IAC recommended that the meaning of suggested we either adopt the ‘‘without interpretation of ‘‘best interest’’ or the best interest obligation should be regard to’’ phrasing or state that the provide a more specific definition of clarified to require ‘‘broker-dealers, proposed phrasing requires a broker- what it means to act in the ‘‘best investment advisers, and their dealer to put aside its interests.103 Some interest.’’ 110 Several commenters associated persons to recommend the commenters further stated that the suggested that the ‘‘best interest’’ investments, investment strategies, ‘‘without regard to’’ phrasing, which is standard should require the ‘‘best’’ or accounts or services, from among those used in Section 913(g) of the Dodd- most beneficial product available,111 they have reasonably available to Frank Act, is the stronger standard of while others (including a majority of the recommend, that they reasonably conduct that Congress intended, and IAC) requested that the Commission believe represent the best available challenged the Commission’s reliance clarify that there is no single ‘‘best’’ options for the investor.’’ 119 on the authority provided in Section recommendation and that the obligation After careful consideration of these 913(f).104 In this vein, some commenters is to adhere to a professional standard comments, we continue to believe that suggested that the Commission should of conduct when making a our proposed approach for enhancing adopt a uniform standard of conduct for recommendation.112 Some commenters the standards of conduct that apply to broker-dealers and investment advisers suggested defining ‘‘best interest’’ as broker-dealers’ recommendations to that was authorized under Section including a duty of loyalty and care.113 retail customers is the appropriate 913(g), and recommended by the staff in Several also suggested that the approach, and therefore we are adopting the Section 913 Study.105 Commission incorporate best execution as proposed the structure and scope of Other commenters, however, and fair pricing and compensation as Regulation Best Interest, including the supported the proposal’s ‘‘without factors for determining compliance with phrasing of the General Obligation, and placing . . . ahead’’ formulation.106 the standard.114 are not expressly defining ‘‘best These commenters expressed concern Several commenters recommended interest’’ in the rule text.120 However, in that a ‘‘without regard to’’ standard that the Commission adopt a definition consideration of these comments, we are would require ‘‘conflict free’’ of best interest that is consistent with providing our views on what the recommendations, which would limit the best interest obligation described by standard generally requires, what it is compensation structures and the the DOL in the BIC Exemption’s intended to achieve, and its alignment offering of certain products.107 Instead, Impartial Conduct Standards,115 and in many respects with fiduciary commenters stated that the appropriate supported a standard which would principles. role of a best interest standard is to require a broker-dealer to act ‘‘solely’’ in 1. Commission’s Approach require disclosure and management of the interest of the retail customer when conflicts of interest.108 Others generally making a recommendation.116 After extensive consideration, and for supported, or did not object to, the Conversely, other commenters the reasons discussed in the Proposing Commission’s decision not to proceed recommended that the ‘‘best interest’’ Release and further below, we are under its 913(g) authority in its current standard could be satisfied even if the adopting a rule to enhance the existing proposal.109 recommendations are in part influenced broker-dealer conduct obligations when by ‘‘self-promotion.’’ 117 they make recommendations to a retail 103 See, e.g., CFA August 2018 Letter. See also Finally, in lieu of a prescribed customer.121 At the same time, we seek Waters Letter (stating that the proposal fails to definition of ‘‘best interest,’’ a number to preserve retail investor access (in adequately explain just what it would require of of commenters advocated for a facts- terms of choice and cost) to differing brokers that is different from the status quo, that the standard should clearly differ from the current types of investment services and ‘‘suitability’’ standard, and that any final rule must regulatory gap.’’). As noted above, Regulation Best products. clearly explain the standard, what it requires and Interest draws from key principles underlying The Commission is adopting prohibits, and how it differs from the status quo). fiduciary obligations, including those that apply to Regulation Best Interest pursuant to the 104 See, e.g., CFA August 2018 Letter; State investment advisers under Advisers Act. Accordingly, as discussed below, the Commission Attorneys General Letter; Waters Letter; FPC Letter; 118 Better Markets August 2018 Letter. has chosen to enhance existing obligations for See, e.g., AAJ Letter; CFA August 2018 Letter. 119 105 See, e.g., Waters Letter; FPC Letter. broker-dealers when they make recommendations IAC 2018 Recommendation. to a retail customer, while, in a separate 120 106 See, e.g., AALU Letter; Cetera August 2018 Another commenter stated that any interpretation, reaffirming and in some cases modification to the proposed rules and guidance Letter; NAIFA Letter; Pickard Letter. clarifying an investment adviser’s fiduciary duty. 107 that would make them ‘‘more restrictive’’ should be See, e.g., AALU Letter; Cetera August 2018 See Fiduciary Interpretation. reproposed for additional public comment. See Letter; NAIFA Letter; Pickard Letter. 110 See, e.g., NASAA August 2018 Letter. ACLI Letter. Because we have provided notice and 108 See, e.g., AALU Letter; Cetera August 2018 111 See, e.g., Financial Engines Letter; CFA the changes we are making are based on comments Letter. August 2018 Letter. we received, reproposal is not necessary. 109 See, e.g., Invesco Letter; IAC 2018 112 See, e.g., Wells Fargo Letter; see also IAC 2018 121 See Proposing Release at 21575. In particular, Recommendation (stating ‘‘we recognize that the Recommendation (‘‘[T]he Commission should we considered the recommendations made by our Commission has chosen not to proceed under its recognize there will often not be a single best option staff in 2011 and the recommendations of the IAC. 913(g) authority in its current proposal, and it is not and that more than one of the available options may See Staff of the U.S. Securities and Exchange our intent to derail that proposal by advocating that satisfy this standard.’’). Commission, Study on Investment Advisers and the Commission change the legal basis for its 113 See, e.g., TIAA Letter; Morningstar Letter. Broker-Dealers As Required by Section 913 of the rulemaking. Moreover, we believe the clarifications Dodd-Frank Wall Street Reform and Consumer 114 See, e.g., CFA Institute Letter; Letter from we have outlined above to the meaning of best Protection Act (Jan. 2011) (‘‘913 Study’’), at 9–10, Mark Heckert, Vice President, Pricing and interest, if implemented, have the potential to available at www.sec.gov/news/studies/2011/ deliver immediate benefits to customers of broker- Analytics, ICE Data Services, (Aug. 7, 2018) (‘‘ICE 913studyfinal.pdf; Recommendation of the Investor dealers and investment advisers alike. Should the Letter’’); FPC Letter. Advisory Committee: Broker-Dealer Fiduciary Duty Commission determine, however, that it cannot 115 See, e.g., AARP August 2018 Letter; Wells (Nov. 2013) (‘‘IAC 2013 Recommendation’’), enforce the clarified best interest standard under Fargo Letter; Schwab Letter; NASAA August 2018 available at https://www.sec.gov/spotlight/investor- the Advisers Act, a majority of the Committee Letter. advisory-committee-2012/fiduciary-duty- believes the Commission should reconsider 116 See, e.g., Galvin Letter. recommendation-2013.pdf; IAC 2018 rulemaking under its 913(g) authority to close that 117 See, e.g., LPL August 2018 Letter. Recommendation.

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express and broad grant of rulemaking cases clarifying an investment adviser’s regulatory obligations. As a result, authority in Section 913(f) of the Dodd- fiduciary duty.123 Regulation Best Interest protects Frank Act.122 As some commenters Regulation Best Interest considers and investors who seek access to the noted, Section 913(g) expressly incorporates (to the extent appropriate) services, products, and payment options authorizes the Commission to adopt obligations that apply to investment offered by broker-dealers. rules that would hold broker-dealers to advice in other contexts, with the goal Although we are not applying the the same standard of conduct as of fostering greater consistency and existing fiduciary standard under the investment advisers. However, the clarity in the level of protection Advisers Act to broker-dealers, key availability of overlapping, yet distinct, provided to retail customers at the time elements of the standard of conduct that rulemaking power under Section 913(g) that a recommendation is made. We are applies to broker-dealers under does not negate the grant of authority tailoring these principles to the Regulation Best Interest will be under Section 913(f). The plain text of structure and characteristics of the substantially similar to key elements of Section 913(f) authorizes the broker-dealer relationship with retail the standard of conduct that applies to Commission to promulgate this rule customers and building upon existing investment advisers pursuant to their addressing the legal and regulatory fiduciary duty under the Advisers standards of care for broker-dealers, and 123 Although we are not adopting a uniform Act 124 at the time that a fiduciary standard of conduct, we note that our recommendation is made. Regulation their associated persons. rules are designed to achieve many of the key goals The Commission is utilizing its advocated for by supporters of a uniform standard Best Interest’s regulatory structure is authority under 913(f) in order to adopt of conduct. For example, in advocating for a unique to broker-dealers—and is an enhanced investor-protection uniform standard of conduct former Commission tailored to the broker-dealer business Chair Elisse B. Walter (then a Commissioner) stated model—but regardless of whether a standard for broker-dealers that that (1) ‘‘[t]o appreciate fully what a fiduciary maintains the availability of both the standard means, and what it really means to act in retail investor chooses a broker-dealer or broker-dealer model and the investment the best interest of an investor, it is absolutely an investment adviser (or both), the adviser model. The Commission has necessary to drill down and determine what duties retail investor will be entitled to a and obligations flow from a fiduciary standard,’’ (2) recommendation (from a broker-dealer) chosen not to apply the existing ‘‘a fiduciary standard is not a substitute for business fiduciary standard under the Advisers practice rules . . . [r]ather, the two are or advice (from an investment adviser) Act to broker-dealers in part because of complementary . . . and can be used by the that is in the best interest of the retail concerns that such a shift would result Commission] to prohibit certain conflicted behavior investor and that does not place the or to require mitigation or management of the interests of the firm or the financial in fewer broker-dealers offering conflict,’’ (3) ‘‘what a fiduciary duty requires transaction-based services to retail depends on the scope of the engagement,’’ and (4) professional ahead of the interests of the customers, which would in turn reduce ‘‘[m]ost important, whatever gloss and guidance the retail investor. choice and may raise costs for certain Commission provides, it should not deviate from As discussed in the proposal, and in the basic principle that financial professionals the discussion below, Regulation Best retail customers. should always act in the best interests of investors, Moreover, the Commission has both large and small.’’ Commissioner Elisse B. Interest, as adopted, incorporates Care chosen not to create a new uniform Walter, Regulating Broker-Dealers and Investment and Conflict of Interest Obligations standard applicable to both broker- Advisers: Demarcation or Harmonization? (May 5, substantially similar to the fiduciary 2009), available at https://www.sec.gov/news/ duties of care and loyalty under Section dealers and investment advisers which, speech/2009/spch050509ebw.htm. among other things, would discard In our Fiduciary Interpretation and in this 206(1) and (2) of the Advisers Act, even decades of regulatory and judicial release, we are providing our views on the duties if not in the same manner as the 913 precedent and experience with the and obligations that flow from the fiduciary duty Study recommendations or identical to and Regulation Best Interest. In this release, we the duties under the Advisers Act.125 fiduciary duty for investment advisers discuss the specific obligations of broker-dealers that has generally worked well for retail under the Disclosure, Care and Conflicts of Interest We extensively considered the 913 clients and our markets. We believe that Obligations, which include requirements to Study as part of developing Regulation adopting a ‘‘one size fits all’’ approach establish policies and procedures that comply with Best Interest, as discussed in the the Conflict of Interest Obligation, specifically to Proposing Release, and believe that the would not appropriately reflect the fact disclose and mitigate (i.e., reasonably reduce), or that broker-dealers and investment eliminate, certain conflicts. As discussed below, enhancements to the broker-dealer advisers play distinct roles in providing these specific obligations are tailored to address standard of conduct incorporate, and in particular concerns that arise as a result of the recommendations or advice and services many aspects (such as the concept of broker-dealer model. For that reason, as well as the mitigation, and the detailed Care to investors, and may ultimately harm other reasons set forth above, the Commission does retail investors. Instead, the not believe that it is necessary to adopt a uniform Obligation), build upon and go beyond Commission has chosen to enhance standard in order to ensure that these specific the recommendations in the 913 Study. obligations also apply to investment advisers, as the existing obligations for broker-dealers Although key elements are IAC suggests. See IAC 2018 Recommendation. In substantially similar, the Commission when they make recommendations to a our Fiduciary Interpretation, we state that ‘‘the retail customer, while, in a separate application of the investment adviser’s fiduciary notes that the obligations of a broker- interpretation, reaffirming and in some duty will vary with the scope of the relationship,’’ dealer under Regulation Best Interest and here we have noted that we are not expressly and the obligations of an investment defining in the rule text the term ‘‘best interest,’’ adviser pursuant to its fiduciary duty 122 Section 913(f) of the Dodd-Frank Act provides and instead are providing in the rule and through the Commission discretionary authority to interpretations what ‘‘best interest’’ means. under the Advisers Act differ in certain ‘‘commence a rulemaking, as necessary or Compliance with each of the specific component respects, taking into account the scope appropriate to the public interest and for the obligations will turn on an objective assessment of of the services and relationships protection of retail customers (and such other the facts and circumstances of how the specific typically offered by broker-dealers and customers as the Commission may by rule provide), components of Regulation Best Interest are satisfied to address the legal or regulatory standards of care at the time that the recommendation is made. for brokers, dealers . . . [and] persons associated Finally, regardless of whether a retail investor 124 Specifically, an investment adviser’s fiduciary with brokers or dealers . . . for providing chooses a broker-dealer or an investment adviser (or duty under the Advisers Act comprises a duty of personalized investment advice about securities to both), the retail investor will be entitled to a care and a duty of loyalty. This combination of care such retail customers.’’ In addition to Section recommendation (from a broker-dealer) or advice and loyalty obligations has been characterized as 913(f), the Commission is promulgating Regulation (from an investment adviser) that is in the best requiring the investment adviser to act in the ‘‘best Best Interest pursuant to other provisions of the interest of the retail investor and that does not place interest’’ of its client at all times. See Fiduciary Exchange Act, including Section 15(c)(6) and the interests of the firm or the financial professional Interpretation. Section 17. ahead of the interests of the retail investor. 125 See Proposing Release at 21590.

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investment advisers. For example, an place the broker-dealer’s interest ahead the time the recommendation is made, investment adviser’s duty of care of the retail customer’s interest; and (3) without placing the financial or other encompasses the duty to provide advice have a reasonable basis to believe that interest of the [broker-dealer] ahead of and monitoring at a frequency that is in a series of transactions is in the best the interest of the retail customer’’ as it the best interest of the client, taking into interest of the retail customer and does was proposed.126 In response to account the scope of the agreed not place the interest of the broker- comments, we are clarifying our views relationship. This difference reflects the dealer ahead of the retail customer’s on what this standard entails and how generally ongoing nature of the advisory interests. Regulation Best Interest it compares to the ‘‘without regard to’’ relationship, and the Commission’s imposes a duty of care that enhances language of Section 913. view that, within the scope of the agreed existing suitability obligations (as By replacing the ‘‘without regard to’’ adviser-client relationship, investment discussed further below). It also language of Section 913(g) and the 913 advisers’ fiduciary duty generally includes a requirement under the Care Study with the ‘‘without placing the applies to the entire relationship. In Obligation to specifically address the financial or other interest of the [broker- contrast, the provision of risk that a broker-dealer’s transaction- dealer] . . . ahead of the interest of the recommendations in a broker-dealer based recommendations and retail customer’’ phrasing, we did not relationship is generally transactional compensation could result in a series of intend to create a ‘‘lower’’ or ‘‘weaker’’ and episodic, and therefore the final recommendations that are not in the standard compared to the language of rule requires that broker-dealers act in best interest or a retail customer—a Section 913(g) and the 913 Study. the best interest of their retail customers ‘‘churning’’ risk unique to the broker- Rather, we are adopting a standard that at the time a recommendation is made dealer model of providing reflects that a broker-dealer should not and imposes no duty to monitor a recommendations and resulting put its interests ahead of the retail customer’s account following a transaction-based compensation. customer’s interest, and thereby aligns recommendation. Regulation Best Interest also includes with (and in certain areas imposes more As noted above, Regulation Best a requirement under the Conflict of specific obligations than) the investment Interest also generally imposes more Interest Obligation for broker-dealers to adviser fiduciary duty, at the time a specific obligations on broker-dealers establish, maintain, and enforce written broker-dealer makes a recommendation under the Disclosure, Care and Conflict policies and procedures reasonably to a retail customer. of Interest Obligations (each of which is designed to (1) mitigate conflicts of As discussed in the Proposing discussed in detail below) than the interest at the associated person level, Release, we do not intend for our principles-based requirements of (2) specifically address the conflicts of standard to require a broker-dealer to investment advisers’ fiduciary duty interest presented when broker-dealers provide conflict-free recommendations. under the Advisers Act. This approach place material limitations on the For example, under Regulation Best is intended to tailor the application of securities or products that may be Interest, a broker-dealer could principles that have developed in the recommended (i.e., only make recommend a more expensive or more context of a different business model recommendations of proprietary or remunerative security or investment over the course of almost 80 years. other limited range of products), and (3) strategy if the broker-dealer has a Moreover, this more specific and eliminate sales contests, bonuses, and reasonable basis to believe there are tailored approach drawing on key non-cash compensation that are based other factors about the security or fiduciary principles (1) is consistent on the sales of specific securities or investment strategy that make it in the with the generally rules-based specific types of securities within a best interest of the retail customer, regulatory regime that applies to broker- limited period of time. The conflicts of based on that retail customer’s dealers, (2) acknowledges that certain interest associated with incentives at the investment profile.127 relevant obligations may already be associated person level and limitations We also agree with commenters that addressed by existing broker-dealer on the securities or products that may we do not believe that is the intent requirements (e.g., broker-dealers are be recommended to retail customers behind the ‘‘without regard to’’ phrase, already subject to a duty of best have raised particular concerns in the as included in Section 913 of the Dodd- execution), (3) allows us to impose context of the broker-dealer, transaction- Frank Act or recommended in the 913 requirements that we are believe are based relationship. Accordingly, the Study, as is evident both from other more appropriately tailored to address Commission believes specific disclosure provisions of Section 913 that the specific conflicts raised by the and additional mitigation requirements acknowledge and permit the existence transaction-based nature of the broker- are appropriate to address those of financial interests under that dealer model, and (4) recognizes that it conflicts. Sales contests, sales quotas, standard, and how our staff articulated would be inappropriate to apply to bonuses and non-cash compensation the recommended uniform fiduciary certain generally applicable obligations that are based on the sales of specific standard in the 913 Study.128 of investment advisers (e.g., duty to securities within a limited period of monitor) in the context of a transaction- time create high-pressure situations for 126 See paragraph (a)(1) of Regulation Best based relationship. Interest. As discussed in Section II.C.2, we are also associated persons to increase the sales adding the phrasing ‘‘does not place the financial These specific obligations include of specific securities or specific types of or other interest of the broker, dealer, or such express requirements relating to the securities within a limited period of natural person . . . ahead of the retail customer’’ Care Obligation, requiring that a broker- time and thus compromise the best to certain provisions of the Care Obligation. dealer exercise reasonable diligence, interests of their retail customers. The 127 See Section II.C.2, Care Obligation. care, and skill to: (1) Understand the 128 See Proposing Release at 21590. As noted in Commission does not believe such the proposal, among other things, Dodd-Frank Act risks, rewards and costs of a conflicts of interest can be reasonably Section 913(g) expressly provides that the receipt of recommendation; (2) have a reasonable mitigated and, accordingly, they must commission-based compensation, or other standard basis to believe that the be eliminated. compensation, for the sale of securities shall not, in recommendation is in the best interest and of itself, violate any uniform fiduciary standard Phrasing of Standard promulgated under that subsection’s authority as of a particular retail customer, based on applied to a broker-dealer. Moreover, Section 913(g) the retail customer’s investment profile, We are adopting the phrasing ‘‘act in does not itself require the imposition of the and that the recommendation does not the best interest of the retail customer at Continued

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Nevertheless, we are concerned that customer’s interest.130 Accordingly, we not to place the adviser’s interests ahead there is a risk that the ‘‘without regard believe this phrasing establishes a of the interests of its client.135 to’’ language would be inappropriately standard that enhances investor While we are not revising this construed to require a broker-dealer to protection by prohibiting a broker- phrasing of the standard, we appreciate eliminate all of its conflicts when dealer from placing its interests ahead of concerns raised by commenters about making a recommendation (i.e., require the retail customer’s interests, and clarifying whether this standard permits recommendations that are conflict free), preserves investor access (in terms of broker-dealers to allow their conflicts to which we believe could ultimately harm both choice and cost) to differing types taint their recommendations or to allow retail investors by reducing their access of investment services and products. broker-dealers to make to differing types of investment services The phrasing also aligns with an recommendations that are motivated by and products and by increasing their investment adviser’s fiduciary their own interests or to put their costs. obligation. As discussed in the The potential for a range of different Fiduciary Interpretation, an investment interests first. We discuss below what it meanings to be given to the phrase adviser’s fiduciary duty under the means to ‘‘act in the best interests,’’ ‘‘without regard to’’ was heightened by Advisers Act comprises a duty of care particularly in the context of satisfying the DOL’s use of this same language for and a duty of loyalty.131 The fiduciary the Care and Conflict of Interest purposes of the Impartial Conduct duty requires that an adviser ‘‘adopt the Obligations. Specifically, we clarify that Standards set forth in the BIC principal’s goals, objectives, or the obligations set forth in Regulation Exemption. We recognize, as noted by ends.’’ 132 This means the adviser must, Best Interest are intended to require some commenters, that the DOL at all times, serve the best interest of its broker-dealers to take steps to reduce interpretation of this phrase does not clients and not subordinate its client’s the effect of (and in some cases require ‘‘conflict-free’’ interest to its own. In other words, the eliminate) conflicts that create an recommendations. Nevertheless, investment adviser cannot place its own incentive to place a broker-dealer’s or an because of the differences in the interests ahead of the interests of its associated person’s interest ahead of the approach to the treatment of conflicts client.133 This combination of care and retail customer’s interest when making under ERISA and under the federal loyalty obligations has been a recommendation, and to make securities laws—ERISA starts by characterized as requiring the recommendations in the best interest of prohibiting conflicts and then through investment adviser to act in the ‘‘best the retail customer even where conflicts exemptions permits certain conflicts, interest’’ of its client at all times.134 continue to exist. We believe that this whereas the federal securities laws Language that would require a broker- approach will result in a standard of generally start with disclosure and dealer to put the retail customer’s conduct that is consistent with what a become more restrictive—we share interest ‘‘first’’ arguably raises many of reasonable retail customer would commenters’ concerns that DOL’s use of the same concerns as the ‘‘without expect.136 the ‘‘without regard to’’ language could regard to’’ language. Accordingly, we alter the way in which conflicts are are adopting a formulation in Regulation 135 See Fiduciary Interpretation at footnote 54 viewed and cause a substantial portion Best Interest that is consistent with how (stating that, in practice, referring to putting a client’s interest first is a plain English formulation of conduct that is currently permitted, we describe the duty of loyalty for commonly used by investment advisers to explain and reasonably accepted and desired by investment advisers in the Fiduciary their duty of loyalty in a way that may be more retail customers, to be limited or Interpretation—that is, a requirement understandable to retail clients). eliminated. Based on market participant 136 See, e.g., Brian Scholl, et al., SEC Office of the Investor Advocate and RAND Corporation, The experience with the implementation 130 In this vein, we believe that a broker-dealer’s Retail Market for Investment Advice (2018), ‘‘financial interest’’ is broad, and that a broker- of—and reaction to the subsequent available at https://www.sec.gov/comments/s7-07- dealer is unlikely to have an ‘‘other interest’’ that overturning of—the DOL Fiduciary 18/s70718-4513005-176009.pdf (‘‘OIAD/RAND’’). is not a ‘‘financial interest.’’ See, e.g., Proposing OIAD/RAND summarized the results of focus Rule, in particular the BIC Release at 21618 (noting ‘‘. . . our interpretation of groups, indicating that in the context of discussing Exemption,129 we continue to believe the types of material conflicts of interest arising expectations for standards of conduct, ‘‘the groups from financial incentives is broad. . .’’). that it is better to use language that typically expected that a financial professional who 131 provides similar investor protections, See, e.g., Proxy Voting by Investment is acting in a client’s best interest’’ to, among other but does not raise these legal Advisers, Advisers Act Release No. 2106 (Jan. 31, things, ‘‘disclose payments they receive that might 2003) (‘‘Investment Advisers Release No. 2106’’). ambiguities. influence their advice [and] avoid taking higher See also Fiduciary Interpretation. compensation for selling one product over a similar The ‘‘without placing the financial or 132 Arthur B. Laby, The Fiduciary Obligations as but less costly product.’’ Further, OIAD/RAND other interest . . . ahead of the interest the Adoption of Ends, 56 Buffalo Law Review 99 summarized focus group comments on of the retail customer’’ phrasing (2008); see also Restatement (Third) of Agency, professionals’ form of compensation, noting that recognizes that while a broker-dealer § 2.02 Scope of Actual Authority (2006) (describing ‘‘although many participants prefer that a a fiduciary’s authority in terms of the fiduciary’s will inevitably have some financial professional be compensated by the client alone, reasonable understanding of the principal’s some might not rule out using a professional who interest in a recommendation—the manifestations and objectives). See Fiduciary is receiving other compensation, for example if the nature and magnitude of which will Interpretation. compensation is openly disclosed and they are vary—the broker-dealer’s interests 133 See Fiduciary Interpretation. comfortable with the professional.’’ The SEC’s cannot be placed ahead of the retail 134 Id. See also Amendments to Form ADV, Office of Investor Advocate and the RAND Advisers Act Release No. 3060 (Jul. 28, 2010) Corporation prepared this research report regarding (adopting amendments to Form ADV and stating the retail market of investment advice prior to, and principal trade provisions of Advisers Act Section that ‘‘under the Advisers Act, an adviser is a separate from, our rulemaking proposals. This 206(3) on broker-dealers. In addition, Dodd-Frank fiduciary whose duty is to serve the best interests report was included in the comment file at https:// Act Section 913 provides that offering only of its clients, which includes an obligation not to www.sec.gov/comments/s7-07-18/s70718-4513005- proprietary products by a broker-dealer shall not, in subrogate clients’ interests to its own,’’ citing 176009.pdf. See also, e.g., Washington, DC and of itself, violate such a uniform fiduciary Investment Advisers Act Release 2106). See SEC v. Roundtable at 49 (‘‘So it seems to me that there is standard, but may be subject to disclosure and Tambone, 550 F.3d 106, 146 (1st Cir. 2008) a tight connection between the obligation that you consent requirements. See Exchange Act Section (‘‘Section 206 imposes a fiduciary duty on have, and our obligations down below here to the 15(k)(1) and Advisers Act Section 211(g)(1). See investment advisers to act at all times in the best conflicts of interest, that it’s really important that also 913 Study at 113; Proposing Release at 21590. interest of the fund. . .’’); SEC v. Moran, 944 F. advisers or brokers spell out what conflicts of 129 See supra footnotes 33 and 34 (citing Supp. 286, 297 (S.D.N.Y 1996) (‘‘Investment interest they have, and what that means in real reduction in services and increase in costs advisers are entrusted with the responsibility and terms to the person before they make a choice, for following DOL). duty to act in the best interest of their clients.’’). example’’).

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Finally, although our standard draws making from the Proposing Release to Regulation Best Interest is consistent from key fiduciary principles, for this final Regulation Best Interest and with many of the key components of the various reasons, including to emphasize the additional interpretations and DOL’s Impartial Conduct Standards. that Regulation Best Interest is tailored guidance we are providing are intended Regulation Best Interest incorporates to the broker-dealer relationship and to further clarify how a broker-dealer principles underlying the DOL distinct from the investment adviser could comply with these requirements. Fiduciary Rule—such as the concept of fiduciary duty, we are not referring to As noted above and discussed in the conflict mitigation—that, based on our Regulation Best Interest as a ‘‘fiduciary’’ Fiduciary Interpretation, an investment expertise in regulating the broker-dealer standard, and we emphasize that adviser’s fiduciary duty under the industry, we believe would further our Regulation Best Interest is separate from Advisers Act requires the adviser to act goal of reducing the effect of conflicts any common law analysis of whether a in the best interests of its clients. We on recommendations and would broker-dealer has fiduciary duties.137 As have chosen to describe the standard by promote recommendations in the best noted in the proposal, fiduciary referring directly to what the standard interest of the retail customer even standards vary, for example, for requires at the time a recommendation where conflicts continue to exist. investment advisers, banks acting as 140 is made. Furthermore, while key 2. General Obligation To ‘‘Act in Best trustees or fiduciaries, and fiduciaries to elements of the standard of conduct that Interest’’ ERISA plans. As we have learned applies to broker-dealers under through our consideration of the Regulation Best Interest will be We agree with commenters that Relationship Summary Proposal, and substantially similar to key elements of further clarity should be provided on from various investor studies, using the the standard of conduct that applies to what it means to ‘‘act in the best term ‘‘fiduciary’’ to describe the investment advisers pursuant to their interest’’ of a retail customer and standard may not sufficiently convey fiduciary duty under the Advisers Act at particularly what it means to make a meaning regarding the specific the time that a recommendation is recommendation in a retail customer’s substance of the standard.138 In made, we are concerned that using the ‘‘best interest’’ under the Care addition, we appreciate commenters’ term ‘‘fiduciary’’ to describe a broker- Obligation. In the guidance that follows concerns that using the term in the dealer’s obligations under Regulation and in the detailed discussion of each context of a different relationship may Best Interest may create confusion by of the Disclosure, Care, Conflict of introduce further legal or compliance suggesting that the standards of conduct Interest, and Compliance Obligations in ambiguity.139 are identical in all respects, when there Section II.C below, we provide further clarity on how a broker-dealer acts in a As articulated in the Proposing are key differences as noted above, retail customer’s best interest when Release, we appreciate the desire for including the scope of the of the duty clarity about the requirements imposed making a recommendation. (e.g., the application of the adviser’s First, in response to comments, we are by Regulation Best Interest, and we have fiduciary duty to the entire relationship sought to provide such clarity by clarifying the relationship between the versus Regulation Best Interest’s General Obligation and the specific specifying by rule the specific recommendation-specific application, components with which a broker-dealer component obligations described in and the application of an adviser’s Section II.C. These specific component is required to comply to satisfy its best fiduciary duty to all clients as opposed interest obligation. The changes we are obligations expressly set forth what it to Regulation Best Interest’s application means to ‘‘act in the best interest’’ of the to retail customers).141 137 In addition to the antifraud provisions of the retail customer in accordance with the federal securities laws, courts interpreting state Similarly, while we are not General Obligation. As articulated in the common law have imposed fiduciary obligations on harmonizing the phrasing of the best proposal, and discussed in more detail broker-dealers in certain circumstances. See interest standard with the DOL’s in the relevant sections specifically Proposing Release at 21584. Generally, courts have definition of ‘‘best interest’’ as reflected found that broker-dealers that exercise discretion or addressing these obligations, these control over customer assets, or have a relationship in the BIC Exemption’s Impartial specific component obligations draw on of trust and confidence with their customers, owe Conduct Standards, as suggested by principles underlying the fiduciary 142 customers a fiduciary duty. Id. In developing some commenters, or otherwise duties of care and loyalty interpreted proposed Regulation Best Interest, the Commission adopting some or all conditions of the has drawn from principles that apply to investment under the Advisers Act and as advice under other regulatory regimes, including BIC Exemption, we gave careful recommended in the 913 Study. state common law fiduciary principles, among consideration to the DOL Fiduciary Rule However, we believe that adopting others. By doing so, we hope to establish greater in developing Regulation Best specific regulatory obligations for consistency in the level of retail customer 143 protections and to make it easier to comply with Interest. Regulation Best Interest broker-dealers appropriately reflects the Regulation Best Interest where other legal regimes, takes into account both market structure and characteristics of broker- such as state common law drawing upon participant experience with the dealer relationships with retail comparable fiduciary principles, might also apply. implementation of—and reaction to the 138 customers and the extensive existing See, e.g., RAND 2018 (‘‘Some participants had subsequent overturning of the DOL never heard of the word, whereas others had heard regulatory regime applicable to broker- it but did not know what it meant in this context. Fiduciary Rule, in particular the BIC dealers. Regulation Best Interest does Others thought the word ‘‘fiduciary implies acting Exemption. As discussed in the not establish a ‘‘safe harbor.’’ The in best interest . . .’’). We have modified the Proposing Release, we believe standard of conduct disclosure required by Form specific component obligations of CRS to eliminate technical words, such as Regulation Best Interest are mandatory, 140 ‘‘fiduciary,’’ and describe the standards of conduct As discussed in the Relationship Summary and failure to comply with any of the Adopting Release, we are adopting a requirement in of broker-dealers, investment advisers, or dual- components would violate the General registrants using similar terminology in a plain- Form CRS for a description of a firm’s applicable English manner. In particular, Form CRS uses the standard of conduct using prescribed wording. Obligation. By contrast, compliance term ‘‘best interest’’ to describe how broker-dealers, 141 See Fiduciary Interpretation. with a safe harbor is optional, and investment advisers, and dual-registrants must act 142 See AARP August 2018 Letter; Wells Fargo failure to comply with the terms of the regarding their retail customers or clients when Letter; Schwab Letter; NASAA August 2018 Letter. safe harbor does not necessarily violate providing recommendations as a broker-dealer or 143 On March 15, 2018, the DOL Fiduciary Rule acting as an investment adviser. See Relationship was vacated by the United States Court of Appeals the relevant legal requirement. Summary Adopting Release. for the Fifth Circuit. Chamber of Commerce v. U.S. Second, while we are declining to 139 See, e.g., Stifel Letter. Dep’t of Labor, 885 F.3d 360 (5th Cir. 2018). expressly define ‘‘best interest’’ in the

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rule text as suggested by some requiring a consideration of intent, the specific requirements of Regulation commenters, we are providing creating ambiguity as to what extent a Best Interest. interpretations and guidance regarding broker-dealer’s interests could influence Further, for the reasons discussed in the application of the specific its recommendations or requiring a the proposal, we confirm that component obligations and in particular weighing of the broker-dealer’s interests Regulation Best Interest is not intended what it means to make a against the retail customer’s interests.145 to limit or eliminate recommendations recommendation in the retail customer’s Some commenters, however, indicated that encourage diversity in a retail ‘‘best interest.’’ Consistent with the support for the ‘‘predominantly customer’s portfolio through investment proposal, compliance with each of the motivated language’’ in the context of in a wide range of products, including, specific component obligations of agreeing with the Commission’s when appropriate, products that may Regulation Best Interest, including the proposed ‘‘without placing the financial involve higher risks or cost to the retail ‘‘best interest’’ requirement in the Care or other interest . . . ahead’’ phrasing of customer, as these products may be in Obligation, will be applied in a the best interest standard.146 the best interest of certain retail principles-based manner. This In consideration of these comments, customers at certain times or in certain principles-based approach to we are modifying these statements to circumstances.150 Regulation Best determining what is in the ‘‘best remove this language and to clarify our Interest will not necessarily obligate a interest’’ is similar to an investment intent. Specifically, Regulation Best broker-dealer to recommend the ‘‘least adviser’s fiduciary duty, which has Interest recognizes that while a broker- expensive’’ or the ‘‘least remunerative’’ worked well for advisers’ retail clients dealer will inevitably have some security or investment strategy, and our markets. As proposed, whether financial interest in a provided the broker-dealer complies a broker-dealer has acted in the retail recommendation—the nature and with the specific component customer’s best interest will turn on an magnitude of which will vary—the obligations.151 In other words, objective assessment of the facts and broker-dealer’s interests cannot be Regulation Best Interest will allow a circumstances of how the specific placed ahead of the retail customer’s broker-dealer to recommend products components of Regulation Best Interest interest.147 Accordingly, Regulation Best that entail higher costs or risks for the are satisfied at the time that the Interest will not per se prohibit a broker- retail customer, or that result in greater recommendation is made (and not in dealer from making recommendations compensation to the broker-dealer, or hindsight). In particular, whether a where conflicts of interest are that are more expensive, than other broker-dealer’s recommendation present.148 Instead, Regulation Best products, provided that the broker- satisfies the requirements of the Care Interest includes specific requirements dealer complies with the specific Obligation is an objective evaluation for broker-dealers to address their component obligations detailed that is not susceptible to a bright line conflicts of interest.149 These specific below,152 including the requirement to test; rather it turns on the facts and requirements are designed to promote make these recommendations exercising circumstances of the particular recommendations that are in the best reasonable diligence, care, and skill to recommendation and the particular interest of the retail customer despite have a reasonable basis to believe that retail customer, at the time the the existence of these conflicts of the recommendation is in the retail recommendation is made. This facts- interest. In other words, customer’s best interest and does not and-circumstances approach recognizes recommendations involving conflicts of place the broker-dealer’s interest ahead that one size does not fit all, and what interest between the broker-dealer and of the retail customer’s interest. is in the best interest of one retail the retail customer will be permissible Finally, some commenters sought customer may not be in the best interest under Regulation Best Interest only to additional clarity whether Regulation of another. the extent that the broker-dealer satisfies Best Interest would extend beyond a We understand that markets evolve particular recommendation, impose a and we encourage broker-dealers to 145 See CFA August 2018 Letter; Better Markets duty to monitor the retail customer’s have an open dialogue with the August 2018 Letter; Wells Fargo Letter. 146 See AXA Letter; FSI August 2018 Letter. account, or apply to unsolicited Commission and Commission’s staff as 153 147 orders. We confirm that, consistent questions arise. See id. See infra Section II.C.2. 148 Such conflicts of interest may include: with the Proposing Release and as As a general matter, however, in Charging commissions or other transaction-based discussed further below, Regulation response to comments, we are changing fees; receiving or providing differential Best Interest would not: (1) Extend compensation based on the product sold; receiving guidance in the Proposing Release beyond a particular recommendation 154 stating that under Regulation Best third-party compensation; recommending proprietary products, products of affiliates or a or generally require a broker-dealer to Interest, a broker-dealer’s financial limited range of products; recommending a security have a continuous duty to a retail interests cannot be the ‘‘predominant underwritten by the broker-dealer or a broker-dealer customer or impose a duty to motivating factor behind’’ a affiliate, including initial public offerings (‘‘IPOs’’); recommending a transaction to be executed in a monitor; 155 (2) require the broker-dealer recommendation, and that a ‘‘broker- principal capacity; allocating trades and research, dealer would violate proposed including allocating investment opportunities (e.g., 150 Id. IPO allocations or proprietary research or advice) Regulation Best Interest’s Care 151 See id. among different types of customers and between Obligation and Conflict of Interest 152 retail customers and the broker-dealer’s own See id. Obligations, if any recommendation was account; considering cost to the broker-dealer of 153 See, e.g., SIFMA August 2018 Letter; predominantly motivated by the broker- effecting the transaction or strategy on behalf of the Transamerica August 2018 Letter; see also generally dealer’s self-interest.’’ 144 Many customer (for example, the effort or cost of buying CFA August 2018 Letter; Better Markets August commenters expressed concerns or selling a complex or an illiquid security); or 2018 Letter. accepting a retail customer’s order that is contrary 154 However, paragraph (a)(2)(iii)(C) of Regulation regarding and requested removal of the to the broker-dealer’s recommendations. While Best Interest addresses a series of recommended ‘‘predominantly motivated’’ language, these practices will not be per se prohibited by transactions. See Section II.C.2.d. stating that it contradicted statements Regulation Best Interest, we are also not saying that 155 However, as discussed below, it is our that there was no scienter requirement these practices are per se consistent with Regulation position that when a broker-dealer agrees with a Best Interest or other obligations under the federal retail customer to provide account monitoring under Regulation Best Interest by securities laws. See also Proposing Release at services: (1) The broker-dealer would be required to 21587. disclose the material facts (including scope and 144 See Proposing Release at 21588. 149 Id at 21588. frequency) of those services pursuant to the

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to refuse to accept a customer’s order transaction or investment strategy greater the likelihood that the that is contrary to the broker-dealer’s involving securities to a retail customer. communication may be viewed as a recommendation; or (3) apply to self- We believed that by applying Regulation ‘‘recommendation.’’ We continue to directed or otherwise unsolicited Best Interest to a ‘‘recommendation,’’ as believe this general framework transactions by a retail customer, that term is currently interpreted under regarding what is a recommendation is whether or not she also receives broker-dealer regulation, we would appropriate, and for the reasons separate recommendations from the make clear when the obligation applied discussed in the Proposing Release, are broker-dealer. and would maintain efficiencies for taking this approach.162 broker-dealers that have already While certain commenters B. Key Terms and Scope of Best Interest established infrastructures to comply recommended formally defining the Obligation with suitability obligations, which are term ‘‘recommendation,’’ including recommendation-based.159 Moreover, 1. Natural Person Who Is an Associated what does not come within that term,163 we believed that focusing on each Person other commenters maintained there is recommendation would appropriately In the Proposing Release, we stated no need to define ‘‘recommendation’’ capture and reflect the various types of that a ‘‘natural person who is an and expressed support for harmonizing recommendations that broker-dealers associated person’’ is a natural person make to retail customers, whether on an the term in accordance with existing who is an associated person as defined 164 episodic, periodic, or more frequent broker-dealer guidance and case law. in Section 3(a)(18) of the Exchange Act: basis and would help ensure that retail We agree with commenters that clarity ‘‘any partner, officer, or director or customers receive the protections that is important, and we continue to believe branch manager of such broker or dealer Regulation Best Interest is intended to that the current principles-based (or any person occupying a similar provide. We received numerous approach underlying existing status or performing similar functions); comments supporting our general Commission precedent and guidance any person directly or indirectly proposed approach to what is a will provide effective clarity. Being controlling, controlled by, or under ‘‘recommendation,’’ while several more prescriptive could result in a common control with such broker or commenters suggested modifications definition that is over inclusive, under 165 dealer; or any employee of such broker regarding the scope of a inclusive, or both. We believe that or dealer, except that any person recommendation or sought additional what constitutes a recommendation is associated with a broker or dealer whose clarity regarding particular scenarios.160 highly fact-specific and not conducive functions are solely clerical or As we indicated in the Proposing to an express definition in the rule text. ministerial shall not be included in the Release, in our view, the determination Furthermore, we believe that the meaning of such term for purposes of of whether a broker-dealer has made a existing framework has worked well, Section 15(b) of this title (other than recommendation that triggers that broker-dealers generally are familiar paragraph 6 thereof).’’ 156 In limiting the application of Regulation Best Interest with the existing framework, and term to only a ‘‘natural person who is should turn on the facts and therefore, that this approach should an associated person,’’ we sought to circumstances of the particular situation continue. Accordingly, we are taking the exclude affiliated entities of the broker- and therefore, whether a approach as set forth in the Proposing dealer that are not themselves broker- recommendation has taken place is not Release, which we believe provides a dealers, as they are not the intended susceptible to a bright line definition. workable framework and clarity for focus of Regulation Best Interest.157 Factors considered in determining broker-dealers regarding the contours of We solicited comment on whether the whether a recommendation has taken a recommendation. To provide further application of the definition was place include whether the clarity, in response to comments, we appropriate, alternative definitions communication ‘‘reasonably could be describe below the types of should be considered, or the scope viewed as a ‘call to action’’’ and communications that we generally view should be broadened or narrowed. We ‘‘reasonably would influence an received no comments and, for the investor to trade a particular security or 162 See Proposing Release at 21592–21593. reasons discussed in the Proposing group of securities.’’ 161 The more 163 See, e.g., Prudential Letter (recommending an Release, are using the term ‘‘natural individually tailored the express definition of ‘‘recommendation’’ that would person who is an associated person,’’ communication to a specific customer codify guidance). 164 See, e.g., SIFMA August 2018 Letter consistent with the definition in Section or a targeted group of customers about (‘‘Similarly, the SEC refers to the FINRA concept of 158 3(a)(18) of the Exchange Act. a security or group of securities, the ‘recommendation’ rather than prescribing a specific definition. We believe this is appropriate, and we 2. Recommendation of Any Securities 159 Id. believe that a carve-out for educational materials Transaction or Investment Strategy would be consistent with that approach.’’); Edward 160 See generally SIFMA August 2018 Letter; Involving Securities Financial Engines Letter; IPA Letter; Putnam Letter; Jones Letter (‘‘We do not believe it is necessary for the SEC to define the phrase ‘at the time the We proposed to apply Regulation Best Cambridge Letter (recommending the Commission adopt FINRA’s approach to determining whether a recommendation is made,’ because its meaning is Interest to broker-dealer communication is a ‘‘recommendation’’). But see plain.’’); Cambridge Letter (‘‘FINRA Rule 2111 sets recommendations of any securities NASAA August 2018 Letter; BlackRock Letter; FSI forth an explicit standard for what constitutes a August 2018 Letter (recommending modifications recommendation and recognizes ‘call to action’ as or clarifications to ‘‘recommendation’’). the hallmark. Cambridge believes this definition is Disclosure Obligation, and (2) such agreed-upon 161 fully understood and in use by the industry.’’ account monitoring services involve an implicit See Proposing Release at 21592–21593; see also NASD Notice to Members 01–23, Online Cambridge also states that harmonizing the final recommendation to hold (i.e., an implicit rule with existing FINRA rules and guidance will recommendation not to buy, sell, or exchange assets Suitability—Suitability Rules and Online Communications (Apr. 2001); Notice of Filing provide clarity to firms, financial professionals, and pursuant to that securities account review) at the Proposed Rule Change to Adopt FINRA Rule 2090 investors). time agreed-upon monitoring occurs, which is a (Know Your Customer) and FINRA Rule 2111 165 See id.; Proposing Release at 21592–21593. recommendation ‘‘of any securities transaction or (Suitability) in the Consolidated FINRA Rulebook, Similarly, FINRA has stated that ‘‘defining the term investment strategy involving securities’’ covered Exchange Act Release No. 62718 (Aug. 13, 2010), ‘recommendation’ is unnecessary and would raise by Regulation Best Interest. 75 FR 51310 (Aug. 19, 2010), as amended, Exchange many complex issues in the absence of specific 156 Proposing Release at 21592–21593. Act Release No. 67218A (Aug. 20, 2010), 75 FR facts of a particular case.’’ Exchange Act Release 157 Id. 52562 (Aug. 26, 2010) (discussing what it means to No. 37588, 1996 SEC LEXIS 2285, at *29 (Aug. 20, 158 Id. make a ‘‘recommendation’’). 1996), 61 FR 44100, 44107 (Aug. 27, 1996).

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as falling outside of the scope of a retail customer to monitor that the broker-dealer does not provide an recommendation. customer’s account: (1) The broker- express recommendation to buy, sell, or We are also generally confirming our dealer is required to disclose the terms hold.171 interpretation in the Proposing Release of such account monitoring services We recognize that a broker-dealer may of the phrase ‘‘any securities transaction (including the scope and frequency of voluntarily, and without any agreement or investment strategy involving those services) pursuant to the with the customer, review the holdings securities.’’ However, in response to Disclosure Obligation 168 and (2) such in a retail customer’s account for the comments regarding the coverage of agreed-upon monitoring involves an purposes of determining whether to certain securities or investment implicit recommendation to hold (i.e., provide a recommendation to the strategies, we are providing further recommendation not to buy, sell, or customer. We do not consider this clarity regarding our interpretation of exchange assets pursuant to that voluntary review to be ‘‘account this phrase, and in certain instances, securities account review) at the time monitoring,’’ nor would it in itself refining our interpretation. For example, the agreed-upon monitoring occurs, create an implied agreement with the as discussed more fully below, we are which is a recommendation ‘‘of any retail customer to monitor the confirming our interpretation that securities transaction or investment customer’s account. Any explicit recommendations of ‘‘any securities strategy involving securities’’ covered recommendation made to the retail transaction’’ (purchase, sale, or by Regulation Best Interest.169 As customer as a result of any such exchange) and any ‘‘investment discussed further below, in our view, a voluntary review would be subject to strategy’’ involving securities (including recommendation of ‘‘an investment Regulation Best Interest. an explicit hold recommendation) are strategy’’ includes implicit hold Finally, in response to comments recommendations ‘‘of any securities recommendations in this context, where received, we have modified the rule text transaction or investment strategy the broker-dealer has agreed to monitor to provide that an ‘‘investment strategy involving securities.’’ a retail customer’s account.170 We are involving securities’’ includes ‘‘account In addition, we are generally interpreting the phrase ‘‘any security recommendations.’’ We interpret confirming our interpretation that a transaction or investment strategy’’ to ‘‘account recommendations’’ to include broker-dealer may agree with a retail include instances where there is an recommendations of securities account customer to take on additional agreement to monitor because in this types generally, as well as obligations beyond those imposed by context there is an implicit recommendations to roll over or transfer Regulation Best Interest, for example, by recommendation to hold at the time the assets from one type of account to agreeing with a retail customer to agreed-upon monitoring occurs when another (e.g., workplace retirement plan provide monitoring of the retail to an IRA). As discussed in more detail customer’s investments on a periodic the broker-dealer’s course of conduct. In cases below, we believe that basis for purposes of recommending where a broker-dealer does not intend to create an recommendations of securities account changes in investments.166 In response implied agreement to monitor the retail customer’s types are consistent with the types of account through course of conduct or otherwise, to comments, it is our position that and to avoid ambiguity over whether an implied recommendations that have been treated when a broker-dealer agrees 167 with a agreement has been formed, broker-dealers should as investment strategies,172 because the take steps to ensure that all communications with 166 Proposing Release at 21594–21595. The the retail customer are consistent with its 171 Our interpretation is generally consistent with Proposing Release referred to ‘‘ongoing’’ monitoring disclosures required under the Disclosure commenters’ views regarding the application of of the retail customer’s investments for purposes of Obligation, which in this case would require the Regulation Best Interest to implicit hold recommending changes in investments. Id. In the broker-dealer to clearly disclose that the broker- recommendations in the context of agreed-upon discussion that follows and the Solely Incidental dealer does not monitor the retail customer’s account monitoring services. See IAC 2018 Interpretation, we are clarifying our views regarding account. Recommendation (‘‘we believe the best interest broker-dealer account monitoring services, and the 168 To avoid ambiguity over whether or when an standard should be applied to the broker-dealer’s application of Regulation Best Interest to such implicit hold recommendation has been made, this monitoring of the customer account, where brokers services. As discussed in the Solely Incidental disclosure should identify with specificity when provide ongoing services to the account. In essence, Interpretation, a broker-dealer that agrees to the agreed upon monitoring will occur. See also this would apply the best interest standard to the monitor a retail customer’s account on a periodic FINRA Regulatory Notice 12–25 at Q14. implicit ‘‘no recommendation’’ recommendation basis for purposes of providing buy, sell, or hold 169 See IAC 2018 Recommendation; NAIFA Letter; that a broker makes when reviewing the account recommendations may still be considered to AFL–CIO April 2019 Letter; see also FINRA and recommending no change.’’); NAIFA Letter provide advice in connection with and reasonably Regulatory Notice 12–25, Suitability—Additional (asserting broker-dealers should be free to agree to, related to effecting securities transactions. Broker- Guidance on FINRA’s New Suitability Rule (May and define the nature of, any ongoing relationship dealers may choose to adopt policies and 2012) at Q3 and accompanying footnotes. via contract, such as including monitoring services). procedures that, if followed, would help 170 See FINRA Rule 2111.03; FINRA Regulatory See also AFL–CIO April 2019 Letter (‘‘adopt a demonstrate that any agreed-upon monitoring is in Notice 12–25. The Commission recognizes that its principles-based obligation to monitor the account, connection with and reasonably related to the position with respect to Regulation Best Interest where the nature and extent of the monitoring broker-dealer’s primary business of effecting differs from that provided in FINRA guidance follows the contours of the relationship’’). See also securities transactions. See Solely Incidental regarding whether implicit hold recommendations supra footnote 166 (encouraging broker-dealers to Interpretation. are subject to the suitability rule. This adopt policies and procedures that, if followed, 167 An agreement to provide account monitoring interpretation applies in the context of the would help demonstrate that any agreed-upon services to a retail customer is not required to be protections of Regulation Best Interest, and does not monitoring is in connection with and reasonably in writing (although whether or not the broker- change the scope of the application of the FINRA related to the broker-dealer’s primary business of dealer is providing account monitoring services, suitability rule. Further, while for purposes of effecting securities transactions in accordance with and, if so, the scope and frequency of such Regulation Best Interest implicit hold the Solely Incidental Interpretation). monitoring services, must be disclosed in writing recommendations are generally recommendations 172 Although FINRA has stated that a pursuant to the Disclosure Obligation). For of ‘‘any securities transaction or investment strategy recommendation concerning the type of workplace example, a broker-dealer’s oral undertaking that the regarding securities’’ where a broker-dealer agrees retirement plan account in which a customer broker-dealer will monitor the retail customer’s to provide account monitoring services, we are not should hold his retirement investments typically account on a periodic basis would create an otherwise addressing the treatment of implicit hold involves a recommended securities transaction, and agreement to monitor the account on the terms recommendations in other contexts. In other words, thus is subject to suitability requirements, FINRA specified orally. Whether an agreement with the except where a broker-dealer agrees to provide did not address whether such a recommendation retail customer has been established in the absence account monitoring services as described, would be an investment strategy in the absence of of a written agreement or express oral undertaking consistent with existing FINRA guidance, such a recommended securities transaction. FINRA will depend on an objective inquiry of the Regulation Best Interest will only apply to explicit Regulatory Notice 13–45, Rollovers to Individual particular facts and circumstances, including hold recommendations. See FINRA Regulatory Retirement Accounts—FINRA Reminds Firms of reasonable retail customer expectations arising from Notice 12–25 at Q3 and accompanying footnotes. Their Responsibilities Concerning IRA Rollovers

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type of securities account recommended interest obligation consistent with an explicit carve out or confirmation is an investment strategy that has the precedent under the anti-fraud that certain communications, such as potential to greatly affect retail provisions of the federal securities laws general education materials, general customers’ costs and investment as applied to broker-dealers, and with retirement planning materials, or returns.173 For example, different types how the term has been applied under general retirement communications, of securities accounts can offer different the rules of self-regulatory organizations including ‘‘pure distribution features, products, or services, some of (‘‘SROs’’).176 Several commenters recommendations,’’ are not which may—or may not—be in the best supported this approach, and ‘‘recommendations’’ subject to interest of certain retail customers.174 specifically agreed with following the Regulation Best Interest.179 Our interpretation is consistent with a existing facts and circumstances The treatment of certain majority of the IAC and other approach as understood under federal communications as ‘‘education’’ rather commenters that stated that such securities laws and SRO rules.177 than ‘‘recommendations’’ is well important recommendations relating to Commenters sought additional clarity understood by broker-dealers. We securities are ‘‘investment strategies regarding the scope of a generally view the following types of involving securities’’ and thus within recommendation and in particular communications as not being the scope of Regulation Best Interest.175 whether certain activities or recommendations of any securities We note that, although we are communications would constitute transaction or investment strategy specifically identifying ‘‘account recommendations, and requested that involving securities as long as they do recommendations’’ as an investment the Commission incorporate or not include, standing alone or in strategy involving securities in the rule specifically identify exceptions or combination with other text, an account recommendation is just exclusions such as the exceptions communications, a recommendation of one example of an investment strategy. recognized in FINRA Rule 2111.03 a particular security or securities or (Suitability) or acknowledged by the particular investment strategy involving a. Recommendation 178 DOL. Some commenters also sought securities: 180 We interpret whether a • General financial and investment ‘‘recommendation’’ has been made to a 176 See Proposing Release at 21592–21595. In this information, including: retail customer that triggers the best regard, Regulation Best Interest does not extend Æ beyond a particular recommendation, for example, Basic investment concepts, such as by imposing a general broker-dealer duty to monitor risk and return, diversification, dollar (Dec. 2013). Taking this approach is consistent with a customer’s account or by applying the duty to cost averaging, compounded return, and Commission precedent finding a recommendation unsolicited orders. tax deferred investment, of a margin strategy to be unsuitable under the 177 See, e.g., AXA Letter; SIFMA August 2018 Æ NASD suitability rule, in light of the associated Letter; IPA Letter; Putnam Letter; FSI August 2018 historic differences in the return of transactions costs and the impact the strategy could Letter; Cetera August 2018 Letter. asset classes (e.g., equities, bonds, or have on customer returns. See F.J. Kaufman & Co., 178 See, e.g., Prudential Letter; Transamerica cash) based on standard market indices, 50 SEC. 164 (1989) (Commission Opinion) (stating August 2018 Letter; SPARK Letter; see also FINRA Æ effects of inflation, that a broker-dealer recommending the purchase of Rule 2111.03 (excluding the following Æ estimates of future retirement securities using a margin strategy ‘‘at a minimum communications from the coverage of Rule 2111 as . . . had an obligation to understand that, in light long as they do not include (standing alone or in income needs, and of the applicable transaction costs, the two combination with other communications) a Æ assessment of a customer’s components of his recommended strategy, when recommendation of a particular security or investment profile; combined, always would have produced returns securities: (a) General financial and investment • Descriptive information about an inferior to those that could have been obtained from information, including: (i) Basic investment one of those components alone.’’). concepts, such as risk and return, diversification, employer-sponsored retirement or 173 See SEC Office of Investor Education and dollar cost averaging, compounded return, and tax benefit plan, participation in the plan, Advocacy, Updated Investor Bulletin: How Fees deferred investment, (ii) historic differences in the the benefits of plan participation, and and Expenses Affect Your Investment Portfolio return of asset classes (e.g., equities, bonds, or cash) based on standard market indices, (iii) effects of the investment options available under (Sep. 2016). the plan; 181 174 In addition to brokerage versus investment inflation, (iv) estimates of future retirement income advisory accounts, there are also many options or needs, and (v) assessment of a customer’s investment profile; (b) Descriptive information account types within brokerage accounts. For 179 See SPARK Letter; NAGDCA Letter. Similarly, about an employer-sponsored retirement or benefit example, brokerage accounts can include: communications regarding participation in a plan plan, participation in the plan, the benefits of plan Education accounts (e.g., 529 Plans and tax-free and communications to make or increase plan participation, and the investment options available Coverdell accounts); retirement accounts (e.g., IRA, contributions, without more, would generally not under the plan; (c) Asset allocation models that are: Roth IRA, or SEP–IRA accounts); and specialty come within ‘‘recommendation.’’ (i) Based on generally accepted investment theory, 180 accounts (e.g., cash or margin accounts, and (ii) accompanied by disclosures of all material facts This concept also applies to investment accounts with access to Forex or options trading). and assumptions that may affect a reasonable strategies. See FINRA Regulatory Notice 11–25, Different brokerage accounts can also offer different investor’s assessment of the asset allocation model Know Your Customer and Suitability—New levels of services, such as access to online trading, or any report generated by such model, and (iii) in Implementation Date for and Additional Guidance or can offer different products, for example, in compliance with Rule 2214 (Requirements for the on the Consolidated FINRA Rules Governing Know- higher dollar amount accounts (e.g., access to Use of Investment Analysis Tools) if the asset Your-Customer and Suitability Obligations (May products with break-points). allocation model is an ‘‘investment analysis tool’’ 2011) at FAQ 9 (‘‘It is important to note, however, 175 See, e.g., IAC 2018 Recommendation covered by Rule 2214; and (d) Interactive that the suitability rule would not apply to a firm’s (‘‘Decisions about which type of account to open investment materials that incorporate the above). explanation of a strategy falling outside the safe- have the potential to greatly affect their costs. The DOL took a similar approach, excluding from harbor provision if a reasonable person would not Moreover, both rollover and account type the term ‘‘recommendation,’’ among other things, view the communication as a recommendation. recommendations are recommendations of an general communications and investment education Accordingly, the suitability rule would cover a ‘investment strategy involving securities’ that can (including plan information, general financial, firm’s recommendation that a customer purchase have substantial potential long-term impacts on investment and retirement information, asset securities using margin, whereas the rule generally investors. Both types of recommendations allocation models and interactive investment would not cover a firm’s brochure that simply inherently involve potential conflicts of interest, materials). See DOL Interpretative Bulletin 96–1; explains the risks and benefits of margin without making it critical that advisers and brokers put their Participant Investment Education, 29 CFR 2509.96– suggesting that the customer take action.’’). clients’ interests ahead of their own in making such 1, 61 FR 29588 (Jun. 11, 1996) (IB 96–1). See also 181 While this descriptive information would be recommendations.’’); Capital Group Letter DOL, Definition of the Term ‘‘Fiduciary’’; Conflict treated as ‘‘education’’ rather than a (‘‘Choosing between a brokerage and an advisory of Interest Rule—Retirement Investment Advice, 81 ‘‘recommendation,’’ we caution broker-dealers to account is an incredibly impactful decision for FR 20945, 20975 (Apr. 8, 2016) (noting that the now ensure that communications by their associated investors. It is very important that these vacated DOL Fiduciary Rule would have carved out persons intended as ‘‘education’’ do not cross the recommendations be made in the best interest of the investment education from the definition of line into ‘‘recommendations.’’ See FINRA retail [customer].’’). investment advice, incorporating much of IB 96–1). Regulatory Notice 13–45.

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• Asset allocation models that are: b. Interpretation of Any Securities to state that an ‘‘investment strategy Æ Based on generally accepted Transaction or Investment Strategy involving securities’’ includes ‘‘account investment theory, Involving Securities recommendations.’’ We interpret Æ accompanied by disclosures of all As proposed, Regulation Best Interest ‘‘account recommendations’’ to include material facts and assumptions that may would apply to recommendations of recommendations by broker-dealers of securities account types generally,188 affect a reasonable investor’s assessment ‘‘any securities transaction’’ (purchase, as well as recommendations to roll over or of the asset allocation model or any sale, and exchange) and any transfer assets from one type of account report generated by such model, and ‘‘investment strategy’’ involving Æ in compliance with FINRA Rule to another (e.g., workplace retirement securities (including explicit 2214 (Requirements for the Use of plan account to an IRA).189 In addition, recommendations to hold a security or Investment Analysis Tools) if the asset the Commission is stating its view that regarding the manner in which it is to allocation model is an ‘‘investment ‘‘any securities transaction or be purchased or sold). In addition, the analysis tool’’ covered by FINRA Rule investment strategy involving Proposing Release stated that securities 2214; 182 and securities’’ not only includes explicit transactions or investment strategies • Interactive investment materials hold recommendations, but also involving securities might also include that incorporate the above. includes implicit hold recommendations to roll over or transfer Thus, for example, a general recommendations that are the result of assets from one type of account to conversation about retirement planning, agreed-upon account monitoring another, such as recommendations to such as providing a company’s between the broker-dealer and retail roll over or transfer assets from a retirement plan options to a retail customer.190 retirement plan.185 Finally, although we customer, would not, by itself, rise to did not propose to cover account type Account Recommendations the level of a recommendation. recommendations generally, we noted Similarly, where a broker-dealer informs The Proposing Release indicated that that evaluating the appropriateness of a retail customer that he or she needs to securities transactions or investment the type of account is an issue that take a required minimum distribution strategies involving securities could relates to both broker-dealers and under the Internal Revenue Code, we include recommendations to roll over or investment advisers, and requested would not interpret such transfer assets from one type of account comment on whether and how we communication, by itself, to rise to the to another, such as recommendations to should address this type of level of a recommendation. Such a roll over or transfer assets in a recommendation. communication would be considered workplace retirement plan account to an In response to the Proposing Release, investment education or descriptive IRA, and requested comment on several commenters supported the information, provided it does not whether and how to address account Commission’s approach; however, involve, for example, a recommendation type recommendations. several commenters also requested Several commenters suggested regarding specific securities to be sold modifications or clarifications regarding expanding Regulation Best Interest to or a recommendation regarding specific products or strategies covered under explicitly cover rollover securities to be purchased with the Regulation Best Interest. For example, a recommendations and proceeds of any sale.183 We agree with majority of the IAC and numerous recommendations by firms regarding commenters that Regulation Best commenters highlighted the conflicts of account types. For example, a majority Interest should not stifle investment interest associated with account type of the IAC explained that rollover education as a means to encourage recommendations, and urged the recommendations ‘‘are frequently financial wellness, or otherwise restrict Commission to apply Regulation Best provided at a critical juncture in an broker-dealers from disseminating Interest to account type investor’s life—retirement—and are information about, for example, recommendations generally, and to IRA often irrevocable decisions,’’ and further retirement plans, and the approach we rollovers.186 Relatedly, several noted that ‘‘[d]ecisions about which are taking to what is or is not considered commenters sought clarity regarding type of account to open have the a ‘‘recommendation’’ achieves this whether and when a rollover or account goal.184 type recommendation would be a 188 In the discussion of the Care Obligation in ‘‘recommendation’’ under Regulation Section II.C.2, we are also setting forth additional 182 In this regard, as an allocation positions regarding the application of the Care 187 recommendation becomes narrower or more Best Interest. Obligation to account type recommendations, as specific, the recommendation gets closer to After careful consideration of well as recommendations to roll over or transfer becoming a recommendation of particular securities comments and feedback, the assets from one account to another. See also and, thus, subject to the suitability rule. See FINRA Fiduciary Interpretation (explaining that ‘‘[a]dvice Regulatory Notice 12–25 at FAQ 8. Commission has modified the rule text about account type includes advice about whether 183 See, e.g., SPARK Letter (asking for to open or invest through a certain type of account confirmation that ‘‘pure ‘distribution retirement investors’’); see also Transamerica (e.g., a commission-based brokerage account or a recommendations’ involving retirement accounts, August 2018 Letter (suggesting the exclusion of fee-based advisory account) and advice about such as those required under Internal Revenue Code various conversations designed to facilitate whether to roll over assets from one account (e.g., section 401(a)(9), are not a ‘recommendation of any retirement savings). a retirement account) into a new or existing account securities transaction or investment strategy 185 See Proposing Release at 21595. that the adviser or an affiliate of the adviser involving securities.’ ’’). However, informing a retail 186 See, e.g., IAC 2018 Recommendation manages’’). customer about a required minimum distribution (supporting the ‘‘expan[sion] of the best interest 189 A majority of the IAC and numerous may become a recommendation where a broker- obligation to cover rollover recommendations and commenters expressed the importance of account dealer includes (standing alone or in combination recommendations by dual registrant firms regarding rollovers and the need for rollovers to be covered with other communications) a recommendation of, account types’’); see also NASAA August 2018 under Regulation Best Interest. See, e.g., IAC 2018 or regarding, a particular security or securities or an Letter; SPARK Letter; Financial Engines Letter; Recommendation; Financial Engines Letter. investment strategy involving securities. See FINRA Cetera August 2018 Letter; AFL–CIO April 2019 190 Several commenters stated that broker-dealers Rule 2111 (Suitability) FAQ. Letter. But see SIFMA August 2018 Letter (viewing should be able to contract with retail customers to 184 See SPARK Letter (suggesting expressly recommendations of an account type as not provide additional services, such as account excluding beneficial conversations about retirement involving a recommendation of a securities monitoring, and that such agreed upon services savings and ‘‘ensuring that Regulation Best Interest transaction or investment strategy involving should be subject to Regulation Best Interest. See, does not discourage broker-dealers in any way from securities). e.g., NAIFA Letter; IAA August 2018 Letter; AFL– having these important conversations with 187 See, e.g., NAGDCA Letter; FPC Letter. CIO April 2019 Letter.

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potential to greatly affect [retail regardless of whether they are tied to a term ‘‘investment strategy involving customers’] costs’’ and that both specific securities transaction.194 securities’’ includes ‘‘account rollovers and account type Existing broker-dealer regulation and recommendations,’’ which we interpret recommendations can ‘‘have substantial guidance stresses that the term to include recommendations of potential long-term impacts on ‘‘investment strategy’’ is to be securities account types generally, as investors.’’ 191 Another commenter interpreted broadly, and would include, well as recommendations to roll over or noted that ‘‘[r]etirees have no practical among others, recommendations transfer assets.199 ability to recoup lost spending power by generally to use a bond ladder, day Thus, such account recommendations returning to work and setting aside trading, ‘‘liquefied home equity,’’ or will be subject to Regulation Best additional retirement savings, so they margin strategy involving securities, Interest even if there is not a are particularly vulnerable to the irrespective of whether the recommendation of a securities adverse consequences of poor advice recommendations mention particular transaction. Although we proposed only and high expenses.’’ 192 Finally, a securities.195 This approach covering account type recommendations majority of the IAC and several appropriately recognizes that customers that are tied to securities transactions, commenters noted that broker-dealers may rely on firms’ and associated and not account type recommendations and investment advisers alike have a persons’ investment expertise and generally, we agree with commenters strong economic incentive to knowledge, and therefore the broker- and a majority of the IAC that consistent recommend investors roll over plan dealer should be responsible for such with other investment strategies assets into an IRA or otherwise transfer recommendations, regardless of whether involving securities, securities account assets to open an account with the those recommendations result in type recommendations should be broker-dealer or investment adviser.193 transactions or generate transaction- covered under Regulation Best Interest After consideration of comments based compensation.196 regardless of whether those received, including concerns expressed Account recommendations, including recommendations result in transactions about the conflicts associated with recommendations of securities account or generate transaction-based recommendations of account types, IRA types generally (e.g., to open an IRA or compensation.200 In addition, as rollovers and retirement advice more other brokerage account), and discussed in the Fiduciary broadly, it is our view that Regulation recommendations to roll over or transfer Interpretation, investment advisers’ Best Interest should apply broadly to assets into an IRA or another securities fiduciary duty applies to advice to recommendations of securities account, are consistent with the types of clients about account types, which transactions and investment strategies recommendations that have been treated satisfies the concerns about parity set involving securities. Accordingly, the as investment strategies under existing forth in the Proposing Release and 197 Commission is including in the rule text suitability rules. Specifically, like protects retail customers of broker- account recommendations as other investment strategies, account dealers and retail clients of investment 201 recommendations that will be covered recommendations are recommendations advisers alike. by Regulation Best. ‘‘Account of an approach or method (i.e., a Where a financial professional who is recommendations’’ include ‘‘strategy’’) for how a retail customer dually registered (i.e., an associated recommendations of securities account should engage in transactions in person of a broker-dealer and a types generally (e.g., to open an IRA or securities, involve conflicts of interest, supervised person of an investment other brokerage account), as well as and can have long-term effects on adviser (regardless of whether the recommendations to roll over or transfer investors’ costs and returns from their professional works for a dual-registrant, 198 affiliated firm, or unaffiliated firm)) is assets from one type of account to investments. In addition, we believe making an account recommendation to another (e.g., a workplace retirement retail customers rely on broker-dealers’ a retail customer,202 whether Regulation plan account to an IRA). and associated persons’ investment Although account recommendations, expertise and knowledge with respect to Best Interest or the Advisers Act will including recommendations of a such recommendations. As a result, apply will depend on the capacity in securities account type generally, as such recommendations must be made which the financial professional making consistent with the retail customer’s well as recommendations to roll over 199 assets from a workplace retirement plan objectives and needs (i.e., investment See, e.g., IAC 2018 Recommendation; Capital profile), irrespective of whether those Group Letter (‘‘Choosing between a brokerage and account to an IRA or to open an IRA an advisory account is an incredibly impactful held at the broker-dealer, will almost recommendations are tied to a specific decision for investors. It is very important that these always involve a ‘‘securities securities transaction. Consistent with a recommendations be made in the best interest of the majority of the IAC’s and other retail [customer].’’). transaction’’ (such as a securities 200 See, e.g., IAC 2018 Recommendation; NASAA purchase, sale, or exchange), and thus commenters’ suggestions, we are modifying the rule text to state that the August 2018 Letter. would generally be subject to Regulation 201 See Fiduciary Interpretation. Best Interest, we are modifying the rule 202 As discussed in more detail below in Section 194 A recommendation that a retail customer roll text to provide that such II.B.3.b, Regulation Best Interest applies to a retail over or transfer assets to an IRA held at the broker- customer who receives a recommendation and uses recommendations are ‘‘investment dealer, or open an IRA or another securities account the recommendation. Among other things, we strategies involving securities’’ for with a broker-dealer, presumes that the interpret a retail customer to use a recommendation purposes of Regulation Best Interest, recommendation would involve transactions in when: (1) The retail customer opens a brokerage securities, even if the rollover or account account with the broker-dealer, regardless of recommendation does not result in transactions or whether the broker-dealer receives compensation; 191 IAC 2018 Recommendation. See also Letter transaction-based compensation. (2) the retail customer has an existing account with from Brian H. Graff, Executive Director and CEO, 195 See FINRA Rule 2111.03; FINRA Regulatory the broker-dealer and receives a recommendation Craig P. Hoffman, General Counsel, Doug Fisher, Notice 12–25 at Q7. from the broker-dealer, regardless of whether the Director of Retirement Policy, American Retirement 196 See FINRA Regulatory Notice 11–02, Know broker-dealer receives or will receive compensation, Association (‘‘ARA’’) (Dec. 13, 2018) (‘‘ARA Your Customer and Suitability—SEC Approves directly or indirectly, as a result of that December 2018 Letter’’); Transamerica August 2018 Consolidated FINRA Rules Governing Know-Your- recommendation; or (3) the broker-dealer receives Letter. Customer and Suitability Obligations (Jan. 2011). or will receive compensation, directly or indirectly 192 Fiduciary Benchmarks Letter. 197 See supra footnotes 172 and 173. as a result of that recommendation, even if that 193 See, e.g., IAC 2018 Recommendation; NASAA 198 See Capital Group Letter; see also IAC 2018 retail customer does not have an account at the August 2018 Letter; Fiduciary Benchmarks Letter. Recommendation; NASAA August 2018 Letter. firm.

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the recommendation is acting.203 As explicit recommendations to hold a Regulation Best Interest should apply to discussed further in the Care Obligation, security or regarding the manner in any recommendations that result from if the individual is acting as a broker- which it is to be purchased or sold to the account monitoring services that a dealer or associated person thereof, he retail customers.204 The Proposing broker-dealer agrees to provide.209 We or she must comply with Regulation Release also recognized that broker- believe that any monitoring service Best Interest and will need to take into dealers may agree with a retail customer agreed to by the broker-dealer, the scope consideration all types of accounts by contract to take on additional and frequency of which would be offered by the financial professional obligations beyond those imposed by required to be disclosed pursuant to the (i.e., both brokerage and advisory Regulation Best Interest, for example, by Disclosure Obligation, would be covered accounts) when making the agreeing with a retail customer to by Regulation Best Interest, as these recommendation of an account that is in provide periodic or ongoing services, activities will result in a the retail customer’s best interest. such as ongoing monitoring of the retail recommendation to purchase, sell, or In the case of an account customer’s investments for purposes of hold a security, or the manner in which recommendation by a financial recommending changes in to purchase, sell, or hold a security, at professional who is only registered as an investments.205 To the extent that a each time the agreed-upon monitoring associated person of broker-dealer broker-dealer takes on such additional occurs.210 Thus, by agreeing to perform (regardless of whether that broker-dealer obligations, the Proposing Release account monitoring services, the broker- entity is a dual-registrant or affiliated indicated that Regulation Best Interest dealer is taking on an obligation to with an investment adviser), Regulation would apply to any recommendations review and make recommendations Best Interest will apply to the about securities or investment strategies with respect to that account (e.g., to buy, recommendation. Further, the involving securities made to retail sell or hold) on that specified, periodic associated person can only recommend customers resulting from such services. basis.211 For example, if a broker-dealer a brokerage account that the broker- Several commenters agreed that agrees to monitor the retail customer’s dealer offers when the associated person broker-dealers should be able to contract account on a quarterly basis, the has a reasonable basis to believe that the with retail customers for additional quarterly review and each resulting recommended brokerage account is in services and be able to expand the recommendation to purchase, sell, or the best interest of the retail customer relationship on their own terms, while hold, will be a recommendation subject and the broker-dealer otherwise other commenters recommended that a to Regulation Best Interest. This is the complies with Regulation Best Interest. duty to monitor apply to broker-dealers case even in instances where the broker- Regulation Best Interest would apply depending on the facts and dealer does not communicate any 206 to account recommendations by the circumstances. Other commenters recommendation to the retail customer. dual-registrant firm, and consistent with suggested that the Commission not We believe that such an ‘‘implicit’’ the Conflict of Interest Obligation, the impose a duty to monitor brokerage recommendation to hold in this context 207 firm would need to, among other things, accounts. should be covered under Regulation establish, maintain and enforce policies We are confirming that, consistent Best Interest in addition to ‘‘explicit’’ 212 and procedures to identify, disclose, with existing broker-dealer regulation, recommendations to hold. and mitigate, any incentives for an Regulation Best Interest will apply to This position differs from FINRA explicit recommendations to hold a guidance, which generally states that associated person of the broker-dealer to 208 place the interest of the firm or the security or securities. We are also the FINRA suitability rule does not cover an implicit recommendation to associated person ahead of the interests confirming that Regulation Best Interest hold.213 We believe that ‘‘implicit’’ hold of the retail customer. does not impose a duty to monitor a In the discussion of the Care retail customer’s account. We agree, however, with commenters that 209 See NAIFA Letter; IAA August 2018 Letter. Obligation below, we discuss how a 210 In agreeing to provide any account monitoring broker-dealer and associated persons of 204 Proposing Release at 21593–21595. services, broker-dealers need to consider whether the monitoring services fit within the broker-dealer a broker-dealer can make 205 Id. We also asked whether broker-dealers who recommendations of securities account exclusion from the Advisers Act. See Solely provide ongoing monitoring should be considered Incidental Interpretation. types, including recommendations to investment advisers. Id. at 21592. 211 The broker-dealer would also be required to 206 open an IRA or to roll over assets into See, e.g., NAIFA Letter (‘‘Additionally, while disclose the existence, scope, and frequency of such an IRA, in the best interest of the retail the best interest standard applies to each account monitoring services pursuant to the recommendation and may not be waived or customer. Disclosure Obligation. To avoid ambiguity over modified by contract as it applies to those whether or when an implicit hold recommendation Hold Recommendations recommendations, it should not be interpreted to has been made, this disclosure should identify with create obligations with respect to other, expanded specificity when the agreed upon monitoring will The Proposing Release stated that services (e.g., ongoing research and monitoring occur. services, regular in-person meetings, etc.). Again, 212 See FINRA Rule 2111.03 (noting ‘‘[t]he phrase Regulation Best Interest would apply to however, advisors and consumers may agree to any securities transaction or investment ‘investment strategy involving a security or expand the relationship in these ways on their own securities’ used in this Rule is to be interpreted strategy involving securities, including terms.’’); see also CFA August 2018 Letter; Better broadly and would include, among other things, an Markets August 2018 Letter (recommending the explicit recommendation to hold a security or 203 See Section II.B.3.d, below for discussion of Commission establish a duty to monitor depending securities.’’); see also NASAA August 2018 Letter. on the facts and circumstances); AFL–CIO April factors the Commission will consider in 213 FINRA Regulatory Notice 11–25 at Q7 (‘‘The 2019 Letter. determining capacity. See also Fiduciary rule, for instance, would not apply where an Interpretation at footnotes 42–44 and accompanying We note that additional commenters maintained associated person remains silent regarding, or text. As discussed in the Fiduciary Interpretation, that if broker-dealers agree with retail customers to refrains from recommending the sale of, securities while advice to prospective clients about these provide ongoing monitoring for purposes of held in an account. That is true regardless of matters is subject to the antifraud provisions under recommending changes in investments, they should whether the associated person previously section 206 of the Advisers Act, the adviser must be considered investment advisers. See NASAA recommended the purchase of the securities, the also satisfy its fiduciary duty with respect to any August 2018 Letter; FPC Letter. We have addressed customer purchased them without a such advice (e.g., regarding account type) once a these comments in the context of the Solely recommendation, or the customer transferred them prospective client becomes a client. Thus, at the Incidental Interpretation. See Solely Incidental into the account from another firm where the same point in time at which the prospective client Interpretation. or a different associated person had handled the becomes a client of the investment adviser (e.g., at 207 See IAA August 2018 Letter. account.’’). See also id. at footnote 21 (‘‘To the account opening), the fiduciary duty applies. Id. 208 See FINRA Regulatory Notice 12–25. extent that a customer account at a broker-dealer

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recommendations in this context, where Although for purposes of Regulation Regulation Best Interest where they the broker-dealer agrees to provide Best Interest, implicit hold involve securities transactions or specified account monitoring services, recommendations will be considered a investment strategies involving are similar to explicit hold recommendation of ‘‘any securities securities. We agree with commenters recommendations that are considered transaction or investment strategy that recommendations to retail ‘‘investment strategies’’ because they regarding securities’’ where a broker- customers to take distributions from would constitute the type of dealer has agreed to provide account proceeds of specific securities or to take recommendations that retail customers monitoring services, we are not in-service loans from an employer- would be expected to rely upon and otherwise changing the treatment of sponsored plan are recommendations of would be a ‘‘call to action’’ in the sense implicit hold recommendations in other a securities transaction, as they would of a recommendation that the customer contexts. In other words, unless the involve a recommendation to sell a stay the course.214 We believe that, in broker-dealer has agreed to provide security.221 However, while such this context, silence is tantamount to an account monitoring services as recommendations to take plan explicit recommendation to hold, and described, Regulation Best Interest distributions are ‘‘recommendations’’ should be viewed as a recommendation would only apply to explicit—and not and thereby subject to Regulation Best to hold the securities for purposes of to implicit—hold recommendations Interest, we reiterate that general Regulation Best Interest.215 Our regarding security positions in an communications by broker-dealers interpretation that the term ‘‘investment account.217 This is consistent with the relating to distributions in the context of strategy involving securities’’ includes fact that Regulation Best Interest would a required minimum distribution or implicit recommendations to hold that not impose a duty to monitor customer education regarding a plan’s options result from an agreement to monitor, at accounts.218 would not, by themselves, constitute the time the agreed-upon monitoring Finally, although certain commenters recommendations that would be subject occurs, is generally consistent with the stated that account monitoring services to Regulation Best Interest.222 treatment of similar broker-dealer should only be performed by investment 219 3. Retail Customer communications as ‘‘investment advisers, we reiterate that Regulation strategies,’’ and applies the Regulation Best Interest does not change the scope We proposed to define retail customer Best Interest protections to retail of account monitoring that broker- as: ‘‘a person, or the legal representative customers relying on a broker-dealer’s dealers may agree to provide, nor does of such person, who: (1) Receives a agreement to monitor the customer’s it change the scope of activities that recommendation of any securities transaction or investment strategy account.216 would come within the ‘‘solely incidental’’ prong of the broker-dealer involving securities from a broker, can be discretionary under applicable federal exclusion to the definition of dealer, or a natural person who is an securities laws, the suitability rule generally would ‘‘investment adviser’’ in the Advisers associated person of a broker or dealer, not apply where a firm refrains from selling a Act. We recognize that a broker-dealer and (2) uses the recommendation security. The rule states that it applies to explicit may voluntarily, and without any primarily for personal, family or recommendations to hold. Unless the facts indicate household purposes.’’ 223 The definition that an associated person’s failure to sell securities agreement with the customer, review in a discretionary account was intended as or the holdings in a retail customer’s was generally intended to track the tantamount to an explicit recommendation to hold, account for the purpose of determining definition of ‘‘retail customer’’ under FINRA would not view the associated person’s whether to provide a recommendation Section 913(a) of the Dodd-Frank Act inaction or silence in such circumstances as a to the customer. We view this voluntary with some differences, as described in recommendation to hold the securities for purposes 224 of the suitability rule.’’). review—and any subsequent the Proposing Release. 214 See FINRA Regulatory Notice 11–25 at Q7 recommendation to the customer—as in In proposing the definition, we (‘‘The rule would apply, for example, when an connection with and reasonably related intended to exclude recommendations associated person meets with a customer during a quarterly or annual investment review and to the broker-dealer’s primary business of effecting securities transactions.220 221 See supra footnotes 185–189 and explicitly advises the customer not to sell any accompanying text. See, e.g., NASAA August 2018 securities in or make any changes to the account or Recommendations Involving Retirement Letter; Fiduciary Benchmarks Letter; IAC 2018 portfolio.’’). While the FINRA guidance goes on to Recommendation. state that the rule generally would not cover an Accounts 222 For example, where a broker-dealer informs a implicit recommendation to hold, it does not Furthermore, based on comments, our retail customer that based on age and other relevant address the particular scenario in which a broker- factors, he or she needs to take a required minimum dealer agrees to monitor an account (such as a position is that recommendations to distribution, but does not otherwise recommend quarterly review) and discloses the terms of that retail customers regarding retirement specifics, such as what securities to sell, or where monitoring, and then during that review is silent on accounts would also be subject to to place the proceeds, the communication would whether the customer should make any changes. generally not be a ‘‘recommendation’’ subject to Id.; see also FINRA Regulatory Notice 12–25 at Q3 Regulation Best Interest. As with other such as including monitoring services); AFL–CIO and accompanying footnotes. communications subject to broker-dealer regulation, April 2019 Letter. 215 See FINRA Regulatory Notice 11–25 at an inquiry of whether a ‘‘recommendation’’ was 217 footnote 21. FINRA Notice to Members 11–25 at Q7. made would depend on the facts and circumstances 216 Our interpretation is generally consistent with 218 Our approach does not require broker-dealers relating to the communication, as discussed more a majority of the IAC’s and other commenters’ to undertake account monitoring, unless they fully above. See supra Section II.B.2.a. views regarding application of Regulation Best choose to do so. See Solely Incidental 223 As we stated in the Proposing Release, we Interest to implicit hold recommendations in the Interpretation. believe that broker-dealers would generally be context of agreed-upon account monitoring 219 See, e.g., NASAA August 2018 Letter; FPC required to obtain sufficient facts about a customer services. See IAC 2018 Recommendation (‘‘We Letter. to determine an account’s primary purpose for believe the best interest standard should be applied 220 See Solely Incidental Interpretation. Absent an purposes of Regulation Best Interest. See Proposing to the broker-dealer’s monitoring of the customer agreement with the customer (which would be Release at 21595. account, where brokers provide ongoing services to required to be disclosed pursuant to the Disclosure 224 See Proposing Release at Section II.C.4. the account. In essence, this would apply the best Obligation), we do not consider this voluntary Section 913(a) defines ‘‘retail customer’’ as a natural interest standard to the implicit ‘‘no review to be ‘‘account monitoring’’ nor would it in person, or the legal representative of such natural recommendation’’ recommendation that a broker itself create an obligation under Regulation Best person who: (1) Receives personalized investment makes when reviewing the account and Interest, provided of course that any advice about securities from a broker or dealer or recommends no change.’’); NAIFA Letter (asserting recommendation made to the customer as a result investment adviser; and (2) uses such advice broker-dealers should be free to agree to, and define of any such voluntary review would be subject to primarily for personal, family, or household the nature of, any ongoing relationship via contract, Regulation Best Interest. purposes.

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related to commercial or business considered to be the legal representative which is broader 235 and would include, purposes but for the definition to of a natural person for purposes of this among others, certain workplace remain sufficiently broad to capture definition. retirement plans. Conversely, a few recommendations related to the various commenters believed that Regulation a. Focus on Natural Persons and Legal reasons retail customers may invest, Representatives of Natural Persons Best Interest should apply to both retail such as saving for retirement, education and institutional customers.236 expenses and other savings purposes. The Commission proposed to extend In response to comments, we are As such, the proposed definition the definition of ‘‘retail customer’’ in modifying the definition to focus on applied to any persons who receive a Regulation Best Interest beyond natural natural persons and their legal recommendation from a broker or dealer persons to any persons to cover non- representatives, and are clarifying that or a natural person who is an associated natural persons (e.g., trusts that we interpret ‘‘legal representatives’’ to person of a broker or dealer, provided represent the assets of a natural person), mean non-professional legal that the recommendation is primarily which the Commission stated it representatives of a natural person, as for personal, family or household believed would benefit from the we discuss below. We believe this purposes. In the case of dual-registrants, protections of Regulation Best Interest. change and clarification provides more the proposed definition was intended to Commenters generally suggested that certainty that institutions and certain apply only to recommendations made the definition of retail customer be 227 professional fiduciaries are not covered by broker-dealers in their brokerage modified to focus on natural persons. for purposes of Regulation Best Interest. capacity, based on a facts and To that end, a number of commenters It would also retain, however, coverage circumstances analysis and consistent suggested eliminating the ‘‘personal, of certain legal entities (i.e., trusts that with existing guidance.225 The proposed family or household purposes’’ qualifier represent the assets of a natural person) definition differed from the definition of from the definition under Dodd-Frank specifically identified in the Proposing Section 913.228 Many commenters ‘‘retail investor’’ in the Relationship Release as ‘‘retail customers’’ within the suggested excluding institutional Summary Proposal as the Relationship scope of Regulation Best Interest, but investors and professional advisers or Summary was intended for a broader would not exclude certain high-net- 226 fiduciaries, including retirement plan range of investors. worth natural persons, as was suggested representatives 229 and family offices,230 The Commission requested comment by some commenters 237 to match the while a few stated that non-professional on the scope and definition of retail current FINRA exclusion of such natural plan fiduciaries should have the same customer and received a range of persons from customer-specific protections as retail customers.231 Many comments requesting: modification of suitability requirements.238 commenters suggested harmonizing the the definition to focus on natural While the Commission recognizes persons; clarification of the ‘‘personal, definition with FINRA’s definition,232 in particular, by excluding: (1) commenters’ concerns regarding family or household purposes’’ compliance costs and burdens if the qualification; harmonization with the Institutional accounts that would be exempted from certain suitability definition of retail customer does not definition in Form CRS; and further align with FINRA’s exclusion of certain guidance surrounding the treatment of protections under FINRA Rule 2111 (Suitability) 233 or (2) institutional institutional accounts and institutional dual-registrants. In consideration of the investors, we have decided not to align comments received, the Commission is investors as defined in Rule 2210 (Communications with the Public),234 our definition with FINRA’s exclusion modifying the definition of ‘‘retail because we believe conflicted customer’’ to mean a natural person, or recommendations can also result in the legal representative of such natural 227 See, e.g., Cetera August 2018 Letter; Invesco harm to high net-worth individuals.239 person, who: (A) Receives a Letter. 228 See FPC Letter; SIFMA August 2018 Letter; recommendation of any securities BlackRock Letter. Contra ACLI Letter (supporting representatives, and persons acting solely on behalf transaction or investment strategy the provision in Section 913 and positing that of such institutional investors. involving securities from a broker, Regulation Best Interest appropriately implements 235 See, e.g., SIFMA August 2018 Letter; TIAA dealer, or a natural person who is an this foundational threshold). Letter; IPA Letter. 229 associated person of a broker or dealer; See, e.g., SIFMA August 2018 Letter; Vanguard 236 NASAA August 2018 Letter, Better Markets Letter; Prudential Letter; ICI Letter; Fidelity Letter. and (B) uses the recommendation August 2018 Letter; FPC Letter. But see Managed 230 See, e.g., TIAA Letter; SIFMA August 2018 Funds Association Letter (suggesting that primarily for personal, family, or Letter; Letter from Stuart J. Kaswell, Executive Vice sophisticated investors should not be treated as household purposes. President and Managing Director, Managed Funds retail customers). The revised definition shifts the focus Association, and Jiri Krol, Deputy CEO, Global 237 See, e.g., Morgan Stanley Letter; FSI August to natural persons, as opposed to any Head of Government Affairs, Alternative Investment 2018 Letter. Management Association (Aug. 7, 2018) (‘‘Managed persons, but otherwise it is adopted 238 See FINRA Rule 4512(c), which includes Funds Association Letter’’). within the definition of ‘‘institutional account’’ any largely as proposed. However, as 231 ARA August 2018 Letter; CFA August 2018 person (whether a natural person, corporation, discussed below, the Commission is Letter. partnership, trust or otherwise) with total assets of providing additional interpretations, 232 See, e.g., UBS Letter; Bank of America Letter; at least $50 million. Currently, under FINRA rules, guidance and clarification regarding: Raymond James Letter; TIAA Letter; Letter from broker-dealers are exempt from the customer- Joseph Giovanniello, Ladenburg Thalmann specific suitability obligations with respect to these The interpretation of the ‘‘personal, Financial Services Inc. (Jul. 30, 2018) (‘‘Ladenburg ‘‘institutional accounts’’ if certain conditions are family, or household purposes’’ Letter’’). met. FINRA Rule 2111(b). qualifier; the interaction of this 233 FINRA Rule 2111(b). Institutional accounts 239 The Commission has brought numerous definition with the definition of ‘‘retail include banks, savings and loan associations, enforcement actions against financial professionals investor’’ in Form CRS; what it means insurance companies, registered investment engaged in schemes to defraud certain high net- companies, state and Federal Registered investment worth individuals, in particular, professional for a retail customer to ‘‘use’’ the advisers, and other persons with total assets of at athletes. See, e.g. SEC v. Charles A. Banks, IV, Civil recommendation; and the status of dual- least $50 million. Action No. 16–CV–3399–TWT (N.D. Ga. Nov. 2, registrants. Furthermore, we are 234 FINRA Rule 2210(a)(4). Institutional investors 2018) (former investment adviser who fraudulently providing guidance on who would be include, in addition to persons with institutional induced a former professional athlete to invest $7.5 accounts, government entities and their million in a sports team and apparel merchandise subdivisions, employee benefit plans, qualified company based on a series of misrepresentations); 225 Id. plans as defined in Exchange Act Section SEC v. Ash Narayan, The Ticket Reserve Inc. a/k/ 226 Id. 3(a)(12)(C), broker-dealers and registered a Forward Market Media, Inc., Richard M. Harmon,

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We believe the benefits of Regulation not be necessary to provide the recommendations 249 for his or her own Best Interest justify compliance costs as protections of Regulation Best Interest to retirement account, including but not these individuals could benefit from the regulated professionals.243 Importantly, limited to IRAs and individual accounts protections included in Regulation Best however, this will not relieve firms or in workplace retirement plans, such as Interest regardless of their net worth, financial professionals retained to 401(k) plans and other tax-favored which may not necessarily correlate to represent the assets of natural persons retirement plans.250 For example, plan a particular level of financial from their own obligations to retail participants receiving recommendations sophistication.240 customers.244 about whether to take a distribution In addition, we view a ‘‘legal We retained the ‘‘personal, family, or from a 401(k) plan or other workplace representative’’ of a natural person to household purposes’’ qualifier,245 but retirement plan and how to invest that only cover non-professional legal are providing additional guidance and distribution would be covered as retail representatives (e.g., a non-professional clarification on our interpretation of this customers. Similarly, a plan participant trustee that represents the assets of a phrase to address comments received. In receiving recommendations for the natural person and similar particular, we interpret ‘‘personal, participant’s individual account held in representatives such as executors, family or household purposes’’ to mean a 401(k) plan or other workplace conservators, and persons holding a that any recommendation to a natural retirement plan would be a retail power of attorney for a natural customer for purposes of Regulation person for his or her account would be person),241 thereby excluding certain Best Interest.251 subject to Regulation Best Interest, other institutions from Regulation Best The Commission acknowledges than recommendations to natural Interest’s coverage. In capturing non- concerns from some commenters that persons seeking these services for professional legal representatives within workplace retirement plans and their commercial or business purposes. the definition of retail customer, we are representatives (e.g., plan sponsors, Accordingly, under this interpretation, providing the protections of Regulation trustees, other fiduciaries) and service ‘‘personal, family or household Best Interest to non-professional persons providers should be included in the purposes’’ would not include, for who are acting on behalf of natural definition of retail customer.252 example, an employee seeking services persons but who are not regulated However, we understand that plan for an employer or an individual who is financial services industry professionals representatives of workplace retirement seeking services for a small business or retained by natural persons to exercise plans typically are not receiving on behalf of another non-natural person recommendations for their own account independent professional judgment, 246 entity such as a charitable trust. As for personal, family or household such as registered investment advisers 247 discussed above and pursuant to the purposes when they engage a broker- and broker-dealers, corporate fiduciaries 248 (e.g., banks, trust companies and similar Care Obligation, we believe broker- dealer to provide services to a financial institutions) and insurance dealers are able to obtain sufficient facts retirement plan established, maintained, companies, and the employees or other to determine the purpose for which a regulated representatives of such recommendation will be used. 249 See Section II.C.2 (describing what constitutes We also confirm that ‘‘personal, a ‘‘recommendation’’ for purposes of Regulation advisers, broker-dealers, corporate Best Interest). 242 family or household purposes’’ would fiduciaries and insurance companies. 250 Such IRAs include, for example, individual Our definition is intended to capture cover retirement accounts, as retirement retirement accounts and individual retirement natural persons and their legal savings is a personal, household or annuities described by Internal Revenue Code representatives who rely directly on the family purpose. Accordingly, the section 408(a) and (b), ‘‘simplified employee pensions’’ (SEPs) described by Code section 408(k), broker-dealer for the recommendation. definition of retail customer will and simple retirement accounts described by Code Accordingly, such non-professional include a natural person receiving section 408(p) (SIMPLE IRAs). In response to legal representatives would not include commenters, we also clarify that workplace 243 See, e.g., Bank of America Letter; Invesco retirement plans include any arrangement available regulated financial industry at a workplace that provides retirement benefits or Letter; Letter from Bob Grohowski, Senior Legal professionals. We believe this responds allows saving for retirement, including, for Counsel, and Jon Siegel, Senior Legal Counsel, T. example, any 401(k) plans or other plan that meet to commenters who stated that it should Rowe Price (Aug. 10, 2018) (‘‘T. Rowe Letter’’); requirements for qualification under Code section Oppenheimer Letter; ICI Letter. 401(a), deferred compensation plans of state and and John A. Kaptrosky, Civil Action No. 16–CV– 244 See also Relationship Summary Adopting local governments and tax-exempt organizations 1417–M (N.D. Tex. May 24, 2016) (investment Release. described by Code section 457, and annuity adviser who misappropriated millions of dollars 245 Regulation Best Interest relies in part on the contracts and custodial accounts described by Code from accounts he managed for professional athletes statutory authority provided in Section 913 of the section 403(b). Likewise, the definition of retail and invested them in online sports and Dodd-Frank Act which includes the statutory investor includes natural persons seeking brokerage entertainment ticket business on whose board he definition of ‘‘retail customer.’’ See Section 913(a) or advisory services for other tax-favored savings served). of the Dodd-Frank Act. arrangements such as an Archer Medical Savings In addition, reports indicate deficiencies in 246 As discussed below, to the extent a plan Account described by Code section 220(d), a Health financial literary among the general population of representative who decides service arrangements Savings Accounts described by Code section 223(d) retail investors. See Federal Research Division, for a workplace retirement plan is a sole proprietor and any similar tax-favored health plan saving Library of Congress, Financial Literacy Among or other self-employed individual who will arrangement, a Coverdell education savings account Retail Investors in the United States (Dec. 30, 2011) participate in the plan, the plan representative will described by Code section 530 and a qualified at 25, available at https://www.sec.gov/news/ be a retail customer to the extent that the sole tuition program or ‘‘529 plan’’ established pursuant studies/2012/917-financial-literacy-study-part2.pdf proprietor or self-employed individual receives to Code section 529. (‘‘Library of Congress Report’’). recommendations directly from a broker-dealer 251 For example, we understand that, although not 240 See Primerica Letter (noting challenges in primarily for personal, family or household common, some 401(k) plans and other individual using wealth and education as proxies for purposes. account plans provide participants total discretion investment sophistication). 247 See supra footnote 223 and accompanying to choose a broker-dealer to provide services for In addition, the definition of ‘‘retail customer’’ text. their individual plan account. See, e.g., 29 CFR under Section 913(a) of the Dodd-Frank Act did not 248 Pursuant to the Care Obligation, a broker- 2550. 404c–1(f), Example 9. make a distinction based on net worth. dealer is required to ascertain the customer’s 252 See, e.g., ARA December 2018 Letter; FPC 241 A non-professional legal representative is investment profile which considers, among other Letter. But see Empower Letter (‘‘It would be covered pursuant to this rule even if another person things, financial situation and needs and helpful if the SEC could confirm that the definition is a trustee or managing agent of the trust. investment objectives, in evaluating a of ‘retail customer’ under RBI does not include 242 See also Relationship Summary Adopting recommendation and whether it is in a retail advice to managers of retirement plans or to their Release. customer’s best interest. fiduciaries or representatives.’’).

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and operated by an employer to provide dealer for ‘‘personal, family, or household purposes, and not simply pension or retirement savings benefits to household purposes.’’ 254 those recommendations for which a employees; and further, as a legal We note, however, that some plan broker-dealer receives compensation.257 representative of a plan participant, representatives may participate under In response to commenters, we interpret must comply with DOL rules.253 As their employer’s workplace plan, for that a retail customer ‘‘uses’’ a such, the Commission does not believe example, in the case of a workplace IRA recommendation of a securities that workplace retirement plans or their or other workplace retirement plan that transaction or investment strategy representatives and service providers is established and maintained by a sole involving securities when, as a result of proprietor or other self-employed generally fall within the definition of the recommendation: (1) The retail individual that includes one or more customer opens a brokerage account retail customer for purposes of employees in addition to the plan with the broker-dealer, regardless of Regulation Best Interest because the representative. To the extent that a plan whether the broker-dealer receives workplace retirement plan is not a representative who decides service compensation,258 (2) the retail customer natural person, and therefore the arrangements for a workplace retirement has an existing account with the broker- workplace retirement plan plan is a sole proprietor or other self- dealer and receives a recommendation representatives are not a non- employed individual who will from the broker-dealer, regardless of professional representative of a natural participate in the plan, the plan whether the broker-dealer receives or person that is receiving a representative would be a retail will receive compensation, directly or recommendation directly from a broker- customer for purposes of Regulation indirectly, as a result of that Best Interest to the extent the sole recommendation, or (3) the broker- 253 It is our understanding that the investment proprietor or self-employed individual dealer receives or will receive responsibilities of plan representatives typically receives recommendations directly from compensation, directly or indirectly as a include, among other things, selecting and a broker-dealer primarily for personal, result of that recommendation, even if monitoring a menu of plan investment options and designating and monitoring ‘‘default’’ investments family or household purposes. that retail customer does not have an 259 for investing account balances of participants who b. Retail Customer Use of the account at the firm. do not make their own investment elections, and When a retail customer opens or has Recommendation that plan representatives typically make these an existing account with a broker-dealer investment selections for a workforce with diverse In the Proposing Release, the investment profiles. See ARA December 2018 Letter the retail customer has a relationship (describing obligations of plan fiduciaries selecting Commission did not specifically address with the broker-dealer and is therefore an investment menu and qualified default whether recommendations subject to in a position to ‘‘use’’ (i.e., accept or investment alternatives); Empower Letter Regulation Best Interest needed to be for reject) the broker-dealer’s (describing plan fiduciary obligations to select compensation, but did state that the investment menus). We also understand that plan recommendation. In this context, tying representatives may receive brokerage and advice proposed definition of retail customer ‘‘use’’ solely to a broker-dealer’s receipt services for plans together with or complimentary would only apply to a person who of compensation would inappropriately with, other services supporting the plan’s ‘‘received a recommendation . . . from result in Regulation Best Interest not establishment, maintenance and operation, such as a broker or dealer or a natural person applying to the broker-dealer’s plan design, recordkeeping and other administrative services. See, e.g., Groom Letter who is an associated person of a broker recommendations to hold securities (describing business models of firms offering or dealer, and used the recommendation positions or to maintain an investment brokerage and advice services together with other primarily for personal, family, or strategy (such as account type), services); SPARK Letter (same). In this context, a household purposes.’’ We stated that recommendations to open an account, plan representative would not be receiving this approach was appropriate because recommendations from a broker-dealer for his or or recommendations that may her own account and considerations material to the it builds upon the guidance provided for plan representative’s investment decisions differ FINRA’s suitability rule.255 In response, 257 See paragraph (b)(1) of Regulation Best from a situation in which a retail customer receives a few commenters recommended that Interest. a recommendation from a broker-dealer for his or the Commission limit the application of 258 As discussed in Section II.B.2.b below, her own account. Regulation Best Interest to account recommendations, including Further, we note that DOL has rules currently in recommendations of a securities account type place (not affected by the Fifth Circuit’s decision recommendations made to retail generally, and recommendations to open an IRA or vacating the DOL Fiduciary Rule) that address how customers for compensation.256 to roll over or transfer assets into an IRA, are plan representatives operate participant-directed Regulation Best Interest applies to a covered by Regulation Best Interest regardless of plans and select investment menus for such plans, retail customer that both receives a whether those recommendations result in see 29 CFR 2550.404c–1, what actions, including transactions or generate transaction-based disclosures, plan representatives must take to be recommendation of any securities compensation. able to raise a defense or claim for investment transaction or investment strategy 259 See Proposing Release at 21596, footnote 160 losses by a participant or beneficiaries, see 29 CFR involving securities by a broker-dealer and accompanying text. See also FINRA Regulatory 2550.404c–5, and also generally require broker- and that uses that recommendation Notice 12–55, Suitability—Guidance on FINRA’s dealers making investment alternatives available for primarily for personal, family, or Suitability Rule (Dec. 2012) at Q6(b) (‘‘The a participant-directed plan to disclose in writing suitability rule would apply when a broker-dealer (among other things) all direct and indirect or registered representative makes a compensation received in connection with 254 Although workplace retirement plans are not recommendation to a potential investor who then providing plan services. See 29 CFR 2550.408b– generally covered by the definition of retail becomes a customer. Where, for example, a 2(c). See also Form 5500, Schedule C, requiring customer in by Regulation Best Interest, based on registered representative makes a recommendation after-the-fact reporting by certain plans of preliminary discussions with DOL staff, we to purchase a security to a potential investor, the information regarding direct and indirect understand that the DOL is considering regulatory suitability rule would apply to the recommendation compensation received by, among others, broker- options in light of the Fifth Circuit’s decision if that individual executes the transaction through dealers and investment advisers, in connection with vacating the DOL Fiduciary Rule, including the the broker-dealer with which the registered services rendered or their position with the plan. types of protections available to such workplace representative is associated or the broker-dealer Accordingly, we agree with those commenters retirement plans and their representatives. receives or will receive, directly or indirectly, who recommended that plan representatives should Department of Labor Regulatory Agenda, Fiduciary compensation as a result of the recommended not be included in the definition of retail customer. Rule and Prohibited Transaction Exemptions, Fall transaction.’’); NASD Notice to Members 04–72, See Empower Letter; Groom Letter; Letter from Nora 2018, available at https://www.reginfo.gov/public/ Transfers of Mutual Funds and Variable M. Everett, President, Retirement and Income do/eAgendaViewRule?pubId=201810&RIN=1210- Annuities—Impermissible Use of Negative Solutions, Principal Financial Group (Aug. 7, 2018) AB82. Response Letters for the Transfer of Mutual Funds (‘‘Principal Letter’’); SPARK Letter; T. Rowe Price 255 See Proposing Release at 21596, footnote 160. and Variable Annuities (Changes in Broker-Dealer Letter; Transamerica August 2018 Letter. 256 See Morgan Stanley Letter; CCMC Letters. of Record) (Oct. 2004).

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ultimately be rejected by the retail rulemakings.264 As discussed above, the the issues surrounding the customer. definition of ‘‘retail customer’’ for determination of whether a dual- Whether the recommendation purposes of Regulation Best Interest has registrant is acting in the capacity of a complies with Regulation Best Interest been revised to apply only to natural broker-dealer or an investment adviser, will be evaluated based on the persons, not all persons, in line with the and asserted that such a determination circumstances that existed at the time definition of ‘‘retail investor’’ for requires a facts and circumstances the recommendation was made to the purposes of Form CRS. In addition, the analysis, with no one factor being retail customer. Accordingly, broker- definition in Form CRS as adopted now determinative.270 dealers should carefully consider the includes the ‘‘personal, family or Many commenters requested that the extent to which associated persons can household purposes’’ qualifier. Commission clarify the treatment of make recommendations to prospective While the definitions have generally dual-registrants and what is expected retail customers (i.e., that have received, been harmonized across the package of when offering products in both types of but not yet ‘‘used’’ the recommendation rulemakings,265 they differ to reflect accounts.271 Some commenters asserted as noted above) in compliance with differences between the Relationship that dually registered financial Regulation Best Interest, including Summary delivery requirement and the professionals should be held to a having gathered sufficient information obligations of broker-dealers under fiduciary standard.272 A few that would enable them to comply with Regulation Best Interest, including that commenters requested clarification on Regulation Best Interest at the time the the Relationship Summary is required how Regulation Best Interest applies to recommendation is made, should the whether or not there is a particular scenarios, some of which prospective retail customer use the recommendation and covers any involved dual-registrants.273 recommendation.260 prospective and existing clients and In response, the Commission is reaffirming the guidance provided in the c. Conformity With Form CRS customers (i.e., a person who ‘‘seeks to receive or receives services’’) of proposal and providing further The proposed definition of ‘‘retail investment advisers as well as broker- clarification on when and how customer’’ differed from the definition dealers.266 For the reasons discussed in Regulation Best Interest would apply to of ‘‘retail investor’’ proposed in the the Proposing Release and in response dual-registrants. As stated in the Relationship Summary Proposal, which to commenters who requested proposal, Regulation Best Interest would was a prospective or existing client or clarification on whether Regulation Best not apply to investment advice provided customer who is a natural person (an Interest applies to prospective to a retail customer by a dual-registrant individual), regardless of the customers,267 we would like to clarify when acting in the capacity of an individual’s net worth, including a trust that the definition of ‘‘retail customer’’ investment adviser, even if the retail or other similar entity that represents does not apply to prospective customers customer has a brokerage relationship 261 natural persons. The proposed who do not receive and use with the dual-registrant or the dual- definition was different from the recommendations from a broker- registrant executes the transaction in its definition of ‘‘retail investor’’ because dealer,268 as discussed above. This brokerage capacity.274 Similarly, as the Relationship Summary was distinction reflects differences between proposed, we are confirming that a dual- intended for an earlier state of the the point in time the Relationship registrant is an investment adviser relationship between an investor and a Summary is delivered to an investor and solely with respect to those accounts for financial professional, was intended to when the obligations of broker-dealers which a dual-registrant provides be required regardless of whether the pursuant to Regulation Best Interest investment advice or receives investor would receive investment attach. compensation that subjects it to the advice primarily for personal, family, or Advisers Act.275 household purposes, and was designed d. Treatment of Dual-Registrants While we acknowledge that some to be delivered by investment advisers In the Proposing Release, the commenters believe all dual-registrants as well as broker-dealers.262 Many Commission stated that Regulation Best commenters recommended that we use Interest applies only in the context of a advisers, a broker-dealer should perform the same the same definition to facilitate analysis when it is engaged in other financial brokerage relationship with a brokerage services (such as, as a bank, a commodity trading compliance for firms and avoid investor customer, and specifically, when a advisor or a future commission merchant). 263 confusion. broker-dealer is making a 270 Proposing Release at 21596. The Commission agrees with recommendation in the capacity of a 271 See, e.g., SIFMA August 2018 Letter; CCMC commenters that using a similar broker-dealer. In particular, for dual- Letters; NASAA August 2018 Letter. 272 definition would provide consistency in registrants (for purposes of this section, See PIABA Letter; AICPA Letter. 273 See SIFMA August 2018 Letter; Letter from the protections, and ease the a broker-dealer that is dually registered compliance burden, of the package of Michael Pieciak, NASAA President, Commissioner as an investment adviser with the Vermont Department of Financial Regulation, rulemakings. Therefore, the definitions Commission), the obligations associated NASAA (Feb. 19, 2019) (‘‘NASAA February 2019 in Form CRS and Regulation Best with Regulation Best Interest were Letter’’). Interest have been revised to generally 274 This analysis would apply even if the dual- intended to apply only when they are conform to each other, consistent with registrant receives transaction-based compensation acting in the capacity as a broker- our respective goals in each of these for executing the transaction because the dual- dealer.269 The Commission recognized registrant did not provide a recommendation in its capacity as a broker-dealer. While Regulation Best 260 See FINRA Regulatory Notice 12–55 at Q6(b). Interest would not apply in this situation, other 264 See Relationship Summary Adopting Release. 261 See Relationship Summary Proposal. provisions of the federal securities laws and SRO 265 Id. 262 See Relationship Summary Proposal, Section rules would apply to the actions taken or services 266 II, footnote 29. Id. provided by the broker-dealer. 267 263 See, e.g., Invesco Letter; BlackRock Letter; ICI See, e.g., SIFMA August 2018 Letter; 275 See Proposing Release at 21596; see also Letter; Committee of Annuity Insurers Letter; Bank Prudential Letter; Money Management Institute Certain Broker-Dealers Deemed Not To Be of America Letter; CFA August 2018 Letter; Cetera Letter. Investment Advisers, Exchange Act Release No. August 2018 Letter; Fidelity Letter; Morgan Stanley 268 See Section II.B.3.b. 51523 (Apr. 12, 2005) at 8 (‘‘Release 51523’’); Letter; Oppenheimer Letter; Raymond James Letter; 269 Although this discussion focuses on the Interpretive Rule Under the Advisers Act Affecting SIFMA August 2018 Letter; TIAA Letter; treatment of broker-dealers that are dually Broker-Dealers, Advisers Act Release No. 2652 (Sep. Transamerica August 2018 Letter. registered with the Commission as investment 24, 2007). See also Fiduciary Interpretation.

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should be held to a fiduciary standard, which are both brokerage and advisory, terms of the relationship with the retail for the reasons discussed in Section whether Regulation Best Interest applies customer and all material conflicts of II.A, the Commission believes that depends on a facts and circumstances interest associated with the Regulation Best Interest enhances the analysis. Regulation Best Interest would recommendation.’’ The Proposing obligations that apply when a broker- apply if the financial professional in her Release states that, for purposes of the dealer makes a recommendation to a brokerage capacity (disclosed pursuant Disclosure Obligation, we would retail customer by drawing from key to the Disclosure Obligation), provides a consider the following to be examples of principles underlying the fiduciary recommendation of a securities material facts relating to the scope and obligation that applies to investment transaction or investment strategy terms of the relationship with the retail advisers under the Advisers Act, while involving securities to the family in the customer: (1) That the broker-dealer was being tailored to the broker-dealer course of the holistic review.282 acting in a broker-dealer capacity with model.276 respect to the recommendation; (2) fees C. Component Obligations As stated in the proposal, determining and charges that would apply to the the capacity in which a dual-registrant As proposed Regulation Best Interest’s retail customer’s transactions, holdings, is making a recommendation is a facts obligation to ‘‘act in the best interest of and accounts; and (3) type and scope of and circumstances test, with no one the retail customer . . . without placing services provided by the broker-dealer, factor being determinative, but the the financial or other interest of the including, for example, monitoring the Commission considers, among other [broker-dealer] ahead of the retail performance of the retail customer’s factors, the type of account, how the customer’’ would have been satisfied by account. account is described, the type of complying with four specified As stated in the Proposing Release, we compensation and the extent to which obligations: A Disclosure Obligation, a understand that broker-dealers typically the dual-registrant made clear to the Care Obligation, and two Conflict of provide information about their services customer or client the capacity in which Interest Obligations.283 Failure to and accounts, which may include it was acting.277 comply with any of these proposed disclosures concerning the broker- In addition and in response to a requirements would have violated dealer’s capacity, fees, services, and commenter’s presentation 278 of Regulation Best Interest.284 conflicts, on their firm websites and in particular scenarios in its comment As discussed above, we have their account opening agreements.285 letter,279 we would like to confirm or determined to retain the overall Furthermore, while broker-dealers are correct the commenter’s understanding structure and scope of the proposed subject to a number of specific of Regulation Best Interest in practice to rule, but are modifying and clarifying disclosure obligations when they effect provide further guidance to firms as it the component obligations that a broker- certain customer transactions, and are relates to their examples of dual- dealer must satisfy in order to meet the subject to the antifraud provisions of the registrants.280 For example, in the General Obligation. As adopted, the federal securities laws, broker-dealers commenter’s explanation of a scenario General Obligation is satisfied only if are not currently subject to an explicit related to a recommendation to open a the broker-dealer complies with four and broad disclosure requirement under fee-based account, we agree that specified component obligations: (1) the Exchange Act regarding the scope Regulation Best Interest would not The Disclosure Obligation; (2) the Care and terms of the broker-dealer apply when a dually registered financial Obligation; (3) the Conflict of Interest relationship.286 To promote broker- professional of a dually registered Obligation; and (4) the Compliance dealer recommendations that are in the broker-dealer and investment adviser, Obligation. Each of these component best interest of retail customers, we who is acting in the capacity of an obligations is discussed below. Whether determined it was necessary to impose investment adviser, recommends a fee- a broker-dealer has acted in the retail a more explicit and broader disclosure based account. We note, however, that customer’s best interest under the obligation on broker-dealers than that the dually registered financial General Obligation will turn on an which currently exists under the federal professional would need to comply with objective assessment of the facts and securities laws and SRO rules.287 the Advisers Act as well as the circumstances of how these specific We solicited comment on the requirements with respect to Form CRS components of Regulation Best Interest Disclosure Obligation and commenters for the firm.281 In response to another are satisfied at the time that the addressed several aspects of this scenario in which a financial recommendation is made (and not in proposed obligation, including the professional who is dually registered hindsight). The specific component interpretation of each required element, provides a holistic review of the overall obligations of Regulation Best Interest as discussed in the relevant sections performance of a family’s accounts, are mandatory, and failure to comply below.288 In consideration of these with any of the components would comments, we are revising the 276 See Section I. violate Regulation Best Interest. Disclosure Obligation to require a 277 Proposing Release at 21596. broker-dealer, prior to or at the time of 278 See SIFMA August 2018 Letter. For purposes 1. Disclosure Obligation the recommendation, to provide to the of the presented scenarios, SIFMA has assumed that We proposed a Disclosure Obligation the customer is a ‘‘retail customer.’’ retail customer, in writing, full and fair 279 Id. that would require a broker-dealer ‘‘to, disclosure 289 of all material facts related 280 For purposes of this section, we have only prior to or at the time of [a] to the scope and terms of the addressed the scenarios applicable to dual- recommendation, reasonably disclose to registrants and have not confirmed or rejected the the retail customer, in writing, the 285 commenter’s analysis of the other scenarios. Proposing Release at 21599. material facts relating to the scope and 286 281 See Fiduciary Interpretation at Section II.B.1. Proposing Release at 21599–21600. In providing advice about account type, the adviser 287 Proposing Release at 21600. should consider both types of accounts (i.e., 282 But see NASAA February 2019 Letter (stating 288 See, e.g., Better Markets August 2018 Letter; brokerage and advisory accounts) when that ‘‘a full fiduciary duty’’ should be imposed on CCMC Letters; LPL August 2018 Letter; Schwab determining whether the advice is in the client’s the financial adviser as to all accounts in this case Letter; Morgan Stanley Letter; CFA August 2018 best interest. See also NASAA February 2019 Letter as the family has probably entrusted their entire Letter; IPA Letter; NASAA Letter; SIFMA August (stating that Regulation Best Interest would not financial well-being to one financial professional). 2018 Letter. apply but instead that the fiduciary duty under the 283 Proposing Release at 21598. 289 See Section II.C.1.c, Disclosure Obligation, Advisers Act would apply). 284 Id. Full and Fair Disclosure.

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relationship with the retail customer Disclosure Obligation to require Disclosure Obligation, while separate and all material facts relating to disclosure of ‘‘material facts’’ relating to obligations with significant individual conflicts of interest that are associated such conflicts of interest that are value, will complement each other and, with the recommendation.290 We are associated with the recommendation. consistent with our layered approach to explicitly requiring in the rule text the Under this approach, all conflicts of disclosure, are designed to build upon disclosure of examples in the Proposing interest as so defined will be covered by each other to provide different levels of Release of the ‘‘material facts relating to Regulation Best Interest (and thus, will key information and may be required to the scope and terms of the relationship be subject to the Conflict of Interest be delivered at different times. In with the retail customer:’’ (1) That the Obligation described below). However, addition, we believe the Relationship broker, dealer or such natural person is only ‘‘material facts’’ regarding these Summary and Disclosure Obligation acting as a broker, dealer or an conflicts of interest are required to be will improve the quality and associated person of a broker-dealer disclosed under the Disclosure consistency of disclosures and thus: (1) with respect to the recommendation; (2) Obligation.293 Reduce the information asymmetry that the material fees and costs that apply to As discussed above, we are adopting may exist between a retail customer and the retail customer’s transactions, a new set of disclosure requirements their broker-dealer, and (2) facilitate holdings, and accounts; and (3) the type designed to reduce retail investor customer comparisons of different and scope of services provided to the confusion in the marketplace for broker-dealers which we expect will, in retail customer, including: any material brokerage and advisory services and to turn, increase competition among limitations on the securities or assist retail investors with the process of broker-dealers, including with respect to investment strategies involving deciding whether to engage a particular fees and costs.298 securities that may be recommended to firm or financial professional and As discussed below, we have the retail customer. whether to establish an investment identified those items of information The Disclosure Obligation requires advisory or brokerage relationship.294 that we consider to be ‘‘material facts’’ the disclosure of all material facts Specifically, we are requiring broker- under the Disclosure Obligation. related to the scope and terms of the dealers and investment advisers to Though there are disclosures in the relationship with the retail customer. deliver to retail investors a Relationship Relationship Summary that could The material facts identified in Summary.295 The Relationship satisfy the Disclosure Obligation, in Regulation Best Interest are the Summary will provide succinct most instances the Relationship minimum of what must be disclosed. information about the relationships and Summary will not be sufficient.299 Similar to what was proposed, broker- services the firm offers to retail Moreover, as discussed below, we dealers will need to disclose in writing investors, fees and costs that retail believe the Disclosure Obligation can be prior to or at the time of a investors will pay, specified conflicts of satisfied to varying degrees with recommendation any material facts that interest and standards of conduct, and existing documents provided to retail relate to the ‘‘scope and terms of the disciplinary history, among other customers, such as account opening relationship.’’ As to what constitutes a things.296 The Relationship Summary documents, with a standalone ‘‘material’’ fact related to the ‘‘scope and has a distinct purpose: It is intended to document, or by some combination. terms of the relationship,’’ the standard summarize information about a However, we encourage broker-dealers, for materiality for purposes of the particular broker-dealer or investment in deciding whether to rely on such an Disclosure Obligation is consistent with adviser in a format that allows for existing disclosure document or the one the Supreme Court articulated comparability among the enumerated whether to include or repeat 291 in Basic v. Levinson. Specifically, a items, encourages investors to ask information from existing disclosures, to fact is material if there is ‘‘a substantial questions, and highlights additional consider the usefulness and ease of likelihood that a reasonable shareholder sources of information. understanding for retail customers of would consider it important.’’ In the As a general matter, the Relationship any existing disclosure document. context of Regulation Best Interest, the Summary reflects an initial layer of Oral Disclosure or Disclosure After a standard is the retail customer, as disclosure, with the Disclosure Recommendation defined in the rule. Obligation reflecting more specific and In response to comments, we are also additional, detailed layers of As discussed in more detail below, a refining and clarifying the treatment of disclosure.297 We believe the number of commenters highlighted conflicts of interest under Regulation Relationship Summary and the practical difficulties associated with Best Interest by: (1) Generally consistent delivering disclosure either in writing, with the fiduciary duty under the person would expect’’ for the reasons discussed or prior to or at the time of a Advisers Act, adopting for purposes of below. recommendation in some instances. Regulation Best Interest, the definition 293 The Conflict of Interest Obligation requires, Although Regulation Best Interest of ‘‘conflict of interest’’ associated with among other things, that a broker-dealer establish requires that the Disclosure Obligation a recommendation as ‘‘an interest that written policies and procedures reasonably be made ‘‘in writing,’’ we recognize the designed to identify and disclose all conflicts of might incline a broker, dealer, or a interest associated with a recommendation. Such challenges associated with providing natural person who is an associated disclosure is required to be provided in accordance written disclosure in each instance that person of a broker or dealer— with the Disclosure Obligation. See Section II.C.3.d. disclosure may be required. For consciously or unconsciously—to make 294 See Relationship Summary Adopting Release. example, a broker-dealer may need to a recommendation that is not 295 See Relationship Summary Adopting Release. supplement, clarify or update written 296 292 See Relationship Summary Adopting Release disinterested’’; and (2) revising the at Section I. For purposes of Form CRS, ‘‘retail disclosure it has previously made before investor’’ is defined as ‘‘a natural person, or the 290 As discussed in more detail below, aspects of legal representative of such natural person, who 298 See infra footnote 1192 and accompanying the Disclosure Obligation may be satisfied by other seeks to receive or receives services primarily for text. regulatory requirements. personal, family, or household purposes.’’ 299 For example, as noted below, a standalone 291 Basic, Inc. v. Levinson, 485 U.S. 224 (1988). 297 Nevertheless, as discussed below where broker-dealer will be able to satisfy the Disclosure 292 This is the same as the definition of ‘‘material relevant, in some instances disclosures made Obligation’s requirement to disclose the broker- conflict of interest’’ discussed in the Proposing pursuant to Form CRS may be sufficient to satisfy dealer’s capacity by delivering the Relationship Release but eliminates ‘‘material’’ and ‘‘a reasonable some aspects of the Disclosure Obligation. Summary to the retail customer.

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or at the time it provides a customer In such circumstances, a broker-dealer We believe it is in the public interest with a recommendation. As we stated in may satisfy its Disclosure Obligation by and consistent with the protection of the Proposing Release, we recognized making supplemental oral disclosure investors to permit such flexibility in that broker-dealers may provide not later than the time of the the delivery of information pursuant to recommendations by telephone and may recommendation, provided that the the Disclosure Obligation. Providing need to offer clarifying disclosure orally broker-dealer maintains a record of the retail customers written summary in some instances subject to certain fact that oral disclosure was provided to information about material facts relating conditions, such as a dual-registrant the retail customer.301 In addition, in to a recommendation and indicating informing a retail customer of the the limited instances where existing that additional information will be capacity in which the dual-registrant is regulations permit disclosure after the forthcoming, the point at which the acting in conjunction with a recommendation is made (e.g., trade additional information will be recommendation. We stated that a confirmation, prospectus delivery), a delivered, and the method by which it broker-dealer could orally clarify the broker dealer may satisfy its Disclosure will be conveyed, highlights for retail capacity in which it is acting at the time Obligation regarding the information customers a useful summary of of the recommendation if it had contained in the applicable disclosure information while allowing for the previously provided written disclosure document by providing such document practical realities of the process by to the retail customer beforehand to the retail customer after the which securities recommendations are disclosing its capacity as well as the recommendation is made. Before made and transactions are executed and method it planned to use to clarify its supplementing, clarifying or updating leaving longstanding existing disclosure capacity at the time of the written disclosures in the limited regimes, particularly those relating to recommendation. circumstances described above, broker- product issuer disclosure, undisturbed. Similarly, although Regulation Best dealers must provide an initial Interest requires a broker-dealer to Other Liabilities Under the Federal disclosure in writing that identifies the Securities Laws disclose, prior to or at the time of a material fact and describes the process recommendation, all material facts through which such fact may be Further, the requirements under relating to the scope and terms of the supplemented, clarified or updated. Regulation Best Interest that particular relationship with the retail customer For example, with regard to product- information be disclosed is not and relating to conflicts of interest that level fees, a broker-dealer could provide determinative of a broker-dealer or are associated with the an initial standardized disclosure of associated person’s other potential liabilities under the general antifraud recommendation, we recognize that in product-level fees generally (e.g., provisions of the federal securities laws some instances a broker-dealer may not reasonable dollar or percentage ranges), for failure to disclose material have all the material facts at the time of noting that further specifics for information to a customer at the time of the recommendation, or that such particular products appear in the a recommendation.303 In addition, we disclosure is provided to the retail product prospectus, which will be customer pursuant to an existing delivered after a transaction in 303 Broker-dealers are liable under the antifraud regulatory obligation, such as the accordance with the delivery method delivery of a product prospectus or a provisions for failure to disclose material the retail customer has selected, such as information to their customers when they have a trade confirmation, after the execution by mail or electronically.302 Similarly, duty to make such disclosure. See Basic v. of the trade.300 In the Proposing Release with regard to the disclosure of a broker- Levinson, 485 U.S. 224, 239 footnote 17 (1988) we stated that in circumstances where a (‘‘Silence, absent a duty to disclose, is not dealer’s capacity, a dual-registrant could broker-dealer determines to provide an misleading under Rule 10b–5.’’); Chiarella v. U.S., disclose that recommendations will be 445 U.S. 222, 228 (1980) (explaining that a failure initial, more general disclosure (such as made in a broker-dealer capacity unless to disclose material information is only fraudulent a relationship guide) followed by otherwise expressly stated at the time of if there is a duty to make such disclosure arising specific information in a subsequent out of ‘‘a fiduciary or other similar relation of trust the recommendation, and that any such disclosure that is provided after the and confidence’’); SEC v. Monarch Funding Corp., statement will be made orally. Or, a 192 F.3d 295, 308 (2d Cir. 1999) (explaining that recommendation (e.g., a trade broker-dealer could disclose that its defendant is liable under Section 10(b) and Rule confirmation) the initial disclosure associated persons may have conflicts of 10b-5 for material omissions ‘‘as to which he had should address when and how a broker- a duty to speak’’). Generally, under the antifraud interest beyond than those disclosed by dealer would provide more specific provisions, a broker-dealer’s duty to disclose the broker-dealer, and that associated material information to its customer is based upon information regarding the material fact the scope of the relationship with the customer, or conflict in a subsequent disclosure persons will disclose, where appropriate, any additional material which is fact intensive. See, e.g., Conway v. Icahn (e.g., after the trade in the trade & Co., Inc., 16 F.3d 504, 510 (2d Cir. 1994) (‘‘A confirmation). We noted also that conflicts of interest not later than the broker, as agent, has a duty to use reasonable efforts whether there is sufficient disclosure in time of a recommendation, and that any to give its principal information relevant to the such disclosure will be made orally. affairs that have been entrusted to it.’’). For both the initial disclosure and any example, where a broker-dealer processes its subsequent disclosure would depend on customers’ orders, but does not recommend the facts and circumstances. 301 See Section II.D, Record-Making and securities or solicit customers, then the material We continue to believe that some Recordkeeping. information that the broker-dealer is required to 302 While using a percentage or dollar range to disclose is generally narrow, encompassing only the flexibility with respect to the provision describe a fee can be appropriate, that range should information related to the consummation of the by broker-dealers of written and oral be designed to reasonably reflect the actual fees to transaction. See, e.g., Press v. Chemical Inv. Servs. disclosure, as well as with respect to the be charged. For example, if the firm offers in almost Corp., 166 F.3d 529, 536 (2d Cir. 1999). However, timing that disclosure is made, is all instances funds with up-front sales charges of courts have found that a broker-dealer’s duty to between 5% and 5.5%, but the disclosure states that disclose material information under the antifraud appropriate in certain circumstances, mutual fund up-front sales charges may ‘‘range from provisions is broader when the broker-dealer is such as when a broker-dealer updates its 0.0% to 5.5%,’’ then the broker-dealer would need making a recommendation to its customer. See, e.g., written disclosures orally in order to to evaluate whether the disclosure should be Hanly, 415 F.2d 589, 597 (2d Cir. 1969). When reflect facts not reasonably known at the revised to more accurately describe the sales charge. recommending a security, broker-dealers generally See discussion in Section II.C.1.a, Disclosure are liable under the antifraud provisions if they do time the written disclosure is provided. Obligation, Material Facts Regarding Scope and not give ‘‘honest and complete information’’ or Terms of the Relationship, Fees and Costs, disclose any material adverse facts or material 300 See infra footnote 525. Particularly of Fees and Costs Disclosed. conflicts of interest, including any economic self-

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remind broker-dealers that even full and disclosure by the associated person securities offered 312 and account fair disclosure of the information would be necessary. monitoring services.313 required by the Disclosure Obligation is As discussed below, in response to not sufficient, standing alone, to satisfy a. Material Facts Regarding Scope and comments, we have revised the the Care Obligation, and that even Terms of the Relationship Disclosure Obligation to require disclosure of ‘‘all material facts relating sufficient disclosure cannot cure a As discussed above, the proposed to the scope and terms of the violation of the Care Obligation. Disclosure Obligation would require a relationship with the retail customer, broker-dealer to, among other things, Disclosures by Natural Persons including: (i) That the broker, dealer or Associated With a Broker-Dealer ‘‘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 Disclosure Obligation applies to a the retail customer, in writing, the a broker-dealer with respect to the broker, dealer, or natural person who is material facts relating to the scope and recommendation; (ii) the material fees an associated person of a broker or terms of the relationship with the retail 304 and costs that apply to the retail dealer. As stated in the Proposing customer.’’ We proposed to consider the customer’s transactions, holdings, and Release, we are requiring not only the following to be examples of material accounts; and (iii) the type and scope of broker-dealer entity, but also facts relating to the scope and terms of services provided to the retail customer, individuals who are associated persons the relationship with the retail including any material limitations on of a broker-dealer (e.g., registered customer: (i) That the broker-dealer was the securities or investment strategies representatives) to comply with acting in a broker-dealer capacity with involving securities that may be specified components of Regulation Best respect to the recommendation; (ii) fees recommended to the retail Interest when making recommendations and charges that would apply to the customer.’’ 314 In addition, we are 305 to retail customers. One commenter retail customer’s transactions, holdings, clarifying the scope of the obligation. requested guidance on how an and accounts; and (iii) the type and As we did in the Proposing Release, associated person should comply with scope of services provided by the we emphasize that although we have the Disclosure Obligation.306 In broker-dealer, including, for example, explicitly identified the capacity in response, we believe that a natural monitoring the performance of the retail which the broker-dealer is acting, person who is an associated person of customer’s account. material fees and costs, and the type and a broker-dealer may in many instances scope of services, as what would at a rely on the disclosures provided by the Commenters requested that we clarify minimum be required to be disclosed as broker-dealer with which he or she is which facts a broker-dealer would be ‘‘material facts relating to the scope and associated to satisfy the Disclosure required to disclose about the scope and terms of the relationship with the retail Obligation. However, when an terms of the relationship it has with a customer,’’ the Disclosure Obligation associated person knows or should have customer under Regulation Best requires broker-dealers and associated known that the broker-dealer’s Interest.308 In particular, several persons to disclose ‘‘all material facts disclosure is insufficient to describe ‘‘all commenters recommended that the relating to the scope of the terms of the material facts,’’ the associated person Commission clarify how a dual- relationship,’’ (emphasis added) and must supplement that disclosure. For registrant should disclose its capacity broker-dealers and such associated example, if an associated person of a regarding its recommendations.309 Other persons thus will need to consider, broker-dealer that offers a full range of commenters recommended that the based on the facts and circumstances, securities products is licensed solely as Commission define the scope of fees a whether there are other material facts a Series 6 Registered Representative,307 broker-dealer must disclose 310 and the relating to the scope and terms of the and can sell only mutual funds, variable form that disclosure should take.311 In relationship with the retail customer annuities and other enumerated addition, some commenters requested that need to be disclosed. This analysis products, that limitation on the scope of clarity on the types of services that a generally should include consideration services provided by the particular broker-dealer would be required to of whether information in the associated person must be sufficiently disclose, including limitations on Relationship Summary constitutes a clear in the broker-dealer’s disclosures; ‘‘material fact’’ that could appropriately otherwise additional clarifying be expanded upon in satisfying the Disclosure Obligation. It would be interest. See, e.g., De Kwiatkowski v. Bear, Stearns possible, but would be unlikely for most & Co., 306 F.3d 1293, 130 (2d Cir. 2002); Chasins v. Smith, Barney & Co., 438 F.2d 1167, 1172 (2d Cir. 312 See, e.g., NY Life Letter (stating that an insurer 1970). See Proposing Release at 21599 footnote 176. may appropriately focus its career agents on the 304 Rule 15l–1(a)(2)(i). 308 See, e.g., SIFMA August 2018 Letter; Edward distribution of variable insurance products that the 305 Proposing Release at 21592. insurer manufactures, so long as limitations on the Jones Letter; NASAA August 2018 Letter; AARP 306 See NASAA August 2018 Letter universe of available products are disclosed to August 2018 Letter; PIABA Letter; Prudential Letter. (recommending that the Commission provide consumers and supervisory procedures are in place 309 specific instructions on how associated persons See, e.g., SIFMA August 2018 Letter; Edward to ensure that a variable insurance product is in the should disclose capacity in which they are acting). Jones Letter. client’s best interest); CFA Institute Letter (stating 307 A candidate who passes the Series 6 exam is 310 See, e.g., Bank of America Letter that the Disclosure Obligation should complement qualified for the solicitation, purchase and/or sale (recommending that the Commission apply a the information presented in Form CRS and provide of the following securities products: Mutual funds ‘‘materiality’’ threshold to determine which fees greater specificity about, among other things, the (closed-end funds on the initial offering only), should be disclosed). type and scope of services offered by the broker- dealer). Variable annuities, Variable life insurance, Unit 311 See, e.g., SIFMA August 2018 Letter (stating investment trusts (UITs), Municipal fund securities 313 See, e.g., IAA August 2018 Letter that a broker-dealer’s disclosure of a range of (e.g., 529 savings plans, local government (recommending that the Commission clarify that investment pools (LGIPs)). FINRA, Series 6— customer costs per product should be sufficient); Regulation Best Interest would apply to all advisory Investment Company and Variable Contracts CFA August 2018 Letter (stating a broker-dealer’s activities that broker-dealers agree to provide (e.g., Products Representative Exam, Permitted Activities, disclosure of percentages or ranges of cost ongoing monitoring for purposes of recommending available at: http://www.finra.org/industry/series6 information would do little to enlighten investors changes in investments)). #permitted-activities. about the true costs of brokers’ advice services). 314 Rule 15l–1(a)(2)(i)(A).

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broker-dealers, for the abbreviated In response to commenters, we are but only offer broker-dealer services format of the Relationship Summary to revising Regulation Best Interest to through a firm that is dually registered sufficiently disclose ‘‘all material facts’’ explicitly require disclosure of capacity, as an investment adviser with the regarding the scope and terms of the which the Proposing Release addressed Commission or with a state, must relationship such that no further in guidance. Therefore, Rule 15l– disclose whether they are acting (or, in information would be required to satisfy 1(a)(2)(i)(A) requires that the broker, the case of the latter, that they are only the Disclosure Obligation. dealer, or natural person who is an acting) as an associated person of a associated person of a broker or dealer, broker-dealer to satisfy the Disclosure Capacity In Which the Broker-Dealer Is prior to or at the time of the Obligation.322 An associated person of a Acting recommendation, provide the retail dual-registrant who does not offer In the Proposing Release, the customer, in writing, full and fair investment advisory services must Commission identified that the capacity disclosure of all material facts relating disclose that fact as a material limitation in which a broker-dealer is acting is a to the scope and terms of the in order to satisfy the Disclosure material fact relating to the scope and relationship with the retail customer, Obligation. terms of a customer relationship subject including that the broker-dealer or such Furthermore, as discussed in greater to the Disclosure Obligation.315 In so natural person is acting as a broker- detail below, we would presume the use identifying this critical element of dealer or an associated person of a of the terms ‘‘adviser’’ and ‘‘advisor’’ by information, we hoped to promote broker-dealer with respect to the (1) a broker-dealer that is not also greater awareness among retail recommendation. registered as an investment adviser or customers of the capacity in which their This disclosure is designed to (2) a financial professional that is not financial professional or firm acts with improve awareness among retail also a supervised person of an respect to recommendations. customers of the capacity in which their investment adviser to be a violation of Several commenters requested financial professional or broker-dealer the Disclosure Obligation under additional guidance on how dual- acts when it makes recommendations so Regulation Best Interest. Disclosure of registrants and their associated persons that the retail customer can more easily capacity may, in part, be made orally could comply with the proposed identify and understand their under the circumstances outlined in Disclosure Obligation in this respect.316 relationship, a goal shared with the Section II.C.1, Oral Disclosure or Some commenters stated that repeated Relationship Summary.320 Form CRS Disclosure After a Recommendation. disclosures of capacity would distract requires a firm to state the name of the For example, a broker-dealer may customers from more important broker-dealer or investment adviser and disclose that: ‘‘All recommendations disclosures related to a recommendation whether the firm is registered with the will be made in a broker-dealer capacity and could lead to confusion.317 While Commission as a broker-dealer, unless otherwise expressly stated at the we received comments expressing investment adviser, or both.321 A time of the recommendation; any such concerns that our proposed approach standalone broker-dealer (i.e., a broker- statement will be made orally.’’ In this might lead to investor confusion,318 dealer not also registered as an case, no further oral or written many of these commenters were seeking investment adviser) will generally be disclosure would be required until a clarity regarding this requirement and able to satisfy the Disclosure recommendation is made in a capacity not its elimination.319 Obligation’s requirement to disclose the other than as a broker-dealer. Similarly, broker-dealer’s capacity by delivering a broker-dealer may disclose that: ‘‘All 315 Proposing Release at 21601. the Relationship Summary to the retail recommendations regarding your 316 See, e.g., NASAA August 2018 Letter customer. brokerage account will be made in a (requesting that the Commission provide guidance For broker-dealers who are dually broker-dealer capacity, and all to associated persons of dual-registrants explaining registered, and for associated persons recommendations regarding your how they should disclose the capacity in which who are either dually registered or, who they are acting and whether they are providing a advisory account will be in an advisory recommendation or advice); Better Markets August are not dually registered but only offer capacity. When we make a 2018 Letter; CFA August 2018 Letter; Fidelity broker-dealer services through a firm recommendation to you, we will Letter; IPA Letter; SIFMA August 2018 Letter; that is dually registered, the information expressly tell you orally which account Edward Jones Letter; CCMC Letters. contained in the Relationship Summary we are discussing’’). In this instance, no 317 See, e.g., Edward Jones Letter (recommending will not be sufficient to disclose their that the Commission not require repeated capacity further disclosure of capacity is disclosures to customers because it would be capacity in making a recommendation. necessary. redundant and potentially confuse customers); Although some commenters expressed SIFMA August 2018 Letter (stating that disclosure concerns about potential investor Capacity in the Context of Names, of capacity should not be required at the time of the confusion caused by ‘‘additional’’ Titles, and Marketing Practices recommendation as it would cause unnecessary delay and distract customers from more important disclosure regarding a dual-registrant’s The Relationship Summary Proposal disclosures regarding account features and capacity, we believe that the Disclosure included a proposed rule that would recommendations); Better Markets August 2018 Obligation will not duplicate or confuse, have restricted broker-dealers and their Letter (stating that one-time written disclosure but instead will provide clarifying detail associated persons (unless they were about a dual-registrant’s advisory capacity, followed registered as, or supervised persons of, by future oral disclosures when they change roles on capacity to supplement the when making recommendations would be information contained in the an investment adviser), when confusing). Relationship Summary. Accordingly, we communicating with a retail investor, 318 See, e.g., Better Markets August 2018 Letter; are clarifying that dually registered CFA August 2018 Letter (stating that flexibility in associated persons and associated 322 Financial professionals with registrations to disclosure will result in disclosures that do not persons who are not dually registered offer services as a representative of a broker-dealer effectively convey key information especially for and investment adviser may offer services through dual-registrants as customers will not understand a dual-registrant, affiliated firms, or unaffiliated the capacity the dual-registrant is acting in at the how frequently, disclosure is required to put firms, or only offer one type of service particular time or its significance). customer on notice of their capacity); Edward Jones notwithstanding their dual licensing. Financial 319 See, e.g., SIFMA August 2018 Letter Letter; IPA Letter; CCMC Letters. professionals who are not dually registered may (requesting that the Commission clarify the 320 See Relationship Summary Proposal at 21420. offer one type of service through a firm that is application of the Disclosure Obligation to dually 321 See Relationship Summary Adopting Release dually registered. See Relationship Summary registered firms and personnel, including what, and at Section II.C. Adopting Release at Section II.B.4.

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from using the term ‘‘adviser’’ or example, that these particular terms are Additionally, some commenters stated ‘‘advisor’’ as part of a name or title often associated with the statutory term that Form CRS alone provides similar (‘‘Titling Restrictions’’).323 After further ‘‘investment adviser,’’ 326 or that investor protections that alleviate the consideration of our policy goals and investors ‘‘typically associate’’ these need for the restriction.333 Along similar the comments we received, and in light terms with registered investment lines, one commenter stated that certain of the disclosure requirements under advisers.327 A few commenters fraud-based securities laws and FINRA Regulation Best Interest, we do not generally noted that the title ‘‘financial rules provide the same protections that believe that adopting a separate rule advisor’’ prevents investors from the proposed restriction seeks to add, restricting these terms is necessary, understanding whether they are making it unnecessary.334 because we presume that the use of the engaging a financial professional who We also received several comments term ‘‘adviser’’ and ‘‘advisor’’ in a name provides advisory services or who sells on the following alternative approaches or title by (1) a broker-dealer that is not brokerage services.328 Moreover, other to the Titling Restrictions on which we also registered as an investment adviser commenters generally stated that names sought comment: (i) A broker-dealer that or (2) an associated person that is not and titles containing ‘‘adviser’’ or used the terms ‘‘adviser’’ or ‘‘advisor’’ as also a supervised person of an ‘‘advisor’’ create investor confusion part of a name or title would not be investment adviser, to be a violation of and/or could mislead investors about considered to provide investment the capacity disclosure requirement the differences between broker-dealers advice solely incidental to the conduct under the Disclosure Obligation as and investment advisers including the of its business as a broker-dealer, and discussed further below.324 applicable standard of care 329 and the (ii) a broker-dealer would not be We received several comments on the services to be provided.330 providing investment advice solely proposed Titling Restrictions, which we Other commenters did not support the incidental to its brokerage business if it have also considered when determining proposed Titling Restrictions, believing ‘‘held itself out’’ as an investment to presume use of such names and titles that the terms ‘‘adviser’’ and ‘‘advisor’’ adviser to retail investors.335 This to be a violation of the capacity are more generically used and second alternative approach would have disclosure.325 Some commenters understood, and refer to financial resulted in a restriction generally supported a restriction on the terms professionals who provide advice and broader in scope than the Titling ‘‘adviser’’ and ‘‘advisor,’’ noting, for financial services more generally.331 Restrictions, as it would also have Several of these commenters stated that encompassed communications and sales 323 See Relationship Summary Proposal, supra the restriction adds little additional practices in addition to the use of names footnote 12, at 21461–63. We also requested investor protection when taken together comment on whether we should explicitly restrict and titles. other terms, including ‘‘wealth manager’’ and with Regulation Best Interest and Form In response to these alternatives, ‘‘financial consultant.’’ Additionally, we requested CRS (i.e., it is duplicative).332 several commenters stated that the comment on whether we should restrict terms that Titling Restrictions were too narrow in are synonymous with ‘‘adviser’’ or ‘‘advisor.’’ 326 See Letter from Lexie Pankratz, Owner, meeting the Commission’s intended 324 We recognize that, in adopting the fee-based Trailhead Consulting, LLC (Aug. 7, 2018) objective of mitigating the risk that brokerage rule in 2005, we declined to place any (‘‘Trailhead Letter’’). limitations on how a broker-dealer may hold itself 327 See, e.g., Letter from Kurt N. Schacht, investors could be misled by the use of out or the titles it may employ. Certain Broker- Managing Director, et al., CFA Institute (Aug. 7, certain names and titles because the Dealers Deemed Not to Be Investment Advisers, 2018) (‘‘CFA Institute CRS Letter’’); Pickard Letter. Advisers Act Release No. 2376 (Apr. 12, 2005). Titling Restrictions did not address 328 See, e.g., Letter from Gerald Lopatin (Jul. 30, 336 However, as we noted in the Relationship Summary other confusing names or titles, and, 2018) (‘‘Lopatin Letter’’); Letter from Paula Hogan Proposal, comments we received in response to (Aug. 6, 2018) (‘‘Hogan Letter’’); Letter from Arlene Chairman Clayton’s request for comment and our Moss (Jul. 31, 2018) (‘‘Moss Letter’’); Letter from 7, 2018) (‘‘HD Vest Letter’’); LPL August 2018 experience prompted us to revisit our approach Daniel Wrenne (Jul. 31, 2018) (‘‘Wrenne Letter’’). Letter; SIFMA August 2018 Letter. But see Pickard from 2005. In addition, given that the new 329 Letter (supporting the restriction and our proposed disclosure requirements under Regulation Best See, e.g., FSI August 2018 Letter; Schwab Letter; CFA Institute CRS Letter; Betterment Letter. alternative holding out approach by noting that Interest and Form CRS will and should necessitate ‘‘[w]e do not think that Reg BI or Form CRS as 330 See, e.g., NASAA August 2018 Letter (stating a reassessment of a broker-dealer’s names, titles, currently proposed is sufficient.’’) and communications with its customers, we believe that ‘‘[t]his rule change will help forestall retail 333 investors’ confusion about the different roles and See, e.g., LPL August 2018 Letter; Morgan it is necessary to re-evaluate the appropriateness of Stanley Letter; Raymond James Letter. these practices in light of these new obligations. See duties owed by broker-dealers/agents and 334 See Cambridge Letter. also generally Relationship Summary Proposal, investment advisers/investment adviser 335 supra footnote 12, at 21459–61 (citing commenters Representatives’’); CFA Institute CRS Letter (stating See Relationship Summary Proposal, supra and studies by the Siegel and Gale Consulting that ‘‘[i]nvestor confusion about the roles and duties footnote 12, at 21463–64. We are not adopting the Group and the RAND Corporation that document of different financial services providers who use proposed alternative approach that would have investor confusion in the marketplace, all of which ‘‘adviser/advisor’’ in their titles has become restricted a broker-dealer from availing itself of the were conducted subsequent to the 2005 fee-based problematic from both an investor protection and solely incidental exclusion if it ‘‘held itself out’’ as brokerage rule); Public Comments from Retail trust standpoint. Use of the proposed CRS, alone, an investment adviser. Use of the terms ‘‘adviser’’ Investors and Other Interested Parties on Standards will not allay the substantial investor confusion in or ‘‘advisor,’’ however, could support a conclusion of Conduct for Investment Advisers and Broker- the marketplace about the differences between depending on other facts and circumstances, that Dealers, Chairman Jay Clayton (Jun. 1, 2017), broker-dealers and investment advisers.’’) the primary business of the firm is advisory in available at https://www.sec.gov/news/public- 331 See LPL August 2018 Letter (stating that nature, in which case the advice provided by the statement/statement-chairman-clayton-2017-05-31. ‘‘restricting use of ‘advisor’ and ‘adviser’ is contrary broker-dealer would not be solely incidental to the We also proposed rules (the ‘‘Affirmative to the plain English meaning the average investor conduct of its brokerage business. See Solely Disclosures’’) that would have required a broker- associates with those terms . . . regardless of the Incidental Interpretation, supra footnote 12, at dealer and an investment adviser to prominently legal contours of the service relationship.’’); NAIFA Section II.B (providing the Commission’s disclose that it is registered as a broker-dealer or Letter (stating that ‘‘[m]any financial professionals interpretation of the solely incidental prong of the investment adviser, as applicable, with the are recognized as and/or refer to themselves as broker-dealer exclusion from the Advisers Act). Commission in print or electronic retail investor ‘advisors/advisers’ or ‘financial advisors/advisers.’ 336 See e.g., Letter from Barbara Roper, Director of communications. As we discuss in a concurrent These words are (aptly) used by professionals who Investor Protection, and Micah Hauptman, rulemaking, we are not adopting the Affirmative offer advice on any number of financial topics.’’); Financial Services Counsel, (Dec. 7, 2018) (‘‘CFA Disclosures. See Relationship Summary Adopting Letter from Investments & Wealth Institute (‘‘IWI’’) December 2018 Letter’’); State Treasurers Letter; Release, supra footnote 12, at Section III. (Aug. 6, 2018) (‘‘IWI August 2018 Letter’’) (stating Waters Letter (noting that the Titling Restrictions 325 See, e.g., CFA August 2018 Letter; IAA August that an outright ban on the use of the terms are too narrow of a fix for investor confusion 2018 Letter; LPL August 2018 Letter; Letter from ‘‘adviser’’ and ‘‘advisor’’ by broker-dealers would because they fail ‘‘to address the numerous other Dennis M. Kelleher, President and CEO, et al., raise First Amendment concerns). titles professionals use.... As a result, most retail Better Markets (Aug. 7, 2018) (‘‘Better Markets CRS 332 See, e.g., Letter from Robert D. Oros, Chief investors cannot easily distinguish between Letter’’). Executive Officer, HD Vest Financial Services (Aug. Continued

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more specifically, because the Titling including through the use of particular Obligation, a broker-dealer, or an Restrictions did not address the broker- terms in names and titles. Firms often associated person, must, prior to or at dealers who ‘‘hold themselves out’’ as spend time and money to market, brand, the time of the recommendation, investment advisers.337 Several of these and create intellectual property by using disclose that the broker-dealer or that commenters instead advocated for these terms in an effort to shape investor associated person is acting as a broker precluding reliance on the solely expectations.341 A name or title is or dealer with respect to the incidental prong by any broker-dealer generally used, and is designed to have recommendation.344 When a broker- that holds itself out as an investment significance, on its own without any dealer or an associated person uses the adviser.338 Some commenters stated that additional context as to what it means. name or title ‘‘adviser’’ or ‘‘advisor’’ certain marketing practices indicate that Given that the titles ‘‘adviser’’ and there are few circumstances 345 in which advice is the main function of the ‘‘advisor’’ are closely related to the that broker-dealer or associated person broker-dealer’s service.339 Additionally, statutory term ‘‘investment adviser,’’ would not violate the capacity one commenter stated that ‘‘the their use by broker-dealers can have the disclosure requirement because the potential for investor confusion is at its effect of erroneously conveying to name or title directly conflicts with the greatest when dealing with broker- investors that they are regulated as information that the firm or professional dealers and dual-registrants that investment advisers, and have the would be acting in a broker-dealer routinely market their services as business model, including the services capacity.346 Therefore, use of the titles advisory in nature....’’340 and fee structures, of an investment ‘‘adviser’’ and ‘‘advisor’’ by broker- adviser.342 Such potential effect dealers and their financial professionals Use of Terms ‘‘Adviser’’ or ‘‘Advisor’’ undermines the objective of the capacity would undermine the objectives of the Financial firms and their disclosure requirement under capacity disclosure requirement by professionals, including broker-dealers Regulation Best Interest to enable a potentially confusing a retail customer and investment advisers, seek to acquire retail customer to more easily identify as to type of firm and/or professional new customers and to retain existing and understand their relationship. they are engaging, particularly since customers by marketing their services, As discussed above, the Disclosure ‘‘investment adviser’’ is defined by Obligation requires broker-dealers to statute separately from ‘‘broker’’ or financial advisers who are mere salespeople and make full and fair disclosure of all ‘‘dealer.’’ those that are investment advisers that must material facts relating to the scope and As a result,347 we presume that the provide advice that is in the best interests of the investor.’’). See also NAIFA Letter (noting that terms of the relationship with a retail use of the terms ‘‘adviser’’ and restricting these terms for broker-dealers and their customer, including the capacity in ‘‘advisor’’ in a name or title by (i) a financial professionals only ‘‘and not for numerous which they are acting with respect to a broker-dealer that is not also registered other professionals using those words and recommendation. The capacity as an investment adviser or (ii) an delivering advice on a wide variety of financial topics creates more consumer confusion and does disclosure requirement is designed to associated person that is not also a not enhance consumers’ understanding of the improve awareness among retail supervised person of an investment specific obligations and standards that apply to customers of the capacity in which their adviser to be a violation of the capacity their advisor(s).’’) firm and/or financial professional acts disclosure requirement under Additionally, several of the commenters who 348 supported the restriction recommended when it makes recommendations so that Regulation Best Interest. modifications such as broadening the restriction to a retail customer can more easily include other terms, including ‘‘wealth manager’’ identify and understand their 344 See Rule 15l–1(a)(2)(i)(A)(i). and ‘‘financial consultant.’’ See, e.g., Financial relationship.343 We believe that in most 345 See infra footnotes 349–351 and Engines Letter; Comment Letter of Altruist cases broker-dealers and their financial accompanying text. Financial Advisors LLC (Aug. 7, 2018) (‘‘Altruist 346 In the Relationship Summary Proposal, we Letter’’); Letter from David John Marotta (April 22, professionals cannot comply with the stated that our proposed restriction on the terms 2018) (‘‘Marotta Letter’’); Galvin Letter; Letter from capacity disclosure requirement by ‘‘adviser’’ and ‘‘advisor’’ would not have applied to Pamela Banks, Senior Policy Counsel, Consumers disclosing that they are a broker-dealer broker-dealers when communicating with Union (Oct. 19, 2018) (‘‘Consumers Union Letter’’). while calling themselves an ‘‘adviser’’ institutions. See Relationship Summary Proposal, 337 See, e.g., CFA August 2018 Letter; FPC Letter; supra footnote 12, at 21462. Given that Regulation IAA August 2018 Letter; Letter from Michael Kitces or ‘‘advisor.’’ Under the Disclosure Best Interest and the Relationship Summary apply (Aug. 2, 2018) (‘‘Kitces Letter’’); LPL August 2018 only to retail customers and retail investors, Letter; MarketCounsel Letter; Waters Letter. 341 See, e.g., Letter from Barbara Roper, Director respectively, our presumption would only apply to 338 See, e.g., IAA August 2018 Letter (noting that of Investor Protection, and Micah Hauptman, the use of ‘‘adviser’’ and ‘‘advisor’’ in such contexts. ‘‘[w]hile names or titles are contributing factors to Financial Services Counsel, CFA (Sep. 14, 2017) Therefore, we do not believe that further investor confusion and the potential for investors to (‘‘CFA September 2017 Letter’’) (‘‘[O]ur study clarification of communications by non-retail be misled, we believe that other factors should be documents how everything from the titles brokers focused broker-dealers is necessary. considered as well. In particular, previous studies use to the way they describe their services is 347 Specifically, in the Proposing Release we noted the confusion arising from ‘we do it all’ designed to send the message that they are in the stated that a standalone broker-dealer would satisfy advertisements and ‘marketing efforts which business of ‘providing expert investment advice, the capacity disclosure by complying with the depicted an ongoing relationship between the comprehensive financial planning, and retirement proposed Relationship Summary and Affirmative broker-dealer and the investor.’ ’’); Betterment planning that is based on their clients’ needs and Disclosure requirements. We provided this Letter; CFA August 2018 Letter; LPL August 2018 goals and that is designed to serve their best proposed guidance in the context of concurrently Letter. interests.’ ’’) proposing the Titling Restrictions. For the reasons 339 See CFA August 2018 Letter (citing to Micah 342 See Relationship Summary Proposal, supra discussed herein, we believe a presumption against Hauptman and Barbara Roper, Financial Advisor or footnote 12, at 21461. the use of these titles by standalone broker-dealers Investment Salesperson? Brokers and Insurers Want 343 Similarly, Form CRS is designed to reduce is more appropriate than a restriction. to Have it Both Ways, January 18, 2017). See also retail investor confusion in the marketplace for 348 If a financial professional is a registered Better Markets CRS Letter (stating that titles present brokerage and investment advisory services and to representative of a broker-dealer that is a dual- a professional as not ‘‘only an expert in financial assist retail investors with the process of deciding registrant but the professional is not also a matters but also someone who will offer advice and whether to engage, or to continue to engage, a supervised person of an investment adviser, this recommendations’’); Letter from Michael Palumbo particular firm or financial professional and professional would similarly be presumptively in (Aug. 7, 2018) (‘‘Palumbo Letter’’); Kitces Letter. whether to establish, or to continue to maintain, an violation of the capacity disclosure requirement if 340 See CFA August 2018 Letter. See also CFA investment advisory or brokerage relationship. A the financial professional uses the title ‘‘adviser’’ or Institute CRS Letter (stating that the proposal broker-dealer firm or financial professional’s use of ‘‘advisor.’’ However, this financial professional may should address ‘‘those who may not expressly refer ‘‘adviser’’ or ‘‘advisor’’ in its name or title would continue to use either the dual-registrant’s materials to themselves as ‘adviser/[advis]or’ but through inhibit a customer’s full understanding of the or may use the firm’s name in the financial their actions convey that meaning to contours of his or her relationship with the firm and professional’s communications even if the firm’s investors. . . .’’). financial professional, undermining Form CRS. name includes the title ‘‘adviser’’ or ‘‘advisor’’

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Although using these names or titles Marketing Communications improve awareness among retail creates a presumption of a violation of As discussed above, several customers of the capacity in which their the Disclosure Obligation in Regulation commenters on the Titling Restrictions firm or financial professional acts when Best Interest, we are not expressly raised concerns that restricting the use it makes recommendations so that the prohibiting the use of these names and of names and titles would be retail customer can more easily identify titles by broker-dealers because we insufficient to address what they viewed and understand their relationship. recognize that some broker-dealers use as the larger issue of broker-dealer As noted above, we are not adopting them to reflect a business of providing marketing communications where a the Commission’s proposed alternative holding out approach that would have advice other than investment advice to broker-dealer and/or its financial addressed broker-dealer marketing retail clients. A clear example is a professional appears to be holding itself out as an investment adviser. Marketing communications through the lens of the broker-dealer (or associated person) that solely incidental exclusion.357 However, 349 communications provide additional acts on behalf of a municipal advisor under our interpretation of the solely or commodity trading adviser,350 or as context to investors and are designed to persuade potential customers to obtain incidental prong of the broker-dealer an advisor to a special entity,351 as these exclusion from the definition of are distinct advisory roles specifically and pay for the firm’s services and 353 investment adviser, a broker-dealer’s defined by federal statute that do not products. They communicate to customers what services firms investment advisory services do not fall entail providing investment advisory understand themselves to be within that prong if the broker-dealer’s services. We also recognize that a providing—including, for broker- primary business is giving investment broker-dealer may provide advice in dealers, recommendations in connection advice or if its investment advisory other capacities outside the context of with and reasonably related to effecting services are not offered in connection investment advice to a retail customer securities transactions. with and are not reasonably related to that would present a similarly The way in which a broker-dealer the broker-dealer’s business of effecting 358 compelling claim to the use of these markets itself may have regulatory securities transactions. By more terms. In these circumstances, firms and consequences. As noted above, Form clearly delineating when a broker- their financial professionals may in CRS requires, among other items, dealer’s performance of advisory their discretion use the terms ‘‘adviser’’ broker-dealers (and investment advisers) activities renders it an investment or ‘‘advisor.’’ 352 In most instances, to state clearly key facts about their adviser, this interpretation provides however, when a broker-dealer uses relationship, including their registration guidance that may be informative to these terms in its name or title in the status and the services they provide.354 broker-dealers when designing context of providing investment advice Broker-dealers (and investment marketing communications that advisers) will also be required through accurately reflect their activities. to a retail customer, they will generally Broker-dealers, dual-registrants, and violate the capacity disclosure Form CRS to provide information to assist retail investors in deciding affiliated broker-dealers of investment requirement under Regulation Best advisers that market their services Interest. whether to engage in an investment advisory or brokerage relationship.355 together should consider whether modifications are needed in their because such firm is dually registered as an Additionally and as discussed above, we are adopting the capacity disclosure marketing communications in light of investment adviser and broker-dealer and is not these new obligations. As we noted in presumptively violating the capacity disclosure requirement under Regulation Best requirement under Regulation Best Interest. Interest, which requires broker-dealers the Relationship Summary Proposal, Moreover, we believe it would be consistent for and their financial professionals to broker-dealers can, and do, provide dual-registrants and dually registered financial investment advice so long as such professionals to use these terms as they would be affirmatively disclose the capacity (e.g., brokerage) in which they are acting with advice comports with the broker-dealer accurately describing their registration status as an exclusion under Advisers Act section investment adviser. respect to their recommendations.356 349 15 U.S.C. 78o–4(e)(4). These obligations are designed to 202(a)(11)(C). While broker-dealers and 350 15 U.S.C. 80b–2(a)(29). their financial professionals may state 351 15 U.S.C. 78o–8(h)(2)(A). 353 Affiliated firms may market advisory and that they provide ‘‘advice’’ in their 352 Some commenters raised concerns that the brokerage services in a single set of marketing communications, those and proposed restriction would not permit financial communications. A dually registered firm also may other statements should not be made in professionals to indicate that they maintain seek to market the primary services provided by its a manner that contradicts the particular certifications that include in the name or advisory and brokerage business lines in a single set title ‘‘adviser’’ or ‘‘advisor.’’ See, e.g., IWI August of communications. We believe this combined disclosures made pursuant to 2018 Letter; Letter from IWI (Oct. 9, 2018) (‘‘IWI approach to providing customers with information Regulation Best Interest and Form CRS, October 2018 Letter’’). Cf. Letter from John about investment services enhances customer and should be reviewed in light of the Robinson (Aug. 6, 2018) (‘‘Robinson Letter’’) choice, and we understand that many such firms Solely Incidental Interpretation.359 We (suggesting that the Commission limit the use of the market in this way in an effort to provide a believe that the combination of new term ‘‘financial planner’’ to investment adviser comprehensive picture of the firm’s services. representatives); FPC Letter (suggesting that the See also Instructions to Form CRS, General disclosure obligations and requirements Commission clarify which certifications or Instruction 5. (Encouraging dual-registrants to and firms’ implementation of these new professional designations may be used for financial prepare one relationship summary discussing both obligations will appropriately address planners). We recognize that these designations are its brokerage and investment advisory services, but commenters’ concerns regarding broker- intended to convey adherence to particular stating that they may prepare two separate standards that financial professionals have met. relationship summaries for brokerage services and dealers that hold themselves out as However, these designations are not rooted in any investment advisory services. Whether the firm statutory construct (as are the titles ‘‘commodity prepares one relationship summary or two, the firm 357 See supra footnote 335 and accompanying trading advisor’’ and ‘‘municipal advisor’’) and must present the brokerage and investment advisory text. given that the terms ‘‘adviser’’ and ‘‘advisor’’ are information with equal prominence and in a 358 See Solely Incidental Interpretation, supra still associated with the statutory term ‘‘investment manner that clearly distinguishes and facilitates footnote 12, Section II.B (providing the adviser,’’ even if used in a designation, a broker- comparison of the two types of services.). Commission’s interpretation of the solely incidental dealer or associated person that uses these 354 See Relationship Summary Adopting Release, prong of the broker-dealer exclusion from the designations would similarly be in presumptive supra footnote 12. Advisers Act.) violation of the capacity disclosure requirement in 355 Id. 359 See Relationship Summary Proposal, supra Regulation Best Interest. 356 See Rule 15l–1(a)(2)(i)(A)(i). footnote 12, at 21461.

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investment advisers, particularly those consideration of the comments received, the retail customer, as defined in the who can change capacities when serving and in light of the obligations being rule. retail investors in a dual capacity.360 imposed by the Relationship Summary, We would generally expect that, to In addition to these new obligations, we are revising Regulation Best Interest satisfy the Disclosure Obligation, FINRA Rule 2210 (regarding its to explicitly require the disclosure of broker-dealers would build upon the members’ communications with the fees and costs, and are providing material fees and costs identified in the public) is designed to ensure that additional clarifying guidance. In Relationship Summary, providing broker-dealer communications with the addition, we are revising the Regulation additional detail as appropriate. These public are fair, balanced, and not Best Interest rule text to refer to ‘‘fees descriptions could include, for example, misleading.361 This rule includes and costs’’ instead of ‘‘fees and an explanation of how and when the general standards, such as a requirement charges,’’ consistent with the approach fees are deducted from the customer’s to not make any false or misleading taken in the Relationship Summary. account (e.g., such as on a per- statements, and specific content Specifically, we are revising the transaction basis or quarterly). Although standards, such as requirements on how Disclosure Obligation to require the fees and costs identified in the to disclose the broker-dealer’s name in disclosure of ‘‘all material facts relating Relationship Summary may provide a marketing communications.362 to the scope and terms of the useful starting point for the Accordingly, we anticipate that FINRA relationship with the retail customer, identification of the material fees and will be reviewing the application of including [. . .] the material fees and costs that may be disclosed pursuant to these rules in light of these new costs that apply to the retail customer’s the Disclosure Obligation, there may be disclosure obligations. The Commission transactions, holdings and other categories of fees and costs that staff also will evaluate broker-dealer accounts.’’ 365 are material under the facts and marketing communications to consider We are also providing additional circumstances of a broker-dealer’s whether additional measures may be guidance addressing the scope of fees business model that must be disclosed necessary. and costs to be disclosed. Namely, the pursuant to the Disclosure Obligation. Fees and Costs Disclosure Obligation requires Particularity of Fees and Costs disclosure of material fees and costs In the Proposing Release, we stated Disclosed; Individualized Disclosure relating to the retail customer’s that fees and charges applicable to the Several commenters recommended transactions, holdings and accounts. retail customer’s transactions, holdings, that the Commission not require that This obligation would not require and accounts would also be examples of broker-dealers provide individualized individualized disclosure for each retail ‘‘material facts relating to the terms and fee disclosures to retail customers. customer. Rather, the use of scope of the relationship’’ 363 As such, Specifically, they recommended that the these fees and charges would generally standardized numerical and other non- Commission clarify that broker-dealers have needed to be disclosed in writing individualized disclosure (e.g., could meet the Disclosure Obligation if reasonable dollar or percentages ranges) prior to, or at the time of, the 366 they provide a range of fees and costs recommendation. While we did not is permissible, as discussed below. or use standardized and hypothetical propose to mandate the form, specific Scope of Fees and Costs To Be Disclosed amounts rather than requiring content, or method for delivering fee disclosure of actual dollar amounts Several commenters asked for disclosure, we stated that we would based on proposed amounts to be clarification about whether all fees and generally expect that, to meet the invested (i.e., individualized fees).369 charges must be disclosed, or only those Disclosure Obligation, broker-dealers These commenters cited concerns about 367 In response, we would build upon the proposed that are ‘‘material.’’ cost and practicality associated with are revising Regulation Best Interest to Relationship Summary by disclosing, generating individualized make explicit that a material fact among other things, additional detail disclosures.370 With regard to product- regarding the scope and terms of the regarding the types of fees and charges level fees in particular, several relationship includes material fees and described in the proposed Relationship commenters expressed concern that Summary.364 costs that apply to the retail customer’s We received a number of comments transactions, holdings and accounts. As 369 See, e.g., Vanguard Letter (recommending that on the proposed Disclosure Obligation noted above, the standard for materiality the Disclosure Obligation could be satisfied by relating to fees and charges. As for purposes of the Disclosure relaying the types and ranges of costs associated Obligation is consistent with the one the with a recommendation, or by using standardized discussed in more detail in the relevant and hypothetical investments, rather than requiring sections below, these comments Supreme Court articulated in Basic v. computation of actual dollar amounts based on generally sought clarity on the scope of Levinson; fees and costs are material proposed amounts to be invested); Capital Group fees and charges to be disclosed, and must be disclosed, if there is ‘‘a Letter (stating that customized mutual fund fee and substantial likelihood that a reasonable expense disclosures for investors at the time of the including the particularity of the fees recommendation would be impractical); SIFMA and charges to be disclosed (i.e., shareholder would consider it August 2018 (recommending the Commission 368 whether standardized or individualized important.’’ As noted above, in the permit disclosure of a range of customer costs per disclosure would be required). In context of this Regulation Best Interest, product); NASAA August 2018 Letter (suggesting the standard of materiality is based on that the Commission mandate its Model Fee Table along with disclosure of other fees paid for services 360 See, e.g., IAA August 2018 Letter; FPC Letter; and any other third party remuneration). Better Markets CRS Letter. 365 Rule 15l–1(a)(2)(i)(A)(ii). 370 See, e.g., TIAA Letter (stating that broker- 361 See FINRA Rule 2210. 366 See Section II.C.1.a, Disclosure Obligation, dealers would need to expend significant resources Additionally, broker-dealers and their financial Fees and Costs, Particularity of Fees and Costs to build new systems and new compliance professionals should keep in mind the applicability Disclosed; Individualized Disclosure. programs in order to provide individualized fee of the antifraud provisions of the federal securities 367 See, e.g., Bank of America Letter disclosure); ICI Letter (recommending that the laws, including section 17(a) of the Securities Act, (recommending that the Commission: (i) Provide Commission confirm that the Disclosure Obligation and Exchange Act Section 10(b) and Rule 10b–5 greater specificity regarding the fees to be disclosed would not require a broker-dealer to separately thereunder, to their marketing practices. under Regulation Best Interest, and (ii) apply a calculate fund fees and expenses); Capital Group 362 See, e.g., FINRA Rule 2210(d)(1) and (d)(3). ‘‘materiality’’ threshold to those fees). Letter (stating that individualized disclosures raise 363 See Proposing Release at 21601. 368 Basic, Inc. v. Levinson, 485 U.S. 224, 224 significant operational burdens and compliance 364 See Proposing Release at 21600. (1988). issues in exchange for, at best, inconsistent utility).

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broker-dealers could not easily calculate product fees, and later supplement that more individualized disclosure where individualized fees and charges information with more particularized appropriate, or in response to a retail associated with the securities about information by delivering the product customer’s request. As a best practice, which they provide recommendations prospectus.375 firms may also consider reviewing with and that doing so might lead to Consistent with this approach, and their retail customers the effect of fees inadvertently providing inconsistent or also in response to comments, we are and costs on the retail customer’s inaccurate fee estimates to their retail further clarifying that a broker-dealer account(s) on a periodic basis.376 The customers.371 In this vein, several recommending a securities transaction costs, errors, delays, and other practical commenters recommended that broker- or an investment strategy involving obstacles to individualized fee dealers should be able to satisfy the securities can meet the Disclosure disclosure are likely to fall over time. Disclosure Obligation regarding Obligation regarding fees and costs We will continue to consider whether to product-level fees by providing retail assessed at the product level by require more personalized fee customers with or referring them to an describing those fees and costs in initial, disclosure, particularly as technology issuer’s offering materials, such as a standardized terms and providing evolves to address operational and prospectus.372 Other commenters, on subsequent particularized disclosure as technological costs. the other hand, stated that the necessary. To the extent that such Commission should not allow the use of subsequent information regarding With regard to the disclosure of percentages or ranges because such a product-level fees and costs appears in product-level fees in particular, while presentation does not adequately inform a currently mandated disclosure we support the goal of bringing greater investors of the fees and charges they document, such as a trade confirmation transparency to all fees incurred, we are will incur.373 or a prospectus, delivery of that seeking to supplement, not supplant, As adopted, the Disclosure Obligation information in accordance with existing the existing regulatory regime currently does not mandate individualized fee regulatory obligations will be deemed to applicable to product-level fees with the disclosure particular to each retail satisfy the Disclosure Obligation, even if adoption of Regulation Best Interest. We customer. Instead, broker-dealers may delivery occurs after the acknowledge that if a broker-dealer disclose ‘‘material facts’’ about material recommendation is made, under the highlights such fees with particularity, fees and costs in terms of more circumstances outlined in Section II.C.1. it may raise a customer’s awareness of standardized numerical and narrative Although it is not required by them, and we encourage as a best 377 disclosures, such as standardized or Regulation Best Interest, broker-dealers practice that broker-dealers do so. We hypothetical amounts, dollar or may refer the customer to any issuer acknowledge also that the nature and percentage ranges, and explanatory text disclosure of the security being extent of product-level disclosures may where appropriate. The disclosure recommended, such as a prospectus, vary. However, we do not believe that should accurately convey why a fee is private placement memorandum, or requiring broker-dealers to deliver being imposed and when the fee is to be offering circular, where more particular product disclosures earlier than is charged. Further, as discussed below,374 information may be found. currently required, to generate fee a broker-dealer will need to supplement We acknowledge that the desire for disclosure not currently required of this standardized disclosure with more greater fee transparency was a issuers, or to recalculate or highlight particularized information if the broker- consistent theme of our investor specific product-level fees already dealer concludes that such information engagement and we believe that the disclosed in an issuer’s offering is necessary to fully and fairly disclose Disclosure Obligation, in conjunction materials will meaningfully improve fee the material facts associated with the fee with the Relationship Summary, disclosure and it may, in fact, be unduly or charge. For example, a broker-dealer significantly advances that goal. burdensome and raise the possibility of might initially disclose a range of Individualized fee disclosure may be errors if broker-dealers were to be helpful to some retail customers, but it obligated to project or calculate product 371 See, e.g., TIAA Letter (stating that calculating can also be costly, prone to errors, and fees based on product issuer individualized fee information for any retail cause delays in trade execution. In information. Accordingly, we believe customer would be difficult and might lead to addition, in some cases the precise that allowing broker-dealers to meet the inadvertently providing inconsistent or inaccurate amount of the fee may be based on the Disclosure Obligation with regard to fee estimate); Capital Group Letter. dollar value of the transaction, and 372 See TIAA Letter (stating that broker-dealers product-level fees by describing those should not be obligated to provide fund-level fee would not be known prior to or at the fees in standardized terms with further disclosure outside of a fund prospectus or to time of the recommendation, meaning detailed, particularized information provide individualized fee disclosure to retail that it could only be expressed in more related to the recommendation provided customers); ICI Letter (stating that when making a general terms, such as a percentage recommendation of a fund, a broker-dealer should either prior to or at the time of the be permitted to direct customers to the fund’s value or range, as an initial matter. We recommendation or afterwards under prospectus as the source of information about fund believe that adopting the Disclosure the circumstances outlined in Section fees and expenses); Oppenheimer Letter (stating Obligation that allows for the use of II.C.1, Oral Disclosure or Disclosure that the fund, not the broker-dealer, is in a better standardized disclosure furthers our position to provide these disclosures, in a manner After a Recommendation, strikes an that is accurate, consistent and complete). goal of informing investors about fees 373 See, e.g., CFA August 2018 Letter (stating that and costs by the time of a 376 Although we encourage firms to have this the Commission should not allow for percentages recommendation in a workable manner. conversation with their retail customers, we are not or ranges because it would do little to inform Nothing in Regulation Best Interest suggesting that engaging in such a best practice investors); PIABA Letter (stating that broker-dealers prevents a broker-dealer from providing would, by itself, create any implied or explicit should disclose the specific charges that their obligation to monitor such fees and costs. customers will incur as a result of the particular such individualized disclosure to its 377 With regard to product-level fees, in recommendation); UMiami Letter (stating that customers should it wish to do so, and particular, broker-dealers may wish to highlight customers should be provided with clear and we encourage firms to assist retail certain categories of fees such as distribution fees, concise information that fully and fairly discloses customers in understanding the specific platform fees, shareholder servicing fees and sub- the specific charges the customer will incur as a transfer agency fees, in order to enhance retail result of a particular recommendation). fees and costs that apply, and to provide customers’ understanding of these fees to the extent 374 See Section II.C.1.c, Disclosure Obligation, applicable to the customer’s transactions, holdings, Full and Fair Disclosure, Layered Disclosure. 375 See supra footnote 302. and accounts.

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appropriate balance between costs to Type and Scope of Services Provided Interest,385 as discussed below, and the firms and benefits to retail customers.378 level of disclosure required under We believe this approach is bolstered In the Proposing Release, we provided Regulation Best Interest.386 by the existence of complementary guidance that the type and scope of Consistent with our approach in the obligations protective of retail services a broker-dealer provides its Proposing Release, we continue to customers that are imposed by retail customers would also be an believe that the type and scope of Regulation Best Interest. For example, to example of what typically would be services a broker-dealer provides to its the extent fees and costs incurred ‘‘material facts relating to the terms and retail customers are ‘‘material facts related to these products create conflicts scope of the relationship,’’ that would relating to the scope and terms of the of interest associated with a require disclosure pursuant to the relationship.’’ Accordingly, we are 380 recommendation, we believe they are Disclosure Obligation. Specifically, revising the rule text to explicitly appropriately highlighted and addressed we stated that broker-dealers should require the disclosure of the ‘‘type and in the context of the conflicts and build upon their disclosure in the scope of services provided to the retail incentives they create to make a Relationship Summary, and provide customer, including any material recommendation, and must be additional information regarding the limitations on the securities or addressed as part of the obligation to types of services that will be provided investment strategies involving disclose material facts about conflicts of as part of the relationship with the retail securities that may be recommended to interest associated with a customer and the scope of those the retail customer,’’ as part of the 381 recommendation, as discussed below.379 services. ‘‘material facts relating to the scope and Moreover, under the Care Obligation, In particular, we noted that under terms of the relationship’’ that must be a broker-dealer recommending a proposed Form CRS broker-dealers disclosed pursuant to the Disclosure securities transaction or investment would provide high-level disclosures Obligation.387 strategy involving securities to a retail concerning services offered to retail We are interpreting the Disclosure customer must consider costs associated investors, including, for example, Obligation to only require disclosure of with that recommendation when recommendations of securities, material facts relating to the type of determining whether it is in the best assistance with developing or executing services provided (e.g., the fact that the interest of that retail customer. As a an investment strategy, monitoring the broker-dealer monitors securities result, disclosure of product-level fees performance of the retail investor’s transactions and investment strategies) and costs to satisfy the Disclosure account, regular communications, and and the scope of services (e.g., Obligation will be supplemented by limitations on selections of products.382 information about the frequency and other aspects of Regulation Best Interest. We recognized that a broker-dealer that duration of the services). In response to While the Disclosure Obligation offers different account types, or offers comments, we are also specifically provides broker-dealers with flexibility varying additional services to the retail addressing the disclosure of information in describing the material fees and costs customer may not be able, within the regarding whether or not the broker- that apply, the disclosure should content and space constraints of the dealer provides account monitoring accurately convey why the fee or charge Relationship Summary, to provide ‘‘all services and whether the broker-dealer is being imposed and when the fee or material facts relating to the scope and has account minimums or similar charge is to be assessed. For example, terms of the relationship’’ with the retail requirements. describing a commission or markup as customer.383 Thus, we stated that In addition, in response to comments, a fee for ‘‘handling services’’ could pursuant to the proposed Disclosure we are clarifying that pursuant to the inappropriately disguise the fee’s true Obligation, we would have generally Disclosure Obligation, broker-dealers nature. Furthermore, while using a expected broker-dealers to disclose need to disclose only material percentage or dollar range to describe a these types of material facts concerning information relating to the ‘‘type and fee can be appropriate, that range the actual services offered as part of the scope of services provided.’’ As should be designed to reasonably reflect relationship with the retail customer discussed in the context of the the actual fee to be charged. For separately from the Relationship disclosure of fees and costs above, the example, a statement that a charge may Summary. standard for materiality of the type and be ‘‘between 5 and 100 basis points’’ Commenters generally agreed that it scope of services to be disclosed is would not be accurate if the fee is in was important for broker-dealers to consistent with the standard articulated almost all instances between 85 and 100 disclose to their customers material in Basic v. Levinson: Information related basis points. However, in this case, a facts about the type and scope of to the type and scope of services broker-dealer could accurately describe services they provide to their provided is material, and must be the fee, for example, as ‘‘generally being customers.384 However, commenters disclosed, if there is ‘‘a substantial between 85 and 100 basis points, sought clarity regarding the application likelihood that a reasonable shareholder sometimes lower, but never above.’’ In of this proposed guidance, and raised some cases, actual dollar values based questions about whether firms would be 385 See, e.g., Betterment Letter (recommending on a hypothetical transaction may specifically required to disclose certain that the Commission ensure that dual-registrants communicate which of their services are advisory facilitate customer understanding. services (e.g., monitoring account A material fact about fees and costs in nature); Northwestern Mutual Letter. performance and providing financial 386 See, e.g., Cetera August 2018 Letter (stating could also include informing a retail education) pursuant to Regulation Best that a best interest standard should include a customer of a fee’s triggering event, such requirement to deliver a summary description of the as a fee imposed because an account relationship between the firm and customer, 380 See Proposing Release at 21602. minimum falls below a threshold and including the scope of services); Committee of 381 Id. Annuity Insurers Letter (recommending the whether fees are negotiable or waivable. 382 See Relationship Summary Proposing Release Commission clarify that a broker-dealer could at 31426. satisfy the Disclosure Obligation by disclosing the 378 See Section II.C.1, Disclosure Obligation, Oral 383 See Section II.C.1.a, Disclosure Obligation, products and services available to its retail Disclosure or Disclosure After a Recommendation. Standard of Conduct. customers and does not need to disclose 379 See Section II.C.1.b, Disclosure Obligation, 384 See, e.g., Pacific Life August 2018 Letter; information particularized to a recommendation). Material Facts Regarding Conflicts of Interest. Cetera August 2018 Letter. 387 Rule 15l–1(a)(2)(i)(A)(iii).

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would consider it important.’’ 388 As that broker-dealers that place material the entire possible range of securities noted above, in the context of limitations on the securities or and investment strategies would convey Regulation Best Interest, this standard investment strategies involving useful information to a retail customer, would apply in the context of retail securities that may be recommended to and therefore we would not consider customers, as defined. retail customers—such as this fact, standing alone, to constitute a We believe the information included recommending only proprietary material limitation.394 in the Relationship Summary may products or a specific asset class—need In addition, we believe that there are provide a useful starting point for the to describe the material facts relating to a number of reasonable practices by identification of the type and scope of those limitations.391 which appropriate limitations are services that must be disclosed pursuant Therefore, in response to comments, determined, including processes for the to the Disclosure Obligation. For we are revising Regulation Best Interest selection of a ‘‘menu’’ of products that example, in the Relationship Summary to explicitly require that, as part of the will be available for recommendations a broker-dealer must describe its disclosure of the type and scope of to retail customers. We further recognize principal brokerage services offered, services provided to the retail customer, that these limitations can be beneficial, including buying and selling securities, a broker-dealer must include ‘‘any such as by helping ensure that a broker- and whether or not it offers material limitations on the securities or dealer and its associated persons recommendations to retail investors.389 investment strategies involving understand the securities they are Additionally, in the Relationship securities that may be recommended to recommending, as required by Summary, if applicable, the broker- the retail customer.’’ 392 For purposes of paragraph (a)(2)(ii)(A) of the Care dealer must address whether or not the this requirement, a ‘‘material limitation’’ Obligation. We have also explicitly firm offers monitoring of investments. placed on the securities or investment stated that Regulation Best Interest We believe that broker-dealers will strategies involving securities could would not prohibit a broker-dealer from generally need to build upon the include, for example, recommending recommending, for example, a limited disclosures made in the Relationship only proprietary products (e.g., any range of products, or only proprietary Summary as appropriate, and to provide product that is managed, issued, or products, provided the broker-dealer additional information regarding the sponsored by the broker-dealer or any of satisfies the component obligations of types of services that will be provided its affiliates), a specific asset class, or Regulation Best Interest. Nonetheless, as part of the relationship with the retail products with third-party arrangements because these firm-wide threshold customer and the scope of those services (e.g., revenue sharing, mutual fund decisions have such a significant effect (e.g., the frequency and duration of the service fees).393 Similarly, the fact that on the subsequent recommendations services), as necessary, in order to meet the broker-dealer recommends only ultimately made to a retail customer, we the Disclosure Obligation’s requirement products from a select group of issuers, are requiring disclosure of the material to disclose ‘‘all material facts’’ regarding or makes IPOs available only to certain limitations on the securities or the type and scope of services provided. clients, could also be considered a investment strategies involving Broker-dealers may be able to satisfy material limitation. To cite another securities that may be recommended— this aspect of the Disclosure Obligation example, if an associated person of a by the broker-dealer and its associated by relying on their existing disclosures dually registered broker-dealer only persons—as well as any associated about the type and scope of their offers brokerage services, and is not able conflicts of interest. services, typically reflected in their to offer advisory services, the fact that Explicitly requiring disclosure of account opening agreement or other the associated person’s services are these limitations is also consistent with account opening related documentation, materially narrower than those offered our approach in the Care and Conflict of so long as the disclosure as a whole by the broker-dealer would constitute a Interest Obligations. As discussed addresses the material facts relating to material limitation. below, despite the potential beneficial the type and scope of services offered to We recognize that, as a practical aspects of some limitations, we are the retail customer. matter, all broker-dealers limit their concerned that such limitations and any offerings of securities and investment associated conflicts of interest can Disclosure of Material Limitations on strategies to a greater or lesser degree. negatively affect the securities or Securities and Investment Strategies We do not believe that disclosing the investment strategies recommended to a In the Proposing Release, we included fact that a broker-dealer does not offer retail customer.395 In recognition of this any limitations on the products and concern, we have revised the Conflict of services offered as an example of a a limited offering); SIFMA August 2018 Letter Interest Obligation to specifically material fact relating to the terms and (stating that a firm should be able to limit its require the establishment of policies offerings to a particular subset of its customers to scope of the relationship that would proprietary product or revenue sharing products as and procedures to identify, disclose, need to be disclosed pursuant to the long as: (1) The broker-dealer discloses that it is and address that risk.396 Furthermore, Disclosure Obligation. We agree with limiting its recommendation to a specific set of we reiterate that even if a broker-dealer securities and (2) the specific set of securities discloses and addresses any material commenters who advocated for helping contains appropriate securities to meet the investors to understand whether a customer’s needs); SPARK Letter (recommending limitations on the securities or broker-dealer limits its product that the Commission permit broker-dealers that investment strategies involving offerings, and to what extent, before only offers proprietary products or a limited menu securities recommended to a retail of investments to satisfy the conflict mitigation customer, and any associated conflicts entering into a relationship with a requirements by: (1) Disclosing any material 390 broker-dealer. We continue to believe limitations on the investment products being of interest, as required by the Disclosure offered and (2) reasonably concluding that the 388 Basic, Inc. v. Levinson, 485 U.S. 224, 224 limitations will not violate the Care Obligation). 394 See Basic, Inc. v. Levinson, 485 U.S. 224, 224 (1988). 391 See Form CRS, Item 2.B.(iii). (1988). 389 See Form CRS, Item 2.B. (Description of 392 Rule 15l–1(a)(2)(A). See also Section II.C.1 for 395 See Section II.C.3, Conflicts of Interest. See Services). a discussion of the materiality standard under Proposing Release at 21608 (asking commenters to 390 See CFA Institute Letter (stating that if a Basic, Inc. v. Levinson, 485 U.S. 224 (1988). comment on whether, and, if so why, the broker-dealer only offers proprietary products, it 393 This is consistent with the approach we are Commission should require specific disclosure on should clearly call attention to the higher product taking in the Relationship Summary Adopting product limitations). cost and the potential cost to the investor of such Release. 396 See Section II.C.4.

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and Conflict of Interest Obligations, it providing monitoring services for the monitoring, will help retail customers would nevertheless need to satisfy the particular retail customer’s account. understand the terms applicable to the Care Obligation in recommending such Accordingly, we believe that whether or particular retail customer’s account. products.397 not the broker-dealer will monitor the While retail customers with multiple retail customer’s account and the scope accounts will have to keep track of the Account Monitoring Services and frequency of any account accounts for which their broker-dealer In the Proposing Release, we monitoring services that a broker-dealer has agreed to monitor, we believe that identified as a material fact relating to agrees to provide are material facts requiring disclosure of this service will the scope and terms of the relationship relating to the type and scope of services provide those retail customers with with the retail customer the type and provided to the retail customer and sufficient clarity about the monitoring scope of services provided by the must be disclosed pursuant to the services they may expect. Requiring all broker-dealer, including, for example, Disclosure Obligation. This disclosure broker-dealers to monitor all retail monitoring the performance of the retail could indicate, for example, that the customer accounts, as one commenter customer’s account.398 Additionally, the broker-dealer will monitor the account suggested, would diminish the options Proposing Release stated that to the or investments at a stated frequency in available to retail customers, who may extent that the broker-dealer agrees with light of the retail customer’s investment wish to have their accounts monitored a retail customer by contract to provide objectives for the purpose of to a greater or lesser degree (including periodic or ongoing monitoring of the recommending an asset reallocation not at all). retail customer’s investments for where appropriate, or that the broker- Account Balance Requirements purposes of recommending changes in dealer will monitor the account investments, Regulation Best Interest periodically to determine whether a The Proposing Release did not would apply to, and a broker-dealer brokerage account continues to be in the address whether a broker-dealer offering would be liable for not complying with retail customer’s best interest. Or, brokerage accounts subject to account the proposed rule with respect to, any broker-dealers that offer no account balance requirements is a ‘‘material fact recommendations about securities or monitoring services could disclose that relating to the scope and terms of the investment strategies made to retail they will not monitor the account or relationship.’’ However, several customers resulting from such consider whether any recommendations commenters to the Form CRS proposal services.399 may be appropriate unless the retail suggested that the Commission require Commenters suggested that broker- customer specifically requests that they firms to disclose any account balance dealers should be required to clearly do so.402 requirements in the Relationship define the nature of account monitoring The Relationship Summary requires Summary.404 We believe that account services offered, with some commenters broker-dealers to explain whether or not balance requirements are a material fact pointing to retail customer confusion on they monitor retail investors’ relating to the terms and scope of the this topic.400 One commenter stated that investments, including the frequency relationship. Consequently, we are disclosure will not help a retail and any material limitations.403 interpreting the Disclosure Obligation to customer of a dual-registrant who has However, as noted above, because the include disclosure of whether a broker- both brokerage and advisory accounts, Relationship Summary provides high- dealer has any requirements for retail who is unlikely to remember which level disclosure, in most cases it customers to open or maintain an accounts his or her financial advisor is generally would not be sufficiently account or establish a relationship, such responsible for monitoring, and for specific to inform investors about the as a minimum account size. We believe which accounts the customer bears that scope and frequency of any account that if a broker-dealer will only open a responsibility. Accordingly, the monitoring services applicable to the brokerage account for a retail customer commenter recommends that we require particular retail customer’s account. The with a specific account minimum, such broker-dealers to monitor all retail Disclosure Obligation is designed to a basic operational aspect of the account customers’ accounts.401 provide investors with an expanded is a material fact relating to the type and As discussed in the Solely Incidental description of the material information scope of services provided. If dollar Interpretation, we disagree with relating to such services. Furthermore, thresholds or other requirements apply commenters who suggested that any as discussed in Section 2.B.2.b., to a retail customer’s ability to maintain monitoring of customer accounts would Regulation Best Interest applies to an existing account, or to avoid require a broker-dealer to register as an recommendations resulting from agreed- additional fees when the threshold is investment adviser and we believe that upon account monitoring services crossed (for example, a ‘‘low account it is important for retail customers to (including implicit hold balance’’ fee), such requirements also understand: (1) The types of account would likely be of importance to a retail recommendations). Requiring disclosure 405 monitoring services (if any) a particular of whether or not the broker-dealer will customer. We further believe retail broker-dealer provides, and (2) whether monitor the retail customer’s account, customers can use facts about different or not the broker-dealer will be and the scope and frequency of such account size requirements for both current and future planning and 397 See Section II.C.2. 402 As discussed in footnote 167, we recognize decision-making purposes. Accordingly, 398 Proposing Release at 21600. that a broker-dealer may voluntarily, and without 399 Id. at 21594. any agreement with the customer, review the 404 See, e.g., NASAA Letter (stating that ‘‘Form 400 See, e.g., NAIFA Letter (asserting broker- holdings in a retail customer’s account for the CRS should specify minimum account size and dealers should be free to agree to, and define the purposes of determining whether to provide a include information on miscellaneous fees different nature of, any ongoing relationship via contract, recommendation to the customer. We do not categories of investors can expect to pay.’’); Cetera such as including monitoring services); see also consider this voluntary review to be ‘‘account August 2018 Letter (stating that Form CRS should RAND 2018 (stating that participants demonstrated monitoring,’’ nor would it in and of itself on its own include ‘‘[w]hether or not the firm has established a lack of clarity on how a financial professional to create an implied agreement with the retail standards for the minimum or maximum dollar would monitor an account); OIAD/RAND (stating customer to monitor the customer’s account. Any amount of various account types;’’ and submitting that some participants perceived that continuous explicit recommendation made to the retail mock-up form that include disclosures of account monitoring of a client’s account is consistent with customer as a result of any such voluntary review minimums); Primerica Letter. See Relationship acting in the client’s best interest). would be subject to Regulation Best Interest. Summary Adopting Release. 401 AFL–CIO April 2019 Letter. 403 See Form CRS, Item 2.B.(i). 405 See Relationship Summary Adopting Release.

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the Commission believes this several commenters suggested that the standardized disclosure does not apply information constitutes a ‘‘material fact’’ Commission should treat risks and how the broker-dealer will notify that must be disclosed pursuant to the associated with a broker-dealer’s the customer when that is the case. For Disclosure Obligation. recommendation as ‘‘material facts example, if an associated person has a relating to the scope and terms of the distinct investment approach, as may be Other Material Facts Related to the relationship’’ that would likely need to the case with persons associated with an Scope and Terms of the Relationship be disclosed prior to, or at the time of independent contractor broker-dealer, In the Proposing Release, although we the recommendation.412 Other the broker-dealer’s standardized identified the broker-dealer’s capacity, commenters opposed requiring disclosure should indicate how its fees and charges, and type and scope of particularized disclosure of the basis of associated persons will notify retail services provided as examples of what individual recommendations, stating customers of their own investment would generally be considered that it is sufficient to disclose that approach. ‘‘material facts relating to the scope and different products are available with While the general basis for the terms of the relationship with the retail different features rather than require recommendation is a material fact for customer,’’ we noted that the Disclosure firms specify why the broker-dealer purposes of the Disclosure Obligation, Obligation would also require broker- recommended one product over we decline to require disclosure of the dealers and their associated persons to another.413 basis for each recommendation, an determine, based on the facts and Our view is that the general basis for approach that could involve significant circumstances, whether there are other a broker-dealer’s or an associated costs and in many cases may simply material facts relating to the scope and person’s recommendations (i.e., what repeat the more standardized disclosure terms of the relationship that would might commonly be described as the that we are already requiring. With need to be disclosed.406 We also asked firm’s or associated person’s investment regard to how conflicts of interest may for comment on whether examples of approach, philosophy, or strategy) is a affect the basis for a particular other information relating to scope and material fact relating to the scope and recommendation, we note that the terms of the relationship should be terms of the relationship with the Disclosure Obligation requires highlighted by the Commission as likely broker-dealer that must be disclosed disclosure of the material facts relating to be considered a material fact relating pursuant to the Disclosure Obligation. to the conflicts of interest associated to the scope and terms of the The process by which a broker-dealer with the recommendation, which will relationship that would need to be and an associated person develop their help retail customers evaluate the disclosed.407 recommendations to retail customers is incentives a broker-dealer or associated A number of commenters provided of fundamental importance to the retail person may have in making a suggestions of additional examples of customer’s understanding of what recommendation; and the Conflict of such material facts that the Commission services are being provided, and Interest Obligation requires a broker- should highlight or explicitly require to whether those services are appropriate dealer to have policies and procedures be disclosed as a ‘‘material fact relating to the retail customer’s needs and goals. to mitigate, and in certain instances, to the scope and terms of the We believe that such a description can eliminate, specified conflicts of interest. relationship.’’ Specifically, commenters be made in standardized or summary Accordingly, to the extent the basis for raised whether a broker-dealer’s basis form; however the disclosure should any recommendation is subject to any for,408 and risks associated with,409 a also address circumstances of when the conflicts of interest, the Commission recommendation, or the standard of believes that the Care Obligation’s conduct applicable to a broker-dealer higher cost investment is being recommended); substantive requirement to have a making a recommendation,410 should be Morningstar Letter (recommending that the reasonable basis for the material facts relating to the scope and Commission require a firm to disclose its analysis recommendation, combined with the terms of the relationship. of the reasons it is recommending a rollover from Disclosure, Conflict of Interest and an ERISA-covered retirement plan to an IRA and Compliance Obligations, provides Basis for and Risks Associated With the why it is in the participant’s best interest). 412 sufficient protections to broker-dealers’ Recommendation See, e.g., PIABA Letter (recommending that the Commission extend the Disclosure Obligation to retail customers. The Proposing Release did not include the risks, benefits, and ramifications of a Similarly, we are interpreting address whether a broker-dealer’s basis recommendation). disclosure of the risks associated with a 413 See, e.g., LPL August 2018 Letter (stating that broker-dealer’s or associated person’s for a recommendation is a ‘‘material fact a broker-dealer could satisfy the Care Obligation if relating to the scope and terms of the it recommends a more expensive investment recommendations in standardized terms relationship.’’ However, several product so long as it discloses that the as a material fact related to the scope commenters requested that the recommended product is not the least expensive and terms of the relationship that needs among the alternatives and is otherwise in the to be disclosed. For example, a broker- Commission treat a broker-dealer’s basis investor’s best interest); Committee of Annuity for a recommendation as a ‘‘material fact Insurers Letter (recommending that the Commission dealer could disclose: ‘‘While we will relating to the scope and terms of the clarify that a broker-dealer could satisfy the take reasonable care in developing and relationship’’ that would likely need to Disclosure Obligation through the use of a making recommendations to you, disclosure describing the products and services securities involve risk, and you may be disclosed prior to, or at the time of available to its retail customers and related conflicts the recommendation, pursuant to the of interest, and that a broker-dealer or associated lose money. There is no guarantee that Disclosure Obligation.411 Similarly, person need not provide a disclosure particularized you will meet your investment goals, or to a recommendation). See also CCMC Letters that our recommended investment 406 See Proposing Release at 21600–21601. (requesting that the SEC confirm that it is sufficient strategy will perform as anticipated. to disclose that different products are available with 407 See Proposing Release at 21607. different features rather than require firms to also Please consult any available offering 408 See infra footnote 411. document why the firm recommended one product documents for any security we 409 See infra footnote 412. over another); IPA Letter (requesting additional recommend for a discussion of risks 410 See infra footnote 417. guidance regarding specificity of disclosure needed associated with the product. We can 411 See, e.g., PIABA Letter (recommending that to demonstrate why a broker-dealer recommended broker-dealers be required to provide a clear and one of multiple different products (with different provide those documents to you, or help understandable explanation as to the other lower terms, cost structures and conditions) that each you to find them.’’ This example is cost investments which are available, and why the meet the customer’s investment objective). purely illustrative. Whether any

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particular disclosure by a broker-dealer basis for believing that the the scope and terms of the relationship’’ is sufficient to meet the Disclosure recommended transaction or investment that would likely need to be disclosed Obligation will depend on the facts and strategy could be in the best interest of prior to, or at the time of the circumstances. at least some retail customers, and is in recommendation under the Disclosure The risks associated with a particular the best interest of a particular retail Obligation.417 Specifically, these recommendation would be relevant to a customer. Moreover, under paragraph commenters requested that the retail customer. However, we believe (a)(2)(B) of Regulation Best Interest, Commission require a firm to disclose that broker-dealers may rely on the discussed below, broker-dealers need to whether it is providing a existing disclosure regime governing disclose ‘‘all material facts relating to recommendation subject to Regulation securities issuers to disclose the risks conflicts of interest that are associated Best Interest or advice subject to a associated with any issuer, security or with the recommendation,’’ which will fiduciary duty.418 offering,414 and it is not our intent to require disclosure of what we believe to The Commission also carefully require the broker-dealer to duplicate or be a significant risk associated with a considered numerous comments expand on those disclosures. Consistent broker-dealer’s recommendations—the concerning the standard of conduct with our approach, discussed above, to broker-dealer’s conflicts of interest. For disclosure in proposed Form CRS, along disclosure of product-level fees and these reasons, we believe that with the results of investor testing and costs, we believe that describing standardized written disclosure of this the Commission’s Feedback Form.419 As product-level risks in standardized information in general terms is discussed more fully in the Relationship terms, with additional information in sufficient. Summary Adopting Release, we are any available issuer disclosure Consistent with the Compliance adopting a requirement in Form CRS for documents delivered in accordance Obligation, broker-dealers should a description of a firm’s applicable with existing regulatory requirements consider developing policies and standard of conduct using prescribed would satisfy the Disclosure Obligation. procedures that address the wording.420 This ‘‘standard of conduct’’ As noted above, we are not seeking to circumstances under which the basis for disclosure (as modified from proposed supplant the developed regulatory a particular recommendation would be Form CRS) both eliminates technical regime currently applicable to offering disclosed to a retail customer. As a best words, such as ‘‘fiduciary,’’ and disclosure with the adoption of practice, firms also should encourage describes the legal obligations of broker- Regulation Best Interest. their associated persons to discuss the dealers, investment advisers, or dual- While we believe that a standardized basis for any particular recommendation registrants using similar terminology in discussion of risks is a material fact that with their retail customers, including plain English. The prescribed wording must be disclosed to satisfy the the associated risks, particularly where Disclosure Obligation, we decline to the recommendation is significant to the 417 See, e.g., NASAA 2018 Letter (recommending that the Commission provide specific instructions impose a disclosure requirement retail customer. For example, the on how associated persons of dually registered specific to each recommendation. As decision to roll over a 401(k) into an firms should disclose capacity in which they are with regard to the disclosure of the IRA may be one of the most significant acting and whether the information they are financial decisions a retail investor providing is a recommendation subject to ‘‘best individualized basis for each interest’’ or advice subject to a fiduciary duty). See recommendation, we believe that such could make. Thus, a broker-dealer also Betterment Letter (recommending that the specific disclosure could involve should discuss the basis of such Commission require broker-dealers to disclose that significant costs and in many cases recommendations with the retail they are ‘‘salespeople who are providing sales customer. Similarly, we encourage recommendations and not advice’’ in lieu of the simply repeat the more standardized adoption of a fiduciary duty on broker-dealers). disclosure that we are requiring, which broker-dealers to record the basis for 418 Id. we believe will sufficiently inform retail their recommendations, especially for 419 Most commenters did not object to the customers, in broad terms, of the nature more complex, risky or expensive proposal’s requirement that broker-dealers and of the risks associated with a products and significant investment investment advisers provide disclosure regarding decisions, such as rollovers and choice their standards of conduct or that such disclosure recommendation. be standardized. See, e.g., CFA Institute Letter In addition, under the Care of accounts, as a potential way a broker- (urging the Commission to require disclosure of the Obligation, a broker-dealer making a dealer could demonstrate compliance standard of conduct under which broker-dealers recommendation of a securities with the Care Obligation. operate); IAA August 2018 Letter. In addition, results of investor studies and surveys indicate that transaction or investment strategy Standard of Conduct 415 retail investors view this information as helpful. involving securities to a retail customer See RAND 2018 (almost one third of survey must consider the risks when As stated in the Proposing Release, respondents selected this section as one of the two determining whether it has a reasonable the Commission intended the most useful; Letter from Mark Quinn, Director of Relationship Summary to touch on Regulatory Affairs, Cetera (Nov. 19, 2018) (‘‘Cetera November 2018 Letter’’) (88% of survey 414 See, e.g., Item 503(c) of Reg. S–K (requiring issues that are also contemplated under respondents somewhat or strongly agreed ‘‘the disclosure of the ‘‘most significant’’ factors that the Disclosure Obligation, such as firm’s obligations to you’’ is an important topic’’). make an offering ‘‘speculative or risky,’’ as well as facilitating greater awareness of key See also Schwab Letter I (Hotspex) (‘‘obligations the an explanation of how each risk ‘‘affects the issuer aspects of a relationship with a firm or firm and its representatives owe me’’ ranked third or the securities being offered.’’ See also Form 10– where survey participants were asked to identify K (requiring a description of the 503(c) risk factors financial professional, such as the four topics as most important for a firm to that are ‘‘applicable to the registrant’’). In some applicable standard of conduct.416 communicate’’). Similarly, commenters on cases, SRO Rules applicable to recommendations of Several commenters on Regulation Best Feedback Forms found this information to be particular securities may also require disclosure of Interest also requested that the useful. See Feedback Forms Comment Summary risks. See, e.g., FINRA Rule 2330 (requiring a (38% of commenters on Feedback Forms graded the FINRA member or its associated persons Commission treat the standard of ‘‘Our Obligations to You’’ section of the recommending deferred variable annuity to have a conduct applicable to a broker-dealer relationship summary as ‘‘very useful’’ and 46% reasonable belief that the customer has been making the recommendation to its retail graded this section as ‘‘useful’’). informed of, among other things, market risk). See customer as a ‘‘material fact relating to 420 Form CRS, Item 3.B.(i).a (stating that ‘‘If you also FINRA Rule 2210(d), requiring, among other are a broker-dealer that provides recommendations things, that statements in member communications subject to Regulation Best Interest, include: ‘When ‘‘are clear and not misleading within the context in 415 See Section II.C.1.a, Disclosure Obligation, we provide you with a recommendation, we have which they are made, and that they provide Capacity in Which the Broker-Dealer is Acting. to act in your best interest and not put our interest balanced treatment of risks and potential benefits.’’ 416 See Proposing Release at 21600. ahead of yours’ ’’).

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also highlights when a firm must satisfy opportunities among retail customers Similarly, several commenters opposed its legal obligation—specifically, in the (e.g., IPO allocation).423 the Commission’s use of the term ‘‘not case of a broker-dealer, when making a While commenters supported the disinterested.’’ 432 These commenters recommendation. disclosure of conflicts of interest, some believe that the term is not clear and We believe the standard of conduct sought clarity on the standard for could, among other things, suggest the determining which conflicts should be elimination of all conflicts.433 One of owed to a retail customer under 424 Regulation Best Interest is a material disclosed, and others requested these commenters recommended that clarity on whether conflicts involving fact relating to the scope and terms of the Commission eliminate the term ‘‘not certain actions (e.g., rollovers) 425 and 434 the relationship. However, given that disinterested’’ while another products (e.g., proprietary products) 426 Form CRS requires firms to disclose in suggested that the Commission clarify should be disclosed.427 prescribed language the applicable whether ‘‘material’’ and ‘‘not Several commenters urged the disinterested’’ are intended to be standard of conduct and, as discussed Commission to define ‘‘conflicts of above, the Disclosure Obligation identical or different standards for interest’’ without a reference to the 435 requires broker-dealers to disclose the brokers and advisers. Other terms ‘‘consciously or commenters opposed the proposed capacity (i.e., brokerage) in which they unconsciously.’’ 428 These commenters are acting with respect to a standard, arguing that it was not as claim that discerning a broker’s broad as the disclosure obligation recommendation, we believe this conscious or unconscious state of mind disclosure to be sufficient and thus applicable to investment advisers. In is ‘‘confusing and inherently particular, some commenters urged the requiring any additional disclosure unknowable.’’ 429 Similarly, one would be duplicative. Commission to apply the standard for commenter stated that a broker-dealer disclosure applicable to investment b. Material Facts Regarding Conflicts of would be unable to draft adequate advisers as articulated by the Supreme Interest policies and procedures that address an Court in SEC. v. Capital Gains Research individual’s mindset, noting that it Bureau.436 Specifically, commenters As noted above, in addition to would be impossible for a broker-dealer requested that the Commission require requiring disclosure of the ‘‘material to anticipate an individual’s disclosure of not only material conflicts 430 facts relating to the scope and terms of unconscious conflicts. Instead, these but also the material facts related to a the relationship,’’ the proposed commenters suggested revised language recommendation.437 Disclosure Obligation would have that eliminates the notion of conscious We are adopting the obligation to 431 required a broker-dealer to disclose ‘‘all or unconscious inclination. disclose conflicts of interest, with material conflicts of interest associated several modifications and clarifications 423 with the recommendation.’’ We See Proposing Release at 21603. to the Proposing Release. Specifically, proposed to interpret a ‘‘material 424 See, e.g., SIFMA August 2018 Letter, Edward Jones Letter (requesting clarity on the definition of Paragraph (a)(2)(i)(B) of Regulation Best conflict of interest’’ as a conflict of materiality with regards to conflicts); Ameriprise Interest requires that broker-dealers interest that a reasonable person would Letter (stating that the definition of ‘‘material disclose ‘‘material facts relating to expect might incline a broker-dealer— conflicts of interest’’ should follow well known and understood principles); Fidelity Letter (stating that conflicts of interest that are associated consciously or unconsciously—to make 438 the Commission should not distinguish between with the recommendation.’’ a recommendation that is not conflicts of interest based on financial incentives 421 disinterested.’’ We generally and all other conflicts of interest); Morgan Stanley 432 See, e.g., IPA Letter (stating that the use of the modeled this proposed interpretation on Letter; CCMC Letters; TIAA Letter; Mass Mutual term ‘‘not disinterested’’ may require unnecessary Letter; Empower Letter. See also IRI Letter (stating legal interpretation); Empower Letter. the Advisers Act approach to that requiring a registered representative to predict identifying conflicts of interest for 433 See, e.g., Empower Letter. what a hypothetical reasonable person might think 434 which investment advisers may face is confusing); ICI Letter (stating that rather than See id. focusing on what a ‘‘reasonable person would 435 See IPA Letter. antifraud liability in the absence of full 436 375 U.S. 180 (1963). See, e.g., CFA August 422 expect . . .’’ the standard should focus on that and fair disclosure. We expressed our nature of the incentive and its effect on a broker- 2018 Letter; Schnase Letter. preliminary belief that a material dealer’s conduct). 437 See, e.g., CFA August 2018 Letter. conflict of interest that generally should 425 See, e.g., CFA Institute Letter. 438 This supplements the disclosure required in be disclosed would include material 426 See, e.g., SIFMA August 2018 Letter; State the Relationship Summary regarding ways in which conflicts associated with Attorneys General Letter; CFA Institute Letter. the broker-dealer and its affiliates make money from 427 See, e.g., Ameriprise Letter; State Attorneys brokerage or investment advisory services they recommending: Proprietary products, General Letter; CFA August 2018 Letter. provide to retail investors, and about the related products of affiliates, or a limited range 428 See, e.g., Edward Jones Letter (urging the material conflicts of interest. The Relationship of products, or one share class versus Commission to articulate a definition of materiality Summary requires firms to disclose, if applicable, another share class of a mutual fund; that does not refer to a person’s unconscious conflicts related to compensation it could receive activity); Empower Letter; Ameriprise Letter. from proprietary products, third-party payments, securities underwritten by the broker- 429 Id. revenue sharing, or principal trading. If firms do not dealer or an affiliate; the rollover or 430 See Great-West Letter. have any of these conflicts, the firm must disclose transfer of assets from one type of 431 See, e.g., Edward Jones Letter (suggesting that at least one other material conflict of interest that the Commission define ‘‘material conflict’’ as an affects retail investors. As described in the account to another (such as a Relationship Summary Adopting Release, we recommendation to roll over or transfer activity that: (i) Affects financial compensation of a person making a recommendation; and (ii) a declined to make a change pursuant to comments assets in an ERISA account to an IRA); reasonable investor would likely view as important that suggested that Regulation Best Interest’s and and allocation of investment to the total mix of information available when Form CRS’s conflicts disclosures be coordinated, considering that recommendation); Ameriprise and that any conflict disclosure obligations under Letter (suggesting that the Commission define Regulation Best Interest should be satisfied upon 421 Proposing Release at 21602. ‘‘material conflict of interest’’ as a conflict of delivery of the Relationship Summary. We 422 See id. (citing Capital Gains (stating that as interest that a reasonable person might conclude recognize that broker-dealers may need to disclose part of its fiduciary duty, an adviser must fully and has the potential to influence the recommendation); additional conflicts at a point in time other than at fairly disclose to its clients all material information Pacific Life August 2018 Letter (suggesting the the beginning of the relationship with a retail in accordance with Congress’s intent ‘‘to eliminate, Commission define ‘‘material conflict of interest’’ as investor. Broker-dealers also may need to include or at least expose, all conflicts of interest which a financial interest of the financial professional additional information about conflicts of interest might incline an investment adviser—consciously making a recommendation that a reasonable person summarized in the Relationship Summary. The or unconsciously—to render advice which was not would expect to affect the impartiality of such Relationship Summary will provide a high-level disinterested’’)). recommendation). Continued

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However, as discussed in more detail interest’’ for investment advisers under Regulation Best Interest definition of below, in response to comments and in Capital Gains.440 ‘‘conflict of interest’’ is modeled on the the light of the Relationship Summary, Several commenters also made regulatory regime applicable to we are: (1) Adopting for purposes of suggestions regarding the Commission’s investment advisers, and is not by its Regulation Best Interest a definition of interpretation of the term ‘‘material’’ as terms explicitly limited to ‘‘material’’ ‘‘conflict of interest’’ associated with a used in the proposed Disclosure conflicts of interest, it would be difficult recommendation ‘‘as an interest that Obligation (i.e., the proposed to envision a ‘‘material fact’’ that must might incline a broker, dealer, or a requirement to disclose ‘‘all material be disclosed pursuant to the Disclosure natural person who is an associated conflicts of interest that are associated Obligation that is not related to a person of a broker or dealer— with the recommendation’’).441 Many conflict of interest that is also material consciously or unconsciously—to make commenters agreed with the under the Basic standard.448 a recommendation that is not Commission’s decision to use a disinterested;’’ and (2) revising the ‘‘materiality’’ standard to determine Interpretation of Disclosure of Material Disclosure Obligation to require those facts about conflicts of interest Facts Relating to Conflicts of Interest disclosure of ‘‘material facts’’ regarding that must be disclosed.442 However, In response to comments, we are such conflicts of interest. Under this several other commenters asked the providing our view regarding what we approach, all conflicts of interest as Commission to clarify the meaning of would consider ‘‘material facts relating interpreted under the Proposing Release ‘‘material.’’ 443 These latter commenters to conflicts of interest that are will be covered by Regulation Best stated, among other things, that the term associated with a recommendation’’ that Interest. ‘‘material’’ in proposed Regulation Best would need to be disclosed under the We believe distinguishing between Interest was not clearly defined and Disclosure Obligation. We believe the ‘‘conflicts of interest’’ and ‘‘material would be subjectively interpreted.444 conflicts of interest identified in the facts’’ regarding such conflicts that Accordingly, many of these commenters Relationship Summary may provide a would be disclosed would make the recommended that the Commission useful starting point for the Disclosure Obligation more consistent adopt a materiality standard based on identification of material facts that need with the proposal’s intent. In the the standard articulated in Basic v. to be disclosed pursuant to the Proposing Release, the Commission Levinson.445 Disclosure Obligation.449 In addition, discussed limiting the disclosure of The Supreme Court in Basic we also view how a broker-dealer’s conflicts under the Disclosure articulated a standard for materiality, investment professionals are Obligation ‘‘consistent with case law stating that information is material if compensated, and the conflicts under the antifraud provisions, which there is ‘‘a substantial likelihood that a associated with those arrangements, as limit disclosure obligations to ‘‘material reasonable shareholder would consider material facts relating to conflicts of 446 facts.’’ it important.’’ This definition of interest that are associated with a After considering the comments, we ‘‘material’’ is well established and thus recommendation.450 While these have determined to retain the proposed limiting disclosure to material facts in conflicts of interest must be summarized approach to conflicts of interest as the Disclosure Obligation will eliminate in the Relationship Summary to the described in Capital Gains. In confusion and reduce the compliance extent they are applicable, we believe particular, we acknowledge commenter burden on broker-dealers in fulfilling that additional details regarding many concerns about discerning a broker’s the Disclosure Obligation. It will also of these conflicts need to be disclosed conscious or unconscious state of mind. help focus the information made 447 under the Disclosure Obligation as However, the description of conflicts of available to retail customers. ‘‘material facts’’ relating to conflicts of interest in Capital Gains is well Accordingly, we interpret ‘‘material interest associated with a established, familiar to many in the facts’’ consistent with the Basic recommendation. industry, particularly dual-registrants, standard. Moreover, while the and guidance already exists regarding Disclosure of Compensation what constitutes a conflict of interest 440 For the same reasons, we have eliminated the phrase ‘‘a reasonable person would expect’’ that Broker-dealers receive compensation under this standard. To provide clarity that typically varies depending on what that this interpretation is limited to was included in the definition of ‘‘material conflict of interest’’ discussed in the Proposing Release at securities transaction or investment Regulation Best Interest, however, we 21602. strategy involving securities is being 441 are revising Regulation Best Interest to See, e.g., Transamerica August 2018 Letter; recommended. The source of the Fidelity Letter; SIFMA August 2018 Letter; Morgan explicitly provide that a ‘‘conflict of compensation may also vary, for interest’’ ‘‘means an interest that might Stanley Letter; IPA Letter; Great-West Letter. 442 example being paid directly by the incline a, broker, dealer, or natural See, e.g., Morgan Stanley Letter; Great-West Letter. investor, or by a product sponsor, or a person who is an associated person of 443 See, e.g., FSI August 2018 Letter combination of both. A broker-dealer a broker-dealer—consciously or (recommending the Commission publish examples may also pay its associated persons unconsciously—to make a of when a conflict is material); Wells Fargo Letter; different rates of compensation recommendation that is not Cetera August 2018 Letter; IPA Letter. 444 See, e.g., Great-West Letter (stating that the depending on the type of security they disinterested,’’ 439 consistent with the Commission appears to have created a very sell.451 Similarly, broker-dealers can scope of the meaning of ‘‘conflict of subjective standard to determine materiality). receive different payments from 445 See, e.g., Mass Mutual Letter; SIFMA August 2018 Letter; Bank of America Letter; CCMC Letters; summary for retail investors so that they can engage 448 in a conversation with their financial professional TIAA Letter; Cetera August 2018 Letter; Fidelity See Fiduciary Interpretation. about investment advisory or brokerage services, Letter. 449 See, e.g., Form CRS, Item 3 (Fees, Costs, and so that the retail investors can choose the type 446 Basic v. Levinson. Conflicts, and Standard of Conduct). of service that best meets their needs, but will not 447 As stated in the Proposing Release, we are 450 See Form CRS, Item 3.C.(i) (‘‘Description of necessarily include all material facts related to a sensitive to the potential that broker-dealers could How Financial Professionals Make Money: particular conflict of interest. We believe many adopt an approach that results in lengthy Summarize how your financial professionals are firms may not be able to capture all of the necessary disclosures that undermine the Commission’s goal compensated, including cash and non-cash disclosures about their conflicts in this short of facilitating meaningful disclosure to assist retail compensation, and the conflicts of interest those standardized disclosure. customers in making informed investment payments create.’’). 439 Rule 15l–1(b)(3). decisions. Proposing Release at 21604. 451 See NASD NTM 03–54.

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different product providers (e.g., mutual the conflicts associated with a be disclosed under Paragraph (a)(2)(i)(B) funds) for a variety of reasons, such as recommendation of a mutual fund were of Regulation Best Interest are the payments for inclusion on a broker- disclosed at the outset of the ‘‘material facts relating to conflicts of dealer’s menu of products offered relationship, no further disclosure need interest’’ created by compensation (sometimes referred to as shelf space). be made at the time of recommendation; sourced from product fees and costs, These compensation arrangements we are not requiring that information rather than the fees and costs create a variety of conflicts of interest regarding conflicts be disclosed on a themselves. that must be addressed under both Form recommendation-by-recommendation CRS and the Disclosure Obligation. basis. Differences in Compensation and We believe that compensation The Disclosure Obligation also does Proprietary Products associated with recommendations to not require specific written disclosure of retail customers and related conflicts of the amounts of compensation received Several commenters recommended interest—whether at the broker-dealer or by the broker-dealer or the financial that required conflict disclosure address the associated person level—is a conflict representative. For example, we are not recommendations where a less of interest about which material facts requiring broker-dealers to disclose the expensive alternative is available, or must be disclosed as part of the amount, if any, they compensate their condition the ability to recommend a Disclosure Obligation. This disclosure financial professionals per transaction, more expensive product on the should summarize how the broker- or for year-end bonuses. We believe that adequacy of a broker-dealer’s conflict dealer and its financial professionals are disclosure of the material facts regarding disclosures.453 Similarly, several compensated for their recommendations conflicts of interest associated with a commenters expressed differing views and, as importantly, the conflicts of recommendation need not entail such on how payment of varying interest that such compensation creates. individualized numerical disclosure, compensation should be handled under This summary should include the and that in any event such a level of the ‘‘best interest’’ standard of sources and types of compensation detail may be difficult and costly to Regulation Best Interest and how related received, and may include the fact that calculate with accuracy, and also conflicts should be disclosed.454 For fees and costs disclosed pursuant to confusing to investors in many example, one commenter identified Paragraph (a)(2)(i)(A) of Regulation Best instances. Instead, disclosure regarding compensation differences within Interest that a retail customer may pay conflicts must reasonably inform directly or indirectly are a source of product lines as an example of a conflict investors so that the investor may use that should be disclosed.455 Several compensation, if that is the case. For the information to evaluate the example, if a broker-dealer receives commenters also recommended that the recommendation, and that can be done Commission require disclosure of compensation derived from the sale of without specific disclosure of the conflicts of interest related to use of securities or other investment products amount of the compensation. Although proprietary products, and whether the held by retail customers of the firm, disclosure of specific compensation including asset-based sales charges or broker-dealer offers alternatives to amounts is not required, depending on 456 service fees on mutual funds, that fact facts and circumstances, full and fair proprietary products. Similarly, and the conflicts associated with the disclosure may require disclosure of the several commenters requested that the receipt of such compensation should be general magnitude of the Commission clarify that broker-dealers fully and fairly described. compensation.452 can limit their offerings to proprietary Broker-dealers could meet the We are also clarifying that while products or products that make revenue Disclosure Obligation by making certain product fees and costs can be a sharing payments if, among other required disclosures of information significant source of compensation regarding conflicts of interest to their received by broker-dealers and 453 See PIABA Letter (stating that where less customers at the beginning of a associated persons, no disclosure expensive alternatives are available, disclosure relationship, and this form of disclosure should include an explanation of why the regarding the particular amounts of recommendation is nevertheless in the best interest may be standardized. However, if these fees and costs is required under standardized disclosure, provided at given other factors associated with the Regulation Best Interest with regard to recommendation); LPL August 2018 Letter such time, does not sufficiently identify conflicts of interest. Instead, what must (recommending that the Commission clarify that a the material facts relating to conflicts of broker-dealer can recommend a product involving interest associated with any particular costs and charges that are within a range of 452 See, e.g., Advantage Investment Management, recommendation, the disclosure would reasonableness that has been disclosed to the Advisers Act Release No. 4455 (Jul. 18, 2016) investor in advance provided the recommendation need to be supplemented so that such (settled order) (the Commission brought an is otherwise in the investor’s best interest); UMiami disclosure is tailored to the particular enforcement action against an adviser for failing to Letter; SIFMA August 2018 Letter. disclose the existence, nature and magnitude of a recommendation. For example, with 454 See, e.g., CFA August 2018 Letter forgivable loan from a broker-dealer that the adviser (recommending that the Commission include regard to mutual fund transactions and had engaged to provide services to the adviser’s compensation differences within product lines as holdings, a broker-dealer might disclose clients); Taberna Capital Management LLC, Advisers Act Release No. 4186 (Sep. 2, 2015) an example of a conflict that should be disclosed); broadly that it is compensated by funds Ameriprise (stating that differential compensation out of product fees or by the funds’ (settled order) (the Commission brought an enforcement action against an adviser for failing to for diverse products aligns with Regulation Best sponsors, and that such compensation disclose the existence, nature, and extent of a Interest provided the firm mitigates the potential gives it an incentive to recommend conflict of interest raised by the adviser’s receipt of related conflicts); Pacific Life August 2018 Letter certain products over other products for certain fees from issuers); BISYS Fund Services, (stating that the definition of ‘‘material conflicts of interest’’ must encompass, among other things, the which the broker-dealer receives less Inc., Advisers Act Release No. 2554 (Sep. 26, 2006) (settled order) (the Commission brought an types of compensation received by the person compensation; later, when a broker- enforcement action against a mutual fund making the recommendation). dealer recommends a particular fund, it administrator for failure to disclose information 455 See CFA August 2018 Letter. could provide more specific detail about concerning the existence or magnitude of the 456 See, e.g., Money Management Institute Letter compensation arrangements, for conflicts of interest created by a marketing (recommending the SEC allow firms to meet the arrangement that called for BISYS to rebate a Conflict of Interest Obligation with respect to their example revenue sharing associated portion of its administrative fees to 27 mutual fund preference for proprietary products through with the fund family. In the alternative, advisers so that the fund advisers would continue disclosure); CFA Institute Letter; IRI Letter; SIFMA so long as the ‘‘material facts’’ regarding to recommend BISYS as an administrator). August 2018 Letter.

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things, appropriate disclosure is associated with recommending recommended that the Commission made.457 proprietary products could include, as explicitly require broker-dealers to As discussed above, we agree with relevant, that the broker-dealer owns the provide full and fair disclosure of commenters who stated that it may be product, and that in addition to any material facts.465 One commenter compatible with the Care Obligation to commission associated with purchasing reasoned that the Commission should recommend a more expensive product the product, the broker-dealer or an not make Regulation Best Interest any that is otherwise in a retail customer’s affiliate may receive additional fees and more stringent than in the Proposing best interest when there are less compensation 461 related to that Release, stating that ‘‘full and fair’’ is expensive alternatives available, to product.462 both inapplicable and unnecessary receive compensation that varies among given the proposed standard under the c. Full and Fair Disclosure products, and to recommend proprietary Disclosure Obligation.466 products.458 However, we also believe As proposed, the Disclosure After careful consideration of the that the conflicts of interest associated Obligation would have required broker- comments received, the Commission is with such practices constitute ‘‘material dealers to ‘‘reasonably disclose’’ adopting the Disclosure Obligation with facts’’ relating to conflicts of interest material facts relating to the scope and revisions to require ‘‘full and fair that must be disclosed under the terms of the relationship with the retail disclosure’’ of all material facts relating Disclosure Obligation. customer, including all material to the scope and terms of the The receipt of higher compensation conflicts of interest associated with the relationship with the retail customer for recommending some products rather recommendation. The Commission used and all material facts relating to than others, whether received by the this formulation in order to give conflicts of interest associated with the broker-dealer, the associated person, or flexibility to broker-dealers in recommendation for the reasons both, is a fundamental and powerful determining the most appropriate way described below. incentive to favor one product over to meet the proposed Disclosure While we do not believe that adopting 459 another. While we are requiring firms Obligation depending on their a ‘‘full and fair disclosure’’ standard is to establish policies and procedures individual business practices. The significantly different from the proposed reasonably designed to mitigate the Commission also provided preliminary requirement to ‘‘reasonably disclose,’’ conflicts of interest that create an guidance on what it believed would be we believe that the Regulation Best incentive for financial professionals to to ‘‘reasonably disclose’’ in accordance Interest serves the Commission’s goal of place the interest of the professional or with the Disclosure Obligation by facilitating disclosure to assist retail broker-dealer ahead of the interest of the setting forth the aspects of effective customers in making informed retail customer, we believe also that full disclosure, including the form and investment decisions.467 In addition, and fair disclosure of the material facts manner of disclosure and the timing and concerning conflicts raised by variable frequency of disclosure. broker-dealers should be subject to less rigorous disclosure obligations than investment advisers’’). compensation schemes is of particularly In this regard, the Commission critical importance for an investor 465 See, e.g., Pace Investor Rights Clinic August requested comment on whether broker- 2018 Letter (urging the Commission to require seeking to evaluate a recommendation dealers should be required to broker-dealers to provide full and fair disclosure of under such circumstances, a concern ‘‘reasonably disclose’’ and whether any conflicts that are not eliminated or mitigated); further underscored by our approach additional guidance as to how broker- Better Markets August 2018 Letter (urging the under the Conflict of Interest Obligation Commission to further enhance the Disclosure dealers could meet this standard should Obligations by requiring broker-dealers to make full of requiring policies and procedures to be provided. The Commission also and fair disclosure of all information required to be mitigate or eliminate certain requested comment on whether disclosed); State Attorneys General Letter; NASAA 460 conflicts. disclosure should explicitly be required August 2018 Letter. The benefits that accrue to a broker- 466 See SIFMA August 2018 Letter. to be ‘‘full and fair.’’ In response, some 467 This approach is consistent with the rationale dealer and its financial professionals commenters raised questions about from recommending proprietary articulated in the Fiduciary Interpretation. See using the term ‘‘reasonably disclose’’ 463 Fiduciary Interpretation at Section II.C (stating, ‘‘In products also raise conflicts of interest and whether broker-dealers should be order for disclosure to be full and fair, it should be that must be disclosed. Material facts sufficiently specific so that a client is able to subject to less rigorous disclosure relating to the conflicts of interest understand the material fact or conflict of interest obligations for recommendations made and make an informed decision whether to provide to retail customers than investment consent. For example, it would be inadequate to 457 See, e.g., SIFMA August 2018 Letter (stating advisers.464 These commenters disclose that the adviser has ‘other clients’ without that a firm should be allowed to limit its offerings describing how the adviser will manage conflicts to proprietary products or revenue sharing between clients if and when they arise, or to 461 products, as long as: (a) The broker-dealer discloses For example, a broker-dealer’s sale of disclose that the adviser has ‘conflicts’ without to its customer that it is limiting the proprietary products potentially generates a further description. Similarly, disclosure that an recommendation to a specific set of securities, and compensation stream for the broker-dealer, in adviser ‘may’ have a particular conflict, without (b) the specific set of securities contains appropriate addition to commissions, which may need to be more, is not adequate when the conflict actually securities to meet the customer’s needs); CFA disclosed under paragraph (a)(2)(i)(A). exists.’’ [However,] ‘‘[t]he word ‘may’ could be Institute Letter (stating that when a firm only offers 462 As discussed further in Section II.C.3, in appropriately used to disclose to a client a potential proprietary products it should disclose not only the addition to disclosure of such conflicts, broker- conflict that does not currently exist but might higher product cost, but the potential cost to the dealers are also required under the Conflict of reasonably present itself in the future.’’). See also investor of such a limited offering). Interest Obligation to establish, maintain, and In the Matter of The Robare Group, Ltd., et al., 458 See generally Section II.A.1, Commission’s enforce written policies and procedures reasonably Advisers Act Release No. 4566 (Nov. 7, 2016) Approach. designed to mitigate or address the conflicts (Commission Opinion) (finding, among other 459 See Proposing Release at 21578 (referencing presented. things, that adviser’s disclosure that it may receive the Commission’s long-held concerns about the 463 See, e.g., CFA August 2018 Letter (stating that a certain type of compensation was inadequate incentives that commission-based compensation a ‘‘reasonable’’ disclosure standard gives firms too because it did not reveal that the adviser actually provides to churn accounts, recommend unsuitable much discretion to determine how the disclosures had an arrangement pursuant to which it received securities, and engage in aggressive marketing of will be presented); Galvin (arguing that the fees that presented a potential conflict of interest); brokerage services); FINRA Report on Conflicts of proposed standard would give broker-dealers more aff’d in part and rev’d in part on other grounds Interest (Oct. 2013), available at https:// opportunities to argue that they acted ‘‘reasonably’’ Robare Group, Ltd., et al. v. SEC, 922 F.3d 468 (D.C. www.finra.org/sites/default/files/Industry/ under the rules). Cir. 2019); SEC v. Blavin, 760 F.2d 706, 711 (6th p359971.pdf (‘‘FINRA Conflicts Report’’) at p. 4. 464 See, e.g., CFA August 2018 Letter (stating that Cir. 1985) (disclosure that investment adviser 460 See generally Section II.C.3. ‘‘[t]he Commission offers no explanation for why ‘‘may’’ trade in recommended securities for its own

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Regulation Best Interest will more to conflicts of interest associated with a client must provide informed consent to closely align the Disclosure Obligation broker-dealer’s recommendations, and the adviser’s conflicts of interest in the with existing requirements for not of all material facts relating to the context of the entire relationship, which investment advisers 468 and is consistent relationship. In addition, the Disclosure can be broader than the informed with disclosure standards in other Obligation only applies to retail consent provided by a retail customer contexts under the federal securities customers. In contrast, the disclosure when making an informed decision to laws.469 requirements imposed by the fiduciary accept or reject a particular The full and fair disclosure standard duty under the Advisers Act generally recommendation by a broker-dealer. We that the Commission is adopting for and Form ADV in particular are broader believe this is appropriate because the broker-dealers under the Disclosure (e.g., Form ADV requires disclosure of investment-adviser client relationship is Obligation is generally similar to the the adviser’s principal owner(s) and generally broader and can include, for disclosure standard applicable to certain financial industry activities and example, unlimited investment investment advisers under the Advisers affiliations, which are not explicitly discretion by the investment adviser to Act.470 Similar to the Proposing required under the Disclosure conduct securities transactions on Release’s interpretation of the phrase Obligation; Form ADV and the fiduciary behalf of the client. The broker-dealer ‘‘reasonably disclose,’’ broker-dealers’ duty also go to disclosure of the entire customer relationship on the other hand obligation to provide full and fair relationship while the Disclosure is generally transaction-based and the disclosure should give sufficient Obligation is tailored to the retail customer must accept (or reject) information to enable a retail investor to recommendation and also given at each recommendation by a broker- make an informed decision with regard relevant points in time). We designed dealer after the broker-dealer has to the recommendation.471 our approach to avoid having retail provided full and fair disclosure as We disagree with commenters who customers receive overwhelming required under the Disclosure believe the ‘‘full and fair’’ standard is amounts of information.472 Obligation. Thus, in this regard, too stringent. While the general Some commenters suggested that Regulation Best Interest will more standard for broker-dealers under the disclosure and informed consent should closely align the Disclosure Obligation Disclosure Obligation will be generally be required in order to comply with the with the existing requirements for similar to the disclosure requirements obligations under Regulation Best investment advisers, as noted above, but applicable to investment advisers, the Interest, similar to the approach taken is tailored to the broker-dealer scope of the required disclosure is not under the fiduciary duty under the relationship.475 The Commission as broad. For example, the Disclosure Advisers Act.473 We have carefully believes that the final Disclosure Obligation only requires disclosure of considered these comments. As noted Obligation along with the protections material facts relating to the scope and above, under the Disclosure Obligation, provided by the requirements of terms of the relationship with the broker-dealers are required to provide Regulation Best Interest, including the broker-dealer, and material facts relating full and fair disclosure such that a retail Care Obligation and Conflict of Interest customer can make an informed Obligation, will further serve to enhance account was false and misleading where the adviser decision with regard to the the protections available to retail actually invested in 10%–25% of the publicly recommendation (i.e., whether to accept available stock of the companies it recommended); customers. ICI Letter (commenting on the Fiduciary (or reject) that recommendation). In One commenter recommended that Interpretation proposing release). making such an informed decision after the Commission clarify what a broker- 468 See Fiduciary Interpretation at Section II.A being provided with full and fair dealer is required to deliver to a retail (stating that ‘‘[t]he [investment adviser’s] fiduciary disclosure, we believe that the retail customer in order to permit the retail duty follows the contours of the relationship between the adviser and its client, and the adviser customer has provided ‘‘informed customer to make an ‘‘informed and its client may shape that relationship by consent’’ in a manner that is analogous decision,’’ and asked the Commission to agreement provided that there is full and fair to the informed consent required to be confirm that it does not require a case- disclosure and informed consent’’ (emphasis provided by a client in the context of an by-case analysis of what is reasonable to added)). investment adviser-client 469 For instance, the Municipal Securities permit the retail customer to make an 474 476 Rulemaking Board requires that municipal advisors relationship. An investment advisory informed decision. In addition, other provide full and fair disclosure of material conflicts commenters underscored the of interest and material legal or disciplinary events. 472 Commenters pointed out that requiring too importance of providing retail See MSRB Rule G–42. In addition, the registration much information regarding conflicts of interest and disclosure requirements of the Securities Act of would go beyond the standard of materiality set customers with sufficient time to review 1933 (‘‘Securities Act’’) are based on the concept forth under Basic. See, e.g., SIFMA August 2018 and comprehend the disclosed that investors in a public offering should be Letter; Cetera August 2018 Letter (citing Basic at information prior to making an provided with full and fair disclosure of material 231, noting that ‘‘an avalanche of trivial informed decision about a information needed for an informed investment information’’ would not be ‘‘conducive to informed 477 decision. See Securities Act Concepts and Their decision making.’’). See also Letter from David recommendation. Other commenters Effects on Capital Formation, Securities Act Release Schwartz, President and CEA, Florida International No. 7314 (Jul. 25, 1996); 61 FR 40044 (Jul. 31, 1996) Bankers Association (‘‘FIBA’’) (Feb. 8, 2019) FIBA Regulation Best Interest, however, assuming the at text accompanying footnote 13; see also SEC v. (‘‘February 2019 Letter’’) (stating that ‘‘the amount retail customer has been provided with full and fair Ralston Purina Co., 346 U.S. 119, 124 (1953). of required disclosure may overwhelm rather than disclosure, the retail customer will be considered to Finally, Regulation FD under the Securities Act was educate’’). have provided informed consent by affirmatively ‘‘designed [in part] to promote the full and fair 473 See, e.g., ASA Letter (stating that the accepting a recommendation. disclosure of information by issuers.’’ See Selective Commission should reaffirm that broker-dealers can 475 See Fiduciary Interpretation (describing an Disclosure and Insider Trading, Securities Act address conflicts of interest by disclosing them and investment adviser’s obligation to provide Release No. 7881 (Aug. 15, 2000), 65 FR 51715 obtaining informed consent); Primerica Letter disclosure designed to put a reasonable client in a (Aug. 24, 2000). (suggesting that the Commission clarify that broker- position to be able to understand and provide 470 See supra footnote 468. See also Fiduciary dealers can effectively address all material conflicts informed consent). Interpretation, stating that the disclosure ‘‘should by providing full and fair disclosure and obtaining 476 See, e.g., CCMC Letters. be sufficiently specific so that a client is able to customer consent); Morgan Stanley Letter. 477 See, e.g., Financial Planning Coalition Letter understand the material fact or conflict of interest 474 As discussed in the Fiduciary Interpretation, (stating that disclosures should be made prior to the and make an informed decision whether to provide a client’s informed consent can be either explicit or, recommendation so a retail customer has sufficient consent.’’ depending on the facts and circumstances, implicit. time to review and understand them, as well as to 471 See Proposing Release at 21604, footnote 208. See Fiduciary Interpretation at Section II.C. Under Continued

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questioned whether providing the fiduciary duty under the Advisers should be made in writing.485 In ‘‘sufficient information’’ to enable a Act.480 response to comments we are providing retail customer to make an informed additional guidance. We are also Form and Manner decision broadens the Disclosure reaffirming guidance that we provided Obligation beyond ‘‘material facts’’ and In the Proposing Release, the in the Proposing Release. ‘‘material conflicts.’’ 478 Commission noted that it was not We have considered the issues raised proposing to specify by rule the form Prescribed Form of Disclosure by the commenters and in the sections (e.g., narrative v. graphical/tabular) or As noted in the Proposing Release, we that follow are providing guidance on manner (e.g., relationship guide or other believe it is important to provide broker- what we believe constitutes ‘‘full and written communications) of disclosure dealers with flexibility in determining fair disclosure’’ for purposes of the required under the Disclosure the most appropriate and effective way Disclosure Obligation, including the Obligation. The Commission stated that to meet the Disclosure Obligation to form and manner, and the timing and disclosure should be concise, clear and reflect the structure and characteristics frequency, of the disclosure. Similar to understandable to promote effective of their relationships with retail the proposal, in lieu of setting explicit communication between a broker-dealer customers.486 Many commenters agreed requirements by rule for what and a retail customer.481 We also stated with this reasoning, arguing that there constitutes full and fair disclosure of all that broker-dealers would be able to was a need to preserve flexibility for material facts, we are providing broker- deliver disclosure required pursuant to broker-dealers to comply with the dealers flexibility in determining the Regulation Best Interest consistent with Disclosure Obligation as proposed.487 most appropriate way to meet the the Commission’s guidance regarding Other commenters believed, however, Disclosure Obligation depending on electronic delivery of documents.482 that the proposed Disclosure Obligation each broker-dealer’s specific business Although we preliminarily believed that gave broker-dealers too much practices. broker-dealers should have the discretion.488 As we noted in the Proposing Release, flexibility to make disclosures by any After careful consideration of these while we are providing flexibility to means, as opposed to requiring a comments, the Commission has decided broker-dealers to meet the Disclosure standard written document at the outset not to require any standard written Obligation, we continue to be sensitive of the relationship, we stated our belief disclosures (other than the Relationship to the potential that broker-dealers that any such disclosure should be Summary) at this time. Although we could opt to disclose all facts, including provided in writing.483 recognize the potential value to retail those that do not meet the materiality Commenters sought further guidance customers of standardizing the threshold.479 We are cognizant of the in a number of areas relating to disclosures required pursuant to the likelihood that some broker-dealers disclosure, including the extent to Disclosure Obligation, we believe that could provide lengthy disclosures that which the Relationship Summary or retail customers can derive value from do not meaningfully convey the material other disclosures may satisfy the disclosures that accommodate the facts regarding the scope and terms of Disclosure Obligation,484 the structure and characteristics of the the relationship and material facts circumstances under which particular broker-dealer. On balance, we regarding conflicts of interest, an standardized disclosure could be recognize the wide variety of business outcome that could undermine the sufficient, as well as how, and the models and practices and we continue Commission’s goal of facilitating extent to which, disclosures made to believe it is important to provide disclosure to assist retail customers in pursuant to the Disclosure Obligation broker-dealers with flexibility to enable making an informed investment them to better tailor disclosure and decision. To this end, broker-dealers 480 While establishing scienter is a requirement to information that their retail customers will only be required to disclose establish violations of Section 206(1) of the can understand and may be more likely Advisers Act, it is not required to establish a material facts about the scope and terms violation of Section 206(2); a showing of negligence to read at relevant points in time, rather of the relationship or conflicts of is adequate. See SEC v. Capital Gains Research interest. Bureau, Inc., 375 U.S. 180, 195 (1963); see also SEC 485 See, e.g., Schwab Letter (arguing that because Although we are adopting the v. Steadman, 967 F.2d at 643 and footnote 5; most recommendations occur over the phone and requirement with revisions to require Steadman v. SEC, 603 F.2d 1126, 1132–34 (5th Cir. through various digital means, the Commission 1979), aff’d on other grounds, 450 U.S. 91 (1981). should remove the ‘‘in writing’’ requirement and full and fair disclosure of all material See also Prohibition of Fraud by Advisers to Certain allow firms to determine the best method for facts, we still believe it is important to Pooled Investment Vehicles, Advisers Act Release disclosure depending on the situation); SIFMA clarify that broker-dealers’ compliance No. 2628 (Aug. 3, 2007). In its adoption of Rule August 2018 Letter (seeking clarification that oral with the Disclosure Obligation will be 206(4)–8 under the Advisers Act, the Commission disclosure at the time of the recommendation may measured against a negligence standard, stated that it would not need to demonstrate that be sufficient to satisfy the Disclosure Obligation in an adviser violating the rule acted with scienter. certain circumstances). But see AARP August 2018 not against a standard of strict liability, 481 See Proposing Release at 21604, footnote 211. Letter (stating that oral disclosures should never be consistent with the Proposing Release. 482 Id. at 21604 and footnote 214. permitted). The Commission has taken this position 483 Id. at 21604 and footnote 213. 486 See Proposing Release at 21604. in other contexts where full and fair 484 See, e.g., Cambridge Letter (arguing that the 487 See, e.g., Prudential Letter; SIFMA August disclosure is required, including under Relationship Summary and Disclosure Obligation 2018 Letter; TIAA Letter; UBS Letter. are duplicative requirements); CUNA Mutual Letter 488 See, e.g., Better Markets August 2018 Letter (seeking greater clarification regarding the extent to (arguing that proving broker-dealer discretion in ask questions); CFA August 2018 Letter (stating that which information provided in other documents this area will virtually assure a failure to if the Commission wants to give investors time to could satisfy the Disclosure Obligation); Financial communicate helpfully with investors); CFA consider the information and make an informed Services Institute August 2018 Letter (arguing that August 2018 Letter (arguing that the flexibility the choice disclosure should be provided as soon as providing the Relationship Summary should be Commission provides will result in disclosure that reasonably feasible and, when possible, no later deemed to satisfy the requirements of the broker- does not effectively convey key information). See than the point of recommendation). dealer’s Disclosure Obligation); Morningstar Letter also Morningstar Letter (supporting the expansion 478 See, e.g., IPA Letter (requesting clarification (arguing that due to the brevity of the Relationship of disclosures, but arguing that ‘‘publicly available on whether providing sufficient information to Summary, additional broker-dealer disclosures disclosures with a standard taxonomy work best enable a retail investor to make an informed would be necessary); Wells Fargo Letter because they empower third parties such as decision broadens the disclosure obligation beyond (recommending that the requirements of the ‘‘fintech’’ and ‘‘reg-tech’’ firms to analyze and material facts); CCMC Letters. Disclosure Obligation be incorporated into Form contextualize critical information and amplify a call 479 Id. CRS). to action for ordinary investors’’).

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than, for example, mandating a firm-level disclosure obligations of where appropriate is a reasonable and standardized all-inclusive (and likely Form CRS so that firms can use the cost-effective way to satisfy the lengthy) disclosure.489 Relationship Summary to help satisfy requirements of the Disclosure We disagree that flexibility will the Disclosure Obligation.492 Obligation, and can also help avoid prevent investors from obtaining Commenters also recommended that duplicative or voluminous disclosure by information necessary to make an broker-dealers should be permitted to not requiring the creation of new informed investment decision and do satisfy the Disclosure Obligation by disclosure documents.496 We recognize not believe that requiring a standard using standardized language generally also that in many instances, information written disclosure beyond the to describe the broker-dealer’s products necessary to satisfy the Disclosure Relationship Summary is necessary at and services available to their retail Obligation may be broadly applicable to this time. We emphasize, however, that customers and related conflicts of a broker-dealer’s retail customers, and the adequacy of the disclosure will interest, including the ranges of therefore the use of standardized depend on the facts and circumstances. remuneration payable to a broker-dealer disclosure may be appropriate. We intend to evaluate broker-dealer in connection with its recommendation However, while broker-dealers may disclosure practices in response to of different products.493 Several choose to standardize certain forms of Regulation Best Interest over time to commenters also suggested that the their disclosure, whether such materials determine whether additional Commission should clarify that the would be sufficient to satisfy the disclosure initiatives may be Disclosure Obligation should not apply Disclosure Obligation will depend on appropriate. where an existing disclosure regime the facts and circumstances.497 For already exists.494 Similarly, other example, disclosures may need to be Relying on Other Disclosures and commenters recommended that the tailored to a particular recommendation Standardized Documents Commission clarify whether broker- if the standardized disclosure does not In the Proposing Release, we dealers could meet the Disclosure sufficiently identify the material facts described how the Disclosure Obligation Obligation by referencing information about a conflict of interest presented by builds upon the requirements of Form required to be disclosed pursuant to a particular recommendation. CRS and the disclosures in the other regulatory requirements such as Accordingly, a broker-dealer remains Relationship Summary.490 We also FINRA disclosure rules.495 responsible for disclosing all material stated that we anticipated that broker- After careful consideration of the facts relating to the scope and terms of dealers may elect to use other comments, the Commission is providing the relationship with the retail customer documents to satisfy elements of the guidance to permit a broker-dealer to (as discussed above), as well as all Disclosure Obligation, such as an utilize existing disclosures and material facts relating to conflicts of account agreement, a relationship guide, standardized documents, such as a interest that are associated with a or a fee schedule.491 product prospectus, relationship guide, recommendation whether or not the Several commenters requested account agreement, or fee schedule to firm relies on other materials to fulfill guidance on their ability to use other help satisfy the Disclosure Obligation. that obligation. documents to meet the requirements of The Commission recognizes that broker- With regard to commenters’ request the Disclosure Obligation. For example, dealers are subject to disclosure that the Relationship Summary be some commenters recommended that requirements other than the Disclosure considered sufficient to satisfy the the Commission harmonize the Obligation and Form CRS, and believes Disclosure Obligation, we note that the Disclosure Obligation with the broad, utilizing such existing disclosures Relationship Summary will provide succinct information and is designed to 489 With respect to the length of disclosure 492 See, e.g., Cambridge Letter (recommending assist retail investors with the process of documents, investor testing of proposed Form CRS that providing the Form CRS should fulfill the deciding whether to engage, or to examined retail investors’ likelihood of reading broker-dealer’s Disclosure Obligation under continue to engage, a particular firm or only longer documents (such as Form ADV Part II Regulation Best Interest); ACLI Letter (noting that or an account opening agreement), only a short a single disclosure fulfilling Regulation Best Interest financial professional, deciding whether document (Form CRS), both, or neither when and Form CRS would reduce the disclosure burdens to establish or continue to maintain a choosing a financial professional, account type or and increase the likelihood consumers will read the brokerage or investment advisory firm. Although the context was specific to Form required information); FSI August 2018 Letter; relationship, and asking questions and CRS and the retail investor’s initial determination Mutual of America Letter; Northwestern Mutual regarding a financial professional, account type or Letter; IPA Letter; Transamerica August 2018 Letter; easily finding additional information. firm, the survey suggests that retail investors may NAIFA Letter. be more likely to read either both longer and shorter 493 See, e.g., LPL August 2018 Letter 496 See Proposing Release at 21599, footnotes 175 disclosures or just shorter disclosures. See RAND (recommending that all investors be provided with and 176. For example, broker-dealers must disclose 2018 (‘‘Whereas Figure 2.20 shows that half of all general disclosures setting forth the ranges of information about a transaction on trade investors reported having reviewed neither a Form remuneration payable to broker-dealers in confirmations pursuant to Exchange Act Rule 10b– ADV nor an account opening agreement in the past connection with its recommendations of different 10. 17 CFR 240.10b–10. See also Morgan Stanley and another 20 percent reported not knowing products); Committee of Annuity Insurers (urging Letter (noting that the securities laws and FINRA whether they had ever done so, Figure 2.21 shows the Commission to clarify that a broker-dealer can rules already require firms to provide significant that about 70 percent of all respondents and of all satisfy the Disclosure Obligation through disclosure disclosures to clients at natural touchpoints in the investors reported that they would be likely to read describing products and services available to its client relationship). either both types of documents or only the retail customers and need not provide a disclosure 497 Similarly, we also note that a number of Relationship Summary when choosing a financial particularized to a recommendation). broker-dealers are modeling their disclosure of fees professional in the future. Just 2 percent of 494 See, e.g., SIFMA August 2018 Letter (asking other than transaction-based fees on the NASAA investors and 1 percent of noninvestors reported the Commission to clarify that the Disclosure Schedule of Miscellaneous Account and Service being likely to read only the longer documents, Obligation does not apply in contexts where there Fees. See NASAA August 2018 Letter. A broker- whereas 29 percent of investors and 13 percent of is an existing regime, such as for equity and debt dealer may use this schedule to comply in part with noninvestors were likely to read only the research); Transamerica August 2018 Letter its obligation to disclose fees and costs pursuant to Relationship Summary.’’ More specifically, Figure (recommending that the Commission recognize that the Disclosure Obligation. We note, however, that 2.21 shows that over 40% of all respondents existing disclosure regimes suffice to meet certain the NASAA Schedule may recommend the indicated they would read both and under 30% disclosure requirements). disclosure of certain fees that may not be required indicated that they would read only the 495 See, e.g., Transamerica August 2018 Letter under the Disclosure Obligation depending on the Relationship Summary.) (stating that the disclosure obligation should facts and circumstances, for example those that are 490 See Proposing Release at 21600. expressly take into consideration existing not ‘‘material facts’’ for purposes of Regulation Best 491 See id. at 21605. disclosures). Interest.

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We recognize that additional details in writing.503 Other commenters informing a retail customer of the regarding many of the topics (e.g., highlighted concerns associated with capacity in which the dual-registrant is services, fees and conflicts of interest) such oral disclosure.504 acting in conjunction with a would in many cases be necessary to After carefully considering the recommendation.507 In such instances, satisfy the Disclosure Obligation. Thus, comments, we are adopting the ‘‘in we believe that it may be necessary as although a broker-dealer could use a writing’’ requirement as proposed, a practical matter to provide oral Relationship Summary and other subject to discussion in Section II.C.1, disclosure of a material fact to standardized disclosures about its Oral Disclosure or Disclosure After a supplement, clarify, or update written products and services to help satisfy the Recommendation. As stated above, we disclosure made previously.508 Disclosure Obligation, these disclosures believe that retail customers would Therefore, firms may make oral may not be sufficient to satisfy the benefit from receiving a written disclosures under the circumstances Disclosure Obligation. Whether the disclosure to assist their investment outlined in Section II.C.1, Oral Relationship Summary standing alone, decisions and form the basis of an Disclosure or Disclosure After a or any additional or existing informed investment decision.505 Recommendation.509 disclosures, satisfy any of these required However, we also believe that broker- When making such an oral disclosure, disclosures in full would depend on the dealers require flexibility to make firms must maintain a record of the fact facts and circumstances. In most proper written disclosures to their that oral disclosure was provided to the instances, broker-dealers will need to customers. Accordingly, the retail customer.510 We are not explicitly provide additional information beyond Commission is not requiring a specific requiring broker-dealers to create a that contained in the Relationship form or method of written disclosure. record documenting the substance of Summary in order to satisfy the Although we are requiring that the oral disclosure itself, but rather a Disclosure Obligation. disclosure be made ‘‘in writing,’’ we record of the fact that such oral recognize that a broker-dealer may need disclosure was made.511 This record In Writing to supplement, clarify or update written should include documentation disclosure it has previously made before We proposed requiring that sufficient to demonstrate that disclosure it provides a retail customer with a disclosures be provided in writing.498 was made to the retail customer, which recommendation. For instance, as we We also stated that requiring written could include, for example, recordings stated in the Proposing Release, we disclosures would help facilitate of telephone conversations or recognized that broker-dealers may investor review of the disclosure, contemporaneous written notations. provide recommendations by telephone Nonetheless, although it is not required promote compliance by firms, facilitate and offer clarifying disclosure orally in by Regulation Best Interest, as a best effective supervision, and facilitate some instances subject to certain practice we encourage broker-dealers more effective regulatory oversight to conditions,506 such as a dual-registrant that make oral disclosures to help ensure and evaluate whether the subsequently provide to their retail disclosure complies with the 503 See PIABA Letter (recommending that the customers in a timely manner written requirements of Regulation Best Commission allow broker-dealers to discharge their disclosure summarizing the information Interest.499 We also stated that the ‘‘in disclosure obligations by: (i) Orally explaining the conveyed orally. writing’’ requirement could be satisfied relationship, any conflicts, how the broker-dealer is paid, and the features, benefits and risks of the either through paper or electronic recommendation; and (ii) confirming the discussion Plain English means consistent with existing by letter or email, which is signed or confirmed as In the Proposing Release, we stated Commission guidance on electronic being accurate by the customer, and retained in that broker-dealers should apply plain delivery of documents. We also customer’s file); SIFMA August 2018 Letter (recommending that the Commission clarify that English principles to written disclosures provided guidance on how broker- oral disclosure at the time of the recommendation including, among other things, the use dealers could comply with the ‘‘in may satisfy the Disclosure Obligation if: (1) The of short sentences and active voice, and writing’’ requirement when associated person documents that the oral avoidance of legal jargon, highly recommendations are given over the disclosure was made, or (2) the firm provides written disclosure after the trade); USAA Letter technical business terms, or multiple 500 telephone. (suggesting that the Commission could allow oral negatives.512 Similarly, several A number of commenters supported product-level disclosures, while providing the commenters recommended that the ‘‘in writing’’ requirement.501 Other client the choice to request confirming disclosure whatever format broker-dealers use for in writing at her option). commenters, however, recommend that 504 See Edward Jones Letter (expressing concern their disclosure, they should be written the Commission also permit the use of that the Commission is implying that a dual- in plain English and easy to oral disclosure.502 For example, several registrant would need to provide an oral point of understand.513 Accordingly, although it commenters recommend that the sale disclosure regarding the capacity in which it is acting when it makes a recommendation, and that 507 See id. at 21605, footnote 216. We stated that Commission permit broker-dealers to such oral disclosure would be difficult to supervise a broker-dealer could orally clarify the capacity in orally disclose information to their and of little value); CCMC Letters (stating that a which it is acting at the time of the dual-registrant should not have to make an oral customers provided they later follow-up recommendation if it had previously provided disclosure of the capacity for each and every written disclosure to the retail customer beforehand conversation it has with retail customers). 498 disclosing its capacity as well as the method it See Proposing Release at 21604. 505 One commenter stated that certain foreign 499 Id. planned to use to clarify its capacity at the time of laws do not permit firms to provide their customers the recommendation. 500 Id. with written materials prior to entering into a 508 For more discussion on guidance relating to 501 See, e.g., Vanguard Letter (recommending that contractual relationship. See FIBA February 2019 updating disclosures, see Section II.C.1.d, the Commission require a consolidated written Letter. In response, we note that the Disclosure Disclosure Obligation, Updating Disclosure. disclosure of all material conflicts); CFA August Obligation requires disclosure to be provided prior 509 2018 Letter. to or at the time of the recommendation and is not See Section II.C.1, Disclosure Obligation, Oral Disclosure or Disclosure After a Recommendation. 502 See Schwab Letter (recommending that the tied to a contractual relationship. In addition, the 510 Commission eliminate the ‘‘in writing’’ requirement staff will continue to evaluate the application of the See Section II.D. and allow firms to design and document the best Disclosure Obligation in circumstances such as the 511 See Section II.C.1, Disclosure Obligation, Oral method depending on the situation); SIFMA August one raised by this commenter. Interested parties are Disclosure or Disclosure After a Recommendation. 2018 Letter; TIAA Letter. But see AARP August invited to provide further feedback on issues 512 Proposing Release at 21604, footnote 213. 2018 Letter (stating that oral disclosures should involving non-U.S.- resident retail customers. 513 See State Attorneys General Letter (stating that never be permitted). 506 See Proposing Release at 21604, footnote 213. all disclosures must be in plain language and easily

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is not required, the Commission disclosure and recommended various However, if a broker-dealer is providing encourages broker-dealers to use plain methods (e.g., hyperlinks to web-based its customers with electronic delivery English in preparing any disclosures documents) but recommended paper (upon their consent) it cannot solely they make in satisfaction of the delivery as the default option.518 Other offer electronic delivery and must make Disclosure Obligation. commenters recommended permitting paper delivery available, upon request. electronic delivery for required Electronic Delivery Both Regulation Best Interest and Form disclosures.519 While investor testing on CRS require firms to provide electronic In the Proposing Release, we took the the proposed Relationship Summary delivery of documents within the position that broker-dealers could indicated that some retail investors framework of the Commission’s existing deliver written disclosures required by generally support some form of guidance regarding electronic Regulation Best Interest in accordance electronic copies, most participants in delivery.523 with the Commission’s existing the study ‘‘generally liked having a guidance regarding electronic delivery paper version of the Relationship d. Timing and Frequency of documents.514 This framework Summary.’’ 520 Similarly, as stated in We proposed requiring broker-dealers consists of the following elements: (1) the Form CRS adopting release, the IAC to provide the disclosures required by Notice to the investor that information has cited one study indicating that the Disclosure Obligation ‘‘prior to or at is available electronically; (2) access to nearly half of investors (49%) still prefer the time of’’ the recommendation. We information comparable to that which to receive paper disclosures through the noted the importance of determining the would have been provided in paper mail, compared with only 33% who appropriate timing and frequency of form and that is not so burdensome that prefer to receive disclosures disclosure that may be effectively the intended recipients cannot electronically, either through email provided ‘‘prior to or at the time of’’ the effectively access it; and (3) evidence to (27%) or accessing them online (6%).521 recommendation.524 In cases where a show delivery (i.e., reason to believe After considering investor testing broker-dealer determines that disclosure that electronically delivered information results and commenters’ concerns and may be more effectively be provided in will result in the satisfaction of the recommendations, the Commission an initial, more general disclosure (such delivery requirements under the federal reaffirms the application of existing as a relationship guide) followed by 515 securities laws). We have furthermore Commission guidance relating to paper specific information in a subsequent clarified that one method to satisfy the and electronic delivery of disclosure disclosure that is provided at a later evidence of delivery element is to obtain documents to broker-dealers in meeting time, the initial disclosure would 516 informed consent from investors. the Disclosure Obligation. Specifically, address when and how a broker-dealer Several commenters agreed with this we believe that broker-dealers should be 517 would provide more specific approach. These commenters able to satisfy the Disclosure Obligation information regarding the material fact typically supported the use of electronic 522 by using electronic delivery. or conflict in a subsequent disclosure. We stated also that in circumstances understood by investors); CFA Institute 518 Id. See also LPL August 2018 Letter (noting where a broker-dealer determines to (recommending that the Commission require a clear that modern communication practices underscore English listing of all conflicts of interest in which the need for the Commission to provide more provide an initial, more general a broker-dealer engages). One commenter requested flexibility to broker-dealers to satisfy their disclosure (such as a relationship guide) that the Commission consider clarifying that the document delivery obligations; and requesting that followed by specific information in a Plain English standard in the Disclosure Obligation the Commission confirm that broker-dealers can is not an English-only requirement to address the deliver disclosures in compliance with existing subsequent disclosure that is provided needs of certain non-U.S. customers. See FIBA guidance regarding electronic delivery of after the recommendation (such as a February 2019 Letter. In response, we note that any documents (which requires paper delivery as a trade confirmation), the initial disclosure should be made consistent with Plain default)). disclosure must address when and how English principles. 519 See, e.g., IPA Letter (urging the Commission to 514 a broker-dealer would provide more See Proposing Release at 21604. We cited to confirm that all required disclosures may be a number of prior Commission releases on delivered electronically); see also AXA Letter specific information regarding the electronic delivery in the Proposing Release, (urging the Commission to encourage the use of material fact or conflict in a subsequent including Use of Electronic Media by Broker- appropriate electronic disclosures, which can make disclosure (e.g., after the trade in the Dealers, Transfer Agents, and Investment Advisers information available to consumers more quickly 525 for Delivery of Information, Exchange Act Release and in a more digestible format); Prudential Letter trade confirmation). We also stated No. 37182 (May 9, 1996), 61 FR 24644 (May 15, (recommending that electronic delivery be deemed 1996) (‘‘1996 Release’’) (providing Commission to comply with the Disclosure Obligation). 523 See Relationship Summary Adopting Release, views on electronic delivery of required 520 See RAND 2018. Section II.C.3. information by broker-dealers, transfer agents and 524 521 Relationship Summary Adopting Release at See Proposing Release at 21605. investment advisers) and Use of Electronic Media, Section II.D.3.a (citing Investor Advisory 525 The Commission has granted exemptions to Exchange Act Release No. 42728 (Apr. 28, 2000), 65 Committee, Recommendation of the Investor as certain dual-registrants, subject to a number of FR 25843 (May 4, 2000) (‘‘2000 Release’’) (providing Purchaser Subcommittee: Promotion of Electronic conditions, from the written disclosure and consent updated interpretive guidance on the use of Delivery and Development of a Summary Disclosure requirements of Advisers Act Section 206(3) (which electronic media to deliver documents on matters Document for Delivery of Investment Company makes it unlawful for an adviser to engage in a such as telephonic and global consent; issuer Shareholder Reports (Dec. 7, 2017), available at principal trade with an advisory client, unless it liability for website content; and legal principles https://www.sec.gov/spotlight/investor-advisory- discloses to the client in writing before completion that should be considered in conducting online committee-2012/recommendation-promotion-of- of the transaction the capacity in which the adviser offerings). electronic-delivery-and-development.pdf (citing is acting and obtains the consent of the client to the 515 See 1996 Release at 24646–47; see also FINRA Investor Education Foundation, ‘‘Investors transaction). The exemptions are subject to several Relationship Summary Proposing Release at 21454. in the United States 2016,’’ December 2016, conditions, including conditions to provide 516 See 2000 Release at 25845–46 (clarifying how available at http://bit.ly/2hMrppX). disclosures at multiple points in the relationship, market intermediaries and other market participants 522 See 1996 Release (stating that ‘‘the including disclosure that the entity may be acting can obtain consent for electronic delivery). Commission believes that broker-dealers . . . in a principal capacity in a written confirmation at 517 See, e.g., CFA August 2018 Letter (stating that similarly should have reason to believe that or before completion of a transaction. See, e.g., In giving firms discretion to choose the delivery electronically delivered information will result in the matter of Merrill Lynch Pierce Fenner & Smith, mechanism would all but ensure that many the satisfaction of the delivery requirements under Incorporated, Investment Advisers Act Release No. investors would never see the disclosures); AARP the federal securities laws. Thus, whether using 4595; (Dec. 28, 2016); In the matter of Robert W. August 2018 Letter (recommending that the paper or electronic media, broker-dealers . . . Baird & Co., Incorporated, Advisers Act Release No. Commission prohibit firms from solely providing should consider the need to establish procedures to 4596 (Dec. 28, 2016); In the matter of UBS Financial electronic access to disclosures and require delivery ensure that applicable delivery obligations are Services, Inc., Advisers Act Release No. 4597 (Dec. of paper copies). met’’); see also 2000 Release. Continued

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that disclosure after the Several other commenters, however, appropriate and effective way to meet recommendation, such as in a trade recommended that the Commission the Disclosure Obligation. Accordingly, confirmation for a particular clarify whether broker-dealers could the Commission has decided not to recommended transaction would not, by meet the Disclosure Obligation at the provide any prescriptive requirements itself, satisfy the Disclosure Obligation, point of sale 531 or after a for the timing and frequency of written because the disclosure would not be recommendation is made.532 disclosures, other than requiring ‘‘prior to, or at the time of the Conversely, several commenters disclosure prior to or at the time of the recommendation.’’ We noted also that recommended that the Commission recommendation. whether there is sufficient disclosure in clarify that it will not require point of In order to make an informed decision both the initial disclosure and any sale or point of recommendation about a securities recommendation, subsequent disclosure would depend on disclosure obligations.533 retail customers must have appropriate the facts and circumstances.526 After carefully considering the information at the time or before a Several commenters supported the comments received, we are providing recommendation is made. Being in Commission’s proposal to require our view on what it means for broker- possession of relevant information gives broker-dealers to make disclosure prior dealers to provide the required investors the tools with which to judge to or at the time of the recommendation, disclosures in writing ‘‘prior to or at the the merits of acting on a particular but disagreed about the precise timing time of’’ the recommendation. As with recommendation. As stated in the with which disclosure should be the ‘‘form and manner’’ of making Proposing Release, the Commission provided.527 For example, some disclosures, the Commission continues believes that broker-dealers should commenters recommended that the to believe that broker-dealers should provide retail customers information Commission require or allow broker- have flexibility with respect to the early enough in the process to give them dealers to meet the Disclosure ‘‘timing and frequency’’ of providing adequate time to consider the Obligation prior to or at account disclosure to determine the most information and promote the investor’s opening.528 Similarly, several understanding in order to make commenters recommended that the information should be provided, whenever informed investment decisions.534 Commission require broker-dealers to possible, at the point of recommendation rather Similarly, the Commission believes that provide disclosure prior to a than at the point of sale); Groom Letter broker-dealers should not provide (recommending that the Commission require recommendation or investment disclosure of material conflicts of interest related to information so early that the disclosure decision.529 Specifically, commenters investing plan distribution proceeds at the fails to provide meaningful information recommended that the Commission inception of any discussions of the matter); PIABA (e.g., does not sufficiently identify require disclosures to be made with Letter (recommending that the Commission require material conflicts presented by a firms to provide specific charges prior to or at the enough time prior to a recommendation time the recommendation is made); FPC Letter particular recommendation, or that a retail customer has sufficient time (stating that disclosures should be made prior to the overwhelms the retail customer with to review and understand them, as well recommendation so the retail customer has disclosures related to a number of as ask questions.530 sufficient time to review and understand them, as potential options that the retail well as to ask questions); Better Markets August 2018 Letter; AARP August 2018 Letter; Bank of customer may not be qualified to 28, 2016); In the matter of Wells Fargo Advisors, America Letter. pursue).535 Nevertheless, in order to LLC, Wells Fargo Advisors Financial Network, LLC, 531 See Pacific Life August 2018 Letter (stating provide broker-dealers the flexibility to Advisers Act Release No. 4598 (Dec. 28, 2016). that material conflicts of interest must be disclosed determine how and when to make 526 See Proposing Release at 21605. at or prior to the point-of-sale or at the time the relevant disclosures pursuant to the 527 See, e.g., CFA August 2018 Letter (stating that recommendation is made). any information that can be provided before the 532 See, e.g., LPL August 2018 Letter (suggesting Disclosure Obligation, we are not transaction is entered into should be provided to that the Commission permit a broker-dealer to mandating a requirement that give investor time to consider it); AARP August satisfy the Disclosure Obligation by directing an disclosures be made within a certain 2018 Letter (stating that all key disclosures should investor in writing to review the recommended timeframe preceding a recommendation. be made significantly in advance of an investment product’s offering documents, along with decision; disclosure made at the time of or hyperlinks to those documents, prior to the However, we continue to encourage immediately prior to investing is not adequate); recommendation or shortly thereafter via a trade broker-dealers to consider whether it Bank of America Letter (stating that disclosure of confirmation); SIFMA August 2018 Letter would be helpful to repeat or highlight material conflicts of interest can be satisfied in (recommending that the Commission confirm that disclosures already made pursuant to advance of a particular recommendation on a one- firms would be permitted to provide disclosures on time basis); Pacific Life August 2018 Letter (stating a website or on a post-trade basis, provided the Disclosure Obligation at the time of that disclosure of material conflicts of interest must customers have been informed in advance of the the recommendation. be disclosed at or prior to the point of sale or at timing of those disclosures). We are also clarifying the ability of a the time the recommendation is made); FPC Letter. 533 See, e.g., SIFMA August 2018 Letter broker-dealer to supplement, clarify, or 528 See, e.g., TIAA Letter (recommending that the (requesting the Commission clarify that there is no Commission require firms to meet their Regulation update information after making a requirement for a point of sale or point of 536 Best Interest and CRS disclosure obligations at or recommendation disclosure, as such a requirement recommendation. In particular, if a before the point the investor: (i) Opens a brokerage would be unworkable for the industry); Morgan broker-dealer determines to disclose account; or (ii) engages the broker-dealer to provide Stanley Letter (noting that point-of-sale disclosures information, in part, after the advice services (including for recommendations pose operational issues and may not afford clients recommendation, such as in a provided by phone)). sufficient time to adequately consider and 529 See, e.g., Better Markets August 2018 Letter understand them); HD Vest Letter (recommending prospectus or trade confirmation, that (stating that disclosure should be provided in a that the Commission not mandate written point of disclosure may be used to supplement, timely fashion so investors have a meaningful recommendation or point of sale disclosure); clarify, or update the initial, general opportunity to read, digest, understand, and discuss Prudential Letter (requesting that the Commission disclosure. For example, any necessary them); FPC Letter; AARP August 2018 Letter. clarify that it is not mandating a point of sale or 530 See, e.g., NAIFA Letter (recommending that point of recommendation disclosure obligation). disclosure be provided at or before the time of a But see NASAA August 2018 Letter (stating that 534 Proposing Release at 21605. recommendation because it helps consumers better only a transaction-by-transaction disclosure 535 Id. understand and evaluate the recommendations they obligation will ensure that broker-dealers are 536 See id. In the proposal, we noted that there receive and preserves flexibility for professionals meeting their ‘‘best interest’’ duties and provide may be material information that the broker-dealer who may be interacting with clients of various investors the level of protection they deserve); may not be in a position to disclose at or prior to levels of financial sophistication, duration of AARP August 2018 Letter (recommending that the the recommendation that may be revealed following relationship, and investment history); CFA August Commission require firms to disclose their fees any the transaction, such as the final transaction 2018 Letter (recommending that transaction-specific time a recommendation is made). information contained in a trade confirmation.

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information in a product offering We have considered these comments would be more effectively conveyed in document, such as information about and results of investor testing and will a more general manner in an initial product risks or fees, may be provided continue to permit broker-dealers to use written disclosure accompanied or in accordance with existing disclosure a layered approach to disclosure. We followed by more specific information mechanisms that occur after a acknowledge that different investors in a separate disclosure. Similarly, we transaction, such as the delivery of a have different preferences for the type believe that providing broker-dealers trade confirmation or a prospectus, and length of disclosures they receive, with flexibility to best target their private placement memorandum, or and that some investors may not read disclosures to their particular retail offering circular.537 However, the additional information provided in any customer base will increase the broker-dealer must comply with the particularized disclosure that likelihood that investors will view circumstances outlined in Section II.C.1, supplements initial, standardized them. Oral Disclosure or Disclosure After a disclosure. Nonetheless, we believe that Recommendation, in order to make any permitting broker-dealers to provide The Commission is not prescribing such disclosure after the their retail customers with a specific procedures obligating broker- recommendation. standardized summary of information dealers to fulfill the Disclosure supplemented by more particularized Obligation in a particular way. Rather, Layered Disclosure information will help avoid the Regulation Best Interest as adopted We proposed to require broker-dealers likelihood that retail customers receive provides broker-dealers with flexibility to provide disclosure prior to or at the a single, potentially voluminous to provide disclosures that are time of the recommendation but gave disclosure document, and enable the consistent with the various ways in guidance on a number of approaches many investors who prefer a shorter, which broker-dealers may already they could take to achieve this summary document to have it available provide disclosure to their customers.541 requirement, including providing to them, with additional information This could include, for example, layered disclosure, in which more available should they wish to have it. providing multiple or ‘‘layered’’ general information is supplemented by This approach to layering information is disclosures either initially or over time, more detailed information provided also consistent with our concurrent but that in total constitute full and fair either at the same time or effort in Form CRS to provide retail disclosure of the information required subsequently.538 We received a number investors with high level information by the Disclosure Obligation. While we of comments supporting our proposed and context concerning key material are not setting forth a prescriptive guidance concerning a layered approach facts, supplemented by additional layers approach regarding exactly when to the Disclosure Obligation.539 In of information regarding their disclosures should be made as suggested addition, investor testing illustrates that relationship. by some commenters, we believe that a many retail investors support a layered We also continue to believe that broker-dealer may determine that 540 approach as well. broker-dealers should have flexibility in certain disclosures are most effective if determining when to make disclosures they are made at multiple points of the 537 In instances where a recommended and whether, in light of their retail transaction is not acted upon by the retail customer, relationship, or alternatively, certain and therefore there is no subsequent delivery of customer base, certain material facts material facts may be conveyed in a disclosure otherwise required by the transaction, more general manner in an initial the fact that such information is not provided That study described layered disclosure as an written disclosure accompanied or would not be a violation of the Disclosure ‘‘approach to disclosure in which key information Obligation. is sent or given to the investor and more detailed followed by more specific 542 538 See Proposing Release at 21605 (suggesting the information is provided online and, upon request, information. Disclosure Obligation could be satisfied, for is sent in paper or by email.’’ See Enhanced example, at multiple points in the relationship or Disclosure and New Prospectus Delivery Option for Updating Disclosures through a layered approach to disclosure, such as Registered Open-End Management Investment an initial disclosure conveying more general Companies, Securities Act Release No. 8998 (Jan. Several commenters recommend that information regarding the material fact or conflict 13, 2009). This layered approach is ‘‘intended to the Commission clarify under what followed by more specific information in a provide investors with better ability to choose the subsequent disclosure). amount and type of information to review, as well circumstances a broker-dealer would be 539 See, e.g., Commonwealth Letter (supporting a as the format in which to review it (online or required to update prior disclosures layered disclosure approach that includes (i) the paper).’’ Id. Other studies that considered the use made pursuant to the Disclosure Relationship Summary at the inception of the of hyperlinks for layered disclosure in proposed Obligation.543 Among the suggestions relationship; (ii) the traditional disclosures Form CRS suggested that retail investors are included in account-opening agreements; (iii) generally interested in receiving additional are to only require broker-dealers to product-specific point-of-sale disclosures (e.g., information, but recognized the possibility that update their disclosures when there are prospectuses and alternative investment offering retail investors may not click on a hyperlink. See, material changes to the disclosed documents); and (iv) more detailed disclosures on e.g., RAND 2018 (finding 58% of participants the firm’s website); IRI Letter (supporting a selecting ‘‘very likely’’ and another 32% selecting principles-based disclosure regime, which leverages ‘‘somewhat likely’’ to click on a hyperlink relating 541 See Proposing Release at 21605. the benefits of layered disclosure to combat to fees; although no other potential hyperlink 542 See id. information overload); Morgan Stanley Letter generated a majority with ‘‘very likely’’ usage, other 543 See, e.g., LPL August 2018 Letter (concurring with the Commission’s proposed potential hyperlinks concerning services, conflicts (recommending that the Commission provide layered approach to disclosure of material facts and investor education generated a majority when additional guidance with respect to the updating regarding the scope of the relationship with the combining responses of ‘‘very likely’’ and and amendment requirements that apply to the client and fees, as well as material conflicts of ‘‘somewhat likely’’ to click on the hyperlink). See Disclosure Obligation); CFA Institute Letter interest associated with the recommendation); Stifel also Kleimann Communication Group, Inc., Report (recommending that the Commission require Letter; Mass Mutual Letter; Triad Advisors Letter; on Development and Testing of Model Client broker-dealers to provide updated disclosures at Investacorp Letter; Ladenburg Letter. Relationship Summary, Presented to AARP and least 30 days before raising or imposing new fees); 540 See, e.g., Study Regarding Financial Literacy Certified Financial Planner Board of Standards, Inc. Bank of America Letter (recommending that the Among Investors As Required by Section 917 of the (Dec. 5, 2018), available at https://www.sec.gov/ Commission require firms to update existing Dodd-Frank Wall Street Reform and Consumer comments/s7-07-18/s70718-4729850-176771.pdf disclosures when there are changes to material Protection Act, August 2012 at iv. A key finding of (indicating that while some participants were conflicts of interest, as well as annually); NAIFA the SEC staff’s 917 study was that Investors favor interested in additional information, others Letter (recommending that the Commission not ‘‘layered’’ disclosure and, wherever possible, the admitted they would not follow the links because require regular disclosure (e.g., quarterly, annual, use of a summary document containing key it was extra effort, they were uninterested, or the etc.) of any new information items, unless the information about an investment product or service. link did not itself suggest what would be there). information has materially changed).

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information; 544 require broker-dealers 2. Care Obligation commenters also requested clarification to update their disclosures at least 30 We proposed the Care Obligation to on the meaning and scope of days before raising or imposing new require a broker-dealer, when making a ‘‘reasonably available alternatives’’ and 545 fees; and require broker-dealers to recommendation of any securities ‘‘otherwise identical securities,’’ update their disclosures when changes transaction or investment strategy including how the phrase ‘‘reasonably are made, as well as annually.546 involving securities to a retail customer, available alternatives’’ would apply in The Commission has carefully to exercise reasonable diligence, care, situations where a broker-dealer considered the commenters’ suggestions skill, and prudence to: (1) Understand operated in an open architecture 554 and is providing guidance on a broker- the potential risks and rewards environment, or maintained a limited dealer’s duty to update disclosures associated with the recommendation, product menu such as where broker- made to customers under Regulation and have a reasonable basis to believe dealers limited available offerings to 555 Best Interest. The Disclosure Obligation that the recommendation could be in proprietary products. Finally, several requires broker-dealers to provide their the best interest of at least some retail commenters recommended the retail customers with full and fair customers; (2) have a reasonable basis to Commission include other factors in disclosure of material facts related to believe that the recommendation is in building a retail customer’s investment 556 several aspects of their relationship with the best interest of a particular retail profile, such as longevity risk, market 557 558 their customers. Therefore, a broker- customer based on that retail customer’s risk, or income profile. dealer cannot provide customers with investment profile and the potential We are adopting the Care Obligation full and fair disclosure if the disclosures risks and rewards associated with the substantially as proposed, but with contain materially outdated, recommendation; and (3) have a certain modifications and additional incomplete, or inaccurate information. reasonable basis to believe that a series guidance to address comments. As Additional disclosure will be necessary of recommended transactions, even if in discussed in more detail below, in when any previously provided the retail customer’s best interest when response to comments, we are revising information becomes materially viewed in isolation, is not excessive and the Care Obligation to remove the term inaccurate, or when there is new is in the retail customer’s best interest ‘‘prudence,’’ as we have concluded that relevant material information (e.g., a when taken together in light of the retail its inclusion creates legal uncertainty new material conflict of interest has customer’s investment profile. As we and confusion, and it is redundant of arisen that is not addressed by the indicated in the Proposing Release, the what we intended in requiring a broker- standardized disclosure).547 Therefore, a Care Obligation was intended to dealer to exercise ‘‘diligence, care, and broker-dealer’s duty to update incorporate and enhance existing skill,’’ and its removal does not change disclosures made to its customers under suitability requirements applicable to the requirements under the Care Regulation Best Interest is based on the broker-dealers under the federal Obligation. Accordingly, the Care facts and circumstances. securities laws by, among other things, Obligation will require broker-dealers to While we are not prescribing an imposing a ‘‘best interest’’ requirement ‘‘exercise reasonable diligence, care, and explicit timeframe in which required that will require a broker-dealer to not skill’’ to meet the three components of updates must be made, generally the place its own interest ahead of the retail the Care Obligation. In addition, after careful Commission encourages broker-dealers customer’s interest, when making consideration of the comments received, to update their disclosures to reflect recommendations.549 we are expressly adding cost to the rule material changes or inaccuracies as soon Commenters generally supported the text as a factor that a broker-dealer must as practicable, and thus generally proposed Care Obligation, including its consider in fulfilling the Care should be no later than 30 days after the principles-based approach, but many Obligation. While certain commenters material change; in the meantime, commenters requested additional guidance or clarification on how a expressed concerns about the broker-dealers are encouraged to prominence of cost and how cost would provide, supplement, or correct any broker-dealer could satisfy the Care Obligation under different be balanced against other factors under written disclosure with oral disclosure the Care Obligation,559 other as necessary prior to or at the time of the circumstances and regarding specific 548 products.550 Relatedly, several recommendation. However, if standard differs from, or even whether it improves updated information is to be provided commenters requested further guidance upon, the existing suitability standard under FINRA either orally, or after a recommendation, regarding the role of costs and other rules’’); AFL–CIO April 2019 Letter (stating ‘‘that such disclosure must be made under the relevant factors when making a best the intent of [proposed Regulation Best Interest] is interest determination,551 while other to codify, rather than enhance, protections investors circumstances outlined in Section II.C.1, currently receive under FINRA’s suitability Oral Disclosure or Disclosure After a commenters expressed concern over the standard’’). Recommendation. usage of the term ‘‘prudence’’ 552 or 554 For purposes of this requirement, we use the expressed concern that Regulation Best term ‘‘open architecture’’ to mean a firm’s product menu that includes both third-party and proprietary 544 See NAIFA Letter. Interest is not a major change from 553 products, or as a concept wherein a firm offers a 545 See CFA Institute Letter. FINRA’s suitability rule. Numerous large range of products to their retail customers that 546 See Bank of America Letter. are not limited, for example, to a small list of 547 See Proposing Release at 21605. 549 As discussed in the Fiduciary Interpretation, approved managers or funds (i.e., a product menu 548 The 30-day period aligns with other the duty of care of the investment adviser’s that is not limited to proprietary products or requirements to update disclosures in similar fiduciary duty includes a duty to provide otherwise constrained to certain retail customers or contexts. For instance, NASD Notice to Members investment advisory services that are in the best registered representatives). See generally FINRA 92–11, Fees and Charges for Services (Feb. 1992) interest of the client. See Fiduciary Interpretation 2013 Conflicts Report; Morgan Stanley Letter. 555 states that its member firms need to provide written at footnote 34. See, e.g., Fidelity Letter; ICI Letter; LPL notification to customers of all service charges 550 See, e.g., NASAA August 2018 Letter; August 2018 Letter; SIFMA August 2018 Letter; when accounts are opened, and . . . written Cambridge Letter; BlackRock Letter. Prudential Letter; Morningstar Letter. notification at least 30 days prior to the 551 See, e.g., Wells Fargo Letter; Primerica Letter; 556 See, e.g., CCMC Letters; Lincoln Financial implementation or change of any service charge. CFA Institute Letter. Letter; Pacific Life August 2018 Letter. Failure to do so could be construed as conduct 552 See, e.g., BISA Letter; Raymond James Letter; 557 See, e.g., Jackson National Letter. inconsistent with just and equitable principles of Transamerica August 2018 Letter. 558 See, e.g., Lincoln Financial Letter. trade under FINRA Rule 2010 (Standards of 553 See, e.g., CFA August 2018 Letter (stating 559 See, e.g., ICI Letter; Putnam Letter; Morgan Commercial Honor and Principles of Trade). ‘‘[n]owhere does the Commission explain how the Stanley Letter; Letter from Eric R. Dinallo,

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commenters supported incorporating factor that a broker-dealer must consider set forth in the rule text. It should never cost into the rule text.560 As noted in the in making a recommendation, it is not be the only consideration. Additional Relationship Summary Adopting a dispositive factor and its inclusion in factors such as those cited by Release, participants in investor testing the rule text is not meant to limit or commenters also should be taken into and roundtables also overwhelmingly foreclose the recommendation of a more consideration as the broker-dealer supported including fees in the costly or complex product that a broker- formulates a recommendation consistent Relationship Summary, and believed dealer has a reasonable basis to believe with the best-interest standard.567 that the ‘‘fees and costs’’ section was the is in the best interest of a particular Though we are declining to expressly most important for determining which retail customer.563 Moreover, we are define ‘‘best interest’’ in the rule text, as type of investment accounts and reiterating that the standard does not discussed above,568 we are providing services are right for that person.561 We necessarily require the lowest cost guidance regarding the application of believe that while the factors that a option, and that while cost is an the Care Obligation and in particular broker-dealer should understand and important factor that always needs to be what it means to make a consider when making a taken into consideration in making a recommendation in the retail customer’s recommendation may vary depending recommendation, it is not the only ‘‘best interest.’’ In addition, to upon the particular product or strategy one.564 Rather, as explained more fully emphasize the importance of recommended, cost—along with below, the evaluation of cost would be determining that each recommendation potential risks and rewards—will more analogous to a broker-dealer’s best is in the best interest of the retail always be a relevant factor that will bear execution analysis, which does not customer and that it does not place the on the return of the security or require the lowest possible cost, but broker-dealer’s interests ahead of the investment strategy involving rather looks at whether the transaction retail customer’s interests, we are securities.562 This would include, for represents the best qualitative execution expressly incorporating into the rule example, both costs associated with the for the customer using cost as one text of Paragraph (a)(2)(ii)(B) and purchase of the security, as well as any factor.565 Paragraph (a)(2)(ii)(C) of Regulation Best costs that may apply to the future sale Several commenters expressed Interest that a broker-dealer must have or exchange of the security, such as concern over the emphasis of ‘‘cost’’ and a reasonable basis to believe that the deferred sales charges or liquidation suggested that, for example, more recommendation ‘‘does not place the costs. Elevating cost to the rule text emphasis be placed on additional or financial or other interest of the [broker- clarifies that this factor must always be subjective factors beyond specific dealer] . . . ahead of the interest of the considered when making a product attributes.566 Those retail customer.’’ While we acknowledge recommendation. Thus, a broker-dealer, commenters stated that the emphasis on that a broker-dealer and an associated in fulfilling its obligation to make a cost may discourage certain products or person can and will have some financial recommendation in the best interest of investment strategies. Our intent is not interest in a recommendation, as noted its retail customer, must exercise to discourage or otherwise limit the above, this addition to the Care reasonable diligence, care, and skill to recommendation of products or Obligation makes clear these interests understand the ‘‘potential risks, investment strategies where a broker- cannot be placed ahead of the retail rewards, and costs’’ associated with the dealer concludes that the customer’s interests when making a recommendation and have a reasonable recommendation is in the best interest recommendation.569 basis to believe that the of the retail customer. Instead, we Finally, we believe that by explicitly recommendation is in the best interest believe that cost will always be relevant requiring in the rule text that the broker- of the retail customer based on these to a recommendation and accordingly dealer have a reasonable basis to believe factors. should be a required consideration as that a recommendation is both in the Importantly, however, while cost, like retail customer’s ‘‘best interest’’ and potential risks and rewards, is always a 563 See Proposing Release at 21587–21589; 21610–21612. 567 564 See Proposing Release at 21610. See, e.g., BlackRock Letter (citing Executive Vice President, General Counsel, consideration of investors’ needs and desired 565 Under the antifraud provisions of the federal Guardian Life (Aug. 7, 2018) (‘‘Guardian August outcomes relative to service offerings of several securities laws and SRO rules, broker-dealers have 2018 Letter’’) (cautioning against inclusion of different managers); Vanguard Letter ‘‘costs’’ into rule text or overemphasizing its a legal duty to seek to obtain best execution of customer orders. See Regulation NMS, Exchange (‘‘considerations include important factors such as importance). product structure, investment features, liquidity, 560 Act Release No. 51808 (Jun. 9, 2005) (‘‘Regulation See, e.g., AFL–CIO April 2019 Letter (stating NMS Release’’); FINRA Rule 5310 (Best Execution volatility, issuer reputation, brand and business ‘‘If, as has been suggested, one goal is to ensure that and Interpositioning). A broker-dealer’s duty of best practices (securities lending activities, portfolio brokers give greater consideration to costs in execution requires a broker-dealer to seek to tracking error, or usage of derivatives in a determining what investments to recommend, execute customers’ trades at the most favorable portfolio)’’); ICI Letter (citing several subjective [Regulation Best Interest] should incorporate an terms reasonably available under the circumstances. factors, such as the ‘‘nature and quality of a explicit requirement to consider costs in the rule See Regulation NMS Release at 160; see also provider’s services (including advantages to the text.’’); NASAA August 2018 Letter; U. of Miami Proposing Release at 21615. Certain commenters investor of consolidating investments as a single Letter (supporting addition of ‘‘costs’’ into rule pointed to best execution analysis as an example of firm, such as higher levels of service that may be text). See also CFA August 2018 Letter (supporting a rule or guidance that is facts-and-circumstances- offered), minimum initial investments, and firm the Commission’s emphasis of cost and associated based. See, e.g., CFA August 2018 Letter (‘‘Just as reputation’’); FIBA February 2019 Letter (citing financial incentives as more important factors, and compliance with the best execution standard will ‘‘highly personalized non-economic reasons stating ‘‘[t]his requirement would be clearer, not always be met by sending trades to the underlying cross-border investment’’). however, if it were incorporated into the rule text, exchange where the lowest cost is displayed, 568 See Section II.A.2. which requires the broker to consider the ‘potential compliance with a best interest standard will not 569 See id. See also AFL–CIO April 2019 Letter risks and rewards associated with the always be satisfied by recommending the lowest (noting ‘‘Adopting a standard that explicitly states recommendation,’ rather than the material cost option.’’). that brokers are prohibited form placing their own characteristics, including costs, of the 566 See, e.g., ICI Letter; BlackRock Letter; Putnam interests ahead of the retail customer’s interests recommended investment or investment strategy.’’). Letter; Transamerica August 2018 Letter; reinforces [investors’ reasonable expectations that 561 See Relationship Summary Adopting Release. Northwestern Mutual Letter; see also Vanguard the financial professionals they rely on for 562 See Vanguard Letter (‘‘We agree that costs and Letter (recognizing the importance of cost, but investment advice will put their interests first]’’ and remuneration should play a central role in meeting urging the Commission to maintain a principles- asserting that ‘‘a requirement to place the the revise best interest standards. Cost is a critical based approach recognizing the importance of customer’s interests ahead of the brokers’ interests factor because of its compounding effect upon ‘‘holistic advice that necessarily contemplates must be included in the operational provisions of performance.’’). factors beyond cost.’’). Reg BI. . . .’’).

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does ‘‘not place the financial or other and (3) applying the obligations relating recommendation.575 We also received interest’’ of the broker-dealer ahead of to a series of recommended transactions numerous comments asking for further the retail customer’s interests, we are (currently referred to as ‘‘quantitative guidance relating to recommendations enhancing the Care Obligation by suitability’’) irrespective of whether a of specific securities or asking how the imposing obligations beyond existing broker-dealer exercises actual or de Care Obligation applies to certain suitability obligations. Under existing facto control over a customer’s factual scenarios.576 With respect to the suitability requirements, a broker-dealer account.572 In addition, it is our view term ‘‘prudence,’’ a number of is required to make recommendations that a broker-dealer should consider comments requested removal of the that are ‘‘suitable’’ for the customer. ‘‘reasonably available alternatives’’ as term, stating that such language is While certain cases and guidance have part of having a ‘‘reasonable basis to unnecessary given the other interpreted FINRA’s suitability rule to believe’’ that the recommendation is in requirements to satisfy the Care require that ‘‘a broker’s the best interest of the retail customer, Obligation, as well as the fact that the recommendations must be consistent which we also believe is an term introduces legal confusion and with his customers’ best interests,’’ and enhancement beyond existing suitability uncertainty.577 Other commenters FINRA has further interpreted the expectations.573 supported the use of the term requirement to be ‘‘consistent with the ‘‘prudence’’ because they believed that a. Exercise Reasonable Diligence, Care, customer’s best interest’’ to prohibit a Regulation Best Interest’s component and Skill broker-dealer from placing his or her obligations generally rested on a interests ahead of the customer’s A broker-dealer is required to ‘‘prudence’’ standard or maintained that interests, this obligation is not explicitly ‘‘exercise reasonable diligence, care, and the Care Obligation ‘‘echoes elements required by FINRA’s rule (or its skill’’ to satisfy the three components of found in the common law ‘prudent supplementary material), nor does the the Care Obligation set forth in person rule,’ ’’ and thus thought its interpretation require recommendations Regulation Best Interest. In the addition was appropriate to capture, or to be in the best interest (as opposed to Proposing Release, we included describe, these obligations.578 ‘‘consistent with the best interest’’) of a ‘‘prudence,’’ and explained that After careful consideration of retail customer.570 We believe that ‘‘prudence’’ ‘‘conveys the fundamental comments, we are revising the Care requiring recommendations to be in the importance of conducting a proper Obligation to remove the term best interest is declarative of what must evaluation of any securities or be done, and therefore stronger than, 575 See, e.g., SIFMA August 2018 Letter; Vanguard investment strategy recommendation in Letter; Morningstar Letter; Edward Jones Letter. requiring recommendations to be accordance with an objective standard 576 See, e.g., SIFMA August 2018 Letter; Direxion ‘‘consistent with’’ the best interest of the of care.’’ 574 Further, we solicited Letter; Chapman Letter. retail customer, which we believe at a comment on all aspects of the Care 577 See, e.g., Primerica Letter (stating ‘‘.... the minimum creates ambiguity as to Obligation, and also asked specifically term [prudence] raises numerous interpretative whether the recommendation must be in issues and compliance risks. Regulatory and whether there was adequate clarity and judicial interpretations of ERISA ‘prudence’ and its the retail customer’s best interest or understanding regarding the term requirements abound, but these are exclusive to something less.571 ‘‘prudence,’’ or whether other terms employee benefit plan duties and do not address The Care Obligation significantly were more appropriate in the context of duties with respect to retail accounts for individual enhances the investor protection customers.’’); Transamerica August 2018 Letter broker-dealer regulation. (‘‘The term ‘prudence’ is one used primarily in the provided as compared to current Several commenters supported ERISA context and is not generally used in the suitability obligations by: (1) Explicitly adopting a principles-based obligation, federal securities laws. We believe inclusion of the requiring in Regulation Best Interest that thus requiring the broker-dealer to term ‘prudence’ in describing the care obligation is recommendations be in the best interest unnecessary and could lead to confusion in assess the adequacy of a interpretation of the care obligation set forth in the of the retail customer and do not place recommendation based on the facts and Proposal’’); IPA Letter (‘‘ ‘Prudence’ is an ERISA the broker-dealer’s interests ahead of the circumstances of each term based on trust law that is not generally used retail customer’s interests; (2) explicitly under the federal securities laws’’). See also Fein requiring by rule the consideration of Letter (discussing that the ‘‘duties of loyalty and 572 See FINRA 2018 Letter (noting that proposed care are the core fiduciary standards that apply costs when making a recommendation; Regulation Best Interest augments and enhances across all fiduciary fields, including trust law, current requirements by, among other things: agency law, and employee benefits law;’’ that 570 See FINRA Regulatory Notice 12–25 at Q1. See ‘‘explicitly impos[ing] a ‘best interest’ standard, ‘‘[b]oth of these duties are reflected in the existing also FINRA Letter to Senators Warren, Brown, and making clear that a broker-dealer cannot put its regulation of broker-dealers and investment Booker (Aug. 3, 2018) (‘‘FINRA 2018 Letter’’) interests ahead of the interests of its customers. advisers when they give investment advice to retail (stating that ‘‘[w]hile FINRA’s suitability rule While FINRA’s suitability rule implicitly requires a customers;’’ and that the ‘‘duty of care—also called implicitly requires a broker-dealer’s broker-dealer’s recommendations to be consistent ‘prudence’—requires a fiduciary to act with care, recommendations to be consistent with customer’s with customers’ best interests, the SEC’s proposed skill and diligence in fulfilling his designated best interests, the SEC’s proposed best interest best interest standard explicitly establishes the functions.’’) (internal citations omitted). standard explicitly establishes the customer’s best customer’s best interest as an overarching standard 578 See LPL August 2018 Letter (‘‘We believe that interest as an overarching standard of care for of care for broker-dealers;’’ ‘‘explicitly requir[ing] each of the four component obligations identified broker-dealers.’’ (internal citations omitted)). Some broker-dealers to consider ‘reasonably available in Regulation BI generally rests on a ‘prudence’ commenters have also made this point. See, e.g., alternatives’ to a recommended security and justify standard that is the foundation of the common law CFA August 2018 Letter (‘‘In enforcing that any choice of a more costly product.... Although principles and the Federal law that have governed standard, however, FINRA has only rarely and very case law and FINRA guidance establish cost and the activities of financial services providers for narrowly enforced the obligation to do what is best available alternatives as factors to consider as part decades. The obligation to provide prudent for the customer—typically in cases that involve of a FINRA suitability assessment, particularly recommendations that are appropriate for an recommending the most appropriate share class of regarding mutual fund share classes, proposed Reg investor’s circumstances is a principal component a particular mutual fund.... Indeed, as we Bl expressly establishes the significance of these of the suitability obligations that apply to detailed in our July 2015 comment letter to the factors’’; and ‘‘remov[ing] the ‘control’ element for investment advisers under the [Advisers Act]’’ Department of Labor, most of the cases in which purposes of quantitative suitability, which would (internal citations omitted); FPC Letter (stating that FINRA and the Commission have asserted an make this obligation more enforceable.’’) (internal ‘‘the duty of care, as described by both Reg BI and obligation for brokers to act in customers’ best citations omitted). CFP Board Standards, echoes elements found in the interest have involved egregious frauds rather than 573 See infra Section II.C.2.c, Application of the common law ‘prudent person rule’ which can serve questions of whether customers’ best interests were Care Obligation—Reasonably Available Alternatives to measure the reasonableness of a prudent being served.’’). and Otherwise Identical Securities. professional’s actions. . . .’’); see also CFA August 571 See, e.g., CFA August 2018 Letter. 574 Proposing Release at 21609. 2018 Letter; NAIFA Letter.

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‘‘prudence.’’ Accordingly, the Care legal regimes,584 and will aid broker- risks and rewards of the Obligation will require broker-dealers to dealers in achieving compliance with recommendation and have a reasonable ‘‘exercise reasonable diligence, care, and Regulation Best Interest as well as basis to believe that the skill’’ to meet the three components of permit broker-dealers to utilize existing recommendation could be in the best the Care Obligation. We are persuaded compliance and supervisory systems interest of at least some retail customers. by commenters that its inclusion in the that already rely on this language. Although potential costs were not proposed rule text to satisfy the Moreover, we note that certain specifically included in the proposed components of the Care Obligation is commenters’ support for the term rule text as a factor to be considered as superfluous and unnecessarily presents ‘‘prudence’’ was based on our part of a recommendation, the the possibility for confusion and legal interpretation of the Care Obligation in Proposing Release identified potential uncertainty.579 We believe requiring the Proposing Release.585 As noted costs associated with a recommendation broker-dealers ‘‘to exercise reasonable above, the removal of the term as an important factor to understand diligence, care, and skill’’ conveys ‘‘the ‘‘prudence’’ does not change the and consider as part of making a fundamental importance of conducting obligations or our interpretation of the recommendation, and likewise as a key a proper evaluation of any securities Care Obligation, which we believe are factor to consider when evaluating recommendation in accordance with an addressed by the ‘‘diligence, care, and whether or not a broker-dealer had a objective standard of care’’ 580 that was skill’’ language and through Regulation reasonable basis to believe it was acting intended by the inclusion of Best Interest more broadly. In light of in the best interest of the retail customer ‘‘prudence.’’ Removing ‘‘prudence’’ concerns regarding legal uncertainty when making the recommendation.588 does not lessen nor otherwise change associated with the term ‘‘prudence,’’ After careful consideration of the requirements or our expectations and our view that its inclusion or comments, the Commission is adopting, under the Care Obligation, or Regulation removal would not change the for the reasons set forth in the Proposing Best Interest more broadly as it was requirements or expectations of Release, Paragraph (a)(2)(ii)(A) of the duplicative of the phrase ‘‘diligence, Regulation Best Interest, we have Care Obligation substantially as care, and skill.’’ 581 The revised determined to remove it from the rule proposed. However, as discussed above, obligation, in requiring the broker- text. in addition to requiring broker-dealers dealer to ‘‘exercise[ ] reasonable Finally, in response to comments, we to understand the potential risks and diligence, care and skill’’ and to have a are retaining the facts-and- rewards associated with the ‘‘reasonable basis to believe that the circumstances determination for the recommendation, we are also expressly recommendation is in the best interest reasons set forth in the Proposing requiring them to understand and 586 . . . and does not place’’ the interest of Release, and providing additional consider the potential costs associated the broker-dealer ahead of the interest of guidance on the application of the with a recommendation. Elevating costs the retail customer, will continue to components of the Care Obligation with to the rule text is consistent with a require an analysis that is comparable to respect to certain securities and under number of commenters’ the notion of ‘‘prudence’’ as described certain scenarios. As we noted in the recommendations and, importantly, in other regulatory frameworks,582 but Proposing Release, such an approach is stresses that cost will always be a salient does so using the terms ‘‘diligence, skill, consistent with how broker-dealers are factor to be considered when making a and care’’—terminology with which currently regulated with respect to the recommendation.589 Additionally, this broker-dealers are familiar and that is suitability of their recommendations requirement that the broker-dealer well understood under the federal and would allow broker-dealers to understands and considers costs is a 583 utilize and incorporate pre-existing securities laws. As such, we believe distinct enhancement over existing compliance systems. In addition, this that the revised language will minimize reasonable basis suitability obligations, approach is generally consistent with the potential confusion and legal which do not expressly require this the principles-based approach uncertainty created by using a term that consideration.590 Nevertheless, we applicable to the duty of care of is predominantly interpreted in other recognize—and emphasize—that cost is investment advisers.587 one important factor among many 579 See supra footnote 577. b. Understand Potential Risks, Rewards, factors, and thus provide additional 580 Proposing Release at 21609. 581 See, e.g., LPL August 2018 Letter (noting that and Costs Associated With guidance below regarding the the component obligations of Regulation Best Recommendation, and Have a importance of weighing and considering Interest generally rest on ‘‘prudence’’ concepts); Reasonable Basis To Believe That the costs in light of other relevant factors Fein Letter. Recommendation Could Be in the Best and the retail customer’s investment 582 See Fein Letter (stating that the ‘‘duty of Interest of at Least Some Retail care—also called ‘prudence’—requires a fiduciary profile. to act with care, skill and diligence in fulfilling his Customers Paragraph (a)(2)(ii)(A) of Regulation designated functions’’) (citing Restatement 3d of Under the proposed ‘‘reasonable Best Interest is intended to incorporate Agency, § 8.08 Duties of Care, Competence, and and build upon broker-dealer’s existing Diligence (‘‘[s]ubject to any agreement with the basis’’ component of the Care principal, an agent has a duty to the principal to Obligation, broker-dealers would be ‘‘reasonable-basis suitability’’ act with care, competence, and diligence normally required to understand the potential obligations and would relate to the exercised by agents in similar broker-dealer’s understanding of the circumstances. . . .’’)). The DOL interpreted 584 particular security or investment ‘‘prudence’’ to represent ‘‘an objective standard of See supra footnote 577. care that requires investment advice fiduciaries to 585 See, e.g., NAIFA Letter. strategy recommended, rather than to investigate and evaluate investments, make 586 Proposing Release at 21587 (‘‘[W]e any particular retail customer. Without recommendations, and exercise sound judgment in preliminarily believe that whether a broker-dealer establishing such a threshold the same way that knowledgeable and impartial acted in the best interest of the retail customer understanding of its particular professionals would.’’ BIC Exemption Release, 81 when making a recommendation will turn on the FR 21208 at 21028–21029. facts and circumstances of the particular 588 583 See, e.g., Proposing Release at 21595, 21609– recommendation and the particular retail customer, See Proposing Release at 21609–21612. See 21613. The discussion that follows addresses what along with the facts and circumstances of how the also supra footnote 572. it means to ‘‘exercise reasonable diligence, care, and four specific components of Regulation Best Interest 589 See, e.g., AFL–CIO April 2019 Letter; NASAA skill’’ in the context of each aspect of the Care are satisfied.’’). August 2018 Letter; U. of Miami Letter. Obligation. 587 See Fiduciary Interpretation. 590 See supra footnote 572.

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recommended security or investment to develop a sufficient understanding of costs of any security or investment strategy involving securities, we do not the security or investment strategy and strategy—a broker-dealer could not believe that a broker-dealer could, as to be able to reasonably believe that it establish a reasonable basis to required by Regulation Best Interest, could be in the best interest of at least recommend these products to retail have a reasonable basis to believe that some retail customers. customers.597 Further, these products it is acting in the best interest of a retail This ‘‘reasonable-basis’’ component of may not be in the best interest of a retail customer when making a the Care Obligation is especially customer absent an identified, short- recommendation.591 important when broker-dealers term, customer-specific trading In order to meet the requirement recommend securities and investment objective. Similarly, when a broker- under Paragraph (a)(2)(ii)(A), a broker- strategies that are complex or risky.593 dealer recommends a potentially high dealer would need to undertake For example, in recent years, the risk product to a retail customer—such reasonable diligence, care, and skill to Commission staff and FINRA have as penny stocks or other thinly-traded understand the nature of the addressed broker-dealer sales practice securities—the broker-dealer should recommended security or investment obligations under existing law relating generally apply heightened scrutiny to strategy involving a security or to complex products, such as inverse or whether such investments are in a retail securities, as well as the potential risks, leveraged exchange-traded products.594 customer’s best interest.598 rewards—and now costs—of the These products, which may be useful Finally, several commenters recommended security or investment for some sophisticated trading expressed concern about the strategy, and have a reasonable basis to strategies, are highly complex financial applicability of Regulation Best Interest believe that the recommendation could instruments and are typically designed to variable annuities and variable life be in the best interest of at least some to achieve their stated objectives on a insurance products.599 Variable retail customers based on that daily basis.595 However, because of the annuities and variable life insurance understanding. A broker-dealer must effects of compounding, the products have generated special adhere to both components of Paragraph performance of these products over attention from regulators and their staff, (a)(2)(ii)(A). For example, a broker- longer periods of time can differ such as statements regarding sales dealer could violate the obligation by significantly from their stated daily practice obligations and specific FINRA not understanding the potential risks, objectives. Thus, broker-dealers rules relating to the recommendation of rewards, or costs of the recommended recommending such products should variable annuities.600 These variable security or investment strategy, even if understand that inverse and leveraged insurance products are often unique and the security or investment strategy exchange-traded products that are reset have different features depending on the could have been in the best interest of daily may not be suitable for, and as a company providing the product, as well at least some retail customers. consequence also not in the best interest as depending on the chosen investment Conversely, even if a broker-dealer of, retail customers who plan to hold options, benefits, fees and expenses, understands the recommended security them for longer than one trading liquidity restrictions, and other or investment strategy, the broker-dealer session, particularly in volatile considerations.601 Consistent with must still have a reasonable basis to markets.596 Without understanding the believe that the security or investment terms, features, and risks of inverse and 597 See id. strategy could be in the best interest of leveraged exchange-traded products—as 598 See, e.g., FINRA Regulatory Notice 17–32, at least some retail customers. Volatility-Linked Exchange Traded Products— with the potential risks, rewards, and FINRA Reminds Firms of Sales Practice Obligations What would constitute reasonable for Volatility-Linked Exchange-Traded Products diligence, care, and skill under 593 See FINRA Rule 2111 (Suitability) FAQ at (Oct. 2017) (explaining that ‘‘The level of Paragraph (a)(2)(ii)(A) will vary Q5.1 (‘‘The reasonable-basis obligation is critically reasonable diligence that is required will rise with depending on, among other things, the important because, in recent years, securities and the complexity and risks associated with the investment strategies that brokers recommend to security or strategy. With regard to a complex complexity of and risks associated with customers, including retail investors, have become product such as a volatility-linked ETP, an the recommended security or increasingly complex and, in some cases, risky.). associated person should be capable of explaining, investment strategy and the broker- See also SEC v. Hallas, No. 17–cv–02999 (S.D.N.Y. at a minimum, the product’s main features and dealer’s familiarity with the filed Apr. 25, 2017). associated risks.’’); FINRA Regulatory Notice 12–03, recommended security or investment 594 See FINRA Regulatory Notice 09–31, Non- Complex Products—Heightened Supervision of Traditional ETFs—FINRA Reminds Firms of Sales Complex Products (Jan. 2012) (stating that 592 strategy. While every inquiry will be Practice Obligations Relating to Leveraged and ‘‘Reasonable diligence must provide the firm or specific to the particular broker-dealer Inverse Exchange-Traded Funds (June 2009); SEC registered representative ‘with an understanding of and the recommended security or staff and FINRA, Investor Alert, Leveraged and the potential risks and rewards associated with the investment strategy, broker-dealers Inverse ETFs: Specialized Products with Extra Risks recommended security or strategy.’ This for Buy-and-Hold Investors (Aug. 1, 2009); SEC understanding should be informed by an analysis generally should consider important Office of Investor Education and Advocacy, Investor of likely product performance in a wide range of factors such as the security’s or Bulletin: Exchange-Traded Funds (ETFs) (Aug. normal and extreme market actions. The lack of investment strategy’s investment 2012). such an understanding when making the objectives, characteristics (including 595 See id. See also Exchange-Traded Funds, recommendation could violate the suitability rule.’’) Securities Act Release No. 10515 (Jun. 28, 2018); (internal citations omitted). any special or unusual features), Use of Derivatives by Registered Investment 599 See related discussion in Section II.C.2.c, liquidity, volatility, and likely Companies and Business Development Companies, Retail Customer Investment Profile. performance in a variety of market and Investment Company Act Release No. 31933 (Dec. 600 See, e.g., FINRA Rule 2330, Members economic conditions; the expected 11, 2015) [80 FR 80883 (Dec. 28, 2015)] Responsibilities Regarding Deferred Variable (‘‘Derivatives Proposing Release’’); Direxion Letter Annuities; FINRA Rule 2320, Variable Contracts of return of the security or investment (recognizing that leveraged ETFs are not Insurance Companies; FINRA Regulatory Notice strategy; as well as any financial appropriate for all customers, and thus the 10–05, Deferred Variable Annuities—FINRA incentives to recommend the security or importance for broker-dealers to perform sufficient Reminds Firms of Their Responsibilities Under investment strategy. Together, this diligence to adequately ‘‘understand the terms and FINRA Rule 2330 for Recommended Purchases or features of such funds, including how they are Exchange of Deferred Variable Annuities (Jan. inquiry should allow the broker-dealer designed to perform, how they achieve that 2010); SEC Updated Investor Bulletin: Variable objective, and the impact that market volatility, the Annuities (Oct. 30, 2018); SEC Investor Bulletin: 591 See Proposing Release at 21609–21610 (for ETF’s use of leverage, and the customer’s intended Variable Life Insurance (Oct. 30, 2018). further discussion regarding this requirement). holding period will have on their performance’’). 601 See id. See also Updated Disclosure 592 See FINRA Rule 2111.05(a). 596 See supra footnotes 593–595. Requirements and Summary Prospectus for Variable

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existing FINRA rules and existing interest of the particular retail customer requested certain modifications to the suitability obligations under the federal based on its understanding of the definition of ‘‘Retail Customer securities laws and SRO rules, investment or investment strategy under Investment Profile.’’ 605 regulators and their staffs have stated Paragraph (a)(2)(ii)(A), and in light of After careful consideration of these the retail customer’s investment that recommendations of these products comments, for the reasons set forth in would require careful attention and a objectives, financial situation, and the Proposing Release, the Commission specific understanding of certain needs. Accordingly, under proposed is adopting the ‘‘customer specific’’ factors, such as whether the product paragraph (a)(2)(ii)(A), the second sub- provides tax-deferred growth, or a death component of the Care Obligation component of the Care Obligation or living benefit, before a broker-dealer would require a broker-dealer to substantially as set forth in the could establish an understanding of the ‘‘exercise reasonable diligence, care, Proposing Release. However, as product, and apply that understanding skill, and prudence to . . . have a included under the reasonable basis to a retail customer’s investment profile reasonable basis to believe that the component of the Care Obligation and in making a recommendation. recommendation is in the best interest for the reasons discussed above, the While we stress the importance of of a particular retail customer based on Commission is expressly incorporating understanding the potential risks, that retail customer’s investment profile ‘‘costs’’ into the rule text to emphasize rewards, and costs associated with a and the potential risks and rewards that broker-dealers must consider the recommended security or investment associated with the recommendation.’’ potential costs associated with a strategy, as well as other factors In the Proposing Release, the recommendation to a particular retail depending on the facts and Commission further articulated that customer. under this standard, a broker-dealer circumstances of each recommendation, As noted above, the Commission is we do not intend to limit or foreclose could not have a reasonable basis to believe that the recommendation is in also incorporating into the rule text that broker-dealers from recommending broker-dealers must have a reasonable complex or more costly products or the ‘‘best interest’’ of the retail basis to believe that the investment strategies where the broker- customer, if the broker-dealer put its recommendation ‘‘does not place the dealer has a reasonable basis to believe interest ahead of the retail customer’s financial or other interest of the broker- that a recommendation could be in the interest. This was intended to incorporate a broker-dealer’s existing dealer ahead of the interest of the retail best interest of at least some retail 606 customers and the broker-dealer has well-established obligations under customer.’’ This addition is intended developed a proper understanding of ‘‘customer-specific suitability,’’ but also to make clear that while a broker-dealer the recommended product or to enhance these obligations by typically will have some interest in a investment strategy. As discussed requiring that the broker-dealer have a recommendation, the broker-dealer below, once a broker-dealer develops an reasonable basis to believe that the cannot put that interest ahead of the appropriate understanding of a recommendation is in the ‘‘best retail customer’s interest when making securities product or investment interest’’ of (rather than ‘‘suitable for’’) the recommendation. strategy, including its potential costs, the retail customer. Commenters largely supported the To address feedback from and believes it could be in the best commenters, the Commission is also interest of at least some retail customers, Commission’s proposed approach, but several commenters requested clarifying providing further interpretations and the broker-dealer will then need to guidance regarding the importance of guidance regarding the application of apply that understanding to reasonably costs and other specific factors in a the Care Obligation, and in particular, determine that the recommended ‘‘best interest’’ evaluation, as well as what it means to make a product or investment strategy is in the more broadly how ‘‘best interest’’ was to recommendation in a retail customer’s particular retail customer’s best interest be determined.602 For example, several best interest and not place the broker- at the time of the recommendation. commenters requested additional dealer’s interest ahead of the retail c. Have a Reasonable Basis To Believe guidance on the role of costs and other customer’s interest. Specifically, the Recommendation Is in the Best ‘‘relevant factors,’’ including subjective recognizing that a facts and Interest of a Particular Retail Customer and qualitative factors such as circumstances evaluation of a Based on That Retail Customer’s shareholder support services, recommendation makes it difficult to Investment Profile and the Potential redemption procedures, or draw bright lines around whether a Risks, Rewards, and Costs Associated qualifications of the investment particular recommendation would meet With the Recommendation and Does adviser.603 Similarly, several the Care Obligation, the Commission is Not Place the Interest of the Broker- commenters asked for clarification that providing further interpretations and Dealer Ahead of the Interest of the Retail ‘‘best interest’’ does not necessarily guidance on how a broker-dealer could Customer mean the lowest cost option or require have a ‘‘reasonable basis to believe’’ that the broker-dealer to look at every single In the Proposing Release, we stated a recommendation is in the best interest possible security.604 Commenters also that beyond establishing an of its retail customer and does not place requested further direction regarding understanding of the recommended the broker-dealer’s interest ahead of the guidance in the Proposing Release securities transaction or investment related to the consideration of retail customer’s interest, as well as strategy, in order to act in the best ‘‘reasonably available alternatives’’ and circumstances when we believe that a interest of the retail customer, a broker- ‘‘otherwise identical securities,’’ and broker-dealer could not have such a dealer would be required to have a reasonable belief. reasonable basis to believe that a 602 See, e.g., Wells Fargo Letter; Primerica Letter; specific recommendation is in the best Great-West Letter; NASAA August 2018 Letter; 605 See, e.g., Committee of Annuity Insurers Cambridge Letter; BlackRock Letter. Letter; Guardian August 2018 Letter; IPA Letter; Annuity and Variable Life Insurance Contracts, 603 See Chapman Letter; BlackRock Letter; Morgan Stanley Letter; Invesco Letter; CFA August Investment Advisers Act Release No. 10569 (Oct. Vanguard Letter; ICI Letter; Morgan Stanley Letter. 2018 Letter. 30, 2018) [83 FR 61730 (Nov. 30, 2018)] (‘‘VA 604 See Great-West Letter; SIFMA August 2018 606 See related discussion in Section II.A.2; see Summary Prospectus Proposal’’). Letter. also Fiduciary Interpretation.

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Factors To Consider Regarding a variable annuity to a particular retail as well as the specific security or Recommendation to a Particular Retail customer, broker-dealers should investment strategy. Customer and Relevance of Cost generally develop a reasonable basis to While the Care Obligation does not Consistent with paragraph (a)(2)(ii)(A) believe that the retail customer will require broker-dealers to document the of the Care Obligation, we are benefit from certain features of deferred basis for a recommendation, broker- incorporating ‘‘costs’’ in the rule text of variable annuities, such as tax-deferred dealers may choose to take a risk based paragraph (a)(2)(ii)(B) of Regulation Best growth, annuitization, or a death or approach when deciding whether or not Interest as a relevant factor that, in living benefit.609 to document certain recommendations. addition to risks and rewards, must As stated in the Proposing Release, For example, broker-dealers may wish always be understood and considered the importance of each factor in to document an evaluation of a by the broker-dealer prior to determining the customer-specific recommendation and the basis for the recommending a particular securities component of the Care Obligation will particular recommendation in certain transaction or investment strategy depend on the facts and circumstances contexts, such as the recommendation of a complex product, or where a involving securities to a particular retail of each recommendation. Thus, one or recommendation may seem inconsistent customer. As discussed above, under more factors may have more or less with a retail customer’s investment paragraph (a)(2)(ii)(A) of the Care relevance—or may not be obtained or objectives on its face.610 Similarly, Obligation, a broker-dealer will be analyzed at all—if the broker-dealer has broker-dealers may consider using required to exercise reasonable a reasonable basis for determining that existing compliance measures, such as diligence, care, and skill to understand the factors are not relevant. Regardless generating and reviewing exception the potential risks, rewards, and costs of of which factors are evaluated—and reports that identify transactions that a recommended security or investment equally important, which factors are not fall outside of firm-specified parameters strategy and have a reasonable basis to evaluated—a broker-dealer must have a to help evaluate and review for believe that it could be in the best reasonable basis to believe that the compliance with the Care Obligation. interest of at least some retail particular recommendation is in the best customers.607 Paragraph (a)(2)(ii)(B) of These measures are not meant to be interest of the particular retail customer exhaustive, but rather are examples of the Care Obligation builds on this and does not place the broker-dealer’s obligation and will require a broker- the sorts of compliance tools and interest ahead of the retail customer’s methods broker-dealers should dealer to have a reasonable basis to interest, consistent with the believe, based on its understanding of generally consider using in evaluating interpretations and guidance provided. whether recommendations are the potential risks, rewards, and costs of For example, recommendations of the the recommendation, and in light of the consistent with a retail customer’s best ‘‘lowest cost’’ security or investment interests. retail customer’s investment profile, that strategy, without consideration of other the recommendation is in the best factors, could violate Regulation Best Retail Customer Investment Profile interest of a particular retail customer Interest. In the same vein, it is important The Proposing Release would have and does not place the broker-dealer’s to consider that a recommendation may required a ‘‘Retail Customer Investment interest ahead of the retail customer’s be considered to be in a retail Profile’’ to include, but not be limited interest. Accordingly, when making a customer’s best interest when viewed in to, ‘‘the retail customer’s age, other recommendation to a particular retail the context of the retail customer’s investments, financial situation and customer, broker-dealers must weigh the portfolio even if seemingly not in a needs, tax status, investment objectives, potential risks, rewards, and costs of a retail customer’s best interest when investment experience, investment time particular security or investment viewed in isolation (e.g., inclusion of horizon, liquidity needs, risk tolerance, strategy, in light of the particular retail what otherwise might be seen as a risky and any other information the retail customer’s investment profile. As investment in the portfolio of a risk- 608 customer may disclose to the broker, discussed above, a broker-dealer’s adverse customer, such as including dealer, or a natural person who is an diligence, care, and skill to understand hedging instruments in a conservative associated person of a broker or dealer the potential risks, rewards, and costs of portfolio). in connection with a a security or investment strategy should The customer-specific component of recommendation.’’ 611 The Proposing generally involve a consideration of Release also explained that broker- factors, depending on the facts and the Care Obligation will rest on whether a broker-dealer had a reasonable basis to dealers would be required to exercise circumstances of the particular ‘‘reasonable diligence’’ to ascertain the recommendation and the particular believe that the recommendation was in retail customer’s investment profile, as the best interest of the particular retail customer at the time of the 610 See FINRA Regulatory Notice 11–25 at FAQ 2 discussed below. (explaining that FINRA Rule 2111 (Suitability) While the factors noted above are recommendation, based on that retail permits firms to take a risk-based approach with examples of important factors to customer’s investment profile and the respect to documenting suitability determinations). consider based on the particular potential risks, rewards, and costs Regulation Best Interest similarly does not require associated with the recommendation, documentation; however, as noted above, we security or investment strategy, this list encourage broker-dealers to take a risk-based is not exhaustive and additional factors, and did not place the financial or other approach when deciding whether or not to including those raised by commenters, interest of the broker, dealer, or such document certain recommendations. could be relevant depending on the natural person ahead of the interest of 611 Proposing Release at 21611 (noting the the retail customer. Thus, as discussed proposed definition of Retail Customer Investment particular security or investment Profile was consistent with FINRA Rule 2111(a) strategy being recommended and further below, the importance of each (Suitability), which provides that ‘‘A customer’s depending on the particular retail factor, and which factors to consider, investment profile includes, but is not limited to, customer’s investment profile. For will depend on the facts and the customer’s age, other investments, financial circumstances of each recommendation, situation and needs, tax status, investment example, prior to recommending a objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any 607 See Proposing Release at 21610–21611. 609 Cf. also FINRA Rule 2330, Members’ other information the customer may disclose to the 608 See related discussion in Section II.C.2.a and Responsibilities Regarding Deferred Variable member or associated person in connection with Section II.C.2.b. Annuities. See Transamerica November 2018 Letter. such recommendation’’).

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retail customer’s investment profile as broker-dealers the flexibility to consider changed.618 The reasonableness of a part of satisfying proposed paragraph additional factors as deemed broker-dealer’s efforts to collect (a)(2)(i)(B), and that when retail necessary.615 Although many of the information regarding a customer’s customer information is unavailable additional factors cited by commenters investment profile information depends despite a broker-dealer’s reasonable may be relevant to securities or on the facts and circumstances of a diligence to obtain such information, a investment strategy recommendations given situation, and the importance of broker-dealer should consider whether under certain facts and circumstances, each factor may vary depending on the it has sufficient understanding of the we are not persuaded that we should facts and circumstances of the particular retail customer to properly evaluate add any specific factor or factors to the case.619 Under Regulation Best Interest, whether the recommendation is in the existing list of profile factors, as with the approach under FINRA’s 612 retail customer’s best interest. particularly given that the list of factors suitability rule, broker-dealers may Furthermore, under the proposed rule, a is non-exhaustive and broker-dealers generally rely on a retail customer’s broker-dealer would not meet its Care can consider additional factors as responses absent ‘‘red flags’’ indicating Obligation if it made a recommendation appropriate under the unique facts and that the information is inaccurate.620 to a retail customer for whom it lacks circumstances of each recommendation. sufficient information to have a Thus, for example, where a broker- Moreover, as noted in the Proposing reasonable basis to believe that the dealer making a variable annuity Release, one or more factors may have recommendation is in the best interest recommendation believes that longevity more or less relevance, or may not be of that retail customer based on such risk is an important factor for a obtained or analyzed at all if the broker- customer’s investment profile. particular retail customer and that such dealer has a reasonable basis for In response to this definition and the factor is necessary to develop a determining that the factor is irrelevant related discussion, commenters reasonable basis to believe that the to that particular best interest identified several additional factors that product is in the best interest of that determination. However, consistent they believed should be included or retail customer, that broker-dealer with existing obligations, where a discussed as part of a retail customer’s should consider and utilize that broker-dealer determines not to obtain investment profile. For example, several factor.616 We believe that this approach or analyze one or more of the factors commenters suggested adding appropriately provides broker-dealers specifically identified in the definition ‘‘longevity risk,’’ ‘‘retirement income with a well-understood starting of ‘‘Retail Customer Investment Profile,’’ needs,’’ or ‘‘lifetime income needs’’ as framework, but also gives broker-dealers the broker-dealer should document its factors that should be included as part the ability to consider additional factors determination that the factor(s) are not of an investor’s investment profile.613 based on the unique nature of its relevant components of a retail Other commenters suggested additional particular securities products, customer’s investment profile in light of factors, such as, for trust accounts, investment strategies, and retail the facts and circumstances of the considering the profile of trust customers. particular recommendation.621 beneficiaries and not the trustee, or Broker-dealers must obtain and adding a retail customer’s ‘‘income analyze enough customer information to Regulation Best Interest, as noted profile.’’ 614 have a reasonable basis to believe that above, does not require documentation While we agree that many of these the recommendation is in the best of the basis for believing a particular factors will likely be relevant to a interest of the particular retail customer. recommendation was in a particular broker-dealer’s recommendation of The significance of specific types of retail customer’s best interest.622 various securities or investment customer information generally will Nevertheless, broker-dealers may wish strategies involving securities, we are depend on the facts and circumstances to consider documenting the basis for adopting the definition of ‘‘retail of the particular case, including the determining that the recommendation is customer investment profile’’ as nature and characteristics of the product in the best interest of the retail customer proposed. We believe that the list of or strategy at issue. Where retail when it is not evident from the factors under ‘‘retail customer customer information is unavailable recommendation itself.623 investment profile’’ is widely despite a broker-dealer’s reasonable Documentation by itself will not cure a understood and importantly, offers diligence, the broker-dealer should recommendation in circumstances in carefully consider whether it has a which a broker-dealer could not have 612 Id. This is similar to the approach articulated sufficient understanding of the retail reasonably believed the below, as well as in FINRA Regulatory Notice 12– customer to properly evaluate whether recommendation was in the best interest 25, which outlines what constitutes ‘‘reasonable the recommendation is in the best of the retail customer at the time the diligence’’ under FINRA’s suitability rule in 617 attempting to obtain customer-specific information interest of that retail customer. In recommendation was made.624 and that the reasonableness of the effort also will addition, a broker-dealer generally depend on the facts and circumstances. See FINRA should make a reasonable effort to 618 See id.; see also Proposing Release at 21611– Regulatory Notice 12–25 at Q16. Moreover, under ascertain information regarding an 21612. Regulation Best Interest, as with the approach existing customer’s investment profile 619 under FINRA’s suitability rule, broker-dealers may See id.; see also FINRA Regulatory Notice 12– generally rely on a retail customer’s responses prior to the making of a 25 at Q16. absent ‘‘red flags’’ indicating that the information is recommendation on an ‘‘as needed’’ 620 See supra footnote 612. inaccurate. Id. basis—that is, where a broker-dealer 621 FINRA Rule 2111.04. 613 See, e.g., IRI Letter, The Committee of Annuity knows or has reason to believe that the 622 As discussed in Section II.C.1, we believe that Insurers Letter, CCMC Letters, Jackson National the basis for and risks associated with a broker- Letter, Pacific Life August 2018 Letter, Lincoln customer’s investment profile has dealer’s recommendations in standardized terms (as Financial Letter, AXA Letter, Principal Letter; opposed to individualized disclosure of the basis Transamerica November 2018 Letter; Letter from 615 See, e.g., CCMC Letters; Jackson National for each recommendation made) is a material fact Mark F. Halloran, VP Managing Director, Business Letter; Pacific Life August 2018 Letter; Committee relating to the scope and terms of the relationship Development, Transamerica (Dec. 14, 2018) of Annuity Insurers Letter; AXA Letter. that is required to be disclosed under the Disclosure (‘‘Transamerica December 2018 Letter’’). 616 See, e.g., AXA Letter; Committee of Annuity Obligation. 614 See, e.g., Jackson National Letter, Lincoln Insurers Letter; Pacific Life August 2018 Letter. 623 See supra footnote 610 and accompanying Financial Letter; Transamerica December 2018 617 See supra footnotes 611–612 and text. Letter. accompanying text. 624 See FINRA Rule 2111 (Suitability) FAQ.

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Application of the Care Obligation— Relatedly, we stated that a broker-dealer means limited to cost.’’ 632 Several other Reasonably Available Alternatives and could not meet the Care Obligation commenters recommended that the Otherwise Identical Securities through disclosure alone.629 Commission confirm that Regulation In the Proposing Release, we provided The Commission received numerous Best Interest will not require broker- guidance on what types of comments relating to the Proposing dealers to offer an unlimited number of 633 recommendations would or would not Release’s discussion of ‘‘reasonably securities or investment strategies. be in the best interest of a particular available alternatives’’ and regarding Commenters also expressed concern retail customer. In particular, the recommendations of ‘‘otherwise over whether the consideration of Proposing Release stated that where a identical securities.’’ 630 For example, ‘‘reasonably available alternatives’’ broker-dealer is choosing among commenters sought clarification would effectively require a broker- identical securities available to the regarding what factors need to be dealer to document the basis of any broker-dealer, it would be inconsistent considered in the evaluation, and also recommendation, as well as concerns with the Care Obligation to recommend how the evaluation could be performed about disclosure’s role in satisfying the 634 the more expensive alternative for the in certain contexts, such as where a Care Obligation. Finally, a majority of customer.625 Similarly, in the Proposing broker-dealer operates with an open the IAC and other commenters sought Release, we noted our belief that it architecture framework, recommends clarification on whether broker-dealers would be inconsistent with the Care only a limited menu of products, or were required to recommend only the 635 Obligation if the broker-dealer made a recommends only proprietary single ‘‘best’’ product. The Care Obligation will require a recommendation to a retail customer in products.631 A majority of the IAC broker-dealer to have a reasonable basis order to: Maximize the broker-dealer’s recommended that Regulation Best to believe, based on its understanding of compensation, further the broker- Interest should be clarified to require the potential risks, rewards, and costs of dealer’s business relationships, satisfy recommendations of ‘‘the investments, the recommended security or firm sales quotas or other targets, or win investment strategies, accounts, or investment strategy involving securities, a firm-sponsored sales contest.626 services, from among those that [the and in light of the retail customer’s We also stated that under the Care broker-dealers, investment advisers, and investment profile, that the Obligation a broker-dealer generally their associated persons] have recommendation is in the best interest should consider reasonable alternatives, reasonably available to recommend, that of a particular retail customer and does if any, offered by the broker-dealer in they reasonably believe represent the not place the broker-dealer’s interest determining whether it has a reasonable best available options for the investor’’ basis for making the ahead of the retail customer’s interest. and that a ‘‘determination regarding the As noted above, determining what is in recommendation.627 The Proposing best reasonably available options should Release explained that this approach a retail customer’s best interest is an be based on a careful review of the objective evaluation turning on the facts would not require a broker-dealer to investor’s needs and goals, as well as analyze all possible securities, all other and circumstances of the particular the full range of the reasonably available recommendation and the particular products, or all investment strategies to products’, strategies’, accounts’, or recommend the single ‘‘best’’ security or retail customer at the time the services’ features, including, but by no 636 investment strategy for the retail recommendation is made. Accordingly, as noted above, a broker- customer, nor necessarily require a dealer’s financial incentives—the recommendation broker-dealer to recommend the least dealer would not satisfy the Care was in the best interest of the retail customer based Obligation by simply recommending the expensive or least remunerative security on the factors noted [therein], in light of the retail or investment strategy. Further, the customer’s investment profile. Nevertheless, this least expensive or least remunerative Proposing Release indicated that under does not mean that a broker-dealer could not recommend the more remunerative of two 632 IAC 2018 Recommendation (emphasis in the Care Obligation, when a broker- reasonably available alternatives, if the broker- original). dealer recommends a more expensive dealer determines the products are otherwise both 633 See LPL August 2018 Letter (recommending security or investment strategy over in the best interest of—and there is no material that the Commission clarify that a financial another reasonably available alternative difference between them from the perspective of— professional can satisfy his or her obligations under the retail customer, in light of the retail customer’s offered by the broker-dealer, the broker Regulation Best Interest, even if he or she limits investment profile.’’ Id. (emphasis in original). recommendations to a smaller number of product dealer would need to have a reasonable 629 Id. at 21612–21613 (further explaining that sponsors because financial professionals basis to believe that the higher cost is ‘‘where a broker-dealer is choosing among identical participating on large platforms may, in practice, be justified (and thus nevertheless is in the securities with different cost structures, we believe discouraged from conducting focused analysis of it would be inconsistent with the best interest product offerings, instead opting for a more cursory retail customer’s best interest) based on obligation for the broker-dealer to recommend the review of a few high-level cost, risk, and other factors (e.g., the product’s or more expensive alternative for the customer, even performance metrics across all available products). strategy’s investment objectives, if the broker-dealer had disclosed that the product See also Fidelity Letter; Cetera August 2018 Letter; characteristics (including any special or was higher cost and had policies and procedures SIFMA August 2018 Letter; Guardian August 2018 unusual features), liquidity, risks and reasonably designed to mitigate the conflict under Letter; Prudential Letter. the Conflict of Interest Obligation, as the broker- 634 See, e.g., Fidelity Letter; Wells Fargo Letter. potential benefits, volatility and likely dealer would not have complied with the Care 635 See 2018 IAC Recommendation (‘‘The performance in a variety of market and Obligation. Such a recommendation, disclosure Commission should recognize that there will often economic conditions), in light of the aside, would still need to be in the best interest of not be a single best option and that more than one retail customer’s investment profile.628 a retail customer, and we do not believe it would of the available options may satisfy this standard,’’ be in the best interest of a retail customer to and that ‘‘compliance should be measured based on recommend a higher-cost product if all other factors whether the broker or adviser had a reasonable 625 Proposing Release at 21612. are equal.’’) (internal citations omitted). basis for the recommendation at the time it was 626 Id. 630 See, e.g., Fidelity Letter; Vanguard Letter; MMI made, and not on how the recommendation 627 Proposing Release at 21608–21610. Letter; BlackRock Letter. ultimately performed for the investor. . . .’’); see 628 Proposing Release at 21612 (emphasis in 631 See, e.g., CFA August 2018 Letter; Wells Fargo also SIFMA August 2018 Letter. original). We similarly noted that ‘‘when a broker- Letter; Fidelity Letter; Morgan Stanley Letter. See 636 As noted and further reiterated below, a dealer recommends a more remunerative security or also LPL August 2018 Letter (suggesting that its broker-dealer will not be required to recommend investment strategy over another reasonably representatives could not conduct a meaningful the single ‘‘best’’ of all possible alternatives that available alternative offered by the broker-dealer, comparison across ‘‘all similar available securities’’ might exist, in part because many different options the broker-dealer would need to have a reasonable and that, such recommendations would be subject may in fact be in the retail customer’s best interest. basis to believe that—putting aside the broker- to legal challenges in hindsight). See infra footnote 640 and accompanying text.

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security without any further analysis of In terms of conducting such an requirement might not allow an these other factors and the retail evaluation, a broker-dealer does not associated person of a broker-dealer to customer’s investment profile. A broker- have to conduct an evaluation of every develop a proper understanding of every dealer could recommend a more possible alternative, either offered security or investment strategy’s expensive security or investment outside of the firm (such as where the potential risks, rewards, or costs, and strategy if there are other factors about firm offers only proprietary or other thus it might not be possible to fulfill the product that reasonably allow the limited range of products) or available the obligation set forth in paragraph broker-dealer to believe it is in the best on the firm’s platform. We appreciate (a)(2)(ii)(A). Furthermore, such a interest of the retail customer, based on commenter concerns about the requirement could encourage broker- that retail customer’s investment profile. impracticality and potential dealers to limit their product menus or Similarly, a broker-dealer could impossibility of such a comparative otherwise restrict access to products and recommend a more remunerative evaluation, particularly where the firm services currently available to retail security or investment strategy if the offers numerous different products, customers, which is contrary to the broker-dealer has a reasonable basis to many of which may have similar purpose and goals of Regulation Best believe that there are other factors about strategies but with other varying Interest.643 the security or investment strategy that characteristics, including cost As discussed above, the make it in the best interest of the retail structures, that may apply differently determination of whether a customer, in light of the retail based on the particular retail recommendation is in the ‘‘best customer’s investment profile. customer.639 We also recognize that interest’’ of the retail customer and does We also continue to have the view different products are rarely perfectly not place the interests of the broker- that, as part of determining whether a equal, and that differences will be both dealer ahead of the retail customer’s broker-dealer has a reasonable basis to quantitative and qualitative in nature. A interest must be based on information believe that a recommendation is in the broker-dealer will not be required to reasonably known to the associated best interest of the retail customer, a recommend the single ‘‘best’’ of all person (based on her reasonable broker-dealer generally should consider possible alternatives that might exist, in diligence, care, and skill) at the time the reasonably available alternatives offered part because many different options recommendation is made. Accordingly, by the broker-dealer. It is our view that may in fact be in the retail customer’s in fulfilling the Care Obligation, the such a consideration is an inherent best interest.640 We are sensitive to associated person should exercise aspect of making a ‘‘best interest’’ commenters’ concern that this reasonable diligence, care, and skill to recommendation, and is a key determination, to the extent it can be consider reasonably available enhancement over existing broker- made at all, may be judged in hindsight alternatives offered by the broker-dealer. dealer suitability obligations, which do even though Regulation Best Interest This exercise would require the not necessarily require a comparative applies at the time of the associated person to conduct a review of assessment among such alternatives.637 recommendation.641 such reasonably available alternatives Similarly, this concept has been applied In particular, we are not requiring a that is reasonable under the in the context of guidance regarding natural person who is an associated circumstances. Consistent with the suitability and heightened supervision person of the broker-dealer to be Compliance Obligation discussed of complex products, stating that when familiar with every product on a broker- below, a broker-dealer should have a broker-dealers are recommending dealer’s platform, particularly where a reasonable process for establishing and complex or costly products, they should broker-dealer operates in an open understanding the scope of such first consider whether less complex or architecture framework or otherwise ‘‘reasonably available alternatives’’ that costly products could achieve the same operates a platform with a large number would be considered by particular objectives for their retail customers.638 of products or options.642 Such a associated persons or groups of associated persons (e.g., groups that 637 While enforcement actions and related 639 See, e.g., Morgan Stanley Letter (‘‘Large firms specialize in particular product lines) in guidance may be construed as interpreting the with an open architecture like Morgan Stanley offer fulfilling the reasonable diligence, care, suitability obligation to include a consideration of an enormous range of products to their clients. To available alternatives, it is generally limited to take but one example, Morgan Stanley offers and skill requirements under the Care certain circumstances, such as recommendations of approximately 300 large capitalization equity Obligation. mutual funds with different share classes or mutual funds to its retail customers.’’); see also What will be a reasonable recommendations of complex or costly products. Morningstar Letter; Primerica Letter; ICI Letter; determination of the scope of See In re Application of Raghavan Sathianathan, Chapman Letter (stating that ‘‘identical’’ is too alternatives considered will depend on Exchange Act Release No. 54722 at 21 (Nov. 8, stringent because they believe all securities have 2006); In the Matter of Wendell D. Belden, 56 S.E.C. distinctions). the facts and circumstances, at the time 496 (2003); FINRA Regulatory Notice 12–03. See 640 Commenters suggesting different approaches of the recommendation, including both also FINRA 2018 Letter; MSRB Rule G–42 acknowledged this concern. See, e.g., IAC 2018 the nature of the retail customer and the (requiring a municipal advisor to inform its Recommendation (‘‘[T]he Commission should retail customer’s investment profile, and municipal entity or obligated person client whether recognize there will often not be a single best option it has investigated or considered other reasonably and that more than one of the available options may the particular associated persons or feasible alternatives to the recommended municipal satisfy this standard.’’). groups of associated persons that are securities transaction). 641 See LPL August 2018 Letter. providing the recommendations. With Thus, although certain enforcement actions and 642 Conversely, where a broker-dealer only has a respect to broker-dealers that materially guidance contemplate a consideration of available few products, an associated person of the broker- limit the range of products or services alternatives under certain situations, it is not a dealer may be expected to understand and consider general expectation. Nevertheless, such statements all of these options when recommending a security that they recommend to retail customers serve as an example and evidence that the concept or investment strategy. We recognize that this facts- (e.g., limits its product offerings to only is not unfamiliar to broker-dealers. and-circumstances approach does not provide a proprietary or other limited menus of 638 See FINRA Regulatory Notice 12–03 (‘‘For clear bright-line rule; however, we are providing products), the Conflict of Interest example, registered representatives should compare further guidance below on a broker-dealer’s process a structured product with embedded options to the for evaluating reasonably available alternatives and same strategy through multiple financial the scope herein. Furthermore, nothing in this excuse for not developing a proper understanding instruments on the open market, even with any discussion excuses a broker-dealer from satisfying of a recommended security or investment strategy’s possible advantages of purchasing a single the Care Obligation. An associated person of the potential risks, rewards, or costs. product.’’). See also supra footnote 635. broker-dealer cannot use a large platform as an 643 See LPL August 2018 Letter.

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Obligation provision requires broker- Importantly, where all reasonably the broker-dealer had a reasonable basis dealers to have reasonably designed available alternatives considered would to believe that the recommendation is in policies and procedures to identify and be inconsistent with a retail customer’s best interest of the retail customer. disclose the material limitations and investment profile, a broker-dealer Finally, broker-dealers or their any conflicts of interest associated with would not be able to form a reasonable associated persons are not required to such limitations, and to prevent such belief that the best of these options is in prepare and maintain documentation limitations and associated conflicts of the best interest of that retail customer. regarding the basis for each specific interest from causing the broker-dealer All recommendations to retail recommendation, including an or associated person to make customers of securities or investment evaluation of a recommended securities recommendations that place the interest strategies are required to satisfy the Care transaction or investment strategy of the broker-dealer or associated person Obligation, and broker-dealers cannot against similar available alternatives. In ahead of the interest of the retail use a limited product menu or a process circumstances where the ‘‘match’’ customer.644 Similarly, where a broker- to determine the scope of reasonably between the retail customer profile and dealer offers numerous products on its available alternatives considered to the recommendation appears less platform, a broker-dealer or an justify a recommendation that is not in reasonable on its face (for example, associated person could reasonably the best interest of the retail customer. where a retail customer’s account limit the universe of ‘‘reasonably We recognize that the process by objective is preservation of income and available alternatives’’ if there is a which a broker-dealer and its associated the recommendation involves higher reasonable process or methodology for persons develop and make risk, or where there are more significant limiting the scope of alternatives or the recommendations to retail customers, conflicts of interest present), the more universe considered for a particular including the scope of reasonably important the process will likely be for retail customer, particular category of available alternatives considered, will a broker-dealer to establish that it had retail customers, or the retail customer depend upon a variety factors, including a reasonable belief that the base more generally.645 the nature of the broker-dealer’s recommendation was in the best interest In addition to the particular retail business.646 The disclosure of this of the retail customer and did not place customer’s investment profile, we process pursuant to the Disclosure the broker-dealer’s interest ahead of the believe the scope of reasonably available Obligation will provide critical retail customer. This could include alternatives considered could depend information to retail customers and reasonably designed policies and upon a variety of factors, including but underscores our acknowledgment that procedures to establish compliance with not limited to, the associated person’s we do not expect every broker-dealer or the Care Obligation, as required by the customer base (including the general associated person to follow the same new Compliance Obligation, and could investment objectives and needs of the process. Instead, consistent with the include maintaining supporting customer base), the investments and Compliance Obligation, broker-dealers documentation for certain services available to the associated and their associated persons must have recommendations.647 person to recommend (including a reasonable process for developing and Application of Care Obligation to limitations due to licensing of the making recommendations to retail Account Type Recommendations associated person), and other factors customers in compliance with the Care such as specific limitations on the Obligation, including the consideration As discussed above, Regulation Best available investments and services with of reasonably available alternatives, Interest will apply to recommendations respect to certain retail customers (e.g., which will depend on the facts and by a broker-dealer of a securities product or service income thresholds; circumstances. account type. Thus, the Care Obligation product geographic limitations; or We emphasize that what is in the will require a broker-dealer to have a product limitations based on account ‘‘best interest’’ of a retail customer reasonable basis to believe that a type, such as those only eligible for IRA depends on the facts and circumstances recommendation of a securities account accounts). A reasonable process would of a recommendation at the time it is type (e.g., brokerage or advisory, or not need to consider every alternative made, including matching the among the types of accounts offered by that may exist (either outside the broker- recommended security or investment the firm) is in the retail customer’s best dealer or on the broker-dealer’s strategy to the retail customer’s interest at the time of the platform) or to consider a greater investment profile at the time of the recommendation and does not place the number of alternatives than is necessary recommendation, and the process for financial or other interest of the broker- in order for the associated person to coming to that conclusion. Whether a dealer ahead of the interest of the retail exercise reasonable diligence, care, and broker-dealer has complied with the customer.648 skill in providing a recommendation Care Obligation will be evaluated based We believe broker-dealers would need that complies with the Care Obligation. on the facts and circumstances at the to consider various factors in time of the recommendation (and not in determining whether a particular 644 See Section II.C.3. Broker-dealers would be account is in a particular retail required to disclose the conflict of interest, as well hindsight) and will focus on whether as the material facts associated with such a conflict customer’s best interest. For example, pursuant to the Disclosure Obligation provision as 646 Accordingly, we believe that disclosure of this broker-dealers generally should described in Section II.C.1. process is of fundamental importance to a retail consider: (1) The services and products 645 We note that where a broker-dealer (or an customer’s understanding of what services are being provided in the account (ancillary associated person) limits the securities or provided, and in deciding whether those services investment strategies that are considered as are appropriate to the retail customer’s needs and ‘‘reasonably available alternatives’’ from the goals, and have thus clarified that the basis for a 647 See supra footnote 610 and accompanying universe of securities or investment strategies broker-dealer’s or an associated person’s text. involving securities offered by the broker-dealer, recommendations as a general matter (i.e., what 648 As discussed in Section II.B.2, whether and this limitation may constitute a material limitation might commonly be described as the firm’s or how Regulation Best Interest applies will depend placed on the securities or investment strategies associated person’s investment approach, on whether the financial professional making the involving securities that may be recommended, philosophy or strategy) is a material fact relating to recommendation is dually registered. which the broker-dealer (or an associated person) the scope and terms of the relationship that must In the section that follows we discuss how the would need to disclose and address as provided in be disclosed pursuant to the Disclosure Obligation. Care Obligation will apply to recommendations to the Disclosure and Conflict of Interest Obligations. See Section II.C.1. open an IRA or to roll over assets into an IRA.

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services provided in conjunction with customer plans to engage in at least a in the best interest of the retail customer an account type, account monitoring moderate level of trading and prefers to at the time of the recommendation and services, etc.); (2) the projected cost to pay for advice in connection with such does not place the financial or other the retail customer of the account; (3) trading on the basis of a consistent interest of the broker-dealer ahead of the alternative account types available; (4) recurring monthly or annual charge.652 interest of the retail customer, taking the services requested by the retail Furthermore, where a retail customer into consideration the retail customer’s customer; and (5) the retail customer’s holds a variety of investments, or investment profile and other relevant investment profile. Moreover, retail prefers differing levels of services (e.g., factors, as well as the potential risks, customer-specific factors, such as those both episodic recommendations from a rewards, and costs of the IRA or IRA identified in the definition of ‘‘Retail broker-dealer and continuous advisory rollover compared to the investor’s Customer Investment Profile,’’ may not services including discretionary asset existing 401(k) account or other be applicable or available in every management from an investment circumstances.655 context, and would depend on the facts adviser), it may be in the retail When making a recommendation to and circumstances at the time of customer’s best interest to recommend open an IRA, or to roll over workplace account type recommendation. For both a brokerage and an advisory retirement plan assets into an IRA rather example, one or more factors may have account. than keeping assets in a previous more or less relevance, or information Similarly, where the financial employer’s workplace retirement plan about those factors may not be obtained professional is only registered as an (or rolling over assets to a new or analyzed at all where the broker- associated person of a broker-dealer employer’s workplace retirement plan), dealer has a reasonable basis for (regardless of whether that broker-dealer broker-dealers should consider a variety believing that a particular factor is or is entity is a dual-registrant or affiliated of factors, the importance of which will not relevant.649 In addition, as with an investment adviser), he or she depend on the particular retail discussed above, we recognize that would need to take into consideration customer’s needs and circumstances. In factors other than cost may properly be only the brokerage accounts addition to the Factors to Consider considered when determining whether available.653 However, even if a broker- Regarding a Recommendation to a an account is in a retail customer’s best dealer only offered brokerage accounts, Particular Retail Customer discussed interest.650 the associated person would above, as well as the Retail Customer’s Where the financial professional nevertheless need to have a reasonable Investment Profile, broker-dealers making the recommendation is dually basis to believe that the recommended should consider a variety of additional registered (i.e., an associated person of account was in the best interest of the factors specifically salient to IRAs and a broker-dealer and a supervised person retail customer. For example, if the workplace retirement plans, in order to of an investment adviser (regardless of retail customer were seeking a compare the retail customer’s existing whether the professional works for a relationship where the financial account to the IRA offered by the dual-registrant, affiliated firms, or professional would have unlimited broker-dealer. These factors should unaffiliated firms)) the financial investment discretion (i.e., having generally include, among other relevant professional would need to make this responsibility for a customer’s trading factors: Fees and expenses; level of evaluation taking into consideration the decisions),654 the associated person service available; available investment spectrum of accounts offered by the would not have a reasonable basis to options; ability to take penalty-free financial professional (i.e., both believe that a brokerage account was in withdrawals; application of required brokerage and advisory taking into the best interest of the retail customer. minimum distributions; protection from account any eligibility requirements Thus, as with limited product menus, a creditors and legal judgments; holdings such as account minimums), and not limited selection of account types of employer stock; and any special just brokerage accounts. For example, would not excuse a broker-dealer from features of the existing account.656 With all other things being equal, it may be making a recommendation not in the respect to available investment options, in the retail customer’s best interest to best interest of the retail customer. we caution broker-dealers not to rely on, recommend a brokerage account to the Application of Care Obligation to IRA for example, an IRA having ‘‘more retail customer who intends to buy and Rollovers and Related investment options’’ as the basis for hold a long-term investment (e.g., Recommendations recommending a rollover. Rather, as maintain an account primarily Regulation Best Interest also applies with other factors, broker-dealers should composed of bonds or mutual funds and consider available investment options in has a stated buy-and-hold strategy), as to recommendations to open an IRA or to roll over assets into an IRA. Thus, the an IRA, among other relevant factors, in opposed to an advisory account (i.e., it light of the retail customer’s current may not be in the retail customer’s best Care Obligation will require a broker- dealer to have a reasonable basis to situation and needs in order to develop interest in this context to pay an a reasonable basis to believe that the ongoing fee for a security that he or she believe that the IRA or IRA rollover is 651 rollover is in the retail customer’s best plans to hold to maturity). On the interest. other hand, it may not be in the retail 652 See id. We reiterate that this is a facts and circumstances determination, and that these While these examples may be relevant customer’s best interest to recommend a examples are not meant to provide a bright line to an analysis of available options, this brokerage account where the retail rule, but rather to illustrate certain considerations list is not meant to be exhaustive. that a broker-dealer could consider when Furthermore, each factor generally 649 As discussed above, where a broker-dealer determining whether a recommended account type determines not to obtain or analyze one or more of is in the best interest of the retail customer. should be analyzed with respect to a the factors specifically identified in the definition 653 For example, if the natural person that is an particular retail customer in order for a of ‘‘Retail Customer Investment Profile,’’ the broker- associated person of the broker-dealer is not broker-dealer to form a reasonable belief dealer generally should document its determination registered as an investment adviser representative, that the factor(s) are not relevant components of a but is associated with a broker-dealer that is a dual- that the recommendation is in the best retail customer’s investment profile in light of the registrant, that associated person would only need facts and circumstances of the particular to consider the brokerage accounts offered by the 655 See infra Section II.C.2; see also FINRA recommendation. firm, and not the firm’s advisory accounts in Regulatory Notice 13–45 (outlining several 650 See id. making the recommendation. considerations regarding IRA rollovers). 651 See id. 654 See Solely Incidental Interpretation. 656 See id.

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interest of that retail customer and does over which the member firm has recommended transactions is in the best not place the financial or other interest ‘‘control,’’ and that if the Commission interest of the retail customer. We of the broker-dealer ahead of the interest does not include the control element of further note that Regulation Best Interest of the retail customer. Finally, as FINRA Rule 2111 as part of the Care does not require a broker-dealer to described above, certain factors may Obligation, that the Commission refuse to accept a customer’s order that have more or less relevance, or not be ‘‘should at a minimum confirm that this is contrary to the broker-dealer’s relevant at all, depending on the requirement applies only to recommendation. Nor does Regulation particular facts and circumstances of recommendations by a single associated Best Interest apply to self-directed or each recommendation. person, not across multiple associated otherwise unsolicited transactions by a persons at the firm who act retail customer, whether or not he or she d. Have a Reasonable Basis To Believe independently.’’ 660 also receives separate recommendations That a Series of Recommended After considering these comments, the from the broker-dealer. Transactions, Even if in the Retail Commission is adopting the proposed With respect to the concern about Customer’s Best Interest When Viewed ‘‘quantitative care’’ component of the applying the requirement ‘‘only to in Isolation, Is Not Excessive and Is the Care Obligation as proposed. As noted recommendations by a single associated Retail Customer’s Best Interest When in the Proposing Release, we believe person, not across multiple associated Taken Together in Light of the Retail that imposing the quantitative care persons at the firm who act Customer’s Investment Profile and Does obligation without a ‘‘control’’ element independently,’’ 665 we note that both Not Place the Interest of the Broker- would provide consistency in the the firm and their associated persons Dealer Ahead of the Interest of the Retail investor protections provided to retail have to comply with the Care Customer customers by requiring a broker-dealer Obligation. If we took this commenter’s As proposed, the third component of to always form a reasonable basis as to suggestion, we are concerned we would the Care Obligation would require a the recommended frequency of trading potentially create a loophole and a broker-dealer to exercise reasonable in a retail customer’s account— perverse outcome that would allow for diligence, care, skill, and prudence to irrespective of whether the broker- avoidance of the Care Obligation, and have a reasonable basis to believe that dealer ‘‘controls’’ or exercises ‘‘de facto permit potentially excessive trading, by a series of recommended transactions, control’’ over the retail customer’s encouraging recommendations across a even if in the retail customer’s best account.661 This would also be number of associated persons. We interest when viewed in isolation, is not consistent with the other components of reiterate our position that, consistent excessive and is in the retail customer’s the Care Obligation, which apply with the other components of the Care best interest when taken together in regardless of whether a broker-dealer Obligation under the Care Obligation, light of the retail customer’s investment ‘‘controls’’ or exercises ‘‘de facto when a series of transactions is profile.657 The Proposing Release noted control’’ over the retail customers’ recommended to a retail customer, a that this requirement is intended to account. broker-dealer must evaluate whether the incorporate and enhance a broker- While the Commission appreciates series of recommended transactions dealer’s existing ‘‘quantitative the concern raised about ‘‘active places the broker-dealer’s interest ahead suitability’’ obligation by applying the traders’’ and the concern relating to a of the retail customer’s—this is true for requirement irrespective of whether a retail customer that could maintain both the associated person making the broker-dealer exercises actual or de several accounts at the same firm, we recommendation, as well as for the facto control over a customer’s account, nevertheless believe that retail firm.666 This will necessarily depend on thereby making the obligation consistent customers could, and should, benefit the facts and circumstances of each with the current requirements for from the protections of this requirement, particular recommendation, and of each ‘‘reasonable basis suitability’’ and namely the protection from a broker- particular series of transactions; ‘‘customer specific suitability.’’ 658 dealer recommending a level of trading however, we note that, as part of We received a few comments that is so excessive that the resulting developing a retail customer’s suggesting modifications to this cost-to-equity ratio or turnover rate investment profile, a broker-dealer is component of the obligation. For makes a positive return virtually required to exercise reasonable example, one commenter recommended impossible.662 As we indicated in the diligence to ascertain the retail the Commission clarify the meaning of Proposing Release, the fact that a customer’s investment profile, which ‘‘series of transactions,’’ while a second customer may have some knowledge of would include seeking to obtain and commenter requested a carve-out for financial markets or some ‘‘control’’ analyze a retail customer’s other ‘‘active traders’’ who are ‘‘interested in should not absolve the broker-dealer of investments.667 trading individual stocks . . . with a the ultimate responsibility to have a Finally, with respect to the meaning great degree of regularity.’’ 659 Another reasonable basis to believe that any of series of recommended transactions, commenter maintained that the recommendations it makes are in the what would constitute a ‘‘series’’ of quantitative suitability obligations best interest of the retail customer.663 recommended transactions would should only apply to those accounts Where a retail customer expresses a depend on the facts and circumstances, desire for ‘‘active trading,’’ 664 a broker- and would need to be evaluated with 657 Proposing Release at 21613. dealer may take this factor into respect to a particular retail customer. In 658 Proposing Release at 21613–21614. consideration when evaluating a other words, a broker-dealer would need 659 See Letter from Keith Lampi, President, to reasonably believe that the level of Alternative and Direct Investment Securities recommendation; however, the broker- Association (‘‘ADISA’’) (Aug. 7, 2018) (‘‘ADISA dealer will nevertheless need to trading (series of recommended Letter’’) (recommending the Commission clarify the reasonably believe that a series of transactions) is appropriate for a meaning of ‘‘series of transactions’’); Letter from particular retail customer, and thus a Joseph C. Cascarelli, Corporate Counsel, Network 1 660 SIFMA August 2018 Letter. bright line definition across all retail Financial Securities (Aug. 7, 2018) (‘‘Network 1 661 Letter’’) (suggesting a ‘‘carve-out exemption See Proposing Release at 21613–21614. formula’’ from Regulation Best Interest to 662 See id. 665 See SIFMA 2018 Letter. accommodate investors and their stockbrokers who 663 See id. 666 See Proposing Release at 21613–21614. specialize in ‘‘active trading’’). 664 See Network 1 Letter. 667 See supra Section II.C.2.c.

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customers would be unworkable. approach reflected our view that to make recommendations that place the Moreover, providing a bright line establishing reasonably designed interest of the broker, dealer, or such definition could encourage firms to policies and procedures is critical to natural person ahead of the interest of focus on a particular number of identifying and addressing conflicts of the retail customer; and (iii) identify transactions rather than focusing on interest. In addition, the proposed and eliminate any conflicts of interest ensuring that a series of approach would serve the Commission’s associated with sales contests, bonuses, recommendations, taken together, are in goal of addressing conflicts of interest and non-cash compensation that are the best interest of the retail customer. that may harm investors while based on the sales of specific securities Finally, a ‘‘series’’ of recommended providing flexibility to establish systems or specific types of securities within a transactions is an established term tailored to broker-dealers’ business limited period of time.673 under the federal securities laws and models. Each of these changes and the SRO rules that is evaluated in concert The Commission solicited comment requirements pursuant to the Conflict of with existing guideposts, such as on the Conflict of Interest Obligation, Interest Obligation is discussed in more turnover rate,668 cost-to-equity ratio,669 including the specific requirements to detail below. and use of in-and-out trading,670 which create policies and procedures with have been developed over time and respect to disclosure, mitigation, and a. Reasonably Designed Policies and which serve as indicators of excessive elimination of conflicts of interest. Procedures trading. Commenters requested changes to We proposed to require broker-dealers several aspects of the Conflict of Interest to establish reasonably designed 3. Conflict of Interest Obligation Obligation, including providing more policies and procedures as we believe We proposed the Conflict of Interest clarity and guidance surrounding when they are critical to identifying and Obligation to require a broker-dealer specific conflicts need to be disclosed, addressing conflicts of interest 674 and entity 671 to: (1) Establish, maintain, and mitigated or eliminated.672 helping ensure compliance with the enforce written policies and procedures In consideration of these comments, requirements to disclose conflicts of reasonably designed to identify, and we are adopting the Conflict of Interest interest pursuant to the Disclosure disclose, or eliminate all material Obligation with revisions to: (1) Create Obligation.675 In addition, policies and conflicts of interest associated with an overarching obligation to establish procedures may minimize compliance recommendations covered by written policies and procedures to costs that may be passed on to retail Regulation Best Interest; and (2) identify and at a minimum disclose, customers.676 As discussed in the establish, maintain and enforce written pursuant to the Disclosure Obligation, Proposing Release, it would be policies and procedures reasonably or eliminate all conflicts of interest reasonable for broker-dealers to use a designed to identify and disclose and associated with the recommendation; risk-based compliance and supervisory mitigate, or eliminate, material conflicts and (2) require broker-dealers to system rather than requiring a detailed of interest arising from financial establish policies and procedures to be review of each recommendation and to incentives associated with such reasonably designed to mitigate or have flexibility to tailor policies and recommendations. This proposed eliminate certain identified conflicts of procedures to their specific business interest. models. The Commission also provided 668 See, e.g., Carras v. Burns, 516 F.2d 251, 258 In addition to the overarching guidance on components a broker-dealer (4th Cir. 1975); Shearson Lehman Hutton Inc., 49 obligation, we specifically require S.E.C. 1119, 1122 at footnote 10 (1989); Laurie Jones should consider including in its Canady, 54 S.E.C. 65, 74 (1999), Exchange Act broker-dealers to establish, maintain, program with regard to the Conflict of Release No. 41250 (Apr. 5, 1999) (using the and enforce written policies and Interest Obligation.677 turnover rate for relevant period), petition denied, procedures reasonably designed to: (i) In response to the proposed policies 230 F.3d 362 (D.C. Cir. 2000). Identify and mitigate any conflicts of and procedures requirement, some 669 See, e.g., Shearson Lehman, 49 S.E.C. at 1121 (stating that ‘‘[o]ne test for excessive trading is the interest associated with relationship between the account opening balance recommendations that create an 673 Rule 15l–1 under the Exchange Act. and the amounts of markups, commissions, and incentive for a natural person who is an 674 See FSI August 2018 Letter (‘‘Experience margin charges’’); Michael E. Tennenbaum, 47 associated person of a broker or dealer shows that investors already ignore much of the enormous volume of regulatory disclosures they are S.E.C. 703 (Jan.19, 1982). to place the interest of the broker or 670 See, e.g., Hecht v. Harris, Upham & Co., 283 being provided. Instead, a more realistic approach F. Supp. 417, 435–36 (N.D. Cal. 1968), modified in dealer, or such natural person making is to require broker-dealers to adopt written part and aff’d, 430 F.2d 1202 (9th Cir. 1970); R.H. the recommendation, ahead of the supervisory procedures to detect and manage Johnson & Co., 36 S.E.C. 467 (1955); Behel, Johnson interest of the retail customer; (ii)(A) conflicts of interest, to avoid those they can and take steps to mitigate the impact of those conflicts & Co., 26 S.E.C. 163 (1947). Cody v. S.E.C., 693 F.3d identify and disclose any material 251, 260 (1st Cir. 2012). that can’t be avoided.’’). 671 Unlike the Disclosure and Care Obligations, limitations placed on the securities or 675 See Proposing Release at Section II.D.3.b. See which apply to a broker or dealer and to natural investment strategies involving also CCMC Letters (policies and procedures persons who are associated persons of a broker or securities that may be recommended requirement should assist broker-dealers in dealer, the Conflict of Interest Obligation (and the (i.e., only make recommendations of managing the potential impact of conflicts of Compliance Obligation discussed in Section II.C.4 interest); FPC Letter (acknowledging the importance below) applies solely to the broker or dealer entity, proprietary or other limited range of of firms’ policies and procedures when providing and not to the natural persons who are associated products) to a retail customer and any financial planning to act in the client’s best persons of a broker or dealer. For purposes of conflicts of interest associated with such interest). discussing the Conflict of Interest Obligation and limitations, in accordance with the 676 See Proposing Release at Section II.D.3.b. See the Compliance Obligation, the term ‘‘broker- also Cambridge Letter (‘‘Cambridge believes the dealer’’ refers only to the broker-dealer entity, and Disclosure Obligation, and (B) prevent SEC’s goals of facilitating disclosure and mitigating not to such individuals. While the Conflict of such limitations and associated conflicts material conflicts of interest, while minimizing Interest Obligation applies only to the broker-dealer of interest from causing the broker, additional compliance costs that may be passed on entity, the conflicts of interest that the broker-dealer dealer, or a natural person who is an to the retail customers can best be accomplished by entity must analyze are conflicts (as defined in requiring broker-dealers to adopt written paragraph (c)(3) of the rule) between: (i) The broker- associated person of the broker or dealer supervisory procedures to detect and manage dealer entity and the retail customer, (ii) the natural conflicts of interest, to avoid those they can and persons who are associated persons and the retail 672 See, e.g., SIFMA August 2018 Letter; Primerica take steps to mitigate the impact of those conflicts customer, and (iii) the broker-dealer entity and the Letter; BISA Letter; CCMC Letters; Wells Fargo that can’t be avoided.’’). natural persons who are associated persons. Letter. 677 Proposing Release at Section II.D.3.b.

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commenters asserted that it was an procedures should be ‘‘actually broader obligation to address conflicts effective means of addressing designed’’ to address conflicts of both at the firm level and at the conflicts 678 while others were interest, we do not believe that the associated person level.690 As to concerned that the Commission was design of policies and procedures commenters’ concerns that the policies providing too much flexibility in should be measured against a standard and procedures requirement provides addressing conflicts of interest.679 A few of strict liability, but should instead be too much flexibility and as discussed in commenters expressed agreement with measured against a standard of more detail below, the Commission has allowing a flexible risk-based approach reasonableness. In addition, we believe changed the specific requirements to be tailored to a broker-dealer’s business that policies and procedures are an addressed by the policies and model as opposed to a detailed review effective tool to identify and address procedures pursuant to the Conflict of of each recommendation.680 A few conflicts of interest, and would allow Interest Obligation to provide more commenters expressed concern with the the Commission to identify and address certainty to firms on which conflicts of Commission’s assertion that policies potential compliance deficiencies or interest should be addressed through and procedures may minimize failures (such as inadequate or disclosure, mitigation or elimination. compliance costs that may be passed on inaccurate policies and procedures, or While the Commission also understands to retail customers, noting the failure to follow the policies and concerns related to compliance costs, uncertainty surrounding how conflicts procedures) early on, reducing the we believe that the revisions to the of interest should be addressed by chance of retail customer harm.686 We Conflict of Interest Obligation, including policies and procedures.681 One also believe that there is no one-size-fits the greater specificity in the rule text, as commenter suggested that the all framework, and, as such, broker- well as the guidance provided below, Commission should adopt a safe harbor dealers should have flexibility to will ease the adjustment of broker- for the Conflicts of Interest Obligation reasonably design their policies and dealers’ existing supervisory and by demonstrating compliance with procedures to tailor them to account for compliance systems and streamline certain existing FINRA rules.682 As their business model, given the compliance with Regulation Best discussed below under the new structure and characteristics of their Interest. Compliance Obligation, some relationships with retail customers, b. Conflicts of Interest commenters suggested that the policies including the varying levels and and procedures requirement should frequency of recommendations provided The Proposing Release distinguished apply to aspects of the entire rule.683 and the types of conflicts that may be between material conflicts of interest in In consideration of the comments presented. This requirement of general and material conflicts of interest received, we are adopting the approach ‘‘reasonably designed’’ policies and arising from financial incentives. Under with respect to reasonably designed procedures is also consistent with the Proposing Release, broker-dealers policies and procedures to identify and Commission rules and regulations in would be required to establish, address conflicts of interest set forth in other contexts, including under the maintain, and enforce policies and the proposal substantially as proposed. Advisers Act.687 Further, the procedures to identify and, in the case As stated in the Proposing Release, we Commission continues to believe that of material conflicts of interest, disclose believe that broker-dealers should have while not required components, as an or eliminate, and in the case of financial flexibility to tailor their policies and effective practice, broker-dealers should incentives, disclose and mitigate, or procedures to their particular business consider including in their supervisory eliminate material conflicts of interest 691 model, focusing on specific areas of and compliance programs the arising from financial incentives. their business that pose the greatest risk components listed in the Proposing The Commission proposed to of noncompliance and greatest risk of Release, which may be relevant in interpret a material conflict of interest potential harm to retail customers as considering whether policies and as a conflict of interest that a reasonable opposed to a detailed review of each procedures are reasonably designed.688 person would expect might incline a recommendation.684 The Commission is not providing a broker—consciously or unconsciously— While we recognize a commenter’s safe harbor to Regulation Best Interest to make a recommendation that is not 685 692 statement that policies and for broker-dealers who demonstrate disinterested. For material conflicts compliance with FINRA rules 689 of interest arising from financial 678 See Fidelity Letter; SIFMA August 2018 Letter; because, while FINRA rules may incentives associated with a Morgan Stanley Letter. recommendation, the Proposing Release 679 See, e.g., NASAA August 2018 Letter; CFA address specific conflicts of interest, Institute Letter; Galvin Letter; Better Markets Regulation Best Interest establishes a discussed compensation practices August 2018 Letter (policies and procedures should established by the broker-dealer, be ‘‘actually designed’’ to achieve those ends, not 686 See infra footnote 809. including fees and other charges for the just ‘‘reasonably designed’’ to do so). But see IRI 687 See Rule 206(4)–7 under the Advisers Act. See services provided and products sold; Letter (‘‘The Conflict of Interest Obligation should also Section 15(g) of the Exchange Act; 15E(g) of the be simplified and streamlined to give BDs the employee compensation or employment Exchange Act. flexibility to determine appropriate steps to manage incentives (e.g., quotas, bonuses, sales 688 material conflicts.’’). These components could include, among other contests, special awards, differential or things: policies and procedures outlining how the 680 See Cambridge Letter; CCMC Letters. But see firm identifies conflicts, identifying such conflicts variable compensation, incentives tied NASAA August 2018 Letter (suggesting the and specifying how the broker-dealer intends to to appraisals or performance reviews); Commission reconsider the risk-based approach to address each conflict; robust compliance and comply with its duties). compensation practices involving third- monitoring systems; processes to escalate identified 681 parties, including both sales See, e.g., Better Markets August 2018 Letter; instances of noncompliance for remediation; CFA Institute Letter. procedures that designate responsibility to business 682 See AXA Letter. line personnel for supervision of functions and 690 ‘‘While FINRA has repeatedly emphasized the 683 See, e.g., NASAA August 2018 Letter persons, including determination of compensation; importance of identifying and managing conflicts (suggesting that, at a minimum, a firm’s policies processes for escalating conflicts of interest; and has a number of rules that address discrete and procedures should require an analysis of the processes for periodic review and testing of the conflicts of interest, there is currently no similarly costs and risks of a product as well as the client’s adequacy and effectiveness of policies and broad conflicts provision in FINRA rules, including financial goals). procedures; and training on policies and the suitability rule.’’ See FINRA 2018 Letter. 684 See Proposing Release at II.D.3.b. procedures. Proposing Release at Section II.D.3.b. 691 See Proposing Release at Section II.D.3. 685 See Better Markets August 2018 Letter. 689 See supra footnote 682. 692 Proposing Release at 21602.

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compensation and compensation that In consideration of comments and as recommendations that are not in the does not result from sales activity, such discussed in more detail below, the best interest of the retail customer. as compensation for services provided Commission has restructured the Therefore, we are adding a provision to third-parties (e.g., sub-accounting or Conflict of Interest Obligation to: (1) requiring broker-dealers to establish, administrative services provided to a Create an overarching obligation to maintain, and enforce written policies mutual fund); receipt of commissions or establish, maintain and enforce written and procedures reasonably designed to sales charges, or other fees or financial policies and procedures that are identify and to eliminate any conflicts incentives, or differential or variable reasonably designed to identify and at a of interest associated with sales compensation, whether paid by the minimum disclose (pursuant to the contests, sales quotas, bonuses, and retail customer or a third-party; sales of Disclosure Obligation), or eliminate, all non-cash compensation that are based proprietary products or services, or conflicts of interest associated with the on the sale of specific securities or products of affiliates; and transactions recommendation; and (2) adopt specific specific types of securities within a that would be effected by the broker- requirements with respect to such limited period of time. dealer (or an affiliate thereof) in a policies and procedures for the For purposes of Regulation Best principal capacity.693 mitigation and elimination of identified Interest, and for the reasons described in In addition, the Commission proposed conflicts of interest. more detail in the context of the to limit conflicts of interest to those In particular, we have revised the Disclosure Obligation, we have also associated with recommendations as proposed policies and procedures amended the rule text by eliminating broker-dealers may provide a range of requirement for mitigation to focus on ‘‘material’’ from ‘‘conflict of interest’’ services not involving a conflicts of interest that create an and codified the definition of a conflict recommendation, and such services are incentive for an associated person to of interest 699 to mean an interest that subject to general antifraud liability and place his or her interests ahead of the might incline a broker-dealer— specific requirements to address interest of the retail customer as consciously or unconsciously—to make 694 associated conflicts of interest. described below, by eliminating the a recommendation that is not Recognizing the phrase ‘‘financial distinction between material conflicts of disinterested.700 While ‘‘material’’ has incentives’’ could be interpreted interest and material conflicts of interest been eliminated, pursuant to the broadly, the Commission solicited arising from financial incentives, and Disclosure Obligation, broker-dealers comment on the proposed requirement removing the affirmative mitigation are required to disclose all material facts and the distinction between the requirement at the firm level. However, relating to conflicts of interest different requirements under the in light of this change, we are adding a associated with recommendations, Conflict of Interest Obligation. In new provision requiring broker-dealers consistent with the Proposing Release’s response, many commenters suggested to establish, maintain, and enforce intent of facilitating disclosure to assist that the scope of the description of written policies and procedures to retail customers in making informed financial incentives be narrowed as it specifically require broker-dealers to investment decisions.701 was too broad and requested guidance identify and disclose material Regarding the application of the or examples of material conflicts of limitations, and any associated conflicts Conflict of Interest Obligation only to interest that would not fall within the of interest a broker-dealer places on the those conflicts of interest associated description of financial incentives.695 securities or investment strategies with recommendations, one commenter Specifically, a number of commenters involving securities that may be stated that given the lack of detail in the suggested that the mitigation obligation recommended to the retail customer, Proposing Release, broker-dealers may should focus on financial incentives at such as recommendations being based have difficulty determining whether the registered representative level as on limited product menus (i.e., only opposed to the firm level.696 A number material conflicts are associated with a make recommendations of proprietary recommendation and how to adequately of commenters suggested that the or other limited range of products) and distinction between material conflicts address such conflicts, which could prevent such limitations and associated create inconsistent application of and financial incentives should be conflicts of interest from causing the 702 removed altogether.697 Commenters also Regulation Best Interest. We continue broker-dealer to make recommendations to believe this approach is appropriate, stated that the mitigation requirement is that place its interest ahead of the retail a higher standard of conduct than the for the reasons discussed in the customer. We believe the policies and Proposing Release 703 and also believe investment adviser fiduciary duty procedures need to address those which allows for conflicts to be certain conflicts of interest inherent in 699 See Section II.D.1. To provide clarity that the addressed through disclosure sufficient the broker-dealer business model by 698 interpretation of ‘‘conflict of interest’’ is limited to for informed consent. heightened measures in order to prevent Regulation Best Interest, the Commission has revised the rule text to include a definition of the 693 term. Id. conflicts of interest, Regulation Best Interest would 694 700 See Proposing Release at 21617. In including impose a higher standard on broker-dealers than is See id. this limitation, the Commission explained that it required of investment advisers with respect to 701 Id. was not intending to change the disclosure such conflicts); Primerica Letter (stating that by 702 See State Attorneys General Letter. (‘‘Given obligations associated with these services under the requiring broker-dealers to disclose and mitigate or the lack of detail in the Proposed Rule, broker- general antifraud provisions of the federal securities eliminate conflicts resulting from financial dealers may have difficulty determining whether laws. incentives, the standard is actually higher than the material conflicts are (1) ‘‘associated with 695 See, e.g., SIFMA August 2018 Letter; Primerica standard that applies under the Advisers Act); recommendations’’ and therefore subject to Letter; BISA Letter; Committee of Annuity Insurers CCMC Letters (stating that the requirement to disclosure or elimination; or (2) ‘‘arising from Letter; IPA Letter; CFA Institute Letter. mitigate or eliminate material conflicts of interest financial incentives associated with such 696 See, e.g., Primerica Letter; TIAA Letter; ICI arising from financial incentives effectively subjects recommendations’’ and therefore subject to Letter; Invesco Letter; Money Management Institute broker-dealers to a higher standard than investment disclosure and mitigation, or elimination. This Letter; Committee of Annuity Insurers Letter. advisers, who are generally able to disclose ambiguity, while designed to give maximum 697 See, e.g., CFA August 2018 Letter; CFA conflicts of interest). See also UBS Letter; ASA flexibility to broker-dealers, may in fact result in Institute Letter; Morgan Stanley Letter; SIFMA Letter. Some commenters also suggested that the inconsistent application of the Proposed Rule August 2018 Letter; CCMC Letters. obligation to address conflicts of interest should be nationwide and further add to the existing 698 See Franklin Templeton Letter (stating that by harmonized between broker-dealers and investment confusion.’’) including this heightened requirement for financial advisers. See, e.g., Schwab Letter. 703 See Proposing Release at 21618.

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that our revised Conflict of Interest interest that are associated with After carefully considering comments, Obligation provides more specificity recommendations covered by we are adopting, similar to the about how to address specific conflicts Regulation Best Interest. In guidance, Proposing Release, an overarching of interest, in conjunction with our the Commission stated that reasonably requirement to establish, maintain, and Disclosure Obligation, which should designed policies and procedures enforce reasonably designed policies address commenters’ concerns. should establish a clearly defined and and procedures to identify and, at a minimum, disclose, in accordance with c. Identifying Conflicts of Interest articulated structure for: determining how to effectively address material the Disclosure Obligation, or eliminate In the Proposing Release, the conflicts of interest identified (i.e., all conflicts of interest associated with Commission stated that having a process whether to eliminate or disclose (and the recommendation. However, as to identify and appropriately categorize mitigate, as required) the material discussed in the following sections, we conflicts of interest is a critical first step conflict); and setting forth a process to are otherwise revising the Conflict of to ensure that broker-dealers have help ensure that material conflicts are Interest Obligation in response to these reasonably designed policies and effectively addressed as required by the comments. Subparagraphs (a)(2)(iii)(B)– procedures to address conflicts of policies and procedures. (D) of the rule text will now require interest in order to comply with the As such, the requirement was policies and procedures that are Conflict of Interest Obligation. As stated intended to provide flexibility to broker- reasonably designed to address specific in the Proposing Release, reasonably dealers regarding how to address conflicts of interest in areas that we designed policies and procedures to conflicts of interest, whether through believe create greater incentives for, and identify conflicts of interest generally disclosure pursuant to the Disclosure increased risk that, the broker-dealer or should do the following: (i) Define such Obligation, or elimination. The associated person may place its or his or conflicts in a manner that is relevant to Commission also indicated that there her own interest ahead of the retail a broker-dealer’s business (i.e., conflicts may be situations in which disclosure customer’s interest, specifically of both the broker-dealer entity and the alone is not sufficient, and broker- conflicts of interest that: (1) Create associated persons of the broker-dealer), dealers may need to establish policies certain incentives to associated persons; and in a way that enables employees to and procedures designed to eliminate (2) conflicts of interest associated with understand and identify conflicts of the conflict or both disclose and material limitations on the securities or interest; (ii) establish a structure for mitigate it.705 The Commission also investment strategies involving identifying the types of conflicts that the provided examples of how a broker- securities, such as, limited product broker-dealer (and associated persons of dealer could eliminate a conflict.706 menus; and (3) sales contests, sales the broker-dealer) may face; (iii) As discussed above, we received quotas, bonuses, and non-cash establish a structure to identify conflicts many comments generally on the compensation based on the sales of in the broker-dealer’s business as it Conflict of Interest Obligation, specific securities or type of security evolves; (iv) provide for an ongoing requesting clarification on which within a limited period of time. (e.g., based on changes in the broker- conflicts needed to be disclosed, versus In adopting this overarching dealer’s business or organizational those that should be mitigated or requirement, we are reaffirming structure, changes in compensation eliminated.707 Some commenters guidance in the Proposing Release on incentive structures, and introduction of suggested that disclosure and informed establishing a process to identify and new products or services) and regular, consent should be considered to determine how to address a conflict, as 712 periodic (e.g., annual) review for the effectively address conflicts, similar to discussed above. Further, similar to identification of conflicts associated the approach taken under the Advisers the Proposing Release, while we are not with the broker-dealer’s business; and Act.708 Some commenters suggested that requiring broker-dealers to develop (v) establish training procedures disclosure alone was sufficient to policies and procedures to disclose and regarding the broker-dealer’s conflicts of address conflicts arising from financial mitigate all conflicts of interest, we are interest, including conflicts of natural incentives.709 For example, a few requiring that broker-dealers develop persons who are associated persons of commenters identified specific types of policies and procedures reasonably the broker-dealer, how to identify such conflicts they believed could be designed to ‘‘at a minimum disclose, or conflicts of interest, as well as defining 713 addressed by appropriate disclosure, eliminate’’ all conflicts. We continue employees’ roles and responsibilities to believe that where a broker-dealer such as third-party payments.710 A few with respect to identifying such cannot fully and fairly disclose a commenters requested that the conflicts of interest.704 conflict of interest in accordance with Most examples of how to eliminate conflicts the Disclosure Obligation, the broker- commenters did not express a view on of interest in the Proposing Release be such guidance relating to the process of dealer should eliminate the conflict or removed.711 identifying conflicts of interest. adequately mitigate (i.e., reduce) the Therefore, for the reasons discussed in 705 See Proposing Release at 21619–21620. explicit statements elsewhere in the Best Interest the Proposing Release, we are reiterating 706 Id. Proposal that Regulation Best Interest would not this guidance here. 707 See supra footnote 672. preclude a firm from offering proprietary 708 d. Overarching Obligation Related to See IPA Letter; Morgan Stanley Letter; ASA products. . . .The SEC should clarify in any Letter. adopting release that firms selling proprietary funds Conflicts of Interest 709 See, e.g., Committee of Annuity Insurers are not obligated to credit fund advisory fees against As proposed, the first component of Letter; Stifel Letter; Mass Mutual Letter; SIFMA other broker-dealer charges. The ability to charge the Conflict of Interest Obligation would August 2018 Letter; HD Vest Letter; Primerica fees to manage proprietary funds is critical to Letter. preserve the ability of firms to offer both proprietary have required a broker-dealer to 710 See, e.g., Invesco Letter; Transamerica August and third-party funds.’’); Committee of Annuity establish, maintain, and enforce written 2018 Letter; Primerica Letter. Insurers Letter (‘‘This suggested method for policies and procedures reasonably 711 See, e.g., ICI Letter (‘‘This example suggests a elimination of material conflicts of interest relating designed to identify, and disclose, or firm that offers proprietary funds should consider to affiliated mutual funds presents a number of relinquishing the advisory fees the firm or its problematic issues. . . .This example is eliminate, all material conflicts of affiliate receives for managing those funds as a exacerbated in the context of variable annuities.’’). means to address conflicts that selling such funds 712 See Section II.C.3.c. 704 Id. creates. This example is inconsistent with the SEC’s 713 Proposing Release at 21620.

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conflict such that full and fair designed to identify and disclose and breadth of the mitigation requirement disclosure in accordance with the mitigate, or eliminate, material conflicts and requested that mitigation be limited Disclosure Obligation is possible. In of interest arising from financial to certain types of compensation 721 or some cases, conflicts of interest may be incentives with such recommendations. solely to financial incentives to the of a nature and extent that it would be In proposing this requirement, we individual registered representative.722 difficult to provide disclosure that recognized the importance of the Many commenters were also concerned adequately conveys to a retail customer brokerage model as a potentially cost- about what they described as the material facts or the nature, effective option for investors, ambiguities in the Proposing Release, magnitude and potential effect of the acknowledging that the compensation including the lack of a definition of the conflict for informed decision-making or structures and arrangements within the term ‘‘mitigate’’ 723 and requested where disclosure may not be sufficiently business model create inherent further guidance surrounding conflicts specific or comprehensible for the retail conflicts 715 but that such compensation that needed to be mitigated versus those customer to understand whether and may be appropriate in light of the time that can be disclosed.724 Some how the conflict will affect the and experience necessary to understand commenters suggested that supervision recommendations he or she receives.714 investments. As such, we aimed to should be adequate mitigation and Also, in certain situations, a broker- promote investor choice and access to requested clarification on whether their dealer, even if not required, may products and instead of requiring existing supervisory practices, if determine that in addition to addressing broker-dealers to establish policies and compliant, were sufficient.725 As a conflict through disclosure, to take procedures to eliminate compensation discussed above under Section II.C.3.b, additional steps beyond disclosure to structures and arrangements,716 a number of commenters expressed also mitigate the conflict of interest. required policies and procedures to concern that the mitigation requirement The Commission acknowledges mitigate those conflicts of interest. is a higher standard of conduct than the commenters’ concerns regarding the We proposed a principles-based investment adviser fiduciary duty and examples of how to eliminate conflicts approach to provide flexibility to firms requested that it be aligned with the of interest that were provided in the to develop and tailor policies and fiduciary duty.726 Proposing Release. The Commission’s procedures that included conflict Many commenters expressed concern intent was not to prevent firms from mitigation measures based on each over some of the examples, and in offering certain products to the extent firm’s circumstances, for example, the particular neutral compensation factors, that they are in a retail customer’s best size, retail customer base, nature and described as a potential mitigation interest. In order to avoid confusion and significance of the conflict, and measure.727 Similarly, some to respond to commenters, we are not complexity of the product.717 We stated including these examples as final that, depending on the conflict and the 721 See, e.g., Cetera August 2018 Letter; SIFMA firm’s assessment, more or less August 2018 Letter. But see CFA August 2018 Letter guidance here as we have instead (stating that the Commission has proposed an decided to focus the rule text on specific demanding measures may be appropriately broad definition of material conflicts 718 conflicts of interest associated with appropriate. We provided examples that arise out of financial incentives and that it certain sales practices based on the sale of situations in which heightened should not be narrowed but a cleaner approach of specific securities that we require to mitigation measures may be appropriate would be to eliminate the artificial distinction and also suggested that broker-dealers between those material conflicts of interest that be eliminated and thus such examples arise from financial incentives and those that do are not necessary. In discussing the assess their policies and procedures as not, and to apply the same obligation to disclose separate mitigation and elimination they may be reasonably designed at the and mitigate all material conflicts, whatever the requirements below, we provide outset but may later cease to be source). 722 See, e.g., Primerica Letter; Committee of guidance on the specific conflicts for reasonably designed based on 719 Annuity Insurers Letter; Cetera August 2018 Letter. which we are requiring these subsequent events or information. See also Wells Fargo Letter (stating that receipt of heightened measures beyond disclosure. Finally, we provided a non-exhaustive fees and other revenue that does not otherwise However, while we have removed the list of potential practices that we believe result in a direct financial incentive at the registered representative level should be disclosed); examples of potential conflicts of broker-dealers should consider including in their policies and ICI Letter (recommending revisions to the proposed interest that may be more appropriately conflict of interest obligation to focus the mitigation avoided, we emphasize that pursuant to procedures, and as discussed above, obligation on the fees, revenue, or other financial the overarching obligation, elimination suggested that some practices may be incentives that may influence the recommendation of a broker-dealer representative—the individual of conflicts of interest is one method of more appropriately avoided as they may be difficult to mitigate.720 making the recommendation); Invesco Letter. addressing the conflict, in lieu of 723 As discussed above, many See, e.g., UVA Letter. disclosure, which broker-dealers may 724 See, e.g., CFA August 2018 Letter; Wells Fargo commenters expressed concern with the find appropriate in certain Letter; Committee of Annuity Insurers Letter; circumstances even when not required NASAA August 2018 Letter; Cetera August 2018 715 See Proposing Release at II.D.3.e. See also Letter; Morningstar Letter. by Regulation Best Interest. Tully Report. 725 See, e.g., BISA Letter; AALU Letter; Primerica 716 e. Mitigation of Certain Incentives to While the Commission’s goal is to promote Letter; Committee of Annuity Insurers Letter. access and choice to investors, as discussed in more 726 Associated Persons Supra footnote 698. detail in Section II.C.3.g, Elimination of Certain 727 See, e.g., SIFMA August 2018 Letter; ICI We proposed to require firms to Conflicts of Interest, the Commission believes it is Letter; Edward Jones Letter; Morgan Stanley Letter; in the public interest and will enhance investor establish, maintain, and enforce written Transamerica August 2018 Letter; Ameriprise protection to require broker-dealers to reasonably Letter; Capital Group Letter; Cetera August 2018 policies and procedures reasonably design policies and procedures to eliminate certain Letter; CCMC Letters; Letter from Michelle Bryan conflicts of interest as we believe such conflicts Oroschakoff, Chief Legal Officer, LPL Financial 714 See id.; see also Fiduciary Interpretation create too strong of an incentive for a broker-dealer (Dec. 18, 2018) (‘‘LPL December 2018 Letter’’) (stating that where an investment adviser cannot to make a recommendation that places the broker- (requesting confirmation that the non-exhaustive fully and fairly disclose a conflict such that the dealer’s interest ahead of the retail customer’s list of potential practices was intended merely as interest. client can provide informed consent, the adviser a list of examples and are not required mitigation 717 should eliminate the conflict or adequately mitigate Proposing Release at II.D.3.e. practices); Mass Mutual February 2019 Letter. But (i.e., modify practices to reduce) the conflict such 718 Id. see NASAA August 2018 Letter (stating that neutral that full and fair disclosure and informed consent 719 Id. compensation across products could constitute are possible). 720 Id. Continued

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commenters suggested that the While disclosure can be an effective transaction based-compensation need Commission should take more of a tool for retail customers to increase not be eliminated pursuant to principles-based approach as they awareness of a conflict of interest,735 in Regulation Best Interest. viewed the Proposing Release as too certain cases, we do not believe that Accordingly, rather than requiring prescriptive because it incorporated disclosure alone sufficiently reduces the mitigation of all firm-level financial examples from the DOL Fiduciary potential effect that these conflicts of incentives, we have determined to Rule.728 One commenter expressed interest may have on recommendations refine our approach by generally concern over the suggestion that made to retail customers.736 Instead, we allowing firm-level conflicts to be heightened mitigation may be believe that broker-dealers are most generally addressed through appropriate if a retail customer has a capable of identifying and addressing disclosure.740 At the same time, we are less sophisticated understanding, stating the conflicts that may affect the persuaded by commenters 741 that there that it is unclear how mitigation would obligations of their associated persons are some conflicts that should be be measured and could create with respect to the recommendations addressed through mitigation at the firm heightened costs and risks for firms.729 they make, and therefore are in the best level due to the potential impact that we Finally, some commenters requested position, to affirmatively reduce the believe certain conflicts of interest confirmation that certain practices are potential effect of these conflicts of (either at the associated person or firm permissible such as use of interest such that they do not taint the level) may have on recommendations to compensation grids,730 receipt of recommendation. retail customers; therefore we are revenue sharing,731 differential We are persuaded by commenters 737 requiring policies and procedures for compensation,732 recommendations that expressed concern that requiring mitigation or elimination of those based on a limited range of products broker-dealers to establish policies and conflicts (as identified in the rule text) and proprietary products,733 and use of procedures reasonably designed to and are not leaving it to the broker- employment benefits.734 mitigate all financial incentives, dealer to determine whether disclosure 742 In response to commenters, we have including any compensation, may result alone is sufficient. We believe that revised the Proposing Release’s in broker-dealers narrowing their this approach appropriately balances requirement with respect to mitigation product shelf and compensation our goal of reducing the potential harm practices which would be inconsistent conflicts of interest may have on broker- to require broker-dealers to establish 738 policies and procedures reasonably with the Commission’s stated goal. dealers’ recommendations to retail designed to identify and mitigate any As stated in the Proposing Release, customers and preserving retail access while the Commission’s goal in (in terms of choice and cost) to conflicts of interest associated with such adopting Regulation Best Interest is to brokerage products and services. recommendations that create an enhance investor protection by reducing incentive for a natural person who is an i. Guidance on Covered Incentives the potential harm to retail customers associated person of a broker- dealer to from conflicts of interest that may affect The Commission interprets this place the interest of the broker-dealer, or broker-dealer recommendations, we requirement to establish, maintain, and such natural person ahead of the want to do so while preserving, to the enforce reasonably designed policies interest of the retail customer. extent possible, access and choice for and procedures to identify and mitigate We agree with commenters that it is investors who prefer to pay for appropriate to focus on the incentives investment recommendations on a adviser’s fiduciary duty, and could further that directly affect the associated person transaction-by-transaction basis, which encourage migration from the broker-dealer to making a recommendation, because we investment adviser model and result in a loss of is the ‘‘pay as you go’’ model that choice for retail customers. See Section I; CCMC believe those conflicts are most likely to broker-dealers generally provide, as well Letters (‘‘Imposing a standard on broker-dealers undermine the associated person’s as preserving retail customer choice of with respect to managing conflicts of interest that ability to make a recommendation that is greater than that imposed on investment advisers, the level and types of advice provided on top of the additional regulatory obligations to is in the best interest of the retail 739 and the products available. As such, which broker-dealers are subject that are not customer, and thus present heightened imposed on investment advisers, threatens to risk of recommendations that are not in 735 See Section II.C.1, Disclosure Obligation; undermine the SEC’s objective of preserving retail a retail customer’s best interest and that Relationship Summary Adopting Release. customer choice and access to the brokerage advice place the associated person’s or firm’s 736 See, e.g., Tully Report; CFA August 2018 model and may introduce a new source of confusion when it comes to investors’ interests ahead of the retail customer’s Letter; AARP August 2018 Letter; Warren Letter (‘‘the [Commission] should not rely on disclosure understanding of the duties they are owed.’’); interest. alone to protect consumers.’’). See also DOL AALU Letter (‘‘Overly-rigid mitigation requirements Fiduciary Rule Release at 20950. ‘‘Disclosure alone could limit consumer choice of products and access has proven ineffective to mitigate conflicts in to professional financial advice’’). See also 913 appropriate mitigation), State Attorneys General Study; Proposing Release at 21575. Letter (suggesting differential compensation be advice.’’ 740 As discussed above in the section about the permitted based solely on neutral factors). 737 See, e.g., Primerica Letter (‘‘The SEC’s current Disclosure Obligation, the Commission believes that 728 formulation of the conflicts obligation thus See, e.g., LPL August 2018 Letter; Cetera compliance with the Disclosure Obligation, August 2018 Letter; Davis Harman Letter. inappropriately, and we believe unintentionally, preferences advisory models over brokerage including disclosure of the material facts relating to 729 See Primerica Letter. models.’’); Transamerica August 2018 Letter the scope and terms of the relationship with the 730 See, e.g., SIFMA August 2018 Letter; (expressing concern that the proposed retail customer and all conflicts of interest, should Committee of Annuity Insurers Letter; Primerica interpretation of financial incentives is overbroad give sufficient information to enable a retail Letter. and may result in broker-dealers narrowing their customer to make an informed decision with regard 731 See, e.g., SIFMA August 2018 Letter; Cetera product shelf, which seems inconsistent with the to the recommendation. See II.D.1. August 2018 Letter. SEC’s stated goal of preserving the broker-dealer Nevertheless, as noted, there may be situations in 732 See, e.g., Cetera August 2018 Letter; model to protect an investor’s right to choose which disclosure alone may not be sufficient to Transamerica August 2018 Letter; Ameriprise between brokerage and advisory accounts). provide ‘‘full and fair’’ disclosure in accordance Letter. 738 The Commission recognizes that a broker- with the Disclosure Obligation discussed above, 733 See, e.g., NY Life Letter; Fidelity Letter; ICI dealer’s financial or other interest can and will and the broker-dealer may need to take additional Letter; T.Rowe Letter. These commenters suggested inevitably exist. steps to mitigate or eliminate the conflict, that disclosure would be an appropriate way to 739 We are persuaded by commenters regarding consistent with an investment adviser’s fiduciary address conflicts of interest associated with limited the competitive issues for broker-dealers that could duty. See Section II.C.3.d. product menus and proprietary products. arise if we require mitigation of firm-level financial 741 See, e.g., CFA August 2018 Letter. 734 See, e.g., AALU Letter. incentives, which is not required by an investment 742 See Section II.C.3.f and g.

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any conflicts of interest that create an examples focus on compensation that where the compensation is less incentive for the associated person to varies based on the advice given, such transparent (for example, an incentive place the interest of the broker-dealer or as commissions, markups/markdowns, from a third-party or charge built into such associated person ahead of the loads, revenue sharing, and Rule 12b–1 the price of the product or a transaction interest of the retail customer, to only fees. versus a straight commission); or in a apply to incentives provided to the situation involving a complex security ii. Guidance on Mitigation Methods associated person, whether by the firm or investment strategy.748 A broker- or third-parties that are within the By requiring that a broker-dealer dealer could reasonably determine control of or associated with the broker- establish policies and procedures through its policies and procedures that dealer’s business.743 It would not cover reasonably designed to ‘‘mitigate’’ these the same mitigation measures could external interests of the associated conflicts of interest, we mean the apply to a particular type of retail person not within the control of or policies and procedures must be customer, type of security or investment associated with the broker-dealer’s reasonably designed to reduce the strategy, or type of incentive across the business.744 In the case of a dually potential effect such conflicts may have board; or in some instances a broker- registered individual, this requirement on a recommendation given to a retail dealer may reasonably determine that would generally only apply to customer. Thus, whether or not a some conflicts create incentives that incentives provided to the associated broker-dealer’s policies and procedures may be more difficult to mitigate, and person when making a recommendation are reasonably designed to mitigate such are more appropriately avoided in their in a brokerage capacity and not when conflicts will be based on whether they entirety or for certain categories of retail making a recommendation in an are reasonably designed to reduce the customers.749 investment advisory capacity as the incentive for the associated person to As noted in the Proposing Release, investment adviser fiduciary duty make a recommendation that places the policies and procedures may be would apply to the advice given in that associated person’s or firm’s interests reasonably designed at the outset, but instance.745 ahead of the retail customer’s interest. may later cease to be reasonably The Commission generally considers As noted in the Proposing Release, in designed based on subsequent events or the following as examples of incentives lieu of mandating specific mitigation information obtained (for example, such to an associated person that would need measures or a ‘‘one-size fits all’’ as through supervision (e.g., exception to be addressed under this revised approach, we are providing broker- testing) of associated person provision: (i) Compensation from the dealers with flexibility to develop and recommendations), and the actual broker-dealer or from third-parties, tailor reasonably designed policies and experience of a broker-dealer should be including fees and other charges for the procedures that include conflict used to revise the broker-dealer’s services provided and products sold; (ii) mitigation measures, based on each measures as appropriate.750 Further, employee compensation or employment firm’s circumstances.746 Reasonably what are considered reasonable incentives (e.g., incentives tied to asset designed policies and procedures mitigation measures may vary based on accumulation and not prohibited under should include mitigation measures that the size of the firm.751 While many (a)(2)(iii)(D), as discussed below, special depend on the nature and significance broker-dealers have programs currently awards, differential or variable of the incentives provided to the in place to manage conflicts of interest, compensation, incentives tied to associated person and a variety of each broker-dealer will need to carefully appraisals or performance reviews); and factors related to a broker-dealer’s consider whether its existing framework (iii) commissions or sales charges, or business model (such as the size of the complies with this provision.752 other fees or financial incentives, or broker-dealer, retail customer base (e.g., In response to commenters’ concerns differential or variable compensation, diversity of investment experience and regarding the potential mitigation whether paid by the retail customer, the financial needs), and the complexity of broker-dealer or a third-party. These the security or investment strategy he may reasonably be expected to be capable of involving securities that is being evaluating the risks of the recommended transaction, and is financially able to bear the risks 743 The ability to control the compensation of recommended), some of which may be of the recommended position in the complex associated person, including incentives, is an weighed more heavily than others. For product.’’ FINRA Rule 2360(b)(19). important mechanism by which broker-dealers example, more stringent mitigation 748 See Proposing Release at 21620–21621. exercise supervisory control over sales practices. 749 Id. 744 For example, if an associated person of a measures may be appropriate in 750 Id. broker-dealer participates in a securities transaction situations where the characteristics of 751 In the FINRA Conflicts Report, FINRA outside of the broker-dealer and receives the retail customer base in general identified certain mitigation measures firms compensation, although the broker-dealer would displays less understanding of the implemented that we believe highlight differences need to approve the transactions and record it in in conflict management frameworks, based on the its books and records under FINRA Rule 3280 incentives associated with particular securities or investment strategies; 747 size of the firm. For example, large firms may (Private Securities Transaction of an Associated address conflicts of interest through enterprise Person), as described in more detail above, this management or operational risk frameworks, and requirement to mitigate certain incentives to an 746 See Proposing Release at 21618. See also components of such programs, for example, risk associated person would not apply to compensation Letter from Steven W. Stone, Morgan, Lewis & and control self-assessments, may provide an that is not an incentive provided by or in the Bockius LLP (May 3, 2019) (‘‘Morgan Lewis Letter’’) opportunity to identify and evaluate possible control of the broker-dealer. (‘‘The Commission should recognize that firms may impacts. By contrast, small firms selling basic Nevertheless, additional registration, disclosure appropriately employ only some—or various products may have a conflicts management or other obligations, and antifraud liabilities may combinations—of these approaches depending on framework that relies largely on the tone set by the apply to any other firm through which an their businesses and business models, firm owner coupled with required supervisory associated person may have such external interests compensation structures, and related conflicts of controls, particularly related to suitability, and the under federal or state law (for example, as a state- interest, and should not prescribe a one-size-fits-all firm’s compensation structure. See FINRA Conflicts registered adviser). We also note that an associated approach to mitigating compensation-related Report. An effective practice FINRA observed at a person of a broker-dealer who receives transaction- conflicts.’’). number of firms is implementation of a based compensation and participates in a private 747 FINRA’s heightened suitability requirements comprehensive framework to identify and manage securities transactions that is not in accordance for options trading accounts require that a conflicts of interest across and within firms’ with FINRA Rule 3280 should be mindful of the registered representative have ‘‘a reasonable basis business lines that is scaled to the size and broker-dealer registration requirements under for believing, at the time of making the complexity of their business. See FINRA Conflicts Section 15 of the Exchange Act. recommendation, that the customer has such Report at 5. 745 See Fiduciary Interpretation; Section II.B.3. knowledge and experience in financial matters that 752 See Proposing Release at 21621.

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methods described in the Proposing establishing differential compensation dealer’s or the associated person’s Release, and, in particular, the based on neutral factors; 757 interest ahead of the retail customer’s references to neutral factors,753 we • eliminating compensation interest. would like to emphasize that this non- incentives within comparable product In response to a commenter’s concern exhaustive list of factors is purely lines by, for example, capping the credit that we suggested in the Proposing illustrative and the factors are not that an associated person may receive Release that some compensation required elements.754 In providing these across mutual funds or other conflicts may be more appropriately examples, we did not intend to take a comparable products across providers; avoided for certain categories of retail prescriptive approach, as suggested by • implementing supervisory customers,761 we would like to clarify some commenters, but a principles- procedures to monitor that such a suggestion is an example based approach designed to provide recommendations that are: Near and not a requirement. Nevertheless, we flexibility to broker-dealers, depending compensation thresholds; near are adopting a requirement to establish, on their business model, level of thresholds for firm recognition; involve maintain, and enforce written policies conflicts, and the retail customers they higher compensating products,758 and procedures reasonably designed to serve.755 proprietary products or transactions in a eliminate the incentives that we believe create the most problematic conflicts, Among other things, firms may adopt principal capacity; or, involve the roll namely incentives to associated persons a range of reasonable alternatives to over or transfer of assets from one type that are tied to recommendations of meet the mitigation requirement of the of account to another (such as specific securities or specific types of Conflict of Interest Obligation. As noted recommendations to roll over or transfer securities within a limited period of above, we recognize that there are a assets in an ERISA account to an IRA) 759 time as we believe these incentives number of different kinds of incentives or from one product class to another; • cannot be adequately mitigated, and are and that, depending on the specific adjusting compensation for likely to result in recommendations that characteristics of an incentive, different associated persons who fail to adequately manage conflicts of interest; place the interest of the broker-dealer or levels and types of mitigation measures associated person ahead of the interests may be necessary. For example, and • limiting the types of retail customer of the retail customer. Furthermore, in incentives tied to asset accumulation accordance with the Care Obligation, a generally would present a different risk to whom a product, transaction or 760 broker-dealer, when making a and require a different level or kind of strategy may be recommended. While the Commission is providing recommendation, is required to, among mitigation, than variable compensation flexibility so that broker-dealers can other things, have a reasonable basis to for similar securities, which in turn may determine the nature and extent of believe that the recommendation is in present a different level or kind of risk mitigation, whether a broker-dealer has the best interest of the particular retail and may require different mitigation developed policies and procedures customer.762 In particular, and methods than differential or variable reasonably designed to mitigate a consistent with existing suitability compensation or financial incentives conflict is not measured against obligations, a broker-dealer is required tied to firm revenues. In certain industry practice (although such to exercise ‘‘reasonable diligence’’ to instances, we believe that compliance practice could be a useful point of ascertain (and consider) the retail with existing supervisory requirements reference). Each firm must look at the customer’s investment profile which, and disclosure may be sufficient, for facts and circumstances surrounding the among other things, includes the retail example, where a firm may develop a mitigation methods, the particular customer’s investment experience and surveillance program to monitor sales 763 broker-dealer’s business model, and risk tolerance. A broker-dealer that activity near compensation whether or not the policies and has established reasonably designed thresholds.756 procedures were reasonably designed policies and procedures to mitigate the As discussed above, while not for the particular firm to reduce the conflicts associated with the incentives required elements, the Commission impact of the incentive in a manner to provided to the associated person would believes the following non-exhaustive prevent the incentive from causing the nevertheless violate Regulation Best list of practices could be used as associated person to place the broker- Interest if the recommendation does not potential mitigation methods for firms comply with the Care Obligation. to comply with (a)(2)(iii)(B) of 757 As noted above, we are not requiring firms to Finally, in response to commenters’ Regulation Best Interest: establish differential compensation based on questions regarding the permissibility of • neutral factors but do believe firms could choose to specific practices, the Commission Avoiding compensation thresholds do so as potential practice to promote compliance that disproportionately increase believes the revised, explicit with the requirement to establish, maintain, and requirements related to: Mitigation of compensation through incremental enforce written policies and procedures reasonably increases in sales; designed to identify and mitigate any conflicts of incentives to associated persons as interest that create an incentive for an associated discussed herein; mitigation of any • minimizing compensation person to place its interest ahead of the interest of material limitations placed on the incentives for employees to favor one the retail customer. securities or investment strategies that type of account over another; or to favor 758 See Morgan Lewis Letter (suggesting, among other things, that firms can conduct surveillance may be recommended to retail one type of product over another, (whether transactions, periodic, or forensic) to customers; and elimination of certain proprietary or preferred provider identify activity that appears to be driven by products, or comparable products sold compensation considerations—whether at the 761 See Primerica Letter (‘‘The SEC’s statements in on a principal basis, for example, by representative, team, or business level—rather than the Proposals regarding the additional protections a customer’s interest). broker-dealers should afford ‘less sophisticated’ 759 See FINRA Exam Report 2017. FINRA retail customers could create a sub-class of retail 753 See, e.g., Mass Mutual February 2019 Letter; observed a variety of effective practices in customers that broker-dealers would have to Edward Jones Letter; IRI Letter; Capital Group recommending the purchase and sale of UITs, identify based on subjective and poorly defined Letter; SIFMA August 2018 Letter; Committee of including tailoring supervisory systems to products’ criteria, and potentially further restrict access to Annuity Insurers Letter. features and sources of risk to customers. help with saving and investing for customers who 754 See Proposing Release at 21621. 760 See, e.g., supra footnote 747; FINRA need it most.’’). 755 See Proposing Release at 21622. Regulatory Notice 12–03, Heightened Supervision 762 See Section II.C.2. 756 FINRA Conflicts Report at 30–31. of Complex Products (Jan. 2012). 763 Id.

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practices, as discussed below, In consideration of these comments, concerned that without requiring a sufficiently address these comments. To and our revisions to remove firm-level broker-dealer to have a process in place the extent the Commission has not conflicts from the proposed mitigation to disclose and address negative effects identified a practice that needs to be provision discussed above, we are of such limitations, retail customers eliminated, it would be permitted, adopting a new requirement to may be unaware that a broker-dealer subject to compliance with the specifically address the conflicts of offers only a limited set of products and requirements of Regulation Best Interest. interest presented when broker-dealers therefore would be unable to make an place any material limitations on the informed investment decision.768 We f. Mitigation of Material Limitations on securities or investment strategies that are also concerned that retail customers Recommendations to Retail Customers may be recommended to a retail may be harmed by such limitations if As part of the proposed requirement customer (i.e., only make they are more likely to result in to manage conflicts of interest arising recommendations of proprietary or recommendations that are not in the from financial incentives through other limited ranges of products). While best interest of the retail customer.769 mitigation, firms would have been we generally believe that most firm- Broker-dealers will be required to required to establish policies and level conflicts of interest can be establish, maintain and enforce written procedures reasonably designed to addressed through appropriate policies and procedures reasonably mitigate the conflicts of interest disclosure, this new provision focuses designed to: (i) Identify and disclose any associated with offering a limited range on the specific firm-level conflicts— material limitations placed on the of products and proprietary products. namely, the conflicts associated with securities or investment strategies We also solicited comment on the establishment of a product menu— involving securities that may be information related to the magnitude of which we believe are most likely to recommended to a retail customer and conflicts of interest when broker-dealers affect recommendations made to retail any conflicts of interest associated with recommend, among other things, customers and have the greatest such limitations, in accordance with the proprietary products and a limited range potential to result in recommendations Disclosure Obligation, and (ii) prevent of products. In response, several that place the interest of the broker- such limitations and associated conflicts commenters requested that the dealer or associated person ahead of the of interest from causing the broker, Commission confirm that a product interest of the retail customer.766 Given dealer, or a natural person who is an menu limited to appropriate alternative the potential impact on associated person of the broker or dealer investments offered by the broker-dealer recommendations to retail customer, we to make recommendations that place the would not violate Regulation Best believe these conflicts should not be left interest of the broker, dealer, or such 764 Interest. Some commenters requested to the broker-dealer to determine natural person ahead of the interest of we clarify that, for certain customers, a whether disclosure alone is sufficient, the retail customer. firm can limit its offerings to proprietary and are requiring broker-dealers to As discussed in the context of the products or products for which the firm establish, maintain, and enforce written Disclosure Obligation and the receives revenue sharing payments if policies and procedures reasonably Relationship Summary, for purposes of the limitation is properly disclosed and designed to (1) identify and disclose any this requirement, a ‘‘material appropriate to meet the retail customer’s material limitations broker-dealers place limitation’’ 770 placed on the securities 765 needs. on their securities offerings or or investment strategies involving investment strategies involving securities would include, for example, 764 See, e.g., SIFMA August 2018 Letter securities and any associated conflicts recommending only proprietary (requesting clarification on how a broker-dealer products (i.e., any product that is could satisfy the Conflict of Interest Obligation if of interest and (2) prevent such the platform is limited to certain bond offerings); limitations and associated conflicts of managed, issued, or sponsored by the Fidelity Letter (stating that given the vast array of interest from causing the broker-dealer financial institution or any of its readily available investment options and the to make recommendations that place the affiliates), a specific asset class, or breadth of securities typically available to products with third-party arrangements customers through broker-dealers, some limitation broker-dealer’s interest ahead of the 771 of the universe of investment options must be interest of the retail customer. (i.e., revenue sharing). In addition, undertaken in order for a broker-dealer to While we believe broker-dealers the fact that the broker-dealer adequately understand, compare and formulate a recommends only products from a select recommendation); Prudential Letter (‘‘It is unclear should be permitted to limit their what ‘significantly limits’ means for firms that offer product offerings from which they make predominantly, but not exclusively, proprietary recommendations to retail customers, a product menu that complies with the first prong products. It is also unclear what constitutes a ‘small of the proposed best interest standard and that provided that they comply with under such approach, firms would periodically choice of investments.’ Additional examples or 767 more prescriptive instructions regarding when firms Regulation Best Interest, we are also assess their product offerings against other products must disclose such limitations would be helpful.’’). available in the marketplace in order to ensure that See also Guardian August 2018 Letter; LPL August investments may not be enough for an investor to their offerings are competitive). 2018 Letter; LPL December 2018 Letter. understand the limitations). 768 See Disclosure Obligation at Section II.C.1. 765 See, e.g., SIFMA August 2018 letter; CFA 766 See CFA August 2018 Letter (‘‘[M]any broker- 769 We believe that by including this requirement Institute Letter; Letter from Emanuel Alves, Senior dealers currently restrict choice by only to address material limitations to product menus, Vice President and General Counsel, John Hancock recommending from a limited menu of proprietary which does not rely on disclosure alone, coupled Life Insurance Company (Aug. 3, 2018) (‘‘John funds or by only recommending products from with the requirements under the Care Obligation, Hancock Letter’’); Ameriprise Letter. See also NY companies that make revenue sharing payments. If we are addressing a commenter’s concern that Life Letter (recommending the Commission require limits on investor choice are of concern to the product limitations can limit investor choice which disclosure of the limits on the universe of available Commission, surely such limits deserve equal in turn harms investors. See CFA August 2018 products, while allowing further context so that scrutiny. After all, evidence suggests that the Letter. firms describe the full scope and impact of those limited menus offered by some firms consist 770 As discussed in Section II.C.1, Disclosure limits); SPARK Letter (recognizing that the SEC did entirely of low quality products that impose Obligation, a limitation is ‘‘material’’ if there is ‘‘a not want to mandate specific mitigation procedures excessive costs, deliver inferior returns, and expose substantial likelihood that a reasonable shareholder or a ‘‘one-size-fits’’ all’’ approach but requesting investors to excessive risk.’’) would consider it important.’’ Basic, Inc. v. further guidance in the case of, among other things, 767 See Section II.C.2 for a related discussion of Levinson, 485 U.S. 224, 224 (1988). In the context broker-dealers who only offer proprietary products the application of the Care Obligation to such of this Regulation Best Interest, this standard would or only offer limited investment menus). But see limitations. See also AFL-CIO April 2019 Letter apply in the context of retail customers, as defined. CFA August 2018 Letter (suggesting that simply (recommending that the Commission make clear 771 See II.C.1.; Relationship Summary Adopting stating that a firm offers a limited selection of that it will hold firms accountable for developing Release.

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group of issuers could also be a material including establishing procedures for Interest Obligations. In fact, we believe limitation. identifying and mitigating the conflicts that these limitations can be beneficial, We recognize, however, that, as a of interests associated with the product, such as by helping ensure that a broker- practical matter, almost all broker- or declining to recommend a product dealer and its associated persons dealers limit their offerings of securities where the firm cannot effectively understand the securities they are and investment strategies to some mitigate the conflict, and identifying recommending, as required by the Care degree. We do not believe that which retail customers would qualify Obligation.780 This requirement is disclosing the fact that a broker-dealer for recommendations from this product designed to allow firms to determine does not offer the entire possible range menu.775 As part of this process, firms whether and how to restrict their menu of securities and investment strategies may consider evaluating the use of of investment options based, among would convey useful information to a ‘‘preferred lists,’’ 776 restricting the retail other things, on their retail customer retail customer, and therefore we would customers to whom a product may be base and area of expertise, while not consider this fact, standing alone, to sold, prescribing minimum knowledge protecting the interests of retail constitute a material limitation.772 requirements for associated persons customers when recommendations are Rather, consistent with the examples of who may recommend certain made from such limited menus by a ‘‘material limitation’’ provided above, products,777 and conducting periodic requiring firms have a reasonably whether the limitation is material will product reviews to identify potential designed process to identify, disclose, depend on the facts and circumstances conflicts of interest, whether the and prevent the conflicts of interest of the extent of the limitation. measures addressing conflicts are associated with such limitations from Adopting this revised requirement is working as intended, and to modify the resulting in recommendations that place critical to ensuring that retail customers mitigation measures or product the broker-dealer’s interests ahead of the are aware of any material limitations selection accordingly.778 The retail customer’s interest. associated with a broker-dealer’s Commission’s intent is not to prevent We also note that the risk that limited recommendation and associated firms from offering proprietary products product menus result in conflicts of interest and that broker- or other limited range of products so recommendations that are not in the dealers, through their policies and long as firms comply with the retail customer’s best interest is also procedures, establish processes to Disclosure, Care,779 and Conflict of addressed through the Care evaluate whether or not such a limited Obligation 781 and required disclosure range of products is consistent with 775 For example, in its Conflicts Report, FINRA pursuant to the Disclosure making recommendations that are in the identified the following as effective practices to identify and manage conflicts of interest for new Obligation.782 retail customer’s best interest and that products: (i) A product review process to identify do not place the interests of the broker- and mitigate conflicts of interest that may be g. Elimination of Certain Conflicts of dealer or associated person ahead of the associated with a product; (ii) evaluation of whether Interest retail customer’s interest, consistent to decline to offer products to customers when the conflicts associated are too significant to be with Care Obligation.773 Broker-dealers Under Section 15(l)(2) of the mitigated effectively; (iii) differentiation of product Exchange Act, the Commission may would be able to satisfy paragraph eligibility between institutional and retail clients; (a)(2)(iii)(C)(1) by identifying any (iv) post-launch reviews of products to identify examine and, where appropriate, material limitations and complying with potential problems; (v) evaluation of registered promulgate rules prohibiting or representatives’ ability to understand a product, the Disclosure Obligation which, as restricting certain sales practices, provide training where necessary, and limit access conflicts of interest, and compensation discussed above, requires disclosure of to products for which they cannot demonstrate ‘‘the type and scope of services sufficient understanding to perform a suitability schemes for brokers, dealers, and provided to the retail customer, analysis and effectively explain a product and its investment advisers that the risks to customers; and (vi) disclosure of product including any material limitations on Commission deems contrary to the conflicts and risks. See FINRA Conflicts Report at public interest and protection of the securities or investment strategies 3, 18–25. investors. As discussed below, the involving securities that may be 776 See FINRA Conflicts Report at 24. recommended to the retail 777 Cf. FINRA Conflicts Report at 19 (stating that Commission finds that it is in the public customer.’’ 774 as an effective practice in evaluating new products, interest and consistent with the Similar to the requirement to a product review committee may engage in these protection of investors to require that activities to address conflicts of interest). broker-dealers establish, maintain, and establish, maintain, and enforce written 778 Cf., e.g., NASD Notice to Members 03–71, policies and procedures reasonably Non-Conventional Investments—NASD Reminds enforce written policies and procedures designed to mitigate certain incentives Members of Obligations When Selling Non- reasonably designed to identify and to associated persons, firms will have Conventional Investments (Nov. 2003). Similarly, eliminate any sales contests, sales under the Compliance Obligation, we suggest that quotas, bonuses, and non-cash flexibility to develop and tailor compliance policies and procedures’ adequacy and reasonably designed policies and effectiveness should be reviewed as frequently as compensation that are based on the procedures to prevent such limitations necessary in connection with changes in business sales of specific securities or specific and the associated conflicts from activities, affiliations, or regulatory and legislative types of securities within a limited developments. See Section II.D.4, Compliance period of time. causing the broker-dealer or associated Obligation. person from placing their interest ahead 779 In particular, consistent with the Care of the retail customer’s interest. In Obligation and as discussed further in Section 780 See also supra footnote 775. developing such policies and II.C.2, Care Obligation, as part of determining 781 See id. whether a broker-dealer has a reasonable basis to 782 Material limitations are material facts that procedures, the Commission believes believe that a recommendation is in the best interest need to be disclosed pursuant to the Disclosure that firms should, for example, consider of the retail customer, broker-dealers generally need Obligation. The Commission is concerned about the establishing product review processes to evaluate reasonably available alternatives offered potential effect that such limitations have on the for products that may be recommended, by the broker-dealer. When a broker-dealer securities or investment strategies involving materially limits is product offerings or offers only securities recommended to a retail customer, and a limited menu of products, it must still comply any associated conflicts of interest, could have on 772 See Basic, Inc. v. Levinson, 485 U.S. 224, 224 with the Care Obligation, and could not use its the ability of a broker-dealer to make a (1988). limited menu to justify recommending a product recommendation in the best interest of the retail 773 See Section II.C.2 and infra footnote 779. that does not satisfy this obligation. See Section customer. See Disclosure Obligation at Section 774 Section II.C.1. II.C.2. II.C.1.

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In the Proposing Release, the Conflict Some commenters generally requested commenters requested clarification that of Interest Obligation would have that certain sales contests and financial incentives not tied to a particular required the establishment of policies incentives be prohibited.789 Of these investment product would be permitted and procedures reasonably designed to commenters, many expressed concern and would not need to be eliminated.792 at a minimum disclose or eliminate all that product-based incentives could A number of commenters requested material conflicts of interest related to lead to recommendations that are not in clarification that incentives based on the recommendation (or to disclose and a customer’s best interest, with some asset growth would be permitted as they mitigate or eliminate those material commenters stating that firms could do not raise the same types of conflicts conflicts of interest arising from find ways to mitigate these conflicts 790 present with product-based sales.793 A financial incentives). We did not and others advocating that they should number of commenters expressed mandate the absolute elimination of, or be prohibited in their entirety.791 Other concern that provisions requiring policies and procedures reasonably elimination of certain conflicts could be designed to eliminate any particular of choice of offerings for which they might in conflict with current treatment under conflicts.783 We were concerned that the otherwise be suited. . . It would also be helpful if the Internal Revenue Code governing the Commission could provide additional examples 794 absolute elimination of specified of the types of conflicts (besides ‘‘sales contests, certain employee benefits. particular conflicts could mean a trips, prizes . . . based on sales of certain After considering comments, we are broker-dealer may not receive securities’’) that likely require elimination.’’); see modifying the rule text of the Conflict 784 also Money Management Institute Letter; compensation for its services. Our Northwestern Mutual Letter; AALU Letter. of Interest Obligation to include new intent, rather, was to identify certain 789 See, e.g., PIABA Letter (favoring a prohibition paragraph (a)(2)(iii)(D), which requires practices that may be more on compensation structures that would incentivize the broker or dealer to establish, appropriately avoided for certain a broker to: Recommend a proprietary product or maintain, and enforce written policies categories of retail customers, including, recommend one type of product line over another; and procedures reasonably designed to and/or which would reward the sale of certain for example, sales contests, trips, prizes, products within a product line’’), Americans for identify and eliminate any sales and other similar bonuses based on Financial Reform (recommending prohibiting contests, sales quotas, bonuses, and sales of certain securities or brokers from adopting practices, such as sales non-cash compensation that are based 785 quotas and contests, that clearly incentivize their accumulation of AUM. representatives to base their recommendations on on the sales of specific securities or We also provided examples of how a their own financial interests rather than the specific types of securities within a broker-dealer could eliminate conflicts customer’s best interests); NASAA August 2018 limited period of time. In adopting this of interest.786 We requested comment on Letter (‘‘[W]e encourage the Commission to proceed new requirement, the Commission further by declaring these two practices—sales elimination, including suggestions of contests and preferential treatment of allocations— believes it will provide certainty to whether certain conflicts should be per se impermissible under Regulation Best broker-dealers regarding the types of required to be eliminated and how Interest.’’); Galvin Letter (identifying the following practices where conflicts of interest are broker-dealers could eliminate conflicts practices as per se violations of the standard as they so pervasive such that they cannot be are contrary to the requirement to provide advice of interest. Specifically, we requested that is in the true best interest of customers: Sales reasonably mitigated and must be comment on whether the Commission contests; sales quotas (especially for in-house should explicitly prohibit receipt of products); and incentives to sell high-cost and high- example, we agree that sales contests improperly certain non-cash compensation (e.g., risk products); See also Warren Letter; Better favoring certain investment products over others Markets August 2018 Letter; CFA August 2018 involve uniquely troubling conflicts and should sales contests, trips, prizes, and other Letter. But see Primerica Letter (‘‘The SEC should generally be impermissible.’’); NY Life Letter (In bonuses based on sales of certain recognize that sales contests, trips, prizes, awards, this context, the proposal notes that single product securities, accumulation of AUM or any and similar bonuses can be used to incentivize sales contests create conflicts that may best be other factor).787 positive behavior and clarify there is no per se eliminated. We agree that it is inappropriate to use a contest or other non-cash compensation to In response, several commenters requirement to eliminate such incentives.’’). 790 See, e.g., SIFMA August 2018 Letter (‘‘With incentivize the sale of a specific investment or requested greater certainty as to whether respect to product-based sales contests, we agree variable insurance product over other available certain conflicts of interest should be that instances where a firm cannot adequately alternatives, irrespective of a consumer’s situation eliminated and if so, which ones.788 mitigate incentives that are misaligned with the and needs.’’) But see AALU Letter (finding that the customer’s best interest, the firm should eliminate Commission should not prohibit currently- such sales contests. A firm, however, may be able compliant compensation arrangements and 783 See Proposing Release at 21619. to mitigate such conflicts through several business models, including non-cash 784 Id. methods. . .under a principles-based regime, we compensation). 785 See id. FINRA rules also establish restrictions ask that the SEC allow firms to decide whether to 792 See, e.g., SIFMA August 2018 Letter; Edward on the use of non-cash compensation in connection mitigate or eliminate such conflicts.’’); Cetera Jones Letter; NY Life Letter; Prudential Letter; LPL with the sale and distribution of certain types of August 2018 Letter (‘‘A commonly-cited example is August 2018 Letter; Transamerica August 2018 products. See FINRA Rules 2310, 2320, 3221, and sales contests or incentives that are focused on sales Letter; Northwestern Mutual Letter; Letter from Eric 5110. of a single product. While we agree that such R. Dinallo, Executive Vice President, General 786 Proposing Release at 21621–21622. arrangements may be per se inappropriate and Counsel, Guardian Life (Feb. 6, 2019) (‘‘Guardian 787 Id. Cetera does not permit them, this judgment is February 2019 Letter’’); Primerica Letter; Cambridge 788 See TIAA Letter (‘‘If the SEC were to provide largely subjective. We suggest that reaching Letter. Some of these commenters stated that more specific direction as to which conflicts are consensus on what other practices fall into this FINRA’s rules and supervisory practices significant enough to warrant complete elimination, category would be well-nigh impossible. So long as appropriately cover these incentives. See broker-dealers would be better able to effectively a broker-dealer can demonstrate that it has made a Transamerica August 2018 Letter; NY Life Letter; address material conflicts of interest in a manner good faith determination regarding identification Northwestern Mutual Letter; Guardian August 2018 consistent with the SEC’s goals and preferred and management of conflicts, it should not be Letter; Primerica Letter. approach.’’); Wells Fargo Letter (‘‘Rather than subject to either regulatory action or private 793 Generally these commenters believed that leaving broker-dealers vulnerable to second- litigation based on those determinations.’’); CFA programs tied to assets under management, total guessing, the SEC should either provide more Institute Letter (‘‘Our view is that recommendations production or revenue growth do not give guidance on how such conflicts may be mitigated aimed at winning sales contests and meeting associated persons an incentive to recommend or simply identify a set of financial incentives that internal quotas are irreconcilable with the concept specific securities that may be inconsistent with a are prohibited.’’); AXA Letter (‘‘In the absence of of a best interest standard and should not be customer’s best interest. See, e.g., SIFMA August clear guidance from the Commission as to which allowed.’’). 2018 Letter; Bank of America Letter; Edward Jones financial incentives must be eliminated, and not 791 See, e.g., PIABA Letter; CFA August 2018 Letter; Transamerica August 2018 Letter; ASA just mitigated and disclosed, broker-dealers may be Letter. See also Fidelity Letter (‘‘The SEC has Letter; UBS Letter; Fidelity Letter; NY Life Letter; forced to curtail otherwise legitimate practices and properly pointed out that certain conflicts of Money Management Institute Letter; IPA Letter. the sale of certain products and services out of an interest can be so problematic that it simply may 794 See AALU Letter; NY Life Letter; Guardian abundance of caution—thereby depriving investors not be possible to mitigate them effectively. For February 2019 Letter; Northwestern Mutual Letter.

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eliminated in their entirety, as we expected to make recommendations in a long as the incentive is not based on the believe they create too strong of an particular retail customer’s best interest sale of specific securities or types of incentive for the associated persons to consistent with the requirements of the securities within a limited period of make a recommendation that places Care Obligation, if they are motivated to time.801 While conflicts of interest are their financial or other interest ahead of ‘‘push’’ certain securities or types of also associated with sales contests, sales the interest of retail customers’ interests securities in order to win a contest or quotas, bonuses and non-cash and therefore would be inconsistent reach a target in order to receive a bonus compensation that apply to, among with Regulation Best Interest.795 or other non-cash compensation. We are other things, total products sold, or asset The requirement is designed to also persuaded that it would be accumulation and growth, we agree eliminate sales contests, sales quotas, difficult, if not impossible, for a firm to with commenters 802 these conflicts bonuses and non-cash compensation establish reasonably designed policies present less risk that the incentive that are based on the sales of specific and procedures to sufficiently mitigate would compromise compliance with the securities and specific types of the incentive created to put the broker- Care Obligation and Conflict of Interest securities within a limited period of dealer’s interest ahead of the retail Obligation such that a recommendation time. We believe that these practices, customer’s interest, as discussed above, could be made that is in a retail particularly when coupled with a time as the point of these practices is simply customer’s best interest and that does limitation, create high-pressure to increase the sale a particular security not place the place the interest of the situations for associated persons to or type of security, for example, in the broker-dealer or associated person engage in sales conduct contrary to the context where a broker-dealer is ahead of the interest of the retail best interest of retail customers. For attempting to reduce its inventory of or customer. purposes of this requirement, we exposure to that security. Accordingly, We also recognize that certain interpret non-cash compensation to we believe that these practices should production requirements may exist for mean any form of compensation be eliminated in order to enhance other reasons, specifically to maintain a received in connection with the sale and investor protection 798 and achieve the contract of employment.803 As distribution of specific securities or goals of Regulation Best Interest. discussed above, we do not intend to specific types of securities that is not By explicitly requiring broker-dealers prohibit the receipt of certain employee cash compensation, including but not to establish, maintain, and enforce benefits by statutory employees, and do limited to merchandise, gifts and prizes, written policies and procedures not believe this provision would apply, travel expenses, meals and lodging reasonably designed to eliminate certain as we do not consider these benefits to except we do not intend it to cover practices, we believe we are responding be non-cash compensation for purposes certain employee benefits, including to commenters who requested certainty of Regulation Best Interest. In addition, healthcare and retirement benefits.796 as to which specific incentives are we do not intend to prohibit training or We recognize that some associated prohibited.799 Also in response to education meetings, including persons may focus their business on commenters requesting clarification as attendance at company-sponsored certain general categories of securities to what practices would be permitted, meetings such as annual conferences,804 (e.g., mutual funds, variable annuities, the requirement to have reasonably provided that these meetings are not bonds, or equities) and that broker- designed written policies and based on the sale of specific securities dealers may provide compensation or procedures to eliminate sales contests, other incentives related to such sales. sales quotas, bonuses, and non-cash 801 Although we are not defining what would As discussed further herein, this compensation applies only to those that constitute a ‘‘limited period of time,’’ as noted above, we are concerned about time limitations that requirement is not designed to prohibit are based on the sales of specific create high-pressure situations for associated broker-dealers from providing such securities or types of securities, and persons to increase the sales of specific securities incentives, provided that they do not does not apply to compensation or specific types of securities which compromise create high-pressure situations to sell a practices based on, for example, total the best interests of their customers. specifically identified type of security products sold, or asset growth or 802 See, e.g., Ameriprise Letter (‘‘We believe such 800 concerns around incentives do not exist with (e.g., stocks of a particular sector or accumulation, and customer respect to programs that reward asset growth or bonds with a specific credit rating) satisfaction. In addition, this asset flows, or recruitment bonuses tied to assets within a limited period of time, such elimination requirement would not under management or revenue growth because that the associated person cannot make prevent firms from offering only these programs do not give associated persons an incentive to recommend specific securities that may a recommendation in the retail proprietary products, placing material not be consistent with a customer’s best interest.’’); customer’s best interest. limitations on the menu of products, or Empower Letter (‘‘We also believe asset-gathering or We believe the conflicts created by incentivizing the sale of such products account-retention incentives should not be subject these practices are in direct opposition to the same level of scrutiny as incentives aimed at through its compensation practices, so increasing sales of particular securities. The to our goal of reducing the effect of potential for a conflict of interest to result in a bad conflicts of interest on broker-dealer 798 See Chairman Jay Clayton, Statement on outcome for a retail investor is much higher when recommendations to retail customers.797 Investor Roundtables Regarding Standards of a recommendation is related to individual securities We agree with many commenters that Conduct for Investment Professionals Rulemaking rather than the type of account in which such (Aug. 22, 2018), available at https://www.sec.gov/ broker-dealers cannot reasonably be securities should be held.’’) news/public-statement/statement-clayton-082218. 803 See Prudential Letter; NY Life Letter; Guardian See also CFA Institute; CFA. February 2019 Letter; AALU Letter. Under the 795 See Section I. See also AFL–CIO April 2019 799 See supra footnote 788 and accompanying Internal Revenue Code, statutory employees are Letter (‘‘The Commission must provide greater text. eligible for certain employee benefits such as 401(k) clarity regarding how the obligation to eliminate or 800 See CCMC Letters (asserting that increasing and health insurance. In order to qualify under this mitigate conflicts would apply to different types of assets under management is a natural outgrowth of definition, full time life insurance sales agents must conflicts. In particular, it must make clear that serving clients well and is fundamentally different devote their principal business to the solicitation of conflicts cannot be addressed through disclosure from sales contests based on a particular product); life insurance or annuities primarily for one alone and that firms would be prohibited from UBS Letter (stating that compensation and other company. See Department of Treasury, Internal artificially creating harmful incentives that rewards based on the growth of overall revenues or Revenue Service, Employer’s Supplemental Tax undermine compliance with the best interest assets under management should continue to be Guide, Publication 15–A (2018), available at standard.’’). permitted as they do not incent sales of one product https://www.irs.gov/pub/irs-pdf/p15a.pdf. 796 Infra footnote 803 and accompanying text. over another but instead simply reward overall 804 See Guardian August 2018 Letter; NY Life 797 See Section I. business growth). Letter.

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or type of securities within a limited interest,806 some commenters suggested Commission believes that the time period. broadening this requirement to a general Compliance Obligation is important to We emphasize that prohibiting certain policies and procedures obligation that help ensure that broker-dealers have incentives does not mean that all other would be reasonably designed to ensure strong systems of controls in place to incentives are presumptively compliant that recommendations are made in the prevent violations of Regulation Best with Regulation Best Interest. As customer’s best interest or reasonably Interest, including the component discussed above, such other incentives designed to ensure compliance with Disclosure and Care Obligations, in 807 and practices that are not explicitly Regulation Best Interest as a whole. addition to the policies and procedures After considering the comments prohibited are permitted provided that required pursuant to the Conflict of received, we are adopting the the broker-dealer establishes reasonably Interest Obligation, and to protect the Compliance Obligation, which requires, designed policies and procedures to interests of retail customers.811 in addition to the policies and disclose and mitigate the incentive procedures required by the Conflict of As with the policies and procedures created, and the broker-dealer and its Interest Obligation, that broker-dealer requirement included in the Conflict of associated persons comply with the entities 808 establish, maintain and Interest Obligation, whether policies Care Obligation. Nevertheless, if the enforce written policies procedures and procedures are reasonably designed firm determines that the conflicts reasonably designed to achieve to comply with Regulation Best Interest associated with these practice are too compliance with Regulation Best will depend on the facts and difficult to disclose and mitigate, the Interest. The Compliance Obligation circumstances of a given situation.812 As firm should consider carefully assessing creates an affirmative obligation under such, the Compliance Obligation does whether it is able to satisfy its best the Exchange Act with respect to the not enumerate specific requirements interest obligation in light of the rule as a whole,809 while providing that broker-dealers must include in their identified conflict and in certain sufficient flexibility to allow broker- policies and procedures as broker- circumstances, may wish to avoid such dealers to establish compliance policies dealers are too varied in their operations practice entirely. and procedures that accommodate a for rules to impose a single set of 4. Compliance Obligation broad range of business models.810 The universally applicable specific required elements. Each broker-dealer when As proposed, under the Conflict of 806 See CFA August 2018 Letter; Fidelity Letter; adopting policies and procedures Interest Obligation, a broker-dealer Vanguard Letter; FPC Letter. should consider the nature of that firm’s entity 805 would be required to: (1) 807 See CFA August 2018 Letter; UBS Letter. 808 operations and how to design such Establish, maintain, and enforce written Similar to the Conflict of Interest Obligation, the Compliance Obligation applies solely to the policies and procedures to prevent policies and procedures reasonably broker or dealer entity, and not to the natural violations from occurring, detect designed to identify, and disclose, or persons who are associated persons of a broker or violations that have occurred, and to dealer. For purposes of discussing the Compliance eliminate all material conflicts of correct promptly any violations that interest associated with Obligation, the term ‘‘broker-dealer’’ refers only to the broker-dealer entity, and not to such have occurred.813 recommendations covered by individuals. See footnote 671 and accompanying Regulation Best Interest; and (2) text. A firm’s compliance policies and establish, maintain and enforce written 809 As noted in the Proposing Release, broker- procedures should be reasonably policies and procedures reasonably dealers are currently subject to supervisory designed to address and be obligations under Section 15(b)(4)(E) of the proportionate to the scope, size, and designed to identify and disclose and Exchange Act and SRO rules, including the mitigate, or eliminate, material conflicts establishment of policies and procedures risks associated with the operations of of interest arising from financial reasonably designed to prevent and detect the firm and the types of business in incentives associated with such violations of, and to achieve compliance with, the which the firm engages.814 As such, the federal securities laws and regulations, as well as Commission is not mandating specific recommendations. As discussed above, applicable SRO rules. See Proposing Release at in response to commenters, we have 21622. Specifically, the Exchange Act authorizes requirements pursuant to the made modifications to the Conflict of the Commission to sanction a broker-dealer or any Compliance Obligation. In addition to Interest Obligation to more associated person that fails to reasonably supervise the required policies and procedures, another person subject to the firm’s or the person’s depending on the size and complexity appropriately focus on the conflicts of supervision that commits a violation of the federal interest that create an incentive for securities laws. Exchange Act Sections 15(b)(4)(E) of the firm, we believe a reasonably broker-dealers and their associated and (b)(6)(A). The Exchange Act provides an designed compliance program generally persons to place the interest of the affirmative defense against a charge of failure to supervise where reasonable procedures and systems broker-dealer or the associated person for applying the procedures have been established Ask While Establishing or Reviewing Their ahead of the interest of the retail Compliance Programs (May 2006), available at and effectively implemented without reason to _ _ customer. believe those procedures and systems are not being https://www.sec.gov/info/cco/adviser compliance complied with. Id. While the Compliance questions.htm (‘‘No one standard set of policies and We solicited comment on the Obligation creates an explicit requirement, we procedures will address the requirements proposed requirement to establish, believe that broker-dealers would likely establish established by the Compliance Rule for all advisers because each adviser is different, has different maintain, and enforce certain policies policies and procedures to comply with Regulation Best Interest pursuant to Section 15(b)(4)(E). In business relationships and affiliations, and and procedures as part of the Conflict of order to comply, broker-dealers could adjust their therefore, has different conflicts of interest.’’). Interest Obligation, including whether current systems of supervision and compliance, as 811 Similar to the discussion included under we should require policies and opposed to creating new systems. Section II.C.3.a, we believe that policies and 810 This approach is similar to the one taken procedures to comply with Regulation Best Interest procedures specifically to assist would allow the Commission to identify and compliance with Regulation Best under rule 206(4)–7 under the Advisers Act which requires policies and procedures reasonably address potential compliance deficiencies or Interest. While commenters generally designed to prevent violations of the Advisers Act, failures (such as inadequate or inaccurate policies viewed the requirement to adopt which should be tailored to address compliance and procedures, or failure to follow the policies and policies and procedures as an effective considerations relevant to the operations of each procedures) early on, reducing the chance of retail adviser. See Compliance Programs of Investment customer harm. means of addressing conflicts of 812 Companies and Investment Advisers, Advisers Act See Section II.C.3. Release No. 2204 (Dec. 17, 2003) (‘‘Advisers Act 813 See Advisers Act Release 2204. 805 See supra footnote 671. Release 2204’’). See also Questions Advisers Should 814 See Section II.C.3.a.

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would also include: 815 Controls; proposed ‘‘any information required periodically update customer account remediation of non-compliance; 816 under paragraph (a)(25)(i) of this information, although as part of training; 817 and periodic review and section.’’ This is a non-substantive developing a ‘‘retail customer’s testing.818 change reflecting the fact that paragraph investment profile,’’ Regulation Best (i) of the new provision requires a Interest may require broker-dealers to D. Record-Making and Recordkeeping record of the information collected from seek to obtain certain retail customer In connection with proposed a retail customer by the broker-dealer information that is currently not Regulation Best Interest, we proposed pursuant to Regulation Best Interest; it required by Rule 17a–3(a)(17).823 In new record-making and recordkeeping does not require the information itself addition, Regulation Best Interest would requirements for broker-dealers with directly as implied by the original require broker-dealers to disclose in respect to certain information collected wording of paragraph (i) of the proposed writing the material facts relating to the from or provided to retail customers. amendment. It is therefore more scope and terms of their relationship Specifically, we proposed amendments accurate to refer in paragraph (ii) to the with the retail customer and the to Exchange Act Rules 17a–3 and 17a– information ‘‘described in,’’ rather than material facts relating to conflicts of 4, which specify minimum ‘‘required under,’’ paragraph (i), as well interest that are associated with the requirements with respect to the records as to update the reference in paragraph investment recommendations provided that broker-dealers must make, and how (ii) to ‘‘paragraph (a)(35)(i) of this to the retail customer. As such, it would long those records and other documents section.’’ not be accurate to state, as suggested by must be kept, respectively. We received Several commenters expressed the commenter, that the Commission’s several comments on the proposed new concern that the proposed rule current books and records requirements requirements and are adopting them amendment would significantly expand for broker-dealers are sufficient to meet substantially as proposed with recordkeeping requirements.821 One recordkeeping requirements to satisfy additional clarifications and guidance to commenter expressed concern that the Regulation Best Interest. The additional address commenters’ concerns. record retention requirements of the books and records requirements the We proposed amending Rule 17a– proposed new paragraph to Rule 17a–3 Commission is adopting today are 3 819 to add a new paragraph (a)(25), would apply to each recommendation designed to allow firms to demonstrate which would require, for each retail made by the broker-dealer rather than to compliance with the substantive customer to whom a recommendation of each account (as required by existing requirements of Regulation Best Interest. any securities transaction or investment paragraph (a)(17) of Rule 17a–3, which We further note that the new record- strategy involving securities is or will be operates on a per-account basis). making requirements would not require provided, a record of all information Another commenter requested the duplication of existing records. collected from and provided to the retail clarification that ‘‘the current books and Rather, if a broker-dealer relied upon customer pursuant to Regulation Best records requirement is sufficient to meet previously existing records to Interest, as well as the identity of each record-keeping requirements to satisfy demonstrate its compliance with natural person who is an associated Reg BI,’’ adding that the Commission Regulation Best Interest for a given person of a broker or dealer, if any, should ‘‘affirm that Reg BI does not recommendation, it would not be responsible for the account. The new create new record-keeping requirements required to create and preserve paragraph would specify that the to prove that an advisor acted in a duplicate copies but instead could neglect, refusal, or inability of a retail client’s best interest.’’ 822 create a new record noting which pre- customer to provide or update any such The Commission notes that the existing documents were provided to information would excuse the broker- proposed new requirements of Rule the customer, or what customer dealer from obtaining that information. 17a–3 are not designed to create information already being preserved by We are adopting the provision additional, standalone burdens for the broker-dealer was relied upon, to substantially as proposed but broker-dealers but instead to provide a meet the obligations of Regulation Best redesignating it as new paragraph (a)(35) means by which they can demonstrate, Interest. However, reliance upon of Rule 17a–3.820 We are also amending and Commission examiners can previously existing records would only the text of paragraph (ii) of the confirm, their compliance with the new be permissible so long as such records amendment as adopted to refer to ‘‘any substantive requirements of Regulation are preserved—a record noting that a information described in paragraph Best Interest. In response to commenter document was relied upon would no (a)(35)(i) of this section’’ rather than the concerns that the proposed longer meet the recordkeeping requirements would significantly obligations of Regulation Best Interest if 815 Cf. FINRA Conflicts Report at 6 (identifying expand their recordkeeping obligations, such document was no longer preserved supporting structures, policies, processes, controls we reiterate that, as stated in the by the broker-dealer. and training as critical to protect customers and the Proposing Release, broker-dealers Commenters also requested that the firm). should already be attempting to collect 816 Id. at 10 (‘‘Most firms’ policies describe an Commission limit new recordkeeping escalation process for handling those conflicts of much of the information that would be requirements to customer profile interest that cannot be handled through other firm required under Regulation Best Interest information itself, not the ‘‘related and policies. . . .’’). pursuant to the FINRA suitability rule 817 ‘‘For firms, training is an important vehicle to and existing Exchange Act books and 823 See Exchange Act Rule 17a–3(a)(17). As communicate firm culture, specific requirements of explained in the Proposing Release, Rule 17a– a firm’s code of conduct and its conflicts records rules. For example, we note that under existing Rule 17a–3(a)(17), 3(a)(17) applies to each account with a natural management framework.’’ Id. at 15. person as a customer or owner, while proposed 818 Cf. Questions Advisers Should Ask While broker-dealers that make Regulation Best Interest would apply to each Establishing or Reviewing Their Compliance recommendations for accounts with a recommendation of any securities transaction or Programs (May 2006), available at https:// natural person as customer or owner are investment strategy involving securities to a retail www.sec.gov/info/cco/adviser_compliance_ already required to create and customer. Because of this difference, the questions.htm; FINRA Conflicts Report. Commission believes it would be appropriate to 819 See Exchange Act Rule 17a–3. locate the record-making requirements related to 820 The Commission is also reserving paragraphs 821 See SIFMA August 2018 Letter; Edward Jones Regulation Best Interest in a new paragraph of Rule (a)(24) through (a)(34) of Rule 17a–3 for use in Letter; Primerica Letter. 17a-3 rather than in an amendment to paragraph connection with future rulemakings. 822 See Raymond James Letter. (a)(17).

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underlying communications.’’ 824 In recommendation-by-recommendation individual recommendation actually response to these concerns, the basis, consistent with our approach made to a customer meets the Commission clarifies that new elsewhere, we are not requiring that requirements of Regulation Best Interest paragraph (a)(35) of Rule 17a–3 as broker-dealers create and maintain on its own. Regulation Best Interest adopted requires a record of all records to evidence best interest applies to recommendations made to a information collected from and determinations on a recommendation- retail customer, rather than to potential provided to the retail customer pursuant by-recommendation basis. Nor have we recommendations considered by the to Regulation Best Interest. Regulation determined to require broker-dealers to broker-dealer but not actually made to Best Interest does not reference, and the provide information to retail customers the customer. Commission does not intend that it relating to the basis for each particular In response to the commenter’s require, ‘‘related and underlying recommendation (i.e., disclose such privacy and cybersecurity concerns with communications’’—rather, it applies information), and thus did not envision respect to the proposed requirement to only to the information that is actually this information to come within the make a record of all information provided to or obtained from the scope of Rule 17(a)(35). collected from the customer pursuant to customer pursuant to Regulation Best Rather, in order to demonstrate Regulation Best Interest, as noted in the Interest. Once again, the purpose of the compliance with Regulation Best Proposing Release 831 and Section II.C new record-making provision is to allow Interest, a broker-dealer must be able to above, although a broker-dealer’s broker-dealers to demonstrate their demonstrate that it had a reasonable customer obligations under Regulation compliance with the substantive basis to believe that each particular Best Interest (e.g., the Care Obligation) requirements of Regulation Best Interest. recommendation made to a retail go beyond those set forth in the FINRA’s Complying with those substantive customer was in the best interest of the suitability rule, the concept of the requirements will require broker-dealers customer at the time of the ‘‘customer’s investment profile’’ that a to obtain from and provide to customers recommendation based on the broker-dealer would be required to certain information, and new paragraph customer’s investment profile and the compile—that is, the customer (a)(35) of Rule 17a–3 requires a record potential risks, rewards, and costs information it would be required to of such information. In response to associated with the recommendation. As obtain—pursuant to Regulation Best comments received requesting noted above, the Commission does not Interest is consistent with that under clarification as to whether information intend this to require, in practice, the FINRA’s suitability rule. As such, we provided to or obtained from a customer creation of extensive new and believe that since broker-dealers are orally would be covered by the new potentially duplicative records for each already required to seek to obtain record-making requirements,825 the and every recommendation to a retail identical types of retail customer Commission clarifies that the customer. Instead, broker-dealers should information pursuant to the FINRA requirements of new paragraph (a)(35) be able to explain in broad terms the suitability rule, broker-dealers should of Rule 17a–3 apply to all information process by which the firm determines already have in place policies and collected from or provided to a retail what recommendations are in its procedures, including training customer pursuant to Regulation Best customers’ best interests, and similarly programs, to address such privacy and Interest, whether provided orally or in to explain how that process was applied cybersecurity concerns. writing (electronically or otherwise).826 to any particular recommendation to a We also proposed an amendment to Several commenters requested retail customer. However, we are not paragraph (e)(5) of Rule 17a–4, which clarification that, except with respect to mandating that broker-dealers create currently requires broker-dealers to the specific recordkeeping requirements and maintain a record of each such maintain and preserve in an easily in the rule text, Regulation Best Interest determination. Nonetheless, as noted accessible place all account information does not require additional records (e.g., above we are providing guidance required by paragraph (a)(17) of Rule records to evidence best interest suggesting that firms may wish to 17a–3 for at least six years after the determinations on a recommendation- adequately document an evaluation of a earlier of the date the account was by-recommendation basis).827 One recommendation and the basis for that closed or the date on which the commenter also stated that, as drafted, recommendation in particular contexts, information was replaced or updated.832 there are significant obstacles and costs, such as the recommendation of a The proposed amendment would including increased privacy and complex product, or where a require broker-dealers to retain any cybersecurity risks, that would result recommendation may seem inconsistent information that the retail customer from implementing the proposed new with a retail customer’s investment provides to the broker-dealer or the rule, in particular with respect to the objectives on its face.829 broker-dealer provides to the retail ‘‘all information collected from .... In addition, in response to requests customer pursuant to the proposed 828 the retail customer’’ requirement. from commenters for confirmation that amendment to Rule 17a–3 being In response, the Commission clarifies the proposed record-making adopted today as Rule 17a–3(a)(35), in that while the substantive requirements requirements do not contemplate addition to the existing requirement to of Regulation Best Interest apply on a broker-dealers needing to create and retain information obtained pursuant to maintain records of why certain Rule 17a–3(a)(17). As a result, broker- 824 See SIFMA August 2018 Letter; Morgan products were recommended over Stanley Letter. dealers would be required to retain all 825 See SIFMA August 2018 Letter; Primerica others on a recommendation-by- records of the information collected 830 Letter. recommendation basis, we confirm from or provided to each retail customer 826 In the case of information provided orally that broker-dealers are not expected to pursuant to Regulation Best Interest for under the circumstances outlined in Section II.C.1, maintain records comparing potential at least six years after the earlier of the Disclosure Obligation, Oral Disclosure or Disclosure investments to one another so long as After a Recommendation, the broker-dealer must date the account was closed or the date maintain a record of the fact that oral disclosure they are able to demonstrate that each was provided to the retail customer. 831 Proposing Release at 21611 (noting that Retail 827 See SIFMA August 2018 Letter; Edward Jones 829 See supra footnote 610 and accompanying Customer Investment Profile is consistent with Letter; Morgan Stanley Letter; CCMC Letters. text. FINRA Rule 2111(a) (Suitability)). 828 See Primerica Letter. 830 See SIFMA August 2018 Letter; CCMC Letters. 832 See Exchange Act Rule 17a–4(e)(5).

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on which the information was replaced modifications, and revisions thereto) customers, that a Compliance Date of or updated. The Commission is describing the policies and practices of one year after effectiveness is an adopting this amendment to Rule 17a– the broker-dealer with respect to appropriate timeframe for firms to 4(e)(5) substantially as proposed, with compliance with applicable laws and conduct the requisite operational the proposed reference to paragraph rules, and supervision of the activities changes to their systems to establish (a)(25) of Rule 17a–3 replaced with a of each natural person associated with internal processes to comply with reference to paragraph (a)(35) to reflect the broker-dealer, for a specified period Regulation Best Interest.838 the redesignation of the latter new rule of time. As such, we did not propose, The Commission also believes that it provision as discussed above. and are not adopting, any additional is important to coordinate the transition The Commission received several recordkeeping requirements with dates of the Relationship Summary comments regarding the proposed respect to the written policies and requirements with those of Regulation amendment to Rule 17a–4 requesting procedures that broker-dealers will be Best Interest to ensure that all retail clarification as to what communications required to create pursuant to investors receive the full suite of would be required to be retained Regulation Best Interest. protections and benefits afforded by the pursuant to the proposed rule amended and new rules. Finally, the amendment beyond those already E. Compliance Date Commission staff intends to offer firms required to be retained by existing We are providing a compliance date significant assistance and support paragraph (b)(4) of Rule 17a–4.833 Rule of June 30, 2020, consistent with the during the transition period and 17a–4(b)(4) requires broker-dealers to transition provisions described in the thereafter with the aim of helping to retain originals of all communications Relationship Summary Adopting ensure that the investor protections and received and copies of all Release.835 In light of the importance of other benefits of the final rule are communications sent by the broker- the protections provided by Regulation implemented in an efficient and dealer relating to its business as such for Best Interest, we believe that this effective manner. a period of not less than three years, the compliance date will provide adequate III. Economic Analysis first two in an easily accessible place. notice and opportunity for broker- In response, the Commission notes dealers to comply with Regulation Best A. Introduction and Primary Goals of that while the records that a broker- Interest, including by creating or the Regulation, Comments on Market dealer would be required to make in updating the necessary disclosures and Failure and Quantification, and Broad connection with Regulation Best Interest to developing, updating or establishing Economic Considerations under new paragraph (a)(35) of Rule their policies and procedures and 1. Introduction and Primary Goals of the 17a–3 may be ‘‘business as such’’ systems, as appropriate, to achieve Regulation records, the Commission believes it is compliance with Regulation Best Regulation Best Interest enhances the important, including for examination Interest. On and after the Compliance broker-dealer standard of conduct purposes, that broker-dealers separately Date, broker-dealers that provide beyond existing suitability obligations retain records that specifically recommendations of securities and aligns the standard of conduct with demonstrate compliance with transactions or investment strategies retail customers’ reasonable Regulation Best Interest and new that register with the Commission paragraph (a)(35) of Rule 17a–3 rather expectations. would be required to comply with Under Regulation Best Interest, than simply including them in the much Regulation Best Interest as of the date of broker-dealers and their associated broader ‘‘business as such’’ category registration. persons will be required to act in the required to be retained under Rule 17a– While most commenters requested an best interest of the retail customer at the 4(b)(4). Rule 17a–3(e)(5) currently serves implementation period of 18–24 time the recommendation is made, the purpose of allowing broker-dealers 836 months, one commenter requested an without placing the financial or other to demonstrate compliance with the implementation period of 12–18 interest of the broker-dealer or an customer information records required 837 months. We believe the operational associated person making the to be made pursuant to Rule 17a– capability needed to develop processes recommendation ahead of the interests 3(a)(17), and the amendment to Rule to comply with Regulation Best Interest of the retail customer. They also will be 17a–3(e)(5) being adopted today will is sufficiently established by firms of all required to address conflicts of interest serve the same purpose with respect to sizes and resources. While we by establishing, maintaining, and records required to be retained by understand commenters’ requests for enforcing policies and procedures broker-dealers to demonstrate periods longer than 12 months after reasonably designed to identify and compliance with Regulation Best effectiveness, the Commission has fully and fairly disclose material facts Interest and new paragraph (a)(35) of determined, in light of the importance about conflicts of interest, and in Rule 17a–3. of the protections afforded by instances where the Commission has Finally, as noted in the Proposing Regulation Best Interest to retail Release, the written policies and determined that disclosure is insufficient to reasonably address the procedures that broker-dealers will be 835 See Relationship Summary Adopting Release. required to create pursuant to 836 See Cetera August 2018 Letter; SIFMA August conflict, to mitigate or, in certain Regulation Best Interest are already 2018 Letter; HD Vest Letter (recommending that the instances, eliminate the conflict. As a currently required to be retained Commission adopt a 24-month implementation result, Regulation Best Interest should period); Northwestern Mutual Letter; IRI Letter enhance the efficiency 839 of pursuant to Exchange Act Rule 17a– (recommending that the Commission adopt an 18- 4(e)(7),834 which requires broker-dealers to-24-month implementation period); CCMC recommendations that broker-dealers to retain compliance, supervisory, and Letters; AXA Letter (recommending that the provide to retail customers, allow retail procedures manuals (and any updates, Commission adopt at least an 18-month customers to better evaluate the implementation period); ACLI Letter; TIAA Letter recommendations received, improve (recommending that the Commission adopt an 18- 833 See Exchange Act Rule 17a–4(b)(4); SIFMA month implementation period). retail customer protection when August 2018 Letter; Edward Jones Letter; Prudential 837 See Raymond James Letter (recommending Letter. that the Commission adopt a 12–18-month 838 See footnote 809 and accompanying text. 834 See Exchange Act Rule 17a–4(e)(7). implementation period). 839 See infra footnote 846 and accompanying text.

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receiving recommendations from may result from Regulation Best from bequeathing wealth toward his or broker-dealers, and, ultimately, reduce Interest. The analysis includes her children’s future education. agency costs 840 and other costs. consideration of the benefits and costs Capital markets facilitate this Importantly, Regulation Best Interest is to retail investors and broker-dealers, allocation and reallocation of resources. designed to preserve, to the extent and also takes into account the broader An investor can allocate available possible, (1) access and choice for implications of Regulation Best Interest resources across financial assets investors who may prefer the for efficiency, competition, and capital available to them in the capital markets, transaction-based model that broker- formation. such that these resources become dealers generally provide, or the fee- available to the investor at the times, Where possible, the Commission has based model that investment advisers and in the market and economic generally provide, or a combination of sought to quantify the likely economic conditions, when he or she needs them. both types of arrangements, and (2) effects of Regulation Best Interest. The There may be many combinations of retail customer choice of the level and Commission is providing both a financial assets or investment strategies types of services provided and the qualitative assessment and quantified that achieve an investor’s allocation securities available. For example, retail estimates of the potential effects of goals, but each of these strategies may customers who intend to buy and hold Regulation Best Interest, where feasible. not necessarily provide the investor a long-term investment on a non- The Commission has incorporated data with the same benefits or cause the discretionary basis may find that paying and other information provided by investor to bear the same costs. The a one-time commission to a broker- commenters to assist it in the analysis expected benefit of allocating resources dealer who recommends such an of the economic effects of Regulation to an investment strategy depends on investment is more cost effective than Best Interest.844 However, as explained the expected utility to the investor from paying an ongoing advisory fee to an below in more detail, because the the expected payoff of the strategy and investment adviser merely to hold the Commission does not have, has not from whether this strategy pays off in same investment.841 Retail customers received, and, in certain cases, does not the market and economic conditions who would prefer advisory accounts but believe it can reasonably obtain data and at the times that the investor cares have not yet accumulated sufficient that may inform on certain economic about. Importantly, the various costs of assets to qualify for investment advisory effects, the Commission is unable to allocating resources to any strategy accounts, which may require customers quantify certain economic effects. The reduce the resources available for to have a minimum amount of assets, Commission further notes that even in consumption and saving. may similarly benefit from cases where it has some data or it has A rational investor seeks out recommendations from broker-dealers. received some data regarding certain investment strategies that are efficient in Other retail customers who hold a economic effects, the quantification of the sense that they provide the investor variety of investments, or prefer these effects is particularly challenging with the highest possible expected net different levels of services from due to the number of assumptions that benefit, in light of the investor’s financial professionals, may benefit it would need to make to forecast how investment objective that maximizes from having access to both brokerage broker-dealers will respond to expected utility.846 From the discussion and advisory accounts. Regulation Best Interest, and how those above, an efficient investment strategy The Commission is mindful of the responses will, in turn, affect the may depend on the investor’s utility costs imposed by, and the benefits broader market for investment advice from consumption, including: (1) His or obtained from our rules. Whenever the and the retail customers’ participation her risk tolerance; (2) time available for Commission engages in rulemaking in financial markets. the funds to be invested, and not under the Exchange Act and is required consumed; (3) the resources that the to consider or determine whether an 2. Broad Economic Considerations investor has currently available (e.g., action is necessary or appropriate in the current wealth) or anticipates to become Investors generally derive utility from public interest. Section 3(f) of the available at some point in the future consuming goods and services over their Exchange Act also requires the (e.g., future income); and (4) the cost to Commission to consider, in addition to lifetime and from bequeathing wealth to 845 the investor of implementing the the protection of investors, whether the others. The amount of goods and strategy. An investor’s efficient action would promote efficiency, services that an investor can consume or investment strategy may change over competition, and capital formation.842 the amount of wealth the investor can time because the investor’s preferences, Also, when making rules pursuant to bequeath is limited by the value of the as well as market conditions and the Exchange Act, S the Commission is resources available to the investor over investment performance, may change required under Section 23(a)(2) to his or her lifetime. These resources over time. consider, among other matters, the generally vary across market and In general, a typical investor may not impact any rule would have on economic conditions and over time. An have the knowledge or the time to competition and is prohibited from investor generally seeks to allocate his identify efficient strategies on his or her adopting any rule that would impose a or her resources across market and own. In addition, investors may be burden on competition not necessary or economic conditions and over time to limited in their access to information appropriate in furtherance of the achieve the highest expected utility and their human computational purposes of the Exchange Act.843 The possible over his or her lifetime. For capacity when evaluating choices.847 As following analysis considers, in detail, example, an investor may decide to the economic effects that the save, and therefore allocate, a 846 See, e.g., Andreu Mas-Colell, Michael D. Commission believes are likely to or proportion of his or her wages to Whinston, & Jerry R. Green, Microeconomic Theory maximize his or her expected utility (1995), specifically Chapter 10: Competitive Markets for a discussion of efficient allocations of 840 See infra footnote 855 and accompanying text. resources. 841 See infra footnote 1353 and accompanying 844 See infra Section III.A.3. 847 See, e.g., Herbert A. Simon, A Behavioral text. 845 See, e.g., Irving Fisher, Theory of Interest, as Model of Rational Choice, 69 Q. J. Econ. 99 (1955) 842 See 15 U.S.C. 77b(b) and 15 U.S.C. 78c(f). Determined by Impatience to Spend Income and for one of the first works on bounded rationality. 843 See 15 U.S.C. 78w(a)(2). Opportunity to Invest it (1930). Continued

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an alternative to attempting to identify suitability may not lead to an efficient may depend on factors such as their efficient strategies on his or her own, an result for the retail customer. perception of the associated person’s investor may solicit advice from The efficiency of a recommendation ability to properly understand and financial professionals. to a retail customer may depend on: (1) account for the customer’s objectives, While there are many types of The menu of securities transactions and any information they have about the financial professionals 848 that can investment strategies the broker-dealer associated person’s or firm’s conflicts of provide advice related to a retail or its associated persons considers and interest with respect to that customer’s finances, we focus here (and makes available to the retail customer; recommendation, and the extent to in Regulation Best Interest) on a type of (2) the return distribution and the costs which these conflicts are expected to professional that retail customers of these securities transactions and result in less than efficient commonly access, namely broker- strategies; (3) the associated person’s recommendations for the retail dealers and their associated persons. understanding of these investment customer. However, other retail options and the retail customer’s customers may rely in full or in part on A broker is any person engaged in the objectives, such as the retail customer’s factors less directly related to the business of effecting transactions in risk tolerance and time preference; and recommendation at hand. Instead, they securities for the account of others.849 A (4) the retail customer’s resource might rely on factors such as their level dealer is any person engaged in the constraints. of trust with the associated person or business of buying and selling securities A recommendation provided by an firm, and in certain circumstances might for its own account, through a broker or associated person of the broker-dealer 850 be inclined to simply accept all of the otherwise. Within the scope of these may be influenced by the conflicts of associated person’s recommendations definitions, a ‘‘broker-dealer’’ (or, a firm interest that the associated person may without evaluating for themselves that fits both definitions) may offer a have or the conflicts of interest that the whether the recommendations are wide variety of services to retail broker-dealer may have at the time of efficient.854 customers. These services include the recommendation. These conflicts As noted above, broker-dealers or buying and selling securities for the can arise as a result of how broker- their associated persons may have retail customer as well as providing dealers generate revenue from various conflicts of interest that could influence limited personalized investment advice securities or investment strategies that their recommendations to retail in the form of recommendations of they make available to retail customers customers at the time when they are whether or not to engage in securities and how broker-dealers compensate provided. transactions or investment strategies their associated persons for providing A retail customer’s choice to accept a 851 involving securities. recommendations to retail customers. In particular recommendation often Federal securities laws and SRO rules the United States, broker-dealers may directly affects the compensation that an govern broker-dealers’ conduct of earn transaction-based compensation associated person or broker-dealer itself business. Among other things, they that is commonly paid either directly by receives. For example, an associated require that a broker-dealer or the retail customer (e.g., commissions person may receive greater associated person ‘‘have a reasonable and markups or markdowns) or compensation from selling certain basis to believe that a recommended indirectly through the investment securities or strategies relative to other transaction or investment strategy sponsor (e.g., 12b–1 fees or revenue securities or strategies. Differences in involving a security or securities is sharing). Broker-dealers may compensation across the securities or suitable for the customer, based on the compensate their associated persons strategies offered by a broker-dealer may information obtained through the that provide recommendations to retail add complexity to an associated reasonable diligence of the [firm] or customers with a portion of the person’s incentives and may create associated person to ascertain the commissions and markups or conflict between the interests of the customer’s investment profile.’’ 852 markdowns these persons generate associated person, who desires to While a suitable recommendation must through their recommendations. Such maximize his or her compensation, and take into account the elements of a retail financial incentives can vary depending the interests of the retail customer, who customer’s investment profile that make on the investment product line, account expects the recommended transaction to securities transactions or an investment type, or other factors (e.g., amount of be efficient for him or her. strategy efficient for that particular retail customer assets brought into the broker- In general, this conflict of interest customer, this requirement for dealer or revenue generated from may result in a broker-dealer customer accounts). recommending securities or investment strategies that are less efficient for the See also Richard H. Thaler, Behavioral Economics: A retail customer generally chooses to Past, Present, and Future, 106 Am. Econ. Rev. 1577 accept or reject a recommendation retail customer. For instance, the (2016) for a discussion of the evolution of bounded supplied by the associated person of the recommended securities or strategies rationality in economics. broker-dealer.853 Some retail customers may be enhancing the associated 848 The list of financial professionals that can person’s compensation at the expense of provide advice related to a retail customer’s may base their decisions on an finances includes broker-dealers and their assessment of whether the the retail customer. Put another way, associated persons, investment advisers, banks, and recommendations they receive would because of the financial incentives, insurance agents. result in securities transactions or broker-dealers and their associated 849 See Section 3(a)(4)(A) of the Securities investment strategies that are efficient Exchange Act. 854 See, e.g., the discussion on investor trust in 850 See Section 3(a)(5)(A) of the Securities for them. These customers’ assessment the markets for financial advice in Section III.B.4.a, Exchange Act. infra. See also Gross Letter. See also Roman Inderst 851 We focus our discussion on recommendations 853 Note, however, that a retail customer may & Marco Ottaviani, How (not) to pay for advice: A that are the focus of Regulation Best Interest but receive automated advice without involvement of framework for consumer financial protection, 105 note that broker-dealers and their representatives an associated person of the broker-dealer. For the J. Fin. Econ 393 (2012) for a discussion of the provide a wide variety of ‘‘agency services’’ as example, a broker-dealer may generate economic surplus extracted by broker-dealers that described in footnote 1 of the Proposing Release. recommendations through an asset allocation provide recommendations to retail customers, and See, e.g., 913 Study. See also infra Section III.B.1.a. model. FINRA Regulatory Notice 12–25; See also how this surplus relates to the factors that 852 See FINRA Rule 2111 (Suitability); see also FINRA Report on Digital Investment Advice (Mar. determine a retail customer’s decision to accept or infra Section III.B.2.b. 2016). reject a recommendation.

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persons may be motivated to over the compensation that the broker- between a retail customer and a broker- recommend certain types or quantities dealer and its associated person obtains dealer, given the features of the of securities or strategies, and those from providing the recommendation. compensation that the broker-dealer and recommendations may place the These limitations restrict the retail its associated persons receive for interests of the broker-dealer or its customer’s ability to reduce the agency providing recommendations (e.g., this associated persons ahead of the interests costs that he or she is facing. compensation does not depend on the of the retail customer, which may not We also recognize that even if the value of the assets in a principal’s result in the retail customer maximizing retail customer were to have full account), the broker-dealer and its his or her expected net benefit. An transparency about the broker-dealer’s associated persons may not have inefficient recommendation may lead to and its associated person’s sufficient incentive to take actions various results for the retail customer, compensation from providing advice, voluntarily that would reduce agency including inferior investment outcomes, the retail customer’s ability to reduce costs to the retail customer, such as such as risk-adjusted expected returns the agency costs may be constrained in voluntarily increasing transparency that are lower relative to other similar other ways. For example, if the menu of with respect to compensation.858 investments or investment strategies. securities from which the associated Although the dynamics of the agency A retail customer may accept a person of the broker-dealer offers relationship between a retail customer recommendation that is less efficient if recommendations is limited, the retail and a broker-dealer may not cause the he or she is unable to assess correctly customer’s and the associated person’s broker-dealer to take steps to increase the efficiency of the recommendation. ability to identify and select a more transparency, competitive factors in the The difference between the net benefit efficient investment may be constrained. broker-dealer industry such as steps to the retail customer from accepting a Different retail customers may face toward transparency taken by other less than efficient recommendation different agency costs depending on broker-dealers may cause increased about a securities transaction or whether they base their decision to act transparency in that relationship. investment strategy, where the on a recommendation on an assessment Competitive dynamics are more associated person or broker-dealer puts of the efficiency of the recommendation. effective in areas where comparisons its interests ahead of the interests of the Specifically, as noted above, a retail can be more easily made. For example, retail customer, and the net benefit the customer that evaluates and uses a in the market for mutual funds retail customer might expect from a recommendation received based on an —particularly index funds— similar securities transaction or assessment about the efficiency of that comparability and competition, among investment strategy that is efficient for recommendation may be more other factors, have driven down fees him or her, as defined above, is an successful in identifying and significantly.859 agency cost.855 As discussed in the controlling, albeit in a limited fashion, Proposing Release and above, this the compensation that the broker-dealer 858 Limited transparency with respect to how agency cost arises because of the and its associated person receive from broker-dealers and their associated persons are conflicts of interest of the broker-dealer the recommendation—such as by being compensated from recommending a security and and its associated persons, and the what constrains their menus of securities may make more likely to reject a less than efficient it difficult for retail customers to grasp the size of differences between the information sets recommendation—compared to a retail the agency costs that they are facing at the time available to the broker-dealer and the customer that makes this decision when they receive the recommendation. As a result, retail customer at the time of the without forming an assessment of the this limited transparency may allow broker-dealers recommendation. and their associated persons to extract efficiency of the recommendation. Thus, informational rents (i.e., in the context of a In certain principal-agent the agency costs may be higher for those transaction, compensation in excess of what is relationships, the principal may be able retail customers that make their competitively feasible that stems solely from the to reduce the agency costs that he or she decision of whether to act on a informational advantage of one party over another) is facing in various ways, including by from the retail customers when providing recommendation received without an recommendations. The adviser business model also structuring the agent’s compensation in assessment of the efficiency of the has its own set of conflicted incentives to gather a way that better aligns the interest of recommendation. assets (based on AUM fees) or maximize the time 856 the agent with that of the principal. While the discussion above focuses that it takes to complete a job (if paid an hourly fee). A feature of the agency relationship Dual-registrants also have an incentive to on the actions that the principal (i.e., the recommend the type of account that is most between a retail customer (the principal) retail customer) can take to reduce the profitable to the firm. See AFL–CIO April 2019 and a broker-dealer (the agent) that is agency costs that he or she is facing, the Letter. See also Morgan Lewis Letter (describing common in many principal-agent agent can also take actions to reduce the investment adviser compensation and conflicts relationships (including the investment disclosure in Form ADV); Bruce Ian Carlin & agency costs to the principal. For Gustavo Manso, Obfuscation, Learning, and the adviser-client relationship) is that the example, in the agency paradigm, when Evolution of Investor Sophistication, 24 Rev. Fin. retail customer generally does not have the principal may forgo sharing a Stud. 754 (2011) for a discussion about the full transparency about the agent’s potentially large surplus with the agent relationship between informational rents and the opacity of recommended investments (e.g., compensation for providing advice and because of the high agency costs, the the sources of the agent’s compensation. securities with complex payoff structures). agent may have an incentive to structure 859 Comparability among index funds that follow Thus, the retail customer, through the the terms of the relationship in a way the same market index is facilitated in part by their decision to accept or reject a that reduces the agency costs to the passive style of investing. Actively managed funds recommendation received, has generally principal.857 In the agency relationship that follow the same investment strategy can show limited understanding of and control different performance due to, among other things, the ‘‘skill’’ of the manager of outperforming the 857 See, e.g., Sanford J. Grossman & Oliver D. Hart, market (or any other benchmark). This skill is 855 See, e.g., Michael C. Jensen, and William. H. The Costs and Benefits of Ownership: A Theory of unobservable and generally hard to measure, which Meckling, Theory of the Firm: Managerial Behavior, Vertical and Lateral Integration, 94 J. Pol. Econ. 691 makes comparisons across actively managed funds Agency Costs and Ownership Structure, 3 J. Fin. (1986) for a discussion of the actions that agents can difficult. In contrast, comparisons across index Econ. 305 (1976) for a more general discussion of take to reduce the agency costs to the principal in funds that follow the same market index and that agency costs. the context of the relationship between an owner have passive investment styles are based more on 856 See, e.g., Stephen A. Ross, The Economic (the principal) and a manager (the agent) when the observable variables, such as fees, rather than Theory of Agency: The Principal’s Problem, 63 Am. agent that has a valuable investment opportunity unobservable variables, such as managerial skill. In Econ. Rev. ( Papers & Proc.) 134 (1973). that can only be financed by the principal. Continued

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While we do not have evidence to information asymmetries that currently quantitative assessment of the severity establish the degree to which broker- limit the ability of retail customers to of the market failure that would prompt dealers can extract large informational evaluate the efficiency of the need for regulatory intervention.867 rents from retail customers under the recommendations they receive from We address these concerns below. current legal and regulatory regime that broker-dealers and their associated With respect to the issue of governs the broker-dealers’ standard of persons. In each of these three ways, appropriately identifying the market conduct, the existing agency costs of the Regulation Best Interest is designed to relationship between the retail customer reduce the agency costs in the failure, one commenter questioned and the broker-dealer would likely be relationship between broker-dealers and whether the relationship between the larger, absent the current legal and their retail customers, including in retail customer and the broker-dealer is regulatory regime.860 In general, situations where the existing legal and a principal-agent relationship.868 This standards and regulation are effective regulatory regime that governs broker- commenter stated that in many means of reducing agency costs when dealers’ standard of conduct has had instances, a broker-dealer’s provision of principals (e.g., retail customers) and limited effectiveness. recommendations to a retail customer agents (e.g., broker-dealers) cannot resembles an arm’s length transaction 3. Comments on Market Failure of the reduce the agency costs on their own by (e.g., purchasing a car) that benefits the Principal-Agent Relationship and negotiating to address the market more informed broker-dealer at the Quantification; Comments That the frictions in their relationship through Broker-Dealer, Commission-Based expense of the less informed retail mechanisms available to them, such as Model Should Be Severely Restricted or customer. This commenter disagreed bilateral contracting 861 or ‘‘side Eliminated with the Commission’s broader view payments.’’ 862 that the market failure stems from the Regulation Best Interest enhances the The economic analysis in the agency costs of the relationship between current standard of conduct for broker- Proposing Release characterized the relationship between a retail customer dealers and codifies it in an Exchange 867 See, e.g., CFA August 2018 Letter at 105, Act rule. Regulation Best Interest is and a broker-dealer as one between a noting that ‘‘[c]orrectly diagnosing the problem designed to: (1) Enhance the current principal (the retail customer) and an requires identifying and analyzing the market standard of conduct applicable to agent (the broker-dealer).863 The failure that has occurred in investment advice analysis noted that the potential conflict securities markets, as well as assessing the broker-dealers and associated persons significance of that problem’’; See also, e.g., Letter when they make a recommendation to a between interests and the differences from Charles Cox, Former SEC Chief Economist, et retail customer of any securities between the information sets available al. (Feb. 6, 2019) (‘‘Former SEC Senior Economists transaction or investment strategy to the agent and the principal may result Letter’’) at 2, noting that ‘‘the Commission confronts in agency costs. It further noted that the important questions about advisers balancing their involving securities; (2) reduce conflicts own compensation against the effect of that of interest that currently exist between inability of the broker-dealers and retail compensation on the customer’s expected returns. retail customers and broker-dealers and customers to overcome the market We wonder if the extreme asymmetry of their associated persons; and (3) reduce frictions underlying these agency costs information and financial sophistication between may result in inefficient allocations of advisers and many of their clients constitutes a market failure that the April proposals are intended this context, disclosure that is more salient with resources. An inability of the principal to ameliorate.’’ In addition, the Former SEC Senior respect to these observable variables may facilitate and the agent to efficiently negotiate Economists Letter raised three main concerns with comparisons across index funds. around the frictions that produce agency the economic analysis in the Proposing Release: (1) 860 See, e.g., Matthew L. Kozora, Security costs and take actions that would The discussion of the potential problems in the Recommendations and the Liabilities of Broker- customer-adviser relationship was incomplete and Dealers (U.S. Sec. & Exch. Comm’n, Working Paper, increase the efficiency of their identified other features of the market for ongoing May 1, 2016), available at https://www.sec.gov/ allocations is what economists refer to retail investment advice that might be problematic; files/Kozora_BD-Liability_05-2016.pdf, which as a ‘‘market failure’’ of the principal- (2) there was inadequate discussion and analysis of provides evidence from investor awards in FINRA agent relationship,864 generally, and of the existing economic literature on financial advice; arbitrations that the author interprets as indicative and (3) there were questions of whether the of informational rents being nonzero. See also our the agency relationship between the disclosure requirements in the Proposing Release more comprehensive discussion in Section III.B.3.c, retail customer and the broker-dealer, would provide meaningful information for infra, about potential investor harm associated with specifically.865 customers. The economic analysis addresses these investment advice, including from potential The analysis in the Proposing Release concerns. For instance, with respect to (1), Section informational rents. recognized that while the Commission III.A.2 provides a more in depth discussion of the 861 See Proposing Release at 21643. potential problems that may arise when a broker- 862 Another way principals and agents negotiate cannot provide a quantified estimate of dealer provides recommendations to a retail around market frictions is through ‘‘side the magnitude of this agency cost, the customer. With respect to (2), Section III.B.3 payments.’’ In a transaction between two parties, a existence of these costs and their engages more fully with the economic literature on side payment is a monetary exchange from one persistence justifies regulatory financial advice. Finally, with respect to (3), party to another that is not part of the transaction. 866 Sections III.B.4, III.C.2, and III.C.4 provide This mechanism is discussed in the literature on intervention. discussions on the effectiveness of the disclosure bilateral externalities, which focuses on how the A number of commenters questioned requirements of Regulation Best Interest. actions of one party can affect the well-being of the this approach. Certain of these 868 See CFA August 2018 Letter at 107, noting that other party. This mechanism also applies to the commenters stated that the Commission ‘‘[t]he Commission’s economic analysis gets off to relationship between a broker-dealer and a retail needs to more fully identify the market a faulty start by mischaracterizing, or at least over- customer because the action taken by a broker- simplifying, the broker-customer ‘advice’ dealer, namely providing a recommendation, may failure that needs to be addressed, and relationship, as a principal-agent relationship. affect the well-being of the retail customer receiving certain commenters stated that the While there are certainly instances where a broker that recommendation. In the literature on bilateral Commission did not provide a and its customer can exhibit features of a bona fide externalities, if the party taking these externality principal-agent relationship—for example when actions is unconstrained, the allocation of resources executing a customer’s order—it’s not clear that, in 863 across the two parties may be inefficient. However, See Proposing Release at 21629–21631. the context of receiving investment in certain circumstances, the parties can avoid this 864 See, e.g., Mas-Colell et al. (1995), supra recommendations, those same characteristics are inefficient outcome through side payments that footnote 846. present. Certainly, the brokerage industry expressly neutralize the effect of the externality on the 865 In general, because frictions such as refutes this characterization, having argued allocations. See, e.g., Mas-Colell et al. (1995), supra asymmetric information are ever present, all successfully in the Fifth Circuit that brokers engage footnote 846, specifically Part 3: Market markets and agency relationships have some degree in nothing more than an arm’s length commercial Equilibrium and Market Failure for a discussion of of market failure. sales transaction, no different from a car dealer bilateral externalities. 866 See Proposing Release at 21631. soliciting interest in inventory.’’

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a broker-dealer and a retail customer,869 also stated that recommendations to retail customers resembles an arm’s and instead stated that the market subject to conflicts of interest may have length transaction that is ‘‘no different failure is due to conflicts of interest no value for retail customers.875 from a car dealer soliciting interest in caused by the way broker-dealers and As an initial matter, in response to inventory,’’ 879 the Commission notes their associated persons are generally comments regarding the need to discuss that under the current regulatory regime compensated for providing fully the existing market failure, it is broker-dealers and their associated recommendations to retail customers.870 important to recognize that the persons are subject to a suitability Similarly, another commenter stated Commission has been studying and standard of conduct that has been that the Commission failed to discuss carefully considering the issues related interpreted to ‘‘be consistent with [the] how the current compensation practices to the broker-dealer-client relationship customer’s best interests.’’ 880 In associated with providing and the related standard of conduct for contrast, in an arm’s length transaction, recommendations to retail customers broker-dealers for many years, which the parties involved are generally not creates incentives for the broker-dealer led to the development of the Proposing subject to a standard of conduct that and its associated persons to favor one Release and the economic analysis would constrain the more informed securities transaction or investment therein.876 In light of the comments on party from acting solely in its own strategy over another when making the Proposing Release, the extensive interest.881 Finally, in response to the recommendations to retail customers.871 outreach by the Commission and staff, commenter’s concern with respect to the This commenter further questioned as well as investor testing, the identification of the market failure,882 whether the information asymmetry and Commission has more specifically and the Commission notes that while the discrepancy in the level of financial fully described the relationship between conflicts of interest arise in many types sophistication between broker-dealers the broker-dealer and the client, the of transactions, in certain instances the and their retail customers constitute a related market failure, and the resulting parties involved can negotiate an market failure.872 One commenter noted potential economic effects of Regulation arrangement between themselves that that the poor performance of actively Best Interest in addressing the market would reduce the effect of conflicts of managed funds that are being failure.877 interest on the allocation of resources recommended by broker-dealers to The Commission continues to believe across the parties and improve the small retail customers reflects a that agency costs are at the root of efficiency of this allocation. The principal-agent problem that causes an existing allocative inefficiencies in the Commission further notes that agency ‘‘enormous’’ wealth transfer from retail market for broker-dealer advice. costs may deter the parties from customers to the financial industry, Moreover, this economic analysis engaging in privately negotiated including broker-dealers.873 This recognizes that a proper understanding arrangements that would improve the commenter stated that this problem of the economic fundamentals of an efficiency of the allocation of resources arises because of the broker-dealer’s investor’s decision to allocate resources between the parties. From this commission-based compensation for across market and economic conditions perspective, the Commission believes providing recommendations and and over time is central to identifying that it is the agency costs rather than the because of the information asymmetries the frictions that cause inefficiencies in conflicts of interest themselves that between the broker-dealer and the retail the agency relationship between a should be viewed as the source of the customer at the time of the broker-dealer and a retail customer. market failure. recommendation.874 This commenter In response to the commenter that In response to the commenter that stated that in a principal-agent noted that the Commission did not 869 See CFA August 2018 Letter at 108, noting that relationship agents do not receive discuss how the compensation received ‘‘[t]ypically, principal-agent relationships don’t compensation from third parties (e.g., by the broker-dealer and its associated involve third party payments to the agent, which persons creates incentives to favor one can adversely affect the level of loyalty the agent investment sponsors), the Commission provides to the principal.’’ notes that the compensation that the security or investment strategy over 870 See CFA August 2018 Letter at 107, noting that investment sponsor provides to the another when making recommendations 883 the Commission ‘‘fails to acknowledge that conflicts agent is ultimately funded by the to retail customers, the Commission of interest are a real problem that result in real harm has incorporated into this economic to investors [. . .]’’ and ‘‘[. . .] the Release fails to principal (i.e., the retail customer).878 In make clear whether the Commission is truly seeking addition, in response to the analysis a detailed discussion of the to address the underlying problem of conflicts’ commenter’s concern that a broker- incentives created by the current harmful impact on investors.’’ dealer’s provision of recommendations compensation practices associated with 871 See Former SEC Senior Economists Letter at providing recommendations to retail 3, noting that ‘‘[n]owhere does the EA emphasize customers.884 In addition, in response to that an adviser’s compensation provides numerous and car dealers, are paid on commission. However, opportunities for her to favor one investment over it has long been recognized that markets for the commenter’s concerns about another on the basis of the compensation it pays to professional advice are different from markets for whether the information asymmetry and her or to her firm.’’ automobiles because information asymmetries are the discrepancy in the level of financial 872 See Former SEC Senior Economists Letter at inherent in these transactions.’’ 875 sophistication between retail customers 2. See also supra footnote 867 that describes in See EPI Letter at 8, noting that ‘‘the SEC never and a broker-dealer and its associated more detail the concerns raised by this commenter. considers that ‘advice’ offered may not just be of 873 See Letter from Monique Morrissey, lower quality than expected, but worse than no persons are the source of market failure, Economist and Heidi Shierholz, Senior Economist advice at all’’ and that ‘‘much of the ‘advice’ the Commission notes that this and Director of Policy, EPI (Aug. 7, 2018) (‘‘EPI provided by broker-dealers not only lacks value, but economic analysis establishes a more Letter’’) at 6, noting that ‘‘[i]n an equilibrium with is actually harmful, steering savers to higher-cost knowledgeable investors, we would expect returns products and costly services that will reduce their 879 See supra footnote 868. from active and passive strategies to be equal. The future standard of living compared to how they 880 fact that actively-managed funds marketed to small would fare in the absence of this ‘advice.’ This may See infra footnote 979 and accompanying text. investors tend to perform poorly reflects a market be true whether or not, in the absence of conflicted 881 However, in certain markets, there may be distortion—naivete´—or a ‘principal-agent problem’ ‘advice,’ investors would have availed themselves market mechanisms in place that would prevent the in economics parlance, which results in enormous of more paid or free advice from more impartial more informed party to a transaction from acting transfers from investors to the financial industry.’’ sources.’’ solely in its own interest. 874 See EPI Letter at 2, noting that ‘‘[c]onflicts of 876 See Proposing Release at 21579–21583. 882 See supra footnote 870. interest between buyers and sellers are 877 See supra Section III.A.2. 883 See supra footnote 871. commonplace. Many salesmen, including brokers 878 See supra footnote 869. 884 See infra Section III.C.4.

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clear link between bounded rationality, In response to these comments, the including firms that are dually including access to information and Commission maintains that the registered as broker-dealers and financial literacy of retail customers, existence of misconduct that investment advisers 892 and broker- and agency costs, and reflects our commenters requested the Commission dealers affiliated with an investment conclusion that the agency costs are at to document does not render the adviser.893 The market for broker-dealer the root of the market failure. approach taken in Regulation Best services encompasses a small set of The Commission further notes that Interest irrational, inappropriate, or large and medium sized broker-dealers the so-called ‘‘informational rent’’ that a unreasonable, nor does it suggest that an and thousands of smaller broker-dealers broker-dealer may be incentivized to alternative approach would be more competing for niche or regional extract from a retail customer to take effective in fulfilling the Commission’s segments of the market.894 The market advantage of the information asymmetry mission. The Commission is aware and for broker-dealer services includes many or the discrepancy in the level of understands the concerns raised by the different markets for a variety of financial sophistication is one commenters with regards to the services, including (1) managing orders component of the agency costs evidence on investor harm and the for customers and routing them to associated with the relationship extent to which such evidence can various trading venues; (2) providing between a retail customer and a broker- inform on our understanding of the advice to customers that is in dealer. In addition, the Commission severity of the market failure in the connection with and reasonably related notes that the evidence on the size of market for broker-dealer advice. As to their primary business of effecting the agency costs associated with such discussed in the Proposing Release and securities transactions; 895 (3) holding informational rents is limited.885 This reiterated in this economic analysis, the retail customers’ funds and securities; evidence is not generally supportive of Commission believes that retail (4) handling clearance and settlement of a commenter’s assessment that the investors can be harmed when they trades; (5) intermediating between retail wealth transfer from retail customers to accept recommendations from a broker- customers and carrying/clearing broker-dealers is ‘‘enormous.’’ 886 The dealer that places the financial or other brokers; (6) dealing in corporate debt Commission agrees with this interest of the broker-dealer or its and equities, government bonds, and commenter, who stated that the way associated persons ahead of the interests municipal bonds, among other broker-dealers are compensated for of the retail customers. In addition, this securities; (7) privately placing providing recommendations and the economic analysis engages more fully securities; and (8) effecting transactions information asymmetry between retail with the economic literature on in mutual funds that involve customers and broker-dealers are financial advice and considers these transferring funds directly to the issuer. important determinants of the agency studies in analyzing the costs and Some broker-dealers may specialize in costs. However, based on the evidence benefits associated with Regulation Best just one narrowly defined service, while discussed below, the Commission Interest.890 disagrees with this commenter’s A number of broker-dealers (see infra footnote 899) assessment that the advice provided by B. Economic Baseline have non-securities businesses, such as insurance the associated persons of the broker- This section discusses, as it relates to or tax services. As of December 2018, there were approximately 17,300 state-registered investment 887 dealer has no value. this rulemaking, the current state of the advisers. The Department of Labor in its Regulatory With respect to the issue of measuring broker-dealer and investment adviser Impact Analysis identifies approximately 398 life the severity of the market failure, some markets; the current regulatory insurance companies that could provide advice to commenters stated that the Commission environment and market practices retirement investors. See infra footnote 1002. 892 surrounding the provision of Not all firms that are dually registered as an failed to take into account existing investment adviser and a broker-dealer offer both academic literature that provides recommendations by broker-dealers; brokerage and advisory accounts to retail investors. evidence of investor harm caused by evidence on the potential value and For example, some dually registered firms offer accepting advice from the associated harm of investment advice; and how advisory accounts to retail investors but offer only brokerage services, such as underwriting services, persons of the broker-dealer. A subset of issues related to trust, financial literacy, to institutional clients. For purposes of the these commenters believed that the and disclosure effectiveness affect discussion of the baseline in this economic evidence provided in some of these conflicts between investors and analysis, a dually registered firm is any firm that is academic studies is compelling and that financial professionals. The economic dually registered with the Commission as an baseline has been revised and expanded investment adviser and a broker-dealer. the Commission should use it to 893 Some broker-dealers may be affiliated with quantify the severity of the market relative to the Proposing Release to investment advisers and not dually registered. From failure.888 One commenter also urged address comments, discussed more fully Question 10 on Form BD, 2,098 (55.7%) broker- the Commission to supplement the below. dealers report that, directly or indirectly, they academic evidence on investor harm control, are controlled by, or are under common 1. Providers of Financial Services 891 control with an entity that is engaged in the with evidence from data available to the securities or investment advisory business. Commission from regulatory a. Broker-Dealers Comparatively, 2,421 (18.2%) SEC-registered oversight.889 investment advisers report an affiliate that is a Regulation Best Interest will affect the broker-dealer in Section 7A of Schedule D of Form market for broker-dealer services, ADV, including 1,878 SEC-registered investment 885 See supra Section III.A.2 and infra Section advisers that report an affiliate that is a registered III.B.3. 890 See infra Section III.B.3.c. broker-dealer. Approximately 77% of total 886 See supra footnote 873. 891 In addition to broker-dealers and Commission- regulatory AUM are managed by the 2,421 SEC- 887 See infra Section III.B.3.b. registered investment advisers discussed below in registered investment advisers. 888 See, e.g., CFA August 2018 Letter; EPI Letter; the baseline, there are a number of other entities, 894 See Risk Management Controls for Brokers or AARP August 2018 Letter; Better Markets August such as state-registered investment advisers, Dealers with Market Access, Securities Exchange 2018 Letter; Former SEC Senior Economists Letter. commercial banks and bank holding companies, Act Release No. 63241 (Nov. 3, 2010) [75 FR 69791, 889 See CFA August 2018 Letter at 112. This and insurance companies, which also provide 69822 (Nov. 15, 2010)]. For simplification, we commenter suggested that we present additional financial advice services to retail customers; present our analysis as if the market for broker- information about the existence and frequency of however, because of unavailability of data, the dealer services encompasses one broad market with the potential harm to investors ‘‘that results from Commission is unable to estimate the number of multiple segments, even though, in terms of conflicted brokerage ‘advice’,’’ which may some of those other entities that are likely to competition, it could also be discussed in terms of collectively be seen as misconduct by financial provide financial advice to retail customers as well numerous interrelated markets. professionals. as their size and the scope of services they provide. 895 See Solely Incidental Interpretation.

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others may provide a wide variety of (14%) report at least one type of non- overstates the number of broker-dealers services. securities business, including insurance, that will be subject to Regulation Best As of December 2018, there were retirement planning, mergers and Interest, because not all broker-dealers approximately 3,764 registered broker- acquisitions, and real estate, among that serve retail investors provide dealers with over 140 million customer others.899 Approximately 73.5% of recommendations to retail investors. We accounts. In total, these broker-dealers registered broker-dealers report retail do not have reliable data to determine 900 have over $4.3 trillion in total assets, customer activity. the precise number of broker-dealers which are total broker-dealer assets as Panel B of Table 1 is limited to the that provide recommendations (and the reported on Form X–17a–5.896 More broker-dealers that report some retail extent to which broker-dealers that than two-thirds of all brokerage assets investor activity. As of December 2018, provide recommendations do so, as and close to one-third of all customer there were approximately 2,766 broker- accounts are held by the 17 largest dealers that served retail investors, with opposed to executing unsolicited broker-dealers, as shown in Table 1, over $3.8 trillion in total assets (89% of trades), and as a result, we have Panel A.897 Of the broker-dealers total broker-dealer assets) and almost assumed, for purposes of this Section III registered with the Commission as of 139 million (97%) customer and Sections IV (Paperwork Reduction December 2018, 563 broker-dealers were accounts.901 Of those broker-dealers Act Analysis) and V (Final Regulatory dually registered as investment serving retail investors, 452 were dually Flexibility Act Analysis) that 2,766 advisers.898 These firms hold over 90 registered as investment advisers.902 broker-dealers will be subject to million (63%) customer accounts. The number of broker-dealers that serve Regulation Best Interest. Approximately 539 broker-dealers retail customers (i.e., 2,766) likely

TABLE 1—PANEL A: REGISTERED BROKER-DEALERS AS OF DECEMBER 2018 903 [Cumulative broker-dealer total assets and customer accounts] 904

Number of Cumulative Cumulative Size of broker-dealer Total number dually total assets number of (total assets) of BDs registered (billion) customer BDs 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

896 Assets are estimated by Total Assets management/financial/other consulting (99), broker-dealer assets (Table 1, Panel B). Of the (allowable and non-allowable) from Part II of the advisory/retirement planning (71), mergers and remaining 81 retail broker-dealers with total assets FOCUS filings (Form X–17A–5 Part II, available at acquisitions (70), foreign exchange/swaps/other in excess of $500 million that are not dual- https://www.sec.gov/files/formx-17a-5_2.pdf) and derivatives (28), real estate/property management registrants, 76 have affiliated investment advisers. correspond to balance sheet total assets for the (30), tax services (15), and other (146). Note that a 903 The data is obtained from FOCUS filings as of broker-dealer. The Commission does not have an broker-dealer may have more than one line of non- December 2018. Note that there may be a double- estimate of the total amount of customer assets for securities business. counting of customer accounts among, in particular, broker-dealers. We estimate broker-dealer size from 900 The value of customer accounts is not the larger broker-dealers as they may report the total balance sheet assets as described above. available from FOCUS data for broker-dealers. introducing broker-dealer accounts as well in their 897 Approximately $4.24 trillion of total assets of Therefore, to obtain estimates of firm size for role as clearing broker-dealers. broker-dealers (98%) are at broker-dealers with total broker-dealers, we rely on the value of broker- 904 In addition to the approximately 143 million assets in excess of $1 billion. Of the 33 dual- dealers’ total assets as obtained from FOCUS individual accounts at broker-dealers, there are registrants in the group of broker-dealers with total reports. Retail sales activity is identified from Form approximately 302,000 omnibus accounts (0.2% of assets in excess of $1 billion, total assets for these BR, which categorizes retail activity broadly (by total accounts at broker-dealers), with total assets of dual-registrants are $2.32 trillion (54%) of aggregate marking the ‘‘sales’’ box) or narrowly (by marking $32.1 billion, across all 3,764 broker-dealers, of broker-dealer assets. Of the remaining 99 broker- the ‘‘retail’’ or ‘‘institutional’’ boxes as types of sales which approximately 99% are held at broker- dealers with total assets in excess of $1 billion that activity). We use the broad definition of sales as we dealers with greater than $1 billion in total assets. are not dual-registrants, 91 have affiliated preliminarily believe that many firms will just mark See also supra footnote 897. Omnibus accounts investment advisers. ‘‘sales’’ if they have both retail and institutional reported in FOCUS data are the accounts of non- 898 This number includes the number of broker- activity. However, we note that this may capture carrying broker-dealers with carrying broker- dealers who are also registered as state investment some broker-dealers that do not have retail activity, dealers. These accounts may have securities of advisers. For purposes of the discussion of the although we are unable to estimate that frequency. multiple customers (of the non-carrying firm), or baseline in this economic analysis, a dual-registrant 901 Total assets and customer accounts for broker- securities that are proprietary assets of the non- is any firm that is dually registered with either the dealers that serve retail customers also include carrying broker-dealer. We are unable to determine Commission or a state as an investment adviser and institutional accounts. Data available from Form BD from the data available how many customer a broker-dealer. Excluding state registered advisers, and FOCUS data is not sufficiently granular to accounts non-carrying broker-dealers may have. there are 359 entities that are dually registered with identify the percentage of retail and institutional The data does not allow the Commission to parse the Commission as an investment adviser and a accounts at firms. the total assets in those accounts to determine to broker-dealer. 902 Excluding state registered advisers, there are whom such assets belong. Therefore, our estimate 899 We examined Form BD filings to identify 359 entities that are dually registered with the may be under inclusive of all customer accounts broker-dealers reporting non-securities business. Commission as an investment adviser and a broker- held at broker-dealers. For the 393 broker-dealers reporting such business, dealer. Of the 31 dual-registrants in the group of 905 Customer Accounts includes both broker- staff analyzed the narrative descriptions of these retail broker-dealers with total assets in excess of dealer and investment adviser accounts for dual- businesses on Form BD, and identified the most $500 million, total assets for these dual-registrants registrants. common types of businesses: Insurance (202), are nearly $2.01 trillion (53%) of aggregate retail

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TABLE 1—PANEL B: REGISTERED RETAIL BROKER-DEALERS AS OF DECEMBER 2018 [Cumulative broker-dealer total assets and customer accounts]

Number of Cumulative Size of broker-dealer Total number dually Cumulative number of (total assets) of BDs registered total assets customer 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 less than $10 million in assets and is category of revenues and constitutes brokerage commissions,907 fees, and weighted more heavily toward fees for approximately 42% of total revenues selling concessions from the fourth broker-dealers with assets in excess of earned by these firms. quarter of 2018 for all broker-dealers, $10 million. For example, for the 114 908 Table 2, Panel B below provides including dual-registrants. We broker-dealers with assets between $1 aggregate revenues by revenue type observe significant variation in the billion and $50 billion, average (commissions, fees, or selling sources of revenues for broker-dealers, revenues from commissions are concessions from sales of IC shares) for with large broker-dealers, on average, approximately $45 million, while broker-dealers delineated by whether generating substantially higher levels of average revenues from fees are the broker-dealer is also a dual- aggregate commission and fee revenues approximately $225 million.911 (on a nominal basis) than smaller In addition to revenue generated from registrant. Broker-dealers dually broker-dealers. On average, broker- commissions and fees, broker-dealers registered as investment advisers have a dealers, including those that are dually may also receive revenues from other significantly larger fraction of their registered as investment advisers, earn sources, including margin interest, revenues from fees compared to about $5.1 million per quarter in underwriting, research services, and commissions or selling concessions, revenue from commissions and nearly third-party selling concessions, such as whereas broker-dealers that are not four times that amount in fees,909 from sales of investment company dually registered generate although the Commission notes that fees (‘‘IC’’) shares. As shown in Table 2, approximately 42% of their advice- encompass various types of fees, not just Panel A, these selling concessions are related revenues as commissions and fees for advisory services.910 The level generally a smaller fraction of broker- only 33% of their advice-related of revenues earned by broker-dealers dealer revenues than either revenues from fees, although we lack (including dually registered firms) for commissions or fees, except for broker- granularity to determine whether commissions and fees increases with dealers with total assets between $10 advisory services, in addition to broker-dealer size, but also tends to be million and $100 million. For these supervision and administrative services, more heavily weighted toward broker-dealers, revenue from third-party contribute to fees at standalone broker- commissions for broker-dealers with selling concessions is the largest dealers.

TABLE 2—PANEL A: AVERAGE BROKER-DEALER REVENUES FROM REVENUE GENERATING ACTIVITIES 912

913 Sales of IC Size of broker-dealer in total assets N Commissions Fees 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

906 Total BDs includes all retail-facing broker- of shareholder accounts) are included. The data 910 With respect to the FOCUS data, additional dealers, including those dual-registrants that have covers both broker-dealers and dually registered granularity of what services comprise ‘‘advisory retail-facing broker-dealers. firms. FINRA’s Supplemental Statement of Income, services’’ is not available. See also Solely Incidental 907 Mark-ups or mark-downs are not included as Line 13975 (Account Supervision and Investment Interpretation. part of the brokerage commission revenue in Advisory Services) denotes that fees earned for 911 An estimate of total fees in this size category FOCUS data; instead, they are included in Net account supervision are those fees charged by the would be 114 broker-dealers with assets between $1 Gains or Losses on Principal Trades, but are not firm for providing investment advisory services billion and $50 billion multiplied by the average fee uniquely identified as a separate revenue category. where there is no fee charged for trade execution. revenue of $225 million, or $25.65 billion in total 908 Source: FOCUS data. Investment Advisory Services generally encompass fees. 909 Fees, as detailed in the FOCUS data, include investment advisory work and execution of client 912 The data is obtained from December 2018 fees for account supervision, investment advisory transactions, such as wrap arrangements. These fees services, and administrative services. Beyond the also include fees charged by broker-dealers that are FOCUS reports and averaged across size groups. broad classifications of fee types included in fee also registered with the Commodity Futures 913 Fees, as detailed in the FOCUS data, include revenue, we are unable to determine whether fees Trading Commission (‘‘CFTC’’), but do not include fees for account supervision, investment advisory such as Rule 12b–1 fees, sub-accounting, or other fees earned from affiliated entities (Item A of services, and administrative services. The data such service fees (e.g., payments by an investment question 9 under Revenue in the Supplemental covers both broker-dealers and dually registered company for personal service and/or maintenance Statement of Income). firms.

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TABLE 2—PANEL A: AVERAGE BROKER-DEALER REVENUES FROM REVENUE GENERATING ACTIVITIES 912—Continued

913 Sales of IC Size of broker-dealer in total assets N Commissions Fees shares

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

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 Exchange Member ...... 785 28.37 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 (Banks, Savings Banks, Credit Unions) ...... 197 7.12 Internet and Online Trading Accounts ...... 192 6.94 Exchange Member Engaged in Exchange Commission Business Other than Floor Activities ...... 171 6.18 Broker or Dealer Selling Tax Shelters or Limited Partnerships—Secondary Market ...... 164 5.93 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 (Insurance Company or Agency) .. 88 3.18 Real Estate Syndicator ...... 94 3.40 Broker or Dealer Selling Securities of Non-Profit Organizations ...... 71 2.57

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

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TABLE 3—LINES OF BUSINESS AT RETAIL BROKER-DEALERS AS OF DECEMBER 2018—Continued

Total Line of business Number of Percent of broker-dealers broker-dealers

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 Of all SEC-registered investment Based on staff analysis of Form ADV Other parties that could be affected by advisers, 359 identify themselves as data, approximately 62% of registered 918 Regulation Best Interest are SEC- or dually registered broker-dealers. investment advisers (8,235) have some state-registered investment advisers, Further, 2,421 investment advisers portion of their business dedicated to because Regulation Best Interest could (18%) report an affiliate that is a broker- retail investors, including both high net affect the competitive landscape in the dealer, including 1,878 investment worth and non-high net worth market for the provision of financial advisers (14%) that report an SEC- individual clients,920 as shown in Panel advice.916 This section first discusses registered broker-dealer affiliate.919 As B of Table 4.921 In total, these firms have SEC-registered investment advisers, shown in Panel A of Table 4 below, in approximately $41.4 trillion of AUM.922 followed by a discussion of state- aggregate, investment advisers have over Approximately 8,200 registered registered investment advisers. $84 trillion in AUM. A substantial investment advisers (61%) serve almost As of December 2018, there were percentage of AUM at investment 32 million non-high net worth approximately 13,300 investment advisers is held by institutional clients, individual clients and have advisers registered with the such as investment companies, pooled approximately $4.8 trillion in AUM, Commission. The majority of SEC- investment vehicles, and pension or while approximately 8,000 registered registered investment advisers report profit sharing plans; therefore, the total investment advisers (60%) serve that they provide portfolio management number of accounts for investment approximately 4.8 million high net services for individuals and small advisers is only 29% of the number of worth individual clients with $6.15 businesses.917 customer accounts for broker-dealers. trillion in AUM.923

TABLE 4—PANEL A: REGISTERED INVESTMENT ADVISERS (RIAS) AS OF DECEMBER 2018 [Cumulative RIA AUM and accounts]

Number of Size of investment adviser Number of dually Cumulative Cumulative (AUM) RIAs registered AUM number of 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

Total ...... 13,299 359 84,621 41,081,750

916 In addition to SEC-registered investment advisers are retail facing (see Item 5.D of Form filled out as greater than 0, the firm is considered advisers, which are the focus of this section, ADV). as providing business to retail investors. Part 1A of Regulation Best Interest could also affect banks, 918 See supra footnote 892. Form ADV. trust companies, insurance companies, and other 919 Item 7.A.1 of Form ADV. 922 The aggregate AUM reported for these providers of financial advice. 920 We note that the data on individual clients investment advisers that have retail investors 917 Of the approximately 13,300 SEC-registered obtained from Form ADV may not be exactly the includes both retail AUM as well as any same as who would be a ‘‘retail customer’’ as investment advisers, 8,410 (63.24%) report in Item institutional AUM also held at these advisers. defined in Regulation Best Interest because the data 923 5.G.(2) of Form ADV that they provide portfolio obtained from Form ADV regarding clients who are Estimates are based on IARD system data as management services for individuals and/or small individuals does not involve any test of use for of December 31, 2018. The AUM reported here is businesses. In addition, there are approximately personal, family, or household purposes. specifically that of those non-high net worth clients. 17,300 state-registered investment advisers, of 921 We use the responses to Items 5.D.(a)(1), Of the 8,235 investment advisers serving retail which 125 are also registered with the Commission. 5.D.(a)(3), 5.D.(b)(1), and 5.D.(b)(3) of Part 1A of investors, 318 are also dually registered as broker- Approximately 13,900 state-registered investment Form ADV. If at least one of these responses was dealers.

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TABLE 4—PANEL B: RETAIL REGISTERED INVESTMENT ADVISERS (RIAS) AS OF DECEMBER 2018 [Cumulative RIA AUM and accounts]

Number of Size of investment adviser Number dually Cumulative Cumulative (AUM) of RIAs registered AUM number of 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 Approximately 81% of state- shows the time series trend of growth in investment advisers, other investment registered investment advisers (13,927) broker-dealers and SEC-registered advisers are registered with state have some portion of their business investment advisers between 2005 and regulators.925 As of December 2018, dedicated to retail investors,927 and in 2018. Over the last 14 years, the number there are 17,268 state-registered aggregate, these firms have of broker-dealers has declined from over investment advisers,926 of which 125 are approximately $324 billion in AUM.928 6,000 in 2005 to less than 4,000 in 2018, also registered with the Commission. Of Approximately 13,910 (81%) state- while the number of investment the state-registered investment advisers, registered advisers serve 14 million non- advisers has increased from 204 are dually registered as broker- high net worth retail clients and have approximately 9,000 in 2005 to over dealers, while approximately 4.6% (786) approximately $137 billion in AUM, 13,000 in 2018. This change in the report a broker-dealer affiliate. In while over 11,497 (67%) state-registered relative numbers of broker-dealers and aggregate, state-registered investment advisers serve approximately 170,000 investment advisers over time likely is advisers have approximately $334 high net worth retail clients with $169 a reflection of the market for investment billion in AUM. Eighty-two percent of billion in AUM.929 advice, and potentially of the choices state-registered investment advisers c. Trends in the Relative Numbers of report that they provide portfolio available to retail investors regarding Providers of Financial Services management services for individuals how to receive or pay for such advice, and small businesses, compared to 63% Over time, the relative number of the nature of the advice, and the for Commission-registered investment broker-dealers and investment advisers attendant conflicts of interest. advisers. has changed. Figure 1 presented below

924 Total IAs includes all retail-facing investment a business development company and has at least 927 We use the responses to Items 5.D.(a)(1), advisers, including those dual-registrants that have $25 million of regulatory AUM; or (6) receives an 5.D.(a)(3), 5.D.(b)(1), and 5.D.(b)(3) of Part 1A. If at retail-facing SEC-registered broker-dealers and SEC- order permitting the adviser to register with the least one of these responses was filled out as greater registered investment advisers. Commission. Although the statutory threshold is than 0, the firm is considered as providing business 925 $100 million, the SEC raised the threshold to $110 Item 2.A. of Part 1A of Form ADV and to retail investors. Form ADV Part 1A. Advisers Act rules 203A–1 and 203A–2 require an million to provide a buffer for mid-sized advisers 928 investment adviser to register with the SEC if it (1) with AUM close to $100 million to determine The aggregate AUM reported for these is a large adviser that has $100 million or more of whether and when to switch between state and investment advisers that have retail investors regulatory AUM (or $90 million or more if an Commission registration. Advisers Act rule 203A– includes both retail AUM as well as any adviser is filing its most recent annual updating 1(a). institutional AUM also held at these advisers. amendment and is already registered with the SEC); 926 There are 70 investment advisers with latest 929 Estimates are based on IARD system data as (2) is a mid-sized adviser that does not meet the reported regulatory AUM in excess of $110 million of February 10, 2018. The AUM reported here is criteria for state registration or is not subject to but that are not listed as registered with the SEC. specifically that of those non-high net worth examination; (3) meets the requirements for one or None of these 70 investment advisers has exempted more of the revised exemptive rules under section status with the Commission. For the purposes of investors. Of the 13,927 state-registered investment 203A; (4) is an adviser (or subadviser) to a this rulemaking, these are considered potentially advisers serving retail investors, 134 may also be registered investment company; (5) is an adviser to erroneous submissions. dually registered as broker-dealers.

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Increases in the number of investment registration, whether federal or state), profitability,932 perceived lower advisers and decreases in the number of and many firms have been more focused regulatory burden, and provisions of broker-dealers could have occurred for a on offering fee-based accounts because more services to retail customers.933 number of reasons, including changes in they provide a more steady source of Some firms have reported record profits regulation and the enforcement of revenue than accounts that charge as a result of moving clients into fee- regulation, anticipation of possible commissions and are dependent on based accounts, and cite that it provides 934 regulatory changes, technological transactions.931 Broker-dealers have ‘‘stability and high returns.’’ innovation (e.g., the increase in indicated that the following factors have 932 automated advisers, which are often contributed to this migration: Provision Commission staff examined a sample of recent colloquially referred to as ‘‘robo- Form 10–K or Form 10–Q filings of large broker- of revenue stability or increase in dealers, many of which are dually registered as advisors’’ and online trading platforms), investment advisers, that have a large fraction of product proliferation (e.g., index mutual retail customer accounts to identify relevant broker- 931 Beyond Commission observations, the funds and exchange-traded products), dealers. See, e.g., Edward Jones 3/14/2019 Form 10– Brookings Report, supra footnote 930, also K available at https://www.sec.gov/Archives/edgar/ and industry consolidation driven by discusses the shift from broker-dealer to investment data/815917/000156459019007788/ck0000815917- economic and market conditions, advisory business models for retail investors, in 10k_20181231.htm; Raymond James 11/21/2018 particularly among broker-dealers.930 part due to the DOL Fiduciary Rule. Declining Form 10–K available at https://www.sec.gov/ transaction-based revenue due to declining Commission staff has observed the Archives/edgar/data/720005/000072000518000083/ commission rates and competition from discount rjf-20180930x10k.htm; Stifel 2/20/2019 Form 10–K transition by broker-dealers from brokerage firms has made fee-based securities and available at https://www.sec.gov/Archives/edgar/ traditional brokerage services to also services more attractive to providers of such data/720672/000156459019003474/sf-10k_ providing investment advisory services securities and services. Although discount 20181231.htm; Wells Fargo 2/27/2019 10–K brokerage firms generally provide execution-only available at https://www.sec.gov/Archives/edgar/ (often under an investment adviser services and do not compete directly in the advice data/72971/000007297119000227/wfc- market with full service broker-dealers and 12312018x10k.htm; and Ameriprise 2/23/2018 930 See Hester Peirce, Dwindling Numbers in the investment advisers, entry by discount brokers has Form 10–K available at https://www.sec.gov/ Financial Industry, Brookings Center on Markets contributed to lower commission rates throughout Archives/edgar/data/820027/000082002718000008/ and Regulation Report (May 15, 2017), available at the broker-dealer industry. Further, fee-based amp12312017.htm. We note that discussions in https://www.brookings.edu/research/dwindling- activity generates a steady stream of revenue Form 10–K and 10–Q filings of this sample of numbers-in-the-financial-industry/ (‘‘Brookings regardless of the customer trading activity, unlike broker-dealers here may not be representative of Report’’), which notes that ‘‘SEC restrictions have commission-based accounts. See also Angela A. other large broker-dealers or of small to mid-size increased by almost thirty percent [since 2000],’’ Hung, et al., Investor and Industry Perspectives on broker-dealers. and that regulations post-2010 were driven in large Investment Advisers and Broker-Dealers, RAND 933 See infra Section III.B.2.e.ii, which discusses part by the Dodd-Frank Act. Further, the Brookings Institute for Civil Justice Technical Report (2008), industry trends, particularly in response to the DOL Report observation of increased regulatory available at https://www.rand.org/content/dam/ Fiduciary Rule. restrictions on broker-dealers only reflects CFTC or rand/pubs/technical_reports/2008/RAND_ 934 See Hugh Son, Morgan Stanley Wealth- SEC regulatory actions, but does not include TR556.pdf (‘‘2008 RAND Study’’), which discusses Management Fees Climb to All-Time High, regulation by FINRA, other SROs, National Futures a shift from transaction-based to fee-based Bloomberg, Jan. 18, 2018, https:// Association (‘‘NFA’’), or the Municipal Securities brokerage accounts prior to recent regulatory www.bloomberg.com/news/articles/2018-01-18/ Rulemaking Board (‘‘MSRB’’). changes. morgan-stanley-wealth-management-fees-hit-

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

Figure 2: Time Series of the Number of Retail Clients of

Investment Advisers (2010- 2018)

~ - ...,..,.,... ~ """"'-- - u.ooo.ooo ' 1o.ooo.ooo _____ .., ______s.ooo.ooo ----

1010~9 1011~9 lOll~ l013J09 2014~9 lOIS~ 1016~ 1017~9 1018~ -:&.stimatecl Noa-HNW ctitllls -- EstimateclHNW CHeats

record-on-stock-rally. Morgan Stanley increased the Stanley Strategic Update (Jan. 18, 2018), available Merrill, Adviser Profile, Wall St. J., Jan. 25, 2018, percentage of client assets in fee-based accounts at https://www.morganstanley.com/about-us-ir/ https://blogs.wsj.com/moneybeat/2018/01/25/wsj- from 37% in 2013 to 44% in 2017, while decreasing shareholder/4q2017-strategic-update.pdf. See also wealth-adviser-briefing-the-reinvention-of-morgan- the dependence on transaction-based revenues from Lisa Beilfuss & Brian Hershberg, WSJ Wealth and-merrill-adviser-profile/. 30% to 19% over the same time period. See Morgan Adviser Briefing: The Reinvention of Morgan and

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d. Registered Representatives of Broker- definition of investment adviser previously.938 We observe in Table 5 Dealers, Investment Advisers, and representatives in Advisers Act rule that approximately 60% of registered Dually Registered Firms 203A–3 and are registered with one or financial professionals are employed by more state securities authorities to dually registered entities. The We estimate the number of associated solicit or communicate with clients.936 percentage varies by the size of the firm. natural persons of broker-dealers We estimate the number of registered For example, for firms with total assets through data obtained from Form U4, representatives and registered IARs, between $1 billion and $50 billion, 67% which generally is filed for individuals including dually-registered of all registered financial professionals who are engaged in the securities or representatives, (together ‘‘registered in that size category are employed by investment banking business of a financial professionals’’) at broker- dually registered firms. Focusing on broker-dealer that is a member of an dealers, investment advisers, and dual- SRO (‘‘registered representatives’’).935 registrants by considering only the dually registered firms only, Similarly, we approximate the number employees of those firms that have approximately 60.5% of total registered of supervised persons of registered Series 6 or Series 7 licenses or are financial professionals at these firms are investment advisers through the number registered with a state as a registered dually registered representatives; of registered investment adviser representative or investment adviser approximately 39.1% are only registered representatives (or ‘‘registered IARs’’), representative.937 We only consider representatives; and less than one who are supervised persons of employees at firms who have retail- percent are only registered investment investment advisers who meet the facing business, as defined adviser representatives.

935 The number of associated natural persons of of registered IARs may undercount the number of in appropriate jurisdictions and with SROs. Firms broker-dealers may be different from the number of supervised persons of investment advisers who and representatives have an obligation to amend registered representatives of broker-dealers because provide investment advice to retail investors and update information as changes occur. Using the clerical/ministerial employees of broker-dealers are because not all supervised persons who provide examination information contained in the form, we associated persons but are not required to register investment advice to retail investors are required to consider an employee a registered financial with FINRA. Therefore, the registered register as IARs. For example, Commission rules professional if he or she has an approved, pending, representative number does not include such exempt from IAR registration supervised persons persons. However, we do not have data on the who provide advice only to non-individual clients or temporary registration status for either Series 6 number of associated natural persons and therefore or to individuals that meet the definition of or 7 (registered representative) or is registered as an are not able to provide an estimate of the number ‘‘qualified client.’’ In addition, state securities investment adviser representative in any state or of associated natural persons. We believe that the authorities may impose different criteria for U.S. territory (IAR). We limit the firms to only those number of registered representatives is an requiring registration as an investment adviser that do business with retail investors, and only to appropriate approximation because they are the representative. licenses specifically required as a registered individuals at broker-dealers that provide advice 937 We calculate these numbers based on Form U4 representative or IAR. and services to customers. filings. Representatives of broker-dealers, 938 See supra footnotes 900 and 927. 936 See Advisers Act, [17 CFR 275.203A–3 investment advisers, and issuers of securities must (2019)]. However, we note that the data on numbers file this form when applying to become registered

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TABLE 5—TOTAL REGISTERED REPRESENTATIVES AT BROKER-DEALERS, INVESTMENT ADVISERS, AND DUALLY REGISTERED FIRMS WITH RETAIL INVESTORS 939

Size of firm % of reps. in % of reps. in % of reps. in % of reps. in % reps. in (total assets for standalone BDs and du- Total dually standalone standalone standalone standalone ally registered firms; AUM for standalone number of registered BD w/an IA BD w/o an IA IA w/a BD IA w/o a BD IAs) reps. 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 that have retail-facing businesses as example, for firms with total assets number of employees who are registered discussed previously.941 between $1 billion and $50 billion,942 representatives, registered investment In Table 6, approximately 25% of approximately 35% of all registered adviser representatives, or dually registered employees at registered employees are dually registered registered representatives.940 Similar to broker-dealers or investment advisers representatives. In contrast, for firms Table 5, we calculate these numbers are dually registered representatives. with total assets below $1 million, 13% using Form U4 filings. Here, we also However, this proportion varies of all employees are dually registered limit the sample to employees at firms significantly across size categories. For representatives.

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 number dually registered Percentages (total assets for standalone BDs and dually registered firms; of employees registered representatives of IARs only AUM for 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 representatives were dually registered as e. Investor Account Statistics adviser representatives are dually registered representatives as of mid- registered representatives. This October 2010.944 In contrast, Investors seek financial advice and percentage is relatively unchanged from approximately 52% of registered services to achieve a number of different 2010. According to information representatives were dually registered as goals, such as saving for retirement or provided in a FINRA comment letter in investment adviser representatives at children’s college education. connection with the 913 Study, 87.6% the end of 2018.945 Approximately 73% of adults live in a of registered investment adviser

939 The classification of firms as dually registered, assets exceed $1 billion. We recognize that our Chairman, U.S. Securities and Exchange standalone broker-dealers, and standalone approach of using firm assets for broker-dealers and Commission, re: File Number 4–606; Obligations of investment advisers comes from Forms BD, FOCUS, customer assets for investment advisers does not Brokers, Dealers and Investment Advisers (Nov. 3, and ADV as described earlier. The number of allow for direct comparison; however, our objective 2010), at 1, available at https://www.sec.gov/ representatives at each firm is obtained from Form is to provide measures of firm size and not to make comments/4-606/4606-2836.pdf. U4 filings. Note that all percentages in the table comparisons between broker-dealers and 945 In order to obtain the percentage of IARs that have been rounded to the nearest whole percentage investment advisers based on firm size. Across both are dually registered as registered representatives of point. broker-dealers and investment advisers, larger broker-dealers, we sum the representatives at dually 940 We calculate these numbers based on Form U4 firms, regardless of whether we stratify on firm total registered entities and those at investment advisers filings. assets or AUM, have more customer accounts, are across size categories to obtain the aggregate 941 See supra footnotes 900 and 927. more likely to be dually registered, and have more number of representatives in each of the two 942 Firm size is defined as total assets from the representatives or employees per firm than smaller categories. We then divide the aggregate dually balance sheet for broker-dealers and dual-registrants broker-dealers or investment advisers. registered representatives by the sum of the dually (source: FOCUS reports) and as AUM for 943 See supra footnotes 899, 920, 940, and 942. registered representatives and the IARs at investment advisers (source: Form ADV). We are Note that all percentages in the table have been investment adviser-only firms. We perform a unable to obtain customer assets for broker-dealers, rounded to the nearest whole percentage point. similar calculation to obtain the percentage of and for investment advisers, we can only obtain 944 See Letter from Angela C. Goelzer, FINRA, to registered representatives of broker-dealers that are information from Form ADV as to whether the firm Jennifer B. McHugh, Senior Advisor to the dually registered as IARs.

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household that invests.946 The OIAD/ finds that approximately 64% of accounts typically trade infrequently, RAND survey indicates that non- households have aggregate IRA with approximately 31% reporting no investors are more likely to be female, (traditional and Roth) balances of less annual transactions and an additional to have lower family income and than $100,000, and approximately 36% approximately 30% reporting three or educational attainment, and to be of investors have balances below fewer transactions per year.954 younger than investors.947 $25,000. As noted in one study, the With respect to particular securities, Approximately 35% of households that growth of assets in traditional IRAs do invest do so through accounts such comes from rollovers from workplace commenters have provided us with as broker-dealer or advisory accounts.948 retirement plans; for example, 58% of additional information about ownership As shown above in Figures 2 and 3, traditional IRAs consist of rollover of mutual funds and IRA account the number of retail investors and their assets, and contributions due to statistics. For example, one commenter AUM associated with investment rollovers exceeded $460 billion in 2015 stated that 56 million U.S. households advisers has increased significantly, (the most recently available data).952 and nearly 100 million individual particularly since 2012. As of December While the number of retail investors investors own mutual funds, of which 2016, nearly $24.2 trillion is invested in obtaining services from investment 80% are held through 401(k) and other retirement accounts, of which $7.5 advisers and the aggregate value of work-based retirement plans, while 63% trillion is in IRAs.949 A total of 43.3 associated AUM has increased, the of investors hold mutual funds outside million U.S. households have either an OIAD/RAND study also suggests that of those plans.955 Of those investors IRA or a brokerage account; an the general willingness of investors to who own mutual funds outside of estimated 20.2 million U.S. households use planning or to take financial advice workplace retirement plans, have a brokerage account, and 37.7 regarding strategies, securities, or approximately 50% use financial 953 million households have an IRA accounts is relatively fixed over time. professionals, while nearly one-third (including 72% of households that also With respect to the account assets purchase direct-sold funds either hold a brokerage account).950 With associated with retail investors, the directly from the fund company or respect to IRA accounts, one commenter OIAD/RAND survey also estimates that through a discount broker.956 documents that 43 million U.S. approximately 10% of investors who households own either traditional or have brokerage or advisory accounts Table 7 below provides an overview Roth IRAs and that approximately 70% hold more than $500,000 in assets, of account ownership segmented by are held with financial professionals, while approximately 47% hold $50,000 account type (e.g., IRA, brokerage, or with the remainder being direct in assets or less. Altogether, investors both) and investor income category market.951 Further, this commenter who have brokerage or advisory 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]

% Both Income category % Brokerage % IRA brokerage only only and 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 professionals, the OIAD/RAND survey use a financial professional and accounts held by investors and whether finds that 36% of its sample of approximately 33% receive some kind they are managed by financial participants report that they currently of recommendation service.958 Of the

946 See OIAD/RAND, defining ‘‘investors’’ as As noted, some survey respondent households have 955 See ICI Letter; see also Sarah Holden, Daniel persons ‘‘owning at least one type of investment both a brokerage and an IRA. See Board of Schrass, & Michael Bogdan, Ownership of Mutual account, (e.g., an employer-sponsored retirement Governors of the Federal Reserve System, Survey of Funds, Shareholder Sentiment, and Use of the account, a non-employer sponsored retirement Consumer Finances (2016), available at https:// internet, 2018, ICI Res. Persp., Nov. 2018, available account such as an IRA, a college savings www.federalreserve.gov/econres/scfindex.htm. The at https://www.ici.org/pdf/per22-06.pdf. investment account, or some other type of SCF Survey data does not directly examine the 956 See Holden et al. (2018), supra footnote 955. investment account such as a brokerage or advisory incidence of households that could use advisory See also ICI Letter. account), or owning at least one type of investment accounts instead of brokerage accounts; however, 957 See SCF Survey, supra footnote 950. To the asset (e.g., mutual funds, exchange-traded funds or some fraction of IRA accounts reported in the extent that investors have IRA accounts at banks other funds; individual stocks; individual bonds; that are not also registered as broker-dealers, our derivatives; and annuities).’’ survey could be those held at investment advisers. 951 data may overestimate the numbers of IRA accounts 947 Id. at 36. See Sarah Holden & Daniel Schrass, The Role of IRAs in US Households’ Saving for Retirement, held by retail investors that could be subject to 948 Id. at 39. Regulation Best Interest. 2018, ICI Res. Persp., Dec. 2018, available at https:// 949 See Sarah Holden & Daniel Schrass, The Role 958 www.ici.org/pdf/per24-10.pdf. See also ICI Letter. See OIAD/RAND at 48. In a focus group of IRAs in U.S. Households’ Saving for Retirement, preceding the survey, focus group participants 952 See Holden & Schrass (2018), supra footnote 2016, ICI Res. Persp., Jan. 2017, available at https:// provided a number of reasons for not using a 951. www.ici.org/pdf/per17-08.pdf. See also ICI Letter. financial professional in making investments, 950 The data is obtained from the Federal Reserve 953 See OIAD/RAND at 50 (noting that this including being unable or unwilling to pay the fees, System’s 2016 Survey of Consumer Finances (‘‘SCF conclusion was limited by the methodology of doing their own financial research, being unsure of Survey’’), a triennial survey of approximately 6,200 comparing participants in a 2007 survey with those how to work with a professional, and being U.S. households, and imputes weights to surveyed in 2018). concerned about professionals selling securities extrapolate the results to the entire U.S. population. 954 See OIAD/RAND. without attending to investors’ plans and goals.

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subset of those investors who report households’ financial decision-makers 36% (7.2 million households) seek holding a brokerage, advisory, or similar use when making decisions about advice from other sources such as account, approximately 33% self-direct savings and investments. Respondents bankers, accountants, and lawyers. their own account, 25% have their can list up to fifteen possible sources Almost 25% (5.0 million households) account managed by a financial from a preset list that includes ‘‘Broker’’ do not use advice from the above professional, and 10% have their or ‘‘Financial Planner’’ as well as sources. account advised by a financial ‘‘Banker,’’ ‘‘Lawyer,’’ ‘‘Accountant,’’ and Panel B of Table 8 below presents the professional.959 For those investors who a list of non-professional sources.961 breakdown of advice received by take financial advice, the OIAD/RAND Panel A of Table 8 below presents the households who have an IRA. study suggests that they may differ in breakdown of where households who Approximately 15% (5.7 million characteristics from other investors. The have brokerage accounts seek advice households) rely on advice services of survey further finds that investors who about savings and investments. The their broker-dealers and 48% (18.3 take financial advice are generally older, table shows that of those respondents million households) obtain advice from retired, and have a higher income than with brokerage accounts, 23% (4.7 financial planners. Approximately 41% other investors, but also may have lower million households) use advice services (15.5 million households) seek advice educational attainment (e.g., high school of broker-dealers for savings and from bankers, accountants, or lawyers, or less) than other investors.960 investment decisions, while 49% (7.8 while the 25% (9.5 million households) Similarly, one question in the SCF million households) take advice from a use no advice or seek advice from other Survey asks what sources of information ‘‘financial planner.’’ Approximately sources.

TABLE 8—PANEL A: SOURCES OF ADVICE FOR HOUSEHOLDS WHO HAVE A BROKERAGE ACCOUNT IN THE U.S. BY INCOME GROUP 962

% Taking % Taking % Taking advice from % Taking no Income category advice from advice from lawyers, advice or from brokers financial bankers, or other sources planners accountants

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 % Taking % Taking advice from % Taking no Income category advice from advice from lawyers, advice or from brokers financial bankers, or other sources planners accountants

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 f. Financial Incentives of Firms and firms to their financial professionals.965 survey participants who reported Financial Professionals While some firms provide base pay for working with a specific individual for their financial professionals ranging investment advice, 70% work with a Commission experience indicates that from approximately $45,000 to $85,000 dual-registrant, 5.4% with a broker- there is a broad range of financial per year, many firms provide dealer, and 5.1% with an investment incentives provided by standalone compensation only through a percentage adviser.964 broker-dealers and dually registered of commissions, plus performance-

959 See OIAD/RAND at 46. other choices. Respondents could also choose ‘‘Do 965 Information on compensation and financial 960 See OIAD/RAND at 48. Not Save/Invest.’’ The SCF Survey allows for incentives generally relates to 2016 compensation 961 See SCF Survey, supra footnote 950, which multiple responses, so these categories are not arrangements for a sample of approximately 20 specifically asks participants ‘‘Do you get advice mutually exclusive. However, we would note that firms, comprising both standalone broker-dealers the list of terms in the question does not from a friend, relative, lawyer, accountant, banker, and dually registered firms. We acknowledge that specifically include ‘‘investment adviser.’’ broker, or financial planner? Or do you do the information provided in this baseline may not 962 See SCFR Survey, supra footnote 950. something else?’’ See Federal Reserve Codebook for be representative of the compensation structures 2016 Survey of Consumer Finances (2016), 963 Id. more generally because of the diversity and available at https://www.federalreserve.gov/ 964 See OIAD/RAND at 53. As documented by econres/files/codebk2016.txt. Other response OIAD/RAND, retail investors surveyed had complexity of services and securities offered by choices presented by the survey include ‘‘Calling difficulty in accurately identifying the type of standalone broker-dealers and dually registered Around,’’ ‘‘Magazines,’’ ‘‘Self,’’ ‘‘Past Experience,’’ relationship that they have with their financial firms. ‘‘Telemarketer,’’ and ‘‘Insurance Agent,’’ as well as professional.

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based awards, such as individual or from approximately 1.5% for accounts award non-cash incentives for meeting team bonuses based on production.966 below $250,000 to 0.5% for accounts in certain performance, best practices, or Commission-based compensation to excess of $1 million.967 If compensation customer service goals, including financial professionals range from 30% rates range between 30% and 95%, a trophies, dinners with senior officers, to 95% of total commissions paid to the firm charging a customer $500 can and travel to annual meetings with other firm on a particular transaction, provide compensation to the financial award winners.968 professional between $150 and $475 for although this compensation is generally 2. Regulatory Baseline and Current each financial plan provided. For fee- reduced by various costs and expenses Market Practices attributable to the financial professional based accounts, assuming that a retail (e.g., clearing costs associated with customer has an account worth Broker-dealers’ current standards of some securities, charges related to an $250,000, the firm will charge account- conduct are governed by federal and SRO or the Securities Investor level fees of $3,750 ($250,000 × 1.5%), state law and regulation as well as the Protection Corporation (‘‘SIPC’’), and and the financial professional can earn rules and guidance of SROs,969 insurance, among others). between $1,170 and $3,560 annually for particularly, for the purposes of this Several firms have varying each account. However, accounts may rulemaking, those related to the commission-based compensation rates also be subject to additional fees beyond suitability of recommendations and depending on the investment type being those described here and the financial disclosure of conflicts of interest. In sold. For example, compensation ranges professionals also may receive response to comment letters that stated from 76.5% for stocks, bonds, options, additional compensation. the Proposing Release did not fully and commodities to 90% for open- In addition to ‘‘base’’ compensation, consider the current market practices, ended mutual funds, private most firms also provide bonuses (based we have provided an overview of these placements, and unit investment trusts. on either individual or team practices reported by commenters and Several firms charge varying performance) or variable compensation, from industry studies.970 Together, commissions on securities depending ranging from approximately 10% to these laws and regulations comprise the on the amount of security sold (e.g., 83% of base compensation. These regulatory baseline. bonuses could be awarded based on rates on certain proprietary mutual a. Federal and State Securities Laws funds range from 0.75% to 5.75% either commissions generated or AUM. depending on the share class), but do While the majority of firms base at least Under the antifraud provisions of the not provide those rates to financial some portion of their bonuses on federal securities laws and SRO rules, professionals based on investment type. production, usually in the form of total broker-dealers are required to deal fairly 971 Some firms also provide incentives for gross revenue, other forms of bonus with their customers. In addition, their financial professionals to compensation are derived from broker-dealers must comply with a wide recommend proprietary securities and customer retention, customer 968 services over third-party or non- experience, and manager assessment of See FINRA Regulatory Notice 16–29, Gifts, performance. Moreover, some firms use Gratuities and Non-Cash Compensation Rules— proprietary securities. Commission rates FINRA Requests Comment on Proposed for some firms, however, decline as the a tiered system within their Amendments to Its Gifts, Gratuities and Non-Cash dollar amount sold increases, and such compensation grids depending on firm Compensation Rules (Aug. 2016). At the time this rates vary across asset classes as well experience and production levels. notice was published, FINRA’s impression was that Financial professionals’ variable investment-specific internal sales contests for non- (e.g., within a given share class, rates cash compensation were not widely used. range from 1.50% to 5.75% depending compensation can also increase when 969 Generally, all registered broker-dealers that on the dollar amount of the fund sold). they enroll retail customers in advisory deal with the public must become members of With respect to compensation to accounts versus other types of accounts, FINRA, a registered national securities association, such as brokerage accounts. Some firms and may choose to become exchange members. See individual financial professionals, if Exchange Act section 15(b)(8) and Exchange Act compensation rates for mutual funds are also provide transition bonuses for rule 15b9–1. FINRA is the sole national securities approximately 90% (as discussed above, financial professionals with prior work association registered with the SEC under section for example), financial professionals can experience based on historical trailing 15A of the Exchange Act. Accordingly, for purposes production levels and AUM. Although of discussing a broker-dealer’s regulatory earn between 0.68% and 5.18%, requirements when providing advice, we focus on depending on the type and amount of many firms do not have any incentive- FINRA’s regulation, examination, and enforcement security sold. based contests or programs, some firms with respect to member broker-dealers. For financial professionals who do 970 See, e.g., AALU Letter; Letter from John L. not earn commission-based 967 We note that some firms could have higher or Thornton, Co-Chair, Committee in Capital Markets lower commission-based compensation rates or Regulation (Jul. 18, 2018) (‘‘CCMR Letter’’); CFA compensation, some firms charge retail asset-based fee percentages than those provided August 2018 Letter; Davis & Harman Letter; EPI customers flat fees ranging from $500 to here. For example, based on a review of Form ADV Letter; Lincoln Financial Letter; NASAA August $2,500, depending on the level of Part 2A (the brochure) of several large dual- 2018 Letter; UVA Letter (which stated that the service required, such as financial registrants (not included in the sample above), Proposing Release did not adequately address asset-based fees for low AUM accounts could range current market practices and/or provide industry planning, while others charge hourly as high as 2.0% to 3.0%, with the average fee for studies and surveys of those practices). rates ranging from $150 to $350 per high AUM accounts ranging between 0.5% to 1.5%. 971 See, e.g., FINRA Rule 2010 (Standards of hour. For dually registered firms that See also AdvisoryHQ, Average Financial Advisor Commercial Honor and Principles of Trade); NASD charge clients based on a percentage of Fees in 2018–2019: Fees Charged by Advisory & Interpretive Material 2310–2, Fair Dealing with Wealth Management Firms, http:// Customers (‘‘Implicit in all member and registered AUM, the average percentage charge www.advisoryhq.com/articles/financial-advisor- representative relationships with customers and varies based on the size of the account: fees-wealth-managers-planners-and-fee-only- others is the fundamental responsibility for fair The larger the AUM, the lower the advisors/. The AdvisoryHQ report shows that dealing. Sales efforts must therefore be undertaken percentage fee charged. Percentage- average asset-based fees range from 1.18% for only on a basis that can be judged as being within accounts less than $50,000 to less than 0.60% for the ethical standards of [FINRA’s] Rules, with based fees for the sample firms range accounts in excess of $30 million, while fixed-fees particular emphasis on the requirement to deal range from $7,500 for accounts less than $500,000 fairly with the public.’’); Charles Hughes & Co. v. 966 Commission experience indicates that some to $55,000 for accounts in excess of $7.5 million. SEC, 139 F.2d 434 (2d Cir. 1943), cert. denied, 321 firms award production bonuses based on Again, we note that these are charges to clients and U.S. 786 (1944); Hanly v. SEC, 415 F.2d 589, 596 commissions generated, while other firms provide are not indicative of the total compensation earned (2d Cir. 1969); see also e.g., 913 Study at 51 and awards based on AUM. by the financial professional per account. footnote 221.

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range of specific obligations specified in basis to believe that a recommended inverse exchange-traded products, and the Exchange Act and the rules securities transaction or investment IRA rollovers.980 thereunder. Moreover, there is a body of strategy involving securities is suitable c. FINRA Report on Conflicts of Interest case law holding that broker-dealers that for the retail customer.974 A broker- exercise discretion or control over dealer cannot disclaim away its In 2013, FINRA published as customer assets, or have a relationship suitability obligation under the guidance a Report on Conflicts of of trust and confidence with their Suitability Rule.975 We reviewed the Interest (‘‘FINRA Conflicts Report’’) to customers, may owe customers a Suitability Rule and drew upon it and provide an overview of effective fiduciary duty, depending on the enhanced the suitability requirement in practices that broker-dealers could circumstances.972 Additionally, some developing Regulation Best Interest.976 employ to manage and mitigate conflicts states provide through statute or FINRA also requires additional specific of interest.981 In the report, FINRA regulation, among other requirements suitability obligations with respect to provides suggestions for broker-dealers such as minimum requirements for sales certain types of securities or for addressing conflicts of interest practices, that broker-dealers have some transactions, such as variable insurance related to three broad areas: A firm-level form of state-specific fiduciary duty to products and derivatives securities, approach to identify and manage their customers in at least some including options and securities-based conflicts of interest; the production and circumstances. Substantial variation futures.977 distribution of new securities; and compensation and other financial exists among states’ fiduciary standards, As discussed by several incentives of associated persons.982 ranging from states with express commenters,978 the regulatory baseline fiduciary standards that apply to broker- With respect to new securities, the also includes FINRA guidance on best FINRA Conflicts Report recommends, dealers to those with limited or no such practices, such as guidance regarding standards.973 among other things, new security review suitability, which provides guidance on committees and disclosure of conflicts b. FINRA Rule 2111: Suitability how broker-dealers and associated related to recommendations of new FINRA Rule 2111 (the ‘‘Suitability persons should comply with suitability securities to customers.983 The FINRA Rule’’) requires that a broker-dealer or obligations when making Conflicts Report also provides guidance associated person have a reasonable recommendations to customers. FINRA to broker-dealers on managing conflicts guidance regarding suitability includes of interest that arise from compensation 972 See, e.g., U.S. v. Skelly, 442 F.3d 94, 98 (2d Regulatory Notice 12–25, which states and financial incentives of broker- Cir. 2006) (fiduciary duty found ‘‘most commonly’’ that under the Suitability Rule, ‘‘a dealers. For example, the FINRA where ‘‘a broker has discretionary authority over broker’s recommendations must be the customer’s account’’); United States v. Szur, 289 Conflicts Report recommends increased consistent with his customers’ best surveillance of recommendations near F.3d 200, 211 (2d Cir. 2002) (‘‘Although it is true 979 that there ‘is no general fiduciary duty inherent in interests,’’ as well as other regulatory compensation thresholds and capping an ordinary broker/customer relationship,’ a notices that provide guidance on the compensation credits across similar relationship of trust and confidence does exist suitability of specific securities or between a broker and a customer with respect to investment strategies involving 980 those matters that have been entrusted to the See, e.g., NASD Notice to Members 94–16, broker.’’) (citations omitted); Leib v. Merrill Lynch, securities, including, but not limited to, NASD Reminds Members Of Mutual Fund Sales Pierce, Fenner & Smith, Inc., 461 F. Supp. 951, 953– mutual funds, variable contracts Practice Obligations (Mar. 1994) and NASD Notice 954 (E.D. Mich. 1978), aff’d, 647 F.2d 165 (6th Cir. including annuities, structured and to Members 95–80, NASD Further Explains 1981) (recognizing that a broker who has de facto Members Obligations and Responsibilities control over non-discretionary account generally complex securities, leveraged and Regarding Mutual Funds Sales Practices (Sep. 1995) owes customer duties of a fiduciary nature; looking (mutual fund suitability and sales practices); NASD to customer’s sophistication, and the degree of trust 974 See FINRA Rule 2111, supra footnote 161. As Notice to Members 96–86, NASD Regulation and confidence in the relationship, among other a ‘‘General Principle,’’ the rule states that associated Reminds Members and Associated Persons that things, to determine duties owed); Arleen W. persons have a ‘‘fundamental responsibility for fair Sales of Variable Contracts are Subject to NASD Hughes, Exchange Act Release No. 4048 (Feb. 18, dealing’’ and that the rule is intended to promote Suitability Requirements (Dec. 1996) and NASD 99– 35, NASD Reminds Members of Their 1948) (Commission Opinion), aff’d sub nom. ethical sales practices and high standards of Responsibilities Regarding Sales of Variable Hughes v. SEC, 174 F.2d 969 (D.C. Cir. 1949) commercial conduct. See FINRA Rule 2111.01. See Annuities (May 1999) (suitability and sales (‘‘Release 4048’’) (noting that fiduciary also, In re Application of Raghavan Sathianathan, practices of variable contracts and variable requirements generally are not imposed upon Exchange Act Release No. 54722 at 10 (Nov. 8, annuities); NASD Notice to Members 05–59, NASD broker-dealers who render investment advice as an 2006) (‘‘Sathianathan’s recommendations . . . were Provides Guidance Concerning the Sale of Structure incident to their brokerage unless they have placed unsuitable because they were designed to maximize Products; and FINRA Regulatory Notice 12–03, themselves in a position of trust and confidence, his own commissions rather than to establish a Complex Products—Heightened Supervision of and finding that Hughes was in a relationship of suitable portfolio.’’). See also 913 Study at 59 and Complex Products (Jan. 2012); (suitability and sales trust and confidence with her clients). See also footnote 187. Gross Letter (which discussed the obligations of practices of structured and complex products); 975 FINRA Rule 2111.02 (Disclaimers). broker-dealers with discretionary or de facto control FINRA Regulatory Notice 09–31, FINRA Reminds 976 over customer accounts); Solely Incidental See supra footnote 161. The primary Firms of Sales Practice Obligations Relating to Interpretation. requirements for the Suitability Rule are described Leveraged and Inverse Exchange-Traded Funds in the Proposing Release at Section IV.B.2.a. 973 See AARP August 2018 Letter; PIABA Letter; (June 2009) (sales practices of leveraged and inverse 977 U. of Miami Letter. See also Michael S. Finke & See, e.g., FINRA Rule 2330 (Members’ ETFs); and FINRA Regulatory Notice 13–45, Thomas Patrick Langdon, The Impact of the Broker- Responsibilities Regarding Deferred Variable Rollovers to Individual Retirement Accounts— Dealer Fiduciary Standard on Financial Advice Annuities); FINRA Rule 2360 (Options); FINRA FINRA Reminds Firms of Their Responsibilities (Working Paper, Mar. 9, 2012) for a discussion of Rule 2370 (Securities Futures); FINRA Rule 2821 Concerning IRA Rollovers (Dec. 2013) (obligations state fiduciary standards. One comment letter also (Sales Practices for Deferred Variable Annuities when recommending a rollover or transfer of assets provided an extensive overview of the fiduciary including a Suitability Obligation). See also 913 from a sponsored retirement plan to an IRA). obligations of state-registered investment advisers, Study at 65–66. 981 See FINRA Conflicts Report, supra footnote ‘‘typified by an expectation of undivided loyalty 978 See CFA August 2018 Letter; Bank of America 459. See also IRI Letter, which notes that the FINRA where the adviser acts primarily for the benefit of Letter; Transamerica August 2018 Letter. Conflicts Report ‘‘. . . provides valuable guidance its clients.’’ See NASAA February 2019 Letter at 22 979 See FINRA Regulatory Notice 12–25; see also as to the elements of an effective practice and footnote 40. This comment letter also stated FINRA Regulatory Notice 13–31, Suitability— framework for managing BDs’ conflicts of that ‘‘[s]ome states also extend these fiduciary FINRA Highlights Examination Approaches, interest. . .’’ See also SIFMA August 2018 Letter; obligations beyond investment advisers to brokers, Common Findings and Effective Practices for CFA August 2018 Letter; Raymond James Letter; especially in dual-hatted scenarios,’’ and that these Complying With its Suitability Rules (Sep. 2013) Ameriprise Letter; ACLI Letter; Fein Letter. fiduciary obligations were extended even when (which provides ‘‘. . . effective practices . . . to 982 See FINRA Conflicts Report, supra footnote broker-dealers handled non-discretionary accounts. help firms enhance compliance and supervision 459. Id. at 23–24 and footnote 41. under the suitability rule’’). 983 Id.

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investment types to prevent as applicable SRO rules.989 Specifically, implications for broker-dealers, and the representatives from preferentially the Exchange Act authorizes the industry response to the DOL Fiduciary recommending securities that yield the Commission to sanction a broker-dealer Rule. Although the DOL Fiduciary Rule largest compensation.984 or any associated person that fails to was vacated by the Fifth Circuit Court reasonably supervise another person of Appeals in June, we discuss the DOL d. Other Broker-Dealer Obligations: subject to the firm’s or the person’s Fiduciary Rule as part of the baseline Disclosure, Supervision, and supervision that commits a violation of because certain broker-dealers and other Compensation the federal securities laws.990 The industry participants may have adjusted Broker-dealers are subject to other Exchange Act provides an affirmative their practices in order to plan for the disclosure obligations under the federal defense against a charge of failure to implementation of the requirements of securities laws and SRO rules. For supervise where reasonable procedures this rule. It is possible that some of instance, under existing antifraud and systems for applying the procedures these broker-dealers may continue to provisions of the Exchange Act, a have been established and effectively operate their business using these broker-dealer has a duty to disclose implemented without reason to believe adjusted practices, while other may material adverse information to its those procedures and systems are not have reverted to the pre-DOL Fiduciary customers.985 Broker-dealers found to be being complied with. Further, under the Rule practices. Below, we discuss actual acting as fiduciaries also have a duty to federal securities laws and FINRA rules, and potential costs, as well as changes disclose material conflicts of interest.986 prices for securities and broker-dealer in services and securities offerings, in Broker-dealers are also prohibited from compensation are required to be fair and response to the DOL Fiduciary Rule as making misleading statements.987 reasonable, taking into consideration all reported by industry participants Courts have found that broker-dealers, relevant circumstances.991 through surveys. We also describe how, in making recommendations, should Broker-dealers also register with and following the Fifth Circuit Court of have disclosed that they were: Acting as report information, including about Appeals decision vacating the DOL a market maker for the recommended their business and affiliates, to the Fiduciary Rule, certain of those costs security; trading as a principal with Commission, the SROs, and other have been reduced and the trend toward respect to the recommended security; jurisdictions through Form BD.992 Form reduction in retail investor access to engaging in revenue sharing with a BD requires information about the services and securities offerings that recommended mutual fund; or background of the applicant, its may have been caused in part by the 988 ‘‘scalping’’ a recommended security. principals, controlling persons, and DOL Fiduciary Rule appears to have Broker-dealers are also currently employees, as well as information about ended and may be reversing. subject to supervisory obligations under the type of business in which the Section 15(b)(4)(E) of the Exchange Act i. Department of Labor’s Fiduciary Rule broker-dealer proposes to engage and all and Temporary Enforcement Policy and SRO rules, including the control affiliates engaged in the establishment of policies and securities or investment advisory As noted above, prior to the Fifth procedures reasonably designed to business.993 Once a broker-dealer is Circuit decision, many firms took steps prevent and detect violations of, and to registered, it must keep its Form BD to come into compliance with the DOL achieve compliance with, the federal current by amending it promptly when Fiduciary Rule, and in particular, the securities laws and regulations, as well the information is or becomes BIC Exemption and other PTEs, inaccurate for any reason.994 In including changes to business 984 Id. 996 addition, firms report similar practices. 985 A broker-dealer may be liable if it does not Following the decision by the Fifth information and additional disclose ‘‘material adverse facts of which it is Circuit, the DOL acknowledged that aware.’’ See, e.g., Chasins v. Smith, Barney & Co., information—such as written customer uncertainty about fiduciary obligations 438 F.2d 1167, 1172 (2nd Cir. 1970); SEC v. Hasho, complaints and other disciplinary and the scope of exemptive relief under 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 the prohibited transaction provisions of Rule 4530 (Reporting Requirements). Release No. 48758 (Nov. 7, 2003) (Commission ERISA and the Internal Revenue Code Opinion) (‘‘When a securities dealer recommends stock to a customer, it is not only obligated to avoid e. DOL Fiduciary Rule as It Relates to following the court’s decision could affirmative misstatements, but also must disclose Current Market Practice temporarily disrupt existing investment material adverse facts of which it is aware. That This section discusses the recently advice arrangements during the includes disclosure of ‘adverse interests’ such as transition period, and also that financial ‘economic self-interest’ that could have influenced vacated DOL Fiduciary Rule,995 the its recommendation.’’) (citations omitted). See also institutions had devoted significant Relationship Summary Proposal. 989 See supra footnote 809. See also Proposing resources to comply with PTEs issued in 986 See, e.g., United States v. Szur, 289 F.3d 200, Release at 21622. connection with the DOL Fiduciary 212 (2d Cir. 2002) (broker’s fiduciary relationship 990 Exchange Act Sections 15(b)(4)(E) and Rule, including the BIC Exemption.997 with customer gave rise to a duty to disclose (b)(6)(A). Based on these concerns, the DOL commissions to customer, which would have been 991 relevant to customer’s decision to purchase stock); See, e.g., Exchange Act Sections 10(b) and issued a temporary enforcement policy Arleen W. Hughes, Exchange Act Release No. 4048 15(c); FINRA Rules 2121 (Fair Prices and Commissions), 2122 (Charges for Services stating that it would not pursue claims (Feb. 18, 1948) (Commission Opinion), aff’d sub against fiduciaries working in good faith nom. Hughes v. SEC, 174 F.2d 969, 976 (D.C. Cir. Performed), and 2341 (Investment Company 1949) (broker-dealer acted in the capacity of a Securities). See also FINRA Rule 3221 (Non-Cash to comply with the BIC Exemption’s fiduciary and, as such, broker-dealer was under a Compensation). Several commenters stated that, as Impartial Conduct Standards for duty to make full disclosure of the nature and part of their overall business practices, they use transactions that would have been non-cash compensation (e.g., firm-sponsored extent of her adverse interest when engaging in exempted by the BIC Exemption or treat principal transactions, ‘‘including her cost of the business conferences), which they believe is in securities and the best price at which the security compliance with existing FINRA Rule 3221 on non- such fiduciaries as violating applicable might be purchased in the open market’’). cash compensation practices. See Guardian August 987 See Proposing Release at footnotes 175–177 2018 Letter; NY Life Letter. 996 See supra footnotes 32–34 and accompanying and 205, and accompanying text. See Exchange Act 992 See Relationship Summary Proposal at 21472; text. Sections 10(b) and 15(c). see also generally Form BD. 997 See U.S. Department of Labor Field Assistance 988 See 913 Study at footnotes 251–54. See also 993 See generally Form BD. Bulletin 2018–02, available at https://www.dol.gov/ id. at footnotes 225–232 (which discuss existing 994 See Exchange Act rule 15b3–1(a). agencies/ebsa/employers-and-advisers/guidance/ SRO rules on disclosures). 995 See supra footnote 32. field-assistance-bulletins/2018-02.

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prohibited transactions rules.998 Prior to ii. Industry Response to DOL Fiduciary certain of the survey participants the Fifth Circuit decision, some broker- Rule reported that they responded to the DOL dealers that offered services to IRAs and Although the DOL Fiduciary Rule Fiduciary Rule and the BIC Exemption other retirement accounts may have became effective in June 2017, the DOL by reducing certain services and access implemented changes to services and provided transitional relief through July to advice to small retirement accounts. securities to comply with and meet the 2019,1003 which is now indefinitely Certain participants further reported conditions of the BIC Exemption and extended under the temporary that they encouraged customers toward other PTEs, including the Impartial enforcement policy put in place in June self-directed accounts and/or advisory Conduct Standards.999 Although the 2018 following the Fifth Circuit accounts, including robo-advisors. Commission does not currently have decision. As described above, a Certain other participants reported that data on the number of firms that may significant subset of broker-dealers have they reduced or eliminated certain have devoted resources to comply with retail customers with retirement securities within certain types of the PTEs,1000 the Commission can accounts and would have been affected retirement accounts that they offered. broadly estimate the maximum number by the DOL Fiduciary Rule, and at least Finally, certain participants reported of broker-dealers that could have some broker-dealers began taking steps that they increased certain fees for some undertaken changes in order to comply to effectuate compliance with the DOL of their customers. However, as it is with requirements of the PTEs from the Fiduciary Rule. A number of generally the case with survey analysis, number of broker-dealers that have commenters stated that we did not the surveys in the aforementioned retail customer accounts. sufficiently consider the existing studies are subject to potential selection Approximately 73.5% (2,766) of regulatory environment and the current biases (i.e., the sample of respondents is registered broker-dealers report sales to market practices of firms and financial not necessarily random) and 1001 professionals in light of the DOL’s retail customers. Similarly, methodological limitations (e.g., the Fiduciary Rule and other existing rules approximately 8,235 (62% of) design of the questionnaire may and regulations.1004 Below, we discuss investment advisers serve high net influence the choices made by the worth and non-high net worth the industry response to the DOL Fiduciary Rule and the effect of the respondents). Given these limitations, it individual clients. The Commission is generally not clear whether the results understands that these numbers are an Fifth Circuit decision on broker-dealers. In the Proposing Release, we of these studies capture significant or upper bound and likely overestimate the marginal changes in broker-dealer broker-dealers and investment advisers predominantly based our discussion of the industry and customer effects of the practices, and whether these changes that provide retirement account services are indicative of broader trends in the and began compliance with the DOL Fiduciary Rule on information 1005 market for advice in response to the requirements of the PTEs.1002 from a single industry study. Commenters provided additional DOL Fiduciary Rule. 1006 998 Id. citations to industry studies, which Changes to Services and Securities 999 See, e.g., Michael Wursthorn, A Complete List describe changes in market practices of Brokers and Their Approach to ‘The Fiduciary across a broader-sample of broker- A number of studies indicated that, as Rule’, Wall St. J., Feb. 6, 2017, https:// dealers in response to the DOL a result of the DOL Fiduciary Rule, www.wsj.com/articles/a-complete-list-of-brokers- 1007 In these studies, and-their-approach-to-the-fiduciary-rule- Fiduciary Rule. certain industry participants had 1486413491?mod=article_inline for a discussion of already or were planning to alter their how broker-dealers adjusted certain practices in laws-and-regulations/rules-and-regulations/ menu of services and securities that completed-rulemaking/1210-AB32-2/ria.pdf. response to the DOL Fiduciary Rule. they made available to retail customers. 1000 In order to perform this analysis, the 1003 See supra footnote 1002. Commission would need to know which financial 1004 See, e.g., AALU Letter; CCMC Letters; CCMR For example, of the 21 SIFMA members firms offer services to IRAs and other retirement Letter; CFA August 2018 Letter; Davis & Harman that participated in the SIFMA Study, accounts. Under the current reporting regimes for Letter; EPI Letter; Lincoln Financial Letter; 53% eliminated or reduced access to both broker-dealers and investment advisers, they Morningstar Letter; NASAA August 2018 Letter; are not required to disclose whether (or what Wells Fargo Letter. certain brokerage advice services and fraction of) their accounts are held by retail 1005 See SIFMA Study, supra footnote 33. The 67% migrated away from open choice to investors in retirement accounts. SIFMA Study surveyed 21 SIFMA members and fee-based or limited brokerage 1001 As of December 2018, 3,764 broker-dealers captured 43% of U.S. ‘‘financial advisors’’ (132,000 services.1008 Another study also have filed Form BD. Retail sales by broker-dealers out of 310,000), 35 million retail retirement were obtained from Form BR. See supra footnote accounts, and 27% of qualified retirement savings discussed a shift from commission- 900. assets ($4.6 trillion out of $16.9 trillion). The types based accounts to fee-based accounts 1002 The Department of Labor Regulatory Impact of retirement accounts serviced by the participants but offered no details about the sample Analysis (‘‘DOL RIA’’) identifies approximately in the SIFMA Study were not defined. or the methodology employed to arrive 4,000 broker-dealers (FINRA, 2016), of which 1006 See, e.g., CCMC Letters; Davis & Harman approximately 2,500 are estimated to have either Letter; EPI Letter; Lincoln Financial Letter. ERISA accounts or IRA accounts serviced by broker- 1007 See, e.g., Financial Services Roundtable & (insurance companies, securities manufacturers, dealers, similar to the estimates that we provide Harper Polling, Department of Labor Fiduciary and broker-dealers) responsible for $10 trillion in above. In addition to broker-dealers, the DOL RIA Rule: National Survey of Financial Professionals AUM and nearly 26 million investment accounts. estimates that other providers of ERISA or IRA (July 2017), available at https://www.sec.gov/ The types of accounts serviced by the participants accounts include: Approximately 10,600 federally comments/ia-bd-conduct-standards/cll4-2641320- in the Chamber Study were not defined. See also registered investment advisers and 17,000 state- 161289.pdf (see Appendix A) (‘‘FSR Study’’). The A.T. Kearney, The $20 Billion Impact of the New registered investment advisers (NASAA 2012/2013 FSR Study surveyed 600 financial advisers in July Fiduciary Rule on the U.S. Wealth Management Report), of which approximately 17,000 of federal 2017, including certified financial planners, Industry, Perspective for Discussion (Oct. 2016), and state investment advisers that are not dually chartered financial analysts, broker-dealers, and available at https://www.atkearney.com/ registered, approximately 6,000 ERISA plan dually registered representatives. See also Center documents/10192/7041991/DOL+Perspective+- sponsors (2013 Form 5500 Schedule C), and for Capital Markets Competitiveness, Fiduciary +August+2016.pdf/b2a2176b-c821-41d9-b12e- approximately 400 life insurance companies (2014 Rule: Initial Impact Analysis, FTI Consulting Report d3d2b0807d69 (‘‘Kearney Study’’). We note that the SNL Financial Data). See U.S. Department of Labor, Presented to the U.S. Chamber of Commerce (Sept. development of business models and practices Regulating Advice Markets: Definition of the Term 7, 2017), available at https:// discussed herein reflect changes made voluntarily ’Fiduciary’, Conflicts of Interest, Retirement www.centerforcapitalmarkets.com/wp-content/ by firms in response to the DOL Fiduciary Rule, but Investment Advice: Regulatory Impact Analysis for uploads/2017/07/Fiduciary-Rule-Initial-Impact- were not necessarily required by the DOL Fiduciary Final Rule and Exemptions (Apr. 2016), available Analysis.pdf (‘‘Chamber Study’’). The Chamber Rule. at https://www.dol.gov/sites/default/files/ebsa/ Study surveyed 14 financial advisory companies 1008 See SIFMA Study, supra footnote 33.

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at the estimates.1009 Finally, another Fiduciary Rule,1014 while the Chamber provided data about historical trends in study documented that at least 29% of Study noted that 13.4 million accounts certain product markets.1018 For their survey participants expected to of the companies surveyed had limited example, one commenter provided data move clients, particularly those with access to certain securities, including for the market of mutual funds and low account balances, to robo- mutual funds, variable annuities, and showed that between 2007 and 2018, advisors.1010 In addition, a number of exchange-traded funds.1015 Finally, the the percentage of assets in load mutual media articles describe several cases of SIFMA Study states that although the funds declined from 27% to 12%, while broker-dealers that have adjusted their DOL Fiduciary Rule applied only in no-load share classes increased from practices with respect to the range of connection with services for retirement 51% to 71% over the same time accounts offered as a result of the DOL accounts, certain of the survey period.1019 Further, this commenter Fiduciary Rule.1011 participants had implemented the stated that this shift has occurred changes to both retirement and non- because of the growth in assets in 401(k) Further, industry studies noted that retirement accounts.1016 These studies plans and other retirement accounts, as certain of their respondents changed do not discuss the attributes of the well as the increase in the number of their securities offerings as a result of securities that the participants chose to 1012 advisory accounts, both of which tend the DOL Fiduciary Rule. For no longer offer. In addition, as noted to invest in no-load share classes. example, 95% of the SIFMA Study above, survey analysis is subject to However, the DOL Fiduciary Rule participants altered their securities certain limitations that, generally, may have caused certain product offerings by reducing or eliminating complicate the interpretation of their markets to adjust.1020 For example, certain asset or share classes; 86% of the results. For instance, it is not generally innovations, including the introduction respondents reduced the number or type clear whether the results of these of T and clean share classes of mutual of mutual funds (e.g., 29% eliminated studies capture significant or marginal funds, can be regarded as a paradigm no-load funds, while 67% reduced the changes in broker-dealer practices, and shift in terms of how product sponsors number of mutual funds), and 48% whether these changes are indicative of compensate broker-dealers for reduced annuity securities offerings.1013 broader trends in the market for advice distribution services. One commenter Similarly, another study found that in response to the DOL Fiduciary Rule. noted that these products may reduce nearly 30% of survey participants Besides the studies mentioned above, the expected fund underperformance eliminated or reduced securities or a number of media articles provide net of costs for retail investors relative services available to retirement anecdotal evidence of broker-dealers to A shares by nearly 50 basis points investors in response to the DOL that chose to no longer offer certain annually.1021 securities.1017 Some commenters also 1009 See Kearney Study (provided by the Davis & The Effect of Costs and Fees Harman and Lincoln Financial Letters). 1014 See American Bankers Association, ABA Some firms may have responded to 1010 See FSR Study, which states that ‘‘[a]dvisors Survey: Department of Labor Fiduciary Rule (July the DOL Fiduciary Rule by either who say the average net worth of their clients is 20, 2017), available at https://www.aba.com/ under $25,000 are more likely to say they will Advocacy/Issues/Documents/dol-fiduciary-rule- presenting customers with the option to definitely, probably, or have already directed more survey-summary-report.pdf (‘‘ABA Study’’). The enter into different and potentially more clients to robo advisor services, both online and at ABA Study conducted a survey of 57 banks about costly advice relationships compared to call centers (43% vs. 29% overall).’’ their understanding of the DOL Fiduciary Rule on a brokerage advice relationship or by 1011 For example, in response to the DOL securities and services available to retirement passing some of the compliance costs to Fiduciary Rule, J.P. Morgan and Merrill Lynch investors. See also Kearney Study, which 1022 phased out commission-based retirement plans and anticipated a shift from mutual funds to exchange- customers. However, one study instead charged fees based on AUM. See Crystal traded funds, and that ‘‘certain high-cost observed that 63% of the responding Kim, BofA, JPMorgan, and the Fiduciary Rule: Will investment products (such as variable annuities) firms that limited or eliminated access They or Won’t They, Barron’s, Mar. 15, 2017, will be phased out as the business model is no to advised brokerage services stated that https://www.barrons.com/articles/bofa-jpmorgan- longer viable under [the DOL Fiduciary Rule].’’ See and-the-fiduciary-rule-will-they-or-wont-they- also FSR Study, which reported that 63% of its they had at least some customers who 1489588442. However, upon the Fifth Circuit’s survey participants anticipated fewer investment chose to move to self-directed accounts ruling on the DOL Fiduciary Rule, J.P. Morgan and options and 56% had already reduced or rather than fee-based accounts and cited Merrill Lynch reversed their earlier decision and anticipated reducing the number of mutual funds the reasons that customers provided as began to offer commission-based retirement plans offered to retirement customers. again. See Jed Horowitz, JPMorgan to Remove Some 1015 See Chamber Study. See also Editorial Board, (1) ‘‘did not want to move to a fee-based Fiduciary Rule Handcuffs, Others May Follow, Tom Perez’s Fiduciary Flop, Wall St. J., Mar. 18, account,’’ (2) ‘‘was not in the retirement AdvisorHub, May 4, 2018, https://advisorhub.com/ 2018, https://www.wsj.com/articles/tom-perezs- investor’s best interest to move to a fee- jpmorgan-to-remove-some-fiduciary-rule-handcuffs- fiduciary-flop-1521412228, which noted that some others-may-follow/; Imani Moise, Merrill Lynch firms restricted sales of commission-based Does about Face on Fiduciary-Era Policy, Reuters, securities such as load mutual funds and variable preparation-for-fiduciary-rule?tag=00000154-3e16- Aug. 30, 2018, https://www.reuters.com/article/us- annuities in retirement accounts. d45e-a175-7f9f48a20001; Bruce Kelly, Wells Fargo Advisors Restricting Investments for Retirement bank-of-america-fiducuary/merrill-lynch-does- 1016 See, e.g., SIFMA Study, supra footnote 33. Accounts, Investment News, May 24, 2017, https:// about-face-on-fiduciary-era-policy- 1017 See Alex Steger, Exclusive: UBS to Cut over www.investmentnews.com/article/20170524/FREE/ idUSKCN1LF1R9. See also Daisy Maxey, Winners 800 Funds from Platform, City Wire, Mar. 13, 2018, and Losers in a Post-Fiduciary World, Wall St. J., 170529959/wells-fargo-advisors-restricting- https://citywireusa.com/professional-buyer/news/ investments-for-retirement-accounts. May 24, 2017, available at https://www.wsj.com/ exclusive-ubs-to-cut-over-800-funds-from-platform/ 1018 See, e.g., ICI Letter. articles/winners-and-losers-in-a-post-fiduciary- a1100101; Michael Thrasher, Ameriprise Drops 1019 world-1495638708; Nir Kaissir, Merrill Lynch Can’t Hundreds of Funds Offered to Brokerage Clients, See id. Restore the Bad Old Days of Conflicts, Bloomberg, WealthManagement.com, June 8, 2017, https:// 1020 See, e.g., James Chen, Clean Shares, Sept. 4, 2018, available at https:// www.wealthmanagement.com/industry/ameriprise- Investopedia, available at https:// www.bloomberg.com/opinion/articles/2018-09-04/ drops-hundreds-funds-offered-brokerage-clients; www.investopedia.com/terms/c/clean-shares.asp, merrill-lynch-can-t-restore-the-bad-old-days-of- Hugh Son, Morgan Stanley to Reduce Wealth Fees stating that ‘‘[t]he mutual fund industry introduced conflicts. Even with Rule Uncertainty, Bloomberg, Jan. 26, clean shares, along with T shares, in response to the 1012 While the industry studies discussed in this 2017, https://www.bloomberg.com/news/articles/ Department of Labor’s fiduciary rule.’’ section examined shifts in services and securities 2017-01-26/morgan-stanley-to-proceed-with-wealth- 1021 See Letter from Aron Szapiro, Director of provided to retail investors, one limitation of these changes-ahead-of-new-rules; Margarida Correia, LPL Policy Research, Morningstar (Sept. 2017). studies is that they did not discuss whether the Puts Final Touches on Product Lineups in 1022 See supra footnote 1011 (which describes quality of advice provided to retail investors also Preparation for Fiduciary Rule, Financial Planning, how certain firms responded to the DOL Fiduciary changed as a result. Mar. 9, 2017, https://www.financial-planning.com/ Rule and later reversed changes in response to the 1013 See SIFMA Study, supra footnote 33. news/lpl-puts-final-touches-on-product-lineups-in- Fifth Circuit decision).

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based account,’’ (3) ‘‘did not meet the large firms with net capital in excess of as part of recruitment efforts.1034 account minimums,’’ or (4) ‘‘wished to $1 billion were expected to have start- However, following the decision by the maintain positions in certain asset up and ongoing compliance costs of $55 Fifth Circuit to vacate the DOL classes which were not eligible for a fee- million and $6 million, respectively, Fiduciary Rule, some firms reinstated based account.’’ 1023 Another study while firms between $50 million and $1 back-end recruiting bonuses.1035 further observed that nearly 40% of the billion in net capital were expected to iii. Additional Evidence of Current responding firms believed that the have start-up and ongoing compliance Market Practices relationship with their customers had costs of $16 million and $3 million, been altered as a result of the DOL respectively. The study further In this section, we include Fiduciary Rule and that customers with estimated that the total start-up information on Commission smaller account balances were nearly compliance costs for large and medium- observations on the broker-dealer ten times more likely to have been size firms combined would have been industry. Commission experience negatively affected by the DOL approximately $4.7 billion, while indicates that there have been a number Fiduciary Rule than customers with ongoing costs would have been of changes to the broker-dealer industry 1036 larger account balances.1024 Further, approximately $700 million per year. and its business practices over time. another study observed that 68% of the Another study observed that the costs Consistent with the trend baseline responding firms were less likely to of complying with DOL Fiduciary Rule provided in Section III.B.1.c and provide services to smaller accounts, would encompass technology, legal, industry studies and anecdotal evidence and 46% anticipated that they may process changes, educational, and described above, we have observed service fewer clients overall.1025 training costs for firms.1030 This study firms choosing to do business with retail One study observed that, generally, forecasted that the DOL Fiduciary Rule investors as investment advisers, not as based on the numbers provided by the may cause a $2 trillion redistribution in broker-dealers, by either migrating respondents, a fee-based account can be assets from broker-dealers to investment existing brokerage accounts to advisory more costly than a brokerage account; advisers, robo-advisors, and self- accounts or directing new retail however, such comparison is generally directed accounts, and a nearly $20 customers to advisory accounts. Beyond broker-dealer trends in hard to make without knowing the billion decrease in revenues to the business practices, Commission securities in the two types of accounts, entire financial services industry, and it is not clear that the survey made experience also indicates that some including broker-dealers. broker-dealers have responded to the this clear to respondents.1026 One The study further forecasted that as a study 1027 observed that approximately DOL Fiduciary Rule and the Fifth result of the DOL Fiduciary Rule Circuit decision vacating the DOL 52% of its survey participants indicated product sponsors ‘‘will be incentivized that they may pass on the costs Fiduciary Rule by modifying their to streamline product offerings, lower existing business practices. For associated with complying with the fees, and improve performance,’’ and example, some firms, consistent with DOL Fiduciary Rule to clients in the investor would pay $7.5 billion less in anecdotal evidence discussed above, form of higher fees, while another study mutual fund and ETF expenses by the eliminated brokerage IRA accounts in stated that more than 6 million client end of 2010. However, as noted above, response to the DOL Fiduciary Rule; accounts of the survey participants may this study does not provide details however, upon the Fifth Circuit be subject to higher costs and fees as a about how it obtained its estimates. decision, the firms reinstituted result of the DOL Fiduciary Rule, Several media articles provide some although it is not clear whether this anecdotal evidence suggesting that as a 1034 See Mason Braswell, Morgan Stanley estimate assumes full adoption of the response to the DOL Fiduciary Rule Resumes Recruiting Offers—Slimmer and DOL- DOL Fiduciary Rule.1028 some broker-dealers began to alter the Compliant, AdvisorHub, Nov. 3, 2016, https:// advisorhub.com/morgan-stanley-resumes- Estimated Costs of Compliance and compensation structures of their recruiting-offers-slimmer-and-dol-compliant/; Deon 1031 Effects on Compensation Structures registered representatives. For Roberts, Wells Fargo Overhauling Bonuses to example, some broker-dealers have Comply with New Rules on Financial Advisers, One study observed that survey indicated that they adjusted their Charlotte Observer, Dec. 14, 2016, https:// respondents were expecting to incur compensation structures by equalizing www.charlotteobserver.com/news/business/ compliance costs as a result of the DOL banking/bank-watch-blog/article120961138.html. commissions and deferred sales charges 1035 Fiduciary Rule that would vary by the See Mason Braswell, Farewell Fiduciary 1032 Rule? Morgan Stanley Sweetens Recruiting Bonuses, 1029 across similar securities. Other size of the respondent. For instance, broker-dealers banned sales quotas, AdvisorHub, May 1, 2018, https://advisorhub.com/ contests, special awards, and farewell-fiduciary-rule-morgan-stanley-sweetens- 1023 recruiting-bonuses/. ‘‘Back-end’’ bonuses are See SIFMA Study, supra footnote 33. 1033 1024 See ABA Study. bonuses, including deferred bonuses expressly contingent on the achievement of sales or 1025 See FSR Study. See also Chamber Study, asset targets. See U.S. Department of Labor, Conflict which found that some survey participants have including this study, are based on a rulemaking of Interest FAQs (Part I—Exemptions) (Oct. 27, added minimum account balances and have with more extensive requirements for changes to 2016), available at https://www.dol.gov/sites/ default/files/ebsa/about-ebsa/our-activities/ migrated away from commission-based models business models than those required by Regulation resource-center/faqs/coi-rules-and-exemptions-part- toward fee-based models. Best Interest. 1.pdf. 1026 See SIFMA Study. We note that only a subset 1030 See Kearney Study. 1036 Information on the broker-dealer industry of the SIFMA Study participants provided 1031 See Son (2017), supra footnote 1017; Tara and business practices comes from a variety of information on the costs associated with brokerage Siegel Bernard, Do Financial Advisers Have to Act Commission resources and generally relates to and advisory accounts. See CFA August 2018 in Your Interest? Maybe, N.Y. Times, Mar. 22, 2018, market trends and changes to business practices Letter. The SIFMA Study did not provide any https://www.nytimes.com/2018/03/22/your-money/ that have emerged in recent years and is comprised information on the set of firms comprised in this financial-advisers-customer-interest.html. of both standalone broker-dealers and dually subset that provided information on brokerage and 1032 See, e.g., Andrew Welsch, Facing Higher registered firms. With respect to industry trends, advisory costs. See also ICI Letter (which provided Costs, Raymond James Cuts Adviser Pay in Rare Commission resources generally verify data cited similar estimates for fees and costs attributable to Move, Financial Planning, July 11, 2017, https:// above in Section III.B.2.e.ii. We acknowledge that brokerage and advisory accounts). onwallstreet.financial-planning.com/news/facing- the information provided in this baseline may not 1027 See FSR Study. higher-costs-raymond-james-cuts-adviser-pay-in- be representative of business practices more 1028 See Chamber Study. rare-move?tag=00000151-16d0-def7-a1db- generally because of the diversity and complexity 1029 See SIFMA Study. As a general matter, we 97f024310000. of services and securities offered by standalone note that the estimates reported by industry studies, 1033 See Bernard (2018). broker-dealers and dually registered firms.

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brokerage IRAs. Other examples of a. Who Seeks Investment Advice 1039 the choice by retail investors to select changes following the Fifth Circuit Approximately 37% of U.S. into broker-sold or direct-sold mutual decision include changes to incentive- households currently engage with funds. These studies find less based compensation in certain types of financial professionals according to financially sophisticated investors are accounts and principal trading OIAD/RAND; however, households who more likely to purchase ‘‘broker-sold’’ restrictions. hire these professionals are not funds and therefore more likely to uniformly distributed among the U.S. receive advice from a financial 3. Investment Advice and Evidence of 1042 population.1040 In addition to OIAD/ professional. Potential Investor Harm RAND, a number of academic studies, As we detail below, retail investors bear costs associated with obtaining A number of commenters expressed provided with comment letters, examine advice from financial professionals, the view that the Proposing Release did characteristics of investors and their propensity for seeking (and following) which may deter some investors, not fully document the problems especially those with limited wealth or attributed to potential conflicts of investment advice. Older, wealthier, more educated, and financially more income, from seeking investment interest stemming from the broker- advice. However, an investor’s lack of dealer model and the resulting harm to literate retail investors are more likely to seek and act on advice obtained from sophistication may also prevent the retail customers.1037 In order to address financial professionals, suggesting that investor from obtaining or using these commenters’ concerns, we analyze investors who may benefit most from investment advice even when advice is academic and industry studies to advice (younger, less educated, and less provided at no cost. One paper present an overview of the market for financially sophisticated) are least likely examines the outcomes from a large 1038 advice for retail customers. Below, to obtain it.1041 Several studies examine sample of active retail investors of a we discuss which types of investors large broker-dealer.1043 These retail seek investment advice; the benefits 1039 One limitation of the majority of the studies investors received unsolicited and attained through investment advice for examined is that we are unable to distinguish unbiased advice from the broker-dealer retail investors; limitations to the value whether the retail investor is seeking and/or at no cost. Although the advice was receiving investment advice from a broker-dealer or of that advice that stem from agency an investment adviser (or some other type of designed to improve the efficiency of costs, particularly those related to financial professional). The studies generally do not the investors’ portfolios, only 5% of conflicts of interest arising from have sufficiently granular data to distinguish investors accepted the offer to receive broker-dealer customers from investment adviser the free advice. Moreover, those that did financial professional compensation; clients. Further, for studies where retail investors and evidence of potential investor harm. can be distinguished by their investment choices accept the advice rarely followed the Where appropriate, we note limitations (e.g., purchasing direct-sold versus broker-sold advice. Investors who participated in to the application of various academic funds), we are unable to determine whether the study had only minimal differences exist between broker-sold funds sold by studies that form the basis of other improvements to their portfolio broker-dealers and broker-sold funds sold by efficiency. The authors cite lack of economic analyses, which investigate investment advisers. As discussed below, some financial sophistication and lack of potential investor harm attributed to commenters expressed the view that buy-and-hold retail investors were more likely to prefer the familiarity or trust as reasons why the recommendations received from services of brokerage accounts over advisory unsolicited advice was not followed.1044 financial professionals. accounts. See infra footnote 1055. 1040 According to OIAD/RAND, the use of financial professionals varies by both income and likely to seek and act on financial advice that are 1037 See, e.g., AARP August 2018 Letter; Better education levels. For example, 38% of retail not captured by the studies suggested by the Markets August 2018 Letter; CFA August 2018 investors with income greater than $100,000 engage commenters). Studies also note that the Letter; EPI Letter; U. of Miami Letter; Morningstar with financial professionals, while only 13.7% of characteristics of investors most likely to seek Letter; PIABA Letter; Letter from Ron A. Rhoades, retail investors with incomes below $25,000 did so. advice are also likely to be those most attractive to Director, Personal Financial Planning Program and Another study, the Survey of Consumer Finance, financial professionals as they have more assets to Assistant Professor of Finance, Gordon Ford College indicates that the use of financial professionals by manage. See Michael S. Finke, Financial Advice: of Business, Western Kentucky University (Aug. 6, American households is closer to 60%, but also Does it Make a Difference? (Working Paper, May 5, 2018) (‘‘Rhoades August 2018 Letter’’); Former SEC includes financial planners, accountants, lawyers, 2012) (which describes the relationship between Senior Economists Letter. and bankers, in addition to broker-dealers and investors and financial professionals). 1038 Although the discussion here generally investment advisers. See SCF Survey, supra 1042 See, e.g., Christopher J. Malloy & Ning Zhu, focuses on studies provided by comment letters, at footnote 950. Mutual Fund Choices and Investor Demographics times we have included additional references either 1041 See, e.g., Utpal Bhattacharya et al., Is (Working Paper, Mar. 14, 2004), available at https:// to more fully articulate specific arguments or to Unbiased Financial Advice to Retail Investors pdfs.semanticscholar.org/16a1/8daed89c3c48 provide counterarguments to studies provided by Sufficient? Answers from a Large Field Study, 25 a765ad3a265018b4d27bd0f4.pdf; John Sabelhaus, comment letters in an effort to present a complete Rev. Fin. Stud. 975 (2012); Daniel Hoechle et al., Daniel Schrass, & Steven Bass, Characteristics of overview of pertinent literature. Because the studies The Impact of Financial Advice on Trade Mutual Fund Investors, 2008, ICI Res. we cite in this section generically discuss Performance and Behavioral Biases, 21 Rev. Fin. Fundamentals, Feb. 2009, available at https:// investment advice or advice rather than 871 (2017); Jeremy Burke & Angela A. Hung, Do www.ici.org/pdf/fm-v18n2.pdf; John Chalmers & recommendations, and use a variety of terms to Financial Advisors Influence Savings Behavior?, Jonathan Reuter, Is Conflicted Advice Better than describe financial professionals or firms (e.g., RAND Labor and Population Report Prepared for No Advice? (Working Paper, Sept. 14, 2015), brokers, advisers, or financial advisers) and the Department of Labor (2015), available at https:// available at https://www.semanticscholar.org/ investors (e.g., investors, customers, or clients), in www.rand.org/content/dam/rand/pubs/research_ paper/Is-Conflicted-Investment-Advice-Better-than- the discussion that follows, we use generic terms reports/RR1200/RR1289/RAND_RR1289.pdf; No-Chalmers-Reuter/3337ce8c3a72bf55dac43f407 of advice or investment advice, financial Claude Montmarquette & Nathalie Viennot-Briot, fd104b93aec863b. See also AARP August 2018 professional, firm, and retail investor or investor. Econometric Models on the Value of Advice of a Letter; CFA August 2018 Letter; EPI Letter (which Although we believe that the studies generally Financial Advisor, CIRANO Project Report No. provided the Chalmers & Reuter (2015) citation; discuss advice as it relates to broker-dealers or 2012RP–17 (July 2012), available at https:// Malloy & Zhu (2004) and Sabelhaus et al. (2009) are investment advisers, because of generic terms used, www.cirano.qc.ca/pdf/publication/2012RP-17.pdf; included because they capture aspects of the such as ‘‘financial adviser,’’ it is possible that other Andreas Hackethal, Michael Haliassos, & Tullio mutual fund selection decision by retail investors types of advice providers (e.g., commercial banks, Jappelli, Financial Advisors: A Case of Babysitters?, that are not captured by the studies suggested by tax consultants, etc.) could be included in some of 36 J. Banking & Fin. 509 (2012). See also AARP the commenters). We provide a more detailed the studies cited below. However, because not all August 2018 Letter; CFA August 2018 Letter; FPC discussion of these studies below in Section authors clearly define which financial professionals Letter; Primerica Letter; Wells Fargo Letter (which III.B.3.c. are included in a given study, we are unable to provided several studies cited here; other studies 1043 See Bhattacharya et al. (2012), supra footnote provide an exhaustive list of all types of financial (e.g., Hoechle et al. (2017)) are included because 1041. professionals that make up the market for advice. they capture characteristics of the investors most 1044 See id.

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b. Benefits and Limitations of notes that investors who engaged detract from returns over time; 1052 and Investment Advice financial professionals for at least 15 (2) the indirect costs to retail investors A number of commenters provided years had approximately 173% more that arise from conflicts of interest academic studies of benefits that assets on average than investors who between financial professionals and investors may obtain from hiring did not hire financial professionals, investors. Financial professionals are financial professionals.1045 One benefit driven by higher household savings generally compensated directly by retail of hiring a firm or financial professional rates and increased asset allocation to investors in three principal ways: is that professional advice can help the non-cash instruments.1049 Further, Commission-based (e.g., broker-dealers), average retail investor overcome financial professionals may be able to fee-based on AUM (e.g., investment common ‘‘investment mistakes’’ that he help retail investors overcome advisers), and flat or hourly fees (e.g., or she may make when investing.1046 information asymmetries that exist financial planners), although some Common ‘‘investment mistakes’’ made between firms that supply securities and financial professionals may receive by retail investors include limited their customers that retail investors compensation in multiple ways for would not be able to disentangle on providing advice to the same allocation of assets to equities, under- 1053 diversification, excessive trading, and their own.1050 investor. One study estimates that the average home bias.1047 These studies also Commenters also provided academic annual costs associated with attempt to identify reasons why retail studies which discussed the limitations commission-based accounts are investors persistently make inefficient of the advice received from financial approximately 75 bps, while the average investment choices. professionals, including how both direct fee-based account costs 130 bps.1054 We Beyond correcting potential and indirect costs of advice can reduce 1051 acknowledge that in addition to the fees ‘‘investment mistakes,’’ academic returns earned by investors. How charged for particular types of services, studies document a multitude of other financial professionals are compensated other expenses may be incurred that benefits that accrue to retail investors as can erode the value of advice in two reduce returns earned by investors, a result of seeking investment advice, primary ways: (1) The direct costs some of which may be earned by the including, but not limited to: Higher associated with purchasing advice financial professional or the firm and household savings rates, setting long- paid by the firm’s product or service term goals and calculating retirement Hackethal, High-Quality Financial Advice Wanted! providers (e.g., fund loads, 12b–1 fees, needs, more efficient portfolio (Working Paper, Feb. 2008), available at http:// citeseerx.ist.psu.edu/viewdoc/ and shareholder servicing fees). diversification and asset allocation, summary?doi=10.1.1.596.2310; Neal M. Stoughton, Some commenters expressed the view increased confidence and peace of Youchang Wu, & Josef Zechner, Intermediated that certain investors (e.g., buy-and-hold mind, improvement in financial Investment Management, 66 J. Fin. 947 (2011). Marsden et al. (2011) documents benefits investors) may prefer to pay a single situations, and improved tax commission relative to an ongoing fee- 1048 attributable to hiring a financial professional, such efficiency. For example, one study as better retirement account diversification and savings goals, but does not find that hiring a 1052 As noted in one study, the direct costs (fees 1045 See infra footnote 1048. financial professional measurably increases the and expenses) may not be transparent to retail 1046 See Bhattacharya et al. (2012), supra footnote amount of overall wealth accumulation for those investors. Coupled with conflicts of interest that 1041. ‘‘Investment mistakes’’ are investors’ actions investors. See also, Burke & Hung (2015), supra can bias any advice provided, information that would go against what a rational investor footnote 1041, for additional studies on the causal asymmetry between financial professionals and would do when undertaking efficient investment relation between the use of a financial professional retail investors may be large. See Finke (2012), decisions (here and below, infra footnote 1047, we and wealth accumulation. Francis M. Kinniry et al., supra footnote 1041. provide studies that analyze common ‘‘investment Putting a Value on Your Value: Quantifying 1053 For example, investment advisers and mistakes’’ made by retail investors). For example, Vanguard Advisor’s Alpha, Vanguard Research supervised persons may receive account-level evidence suggests that retail investors tend to trade (Sept. 2016), available at https:// advisory fees, and may also receive compensation too frequently. See Brad M. Barber & Terrance www.vanguard.com/pdf/ISGQVAA.pdf, estimates for the sale of securities or other investment Odean, Trading is Hazardous to Your Wealth: The the value to investors associated with obtaining products, including asset-based sales charges or Common Stock Performance of Individual financial advice of approximately 3% in net returns service fees for the sale of mutual funds to their Investors, 55 J. FIN. 773 (2000). to investors, associated with suitable asset advisory clients. See Items 5.C, 5.E, and 14.A of 1047 As described in Bhattacharya et al. (2012), allocation, managing expense ratios, behavioral Form ADV Part 2A; Items 4.A.2, 4.B, and 5 of Form supra footnote 1041, possible explanations for coaching, alleviating home bias, among others. See ADV Part 2B. When we refer to advisers and common ‘‘investment mistakes’’ may arise from also AARP August 2018 Letter; CCMC Letters; CFA supervised persons receiving fees for the sale of behavioral biases (e.g., cognitive errors), the cost of August 2018 Letter; Edward Jones Letter; Letter securities or other investment products, we information acquisition, or the selection of the from Brian M. Nelson (Jul. 10, 2018) (‘‘Nelson generally mean advisers that are also registered financial professional. See, e.g., Luigi Guiso, Paolo Letter’’) (which provided several of these studies; broker-dealers or advisers whose affiliated broker- Sapienza, & Luigi Zingales, People’s Opium? other studies were included because they capture dealers receive these fees. Form ADV instructs Religion and Economic Attitudes, 50 J. Monetary aspects of the benefits of advice for retail investors advisers that if they receive compensation in Econ. 225 (2003); Laurent E. Calvet, John Y. that are not captured by the studies suggested by connection with the purchase or sale of securities, Campbell, & Paolo Sodini, Down or Out: Assessing the commenters (e.g., Marsden et al. (2011), Finke they should carefully consider the applicability of the Welfare Costs of Household Investment et al. (2011)). broker-dealer registration requirements of the Mistakes, 115 J. Pol. Econ. 707 (2007); Barber & 1049 See Montmarquette & Vionnet-Briot (2012), Exchange Act and any applicable state securities Odean (2000), supra footnote 1046; Karen K. Lewis, supra footnote 1041. While this study describes the statutes. See Form ADV, Part 2A, Note to Item 5.E. Trying to Explain Home Bias in Equities and benefits of hiring financial professionals on asset 1054 See John H. Robinson, Who’s the Fairest of Consumption, 37 J. Econ. Literature 571 (1999). accumulation, it also notes that termination of Them All? A Comparative Analysis of Financial 1048 See, e.g., Mitchell Marsden, Catherine D. relationships with financial professionals resulted Advisor Compensation Models, 20 J. Fin. Plan. 56 Zick, & Robert N. Mayer, The Value of Seeking in a significant loss of overall investment asset (2007). See also AARP August 2018 Letter. One Financial Advice, 32 J. Fam. & Econ. Issues 625 value. See Primerica Letter; Wells Fargo Letter study, however, argues that when the direct costs (2011); Jinhee Kim, Jasook Kwon, & Elaine A. (which provided references to this academic study). associated with commissions are combined with the Anderson, Factors Related to Retirement 1050 See Roman Inderst & Marco Ottaviani, estimated agency costs, there is little difference in Confidence: Retirement Preparation and Workplace Financial Advice, 50 J. Econ. Literature 494 (2012). the costs between commission-based and fee-based Financial Education, 16 J. Fin. Counseling & Plan. See also AARP August 2018 Letter. advice. See Quinn Curtis, The Fiduciary Rule 77 (2005); Michael S. Finke, Sandra J. Huston, & 1051 See, e.g., AARP August 2018 Letter; CFA Controversy and the Future of Investment Advice Danielle D. Winchester, Financial Advice: Who August 2018 Letter; EPI Letter; Letter from Ron A. (Univ. of Va. Sch. of Law, Law & Econ. Research Pays, 22 J. Fin. Counseling & Plan. 18 (2011); Daniel Rhoades, Director, Personal Financial Planning Paper Series No. 2018–04, Mar. 2018). See also Bergstresser, John M.R. Chalmers, & Peter Tufano, Program and Assistant Professor of Finance, Gordon UVA Letter. We note that services provided may Assessing the Costs and Benefits of Brokers in the Ford College of Business, Western Kentucky also vary between brokerage and advisory accounts, Mutual Fund Industry, 22 Rev. Fin. Stud. 4129 University (Dec. 6, 2018) (‘‘Rhoades December 2018 which could also affect differences in costs paid by (2009); Ralph Bluethgen, Steffen Meyer, & Andreas Letter’’). retail investors.

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based obligation that is tied to AUM in however, indicated that commission- reputation,1066 may be able to mitigate their account.1055 We note that this based compensation provides benefits to the risk of financial professionals acting choice may be dependent on the investors.1061 One study finds that on conflicts of interest to the detriment investor’s holding period and other conflicts of interest are likely to be of their customers.1067 In addition to ongoing expenses that affect an present in all forms of compensation direct payments of commissions from investor’s net return over time. For earned by financial professionals. For retail investors, financial professionals example, a buy-and-hold investor that example, fee-based compensation could may receive payments from third chooses an account where fees are based result in so-called ‘‘reverse churning’’ parties, such as securities issuers, which on AUM may pay more over time than and a disincentive to reduce AUM, even can increase costs to investors through a similar buy-and-hold investor that if that would be in the investor’s best higher management fees and reduced pays a single commission. Further, some interest, while flat-fee models can lead net returns, and provide incentives to commission-based securities, such as to shirking and overbilling.1062 recommend these securities over those mutual funds, may have ongoing However, due to limitations on the data that do not provide such incentives.1068 expenses, including 12b–1 fees, which available regarding fee-based advice, While a number of studies suggest could lead to an erosion of net returns most of the academic studies to date that conflicts of interest may lead to over time.1056 Such ongoing expenses, regarding conflicts of interest focus on investor harm, one study, which however, may not be adequately commission-based compensation provides a survey of the literature on accounted for by investors when making models. As such, the potential conflicts conflicts of interest, states that investment decisions about the type of associated with the fee-based ‘‘although conflicts of interest are account to open and what type of compensation models, including fee- omnipresent when contracting is costly security to purchase.1057 Several based compensation earned by broker- and parties are imperfectly informed, commenters provided analyses to show dealers, have not been subject to as there are important factors that mitigate the expected effect of one-time costs and much analysis. Studies show that their impact and, strikingly, it is ongoing expenses (e.g., operating costs commission-based compensation possible for customers of financial or advisory fees) to investors from both potentially leads to biased advice, institutions to benefit from the existence commission-based and fee-based including excessive trading in accounts of such conflicts . . . The existence of perspectives, conditional on the and recommendations to purchase high- a conflict of interest . . . does not mean investor’s holding period.1058 commission securities, both of which that . . . the customers of that Separately, investors may face benefit the financial professional and indirect costs that are a result of agency may lead to lower net returns.1063 Commissions); MSRB Rules G–15 and G–30, problems that emerge when financial Financial professionals also may amended pursuant to Exchange Act Release No. 79347 (Nov. 17, 2016) [81 FR 84637] (Nov. 23, professionals seek to maximize their benefit from other forms of transaction- 2016); and FINRA Rules 2121 and 2232, amended own compensation and take actions that based payment from customers, such as pursuant to Exchange Act Release No. 79346 (Nov. place their own interests ahead of the mark-ups and mark-downs; for instance, 17, 2016) [81 FR 84659] (Nov. 23, 2016). investors that they are supposed to one study documents that the size of the 1066 See William P. Rogerson, Reputation and Product Quality, 14 Bell J. Econ. 508 (1983); 1059 mark-up or mark-down is significantly serve. A number of commenters and Benjamin Klein & Keith B. Leffler, The Role of academic studies have stated that positively related to whether the broker- Market Forces in Assuring Contractual commission-based compensation is dealer solicits the transaction and Performance, 89 J. Pol. Econ. 615 (1981); W. Bentley more likely to contribute to conflicts of whether the broker-dealer acts in a MacLeod, Reputations, Relationships, and Contract principal capacity.1064 Because mark- Enforcement, 45 J. Econ. Literature 595 (2007) for interest between financial professionals theoretical models of the effect of reputation on and retail investors than fee-based ups and mark-downs are payments from investment quality. See AARP August 2018 Letter. compensation.1060 Other commenters, the customer to the broker-dealer, they For example, FINRA and MSRB introduced rules in give rise to conflicts of interest between May 2018 regarding mark-up disclosure rules for same-day trades, allowing investors to be able to see 1055 a broker-dealer and his or her customer See, e.g., Cetera August 2018 Letter; AALU what they have paid for riskless principal Letter; Pacific Life August 2018 Letter; NAIFA at the time of a recommendation, transactions (FINRA Rule 2232 and MSRB Rule Letter; Empower Retirement Letter; CCMR Letter; particularly if they are opaque to the G–15). The Commission has also brought Primerica Letter. customer, at the time of the enforcement cases for undisclosed excessive 1056 See CFA August 2018 Letter; EPI Letter. See markups under Exchange Act Rule 10b–5. also ICI Letter (which described a shift from load recommendation. Mechanisms, including regulation,1065 disclosure, and 1067 See, e.g., Inderst & Ottaviani (2012), supra to no load funds, decreasing expense ratios, and a footnote 1050. See also Bolton et al. (2007), infra decline in the percentage of funds that charge footnote 1073, which posits that competition or 12b–1 fees). 1061 See AALU Letter; Invesco Letter; ACLI Letter; consolidation affect reputation costs and provide a 1057 See infra footnote 1084 and corresponding NAIFA Letter. See Burke et al. (2015), supra disciplining mechanism for providers of financial discussion. footnote 1059 for a survey on the academic advice. Although various mechanisms exist to 1058 See, e.g., Cetera August 2018 Letter and literature on conflicts of interest. address agency problems in general, such as November 2018 Letter; Pacific Life August 2018 1062 See Robinson (2007), supra footnote 1054. monitoring, bonding, and contracting (see, e.g., Letter. 1063 See, e.g., Stoughton et al. (2011), supra Finke (2012), supra footnote 1041), the agency 1059 See Jeremy Burke et al., Impacts of Conflicts footnote 1048; Roman Inderst & Marco Ottaviani, problem between financial professionals and retail of Interest in the Financial Services Industry (RAND Misselling Through Agents, 99 Am. Econ. Rev. 883 investors is not necessarily one that can be solved Labor & Population, Working Paper No. WR–1076, (2009); Max Beyer, David de Meza, & Diane cost-effectively through these approaches. See infra Feb. 2015), available at https://www.rand.org/pubs/ Reyniers, Do Financial Advisor Commissions Section III.A.2 for a discussion of limitations to working_papers/WR1076.html; Hamid Mehran & Distort Client Choice?, 119 Econ. Letters 117 (2013). these approaches. See also Curtis (2018), supra Rene M. Stulz, The Economics of Conflicts of See also AARP August 2018 Letter. Financially footnote 1054. See also AARP August 2018 Letter; Interest in Financial Institutions, 85 J. Fin. Econ. unsophisticated investors, as discussed by CFA August 2018 Letter; UVA Letter. 267 (2007). See also Letter from D. Bruce Johnsen, Stoughton et al. (2011), are those most likely to 1068 See Stoughton et al. (2011), supra footnote Professor of Law, Scalia Law School, George Mason purchase inefficient assets. 1048. The authors also state that ‘‘[i]n addition to University (Aug. 7, 2018) (‘‘Johnsen Letter’’); 1064 See Allen Ferrell, The Law and Finance of the advisory fees charged to the clients, wrap Robinson (2007), supra footnote 1054. Broker- Broker-Dealer Mark-Ups (Harvard John M. Olin Ctr. account managers may receive rebates from fund dealers may act in a brokerage (i.e., agency) capacity for Law, Econ., and Bus., Discussion Paper, Apr. 6, management companies as well,’’ and that wrap or a dealer (i.e., principal) capacity. See Proposing 2011), available at https://www.finra.org/sites/ accounts have increased in popularity. See also Release at Section I. While the discussion is framed default/files/NoticeAttachment/p123492.pdf. See Mark Egan, Brokers vs. Retail Investors: Conflicting in terms of agency problems, it is applicable to both AARP August 2018 Letter. Interests and Dominated Products, J. Fin. capacities. 1065 See, e.g., antifraud provisions of the federal (forthcoming 2019). See also AARP August 2018 1060 See IPA Letter; CFA August 2018 Letter. securities laws, FINRA Rule 2121 (Fair Prices and Letter; CFA August 2018 Letter.

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institution will be harmed . . . [A] between the financial professional and Although financial professionals may variety of mechanisms help control investors.1072 Information asymmetry be hired to help overcome ‘‘investment conflicts of interest and their impact arises when information necessary to mistakes’’ made by investors,1076 a [e.g., a financial institution’s assess the quality of the advice received number of studies show that financial reputation].’’ 1069 Another study of may not be available to the retail professionals themselves may be subject commission-based compensation in the investor, even when it is available to the to the same behavioral biases as United Kingdom indicates that financial professional. For example, a unadvised retail investors, such as commission-based compensation leads financial professional may disclose return chasing and overconfidence.1077 to significant bias in certain types of conflicts of interest that could affect the One study, using data on Canadian securities (e.g., with profit bonds or advice provided, but the information investors and their financial distribution bonds) and financial may not be sufficiently precise to help professionals, observes that financial professionals and when bias exists, a retail investor gauge how those professionals appear to have the same retail investors are harmed and the costs conflicts affect the advice provided. ‘‘misguided beliefs’’ as their investors, associated with such harm are Conflicts of interest, therefore, can and therefore do not correct, and may significant; however, the study also erode the benefits of advice provided to even exacerbate common investment states that the advice market in the retail investors, particularly if investors mistakes.1078 In that study, financial United Kingdom is not overrun with are unaware that the conflicts exist or if professionals invested in the same bias (‘‘adviser recommendations are not they do not understand the implications manner that they recommended to their dominated by self-interest’’) and the of conflicts.1073 Financial professionals market for advice generally works may use this information asymmetry, Research, Working Paper No. 17929, Mar. 2012), well.1070 particularly with unsophisticated available at https://www.nber.org/papers/ Although financial professionals may investors, to capture economic rents for w17929.pdf. See also AARP August 2018 Letter; CFA August 2018 Letter; EPI Letter. Although the aid retail investors in correcting themselves, and this could exacerbate Mullainathan et al. (2012) study included both common investing mistakes and biases that investors sometimes exhibit, broker-dealers and investment advisers, the study overcoming informational hurdles such as return chasing or under- notes that most professionals in their sample associated with securities transactions diversification.1074 One experimental focused on the lower end of the retail spectrum and study sent ‘‘mystery shoppers’’ to tended to be compensated through commissions or investment strategies, the average rather than fees based on AUM. See also Santosh retail investor may not be able to assess broker-dealers and investment advisers Anagol, Shawn Cole, & Shayak Sarkar, the quality of advice received from in several large cities in the United Understanding the Advice of Commissions financial professionals.1071 The States and found that financial Motivated Agents: Evidence from the Indian Life professionals provided Insurance Market (Harvard Bus. Sch., Working difficulty in assessment can arise from Paper No. 12–055, Oct. 2015), available at https:// several sources, including a large degree recommendations that benefited www.hbs.edu/faculty/Publication%20Files/12-055_ of heterogeneity in the quality of advice, themselves and exacerbated behavioral 13c23c02-e57f-4aea-9630-316aa4b772ce.pdf, which insufficient financial literacy on the part biases on the part of investors, including used a similar audit approach to evaluate the quality of advice provided by life insurance agents of investors, and information asymmetry return chasing or recommendations of 1075 in India, and found that agents recommended high-cost actively managed funds. unsuitable products and strategies that paid high 1069 See Mehran & Stulz (2007), supra footnote commissions. 1059. See also Johnsen August 2018 Letter. 1072 See, e.g., Bluethgen et al. (2008), supra 1076 See supra footnote 1046. 1070 See Robert Laslett, Tim Wilsdon, & Kyla footnote 1048. Although this study documents 1077 See, e.g., Mullinathan et al. (2012), supra Malcolm, Polarisation: Research into the Effect of reasons why investors may be unable to assess the footnote 1075; Terrance Odean, Are Investors Commission Based Remuneration on Advice, quality of advice, the focus is on using adviser Reluctant to Realize Their Losses?, 53 J. Fin. 1775 Charles River Associates Report Submitted to the characteristics as screening mechanisms to alleviate (1998); Zur Shapira & Itzhak Venezia, Patterns of U.K. Financial Services Authority (Jan. 2002), the first complication noted, the high degree of Behavior of Professionally Managed and available at http://www.crai.com/sites/default/files/ heterogeneity in the quality of advice. The paper Independent Investors, 25 J. Banking & Fin. 1573 publications/polarisation-research-into-the-effect- finds that good predictors of high quality advice (2001). See also AARP August 2018 Letter. See also of-commission-based-remuneration-on-advice.pdf. include the financial professional’s cognitive ability Anagol et al. (2015), supra footnote 1075, which Laslett et al. (2002) estimate harm resulting from (e.g., analytical skills, rationality, and financial documents that life insurance agents in India biased advice of approximately £140 million per knowledge), how financial professionals are purchase the same inefficient products that they year. Following the ban on commission-based compensated (financial professionals that have a recommend to their clients. One study of Canadian compensation in the U.K. in 2013, another study high fraction of commission-based revenue are less financial professionals and their clients observed a finds that while the quality of financial advice likely to recommend high quality investments, e.g., commonality among portfolios of a given financial increases, increased costs of providing advice lead index funds), and the firm’s business model. See professional, and that the financial professional’s some financial professionals to turn away small also Finke (2012), supra footnote 1041; AARP own portfolio allocations strongly predicted the retail investors. See Tracey McDermott & Charles August 2018 Letter. See also Relationship Summary asset allocations of his or her customers, indicating Roxbury, Financial Advice Market Review, Adopting Release. limited customization, regardless of the customer’s Financial Conduct Authority and HM Treasury 1073 See, e.g., Inderst & Ottaviani (2012), supra risk tolerance, age, or financial sophistication. Final Report (Mar. 2016), available at https:// footnote 1050; Patrick Bolton, Xavier Freixas, & Joel Although the results of this paper indicate that www.fca.org.uk/publication/corporate/famr-final- Shapiro, Conflicts of Interest, Information conflicts of interest are unlikely to motivate advice report.pdf (which provides an overview of the Provision, and Competition in the Financial because financial professionals and their investors effects of the Retail Distribution Review by the Services Industry, 85 J. Fin. Econ. 297 (2007). See hold similar portfolios, it does raise questions of the Financial Conduct Authority in the United also AARP August 2018 Letter. high cost of financial advice when customization is Kingdom). Further, McDermott & Roxbury (2016) 1074 See, e.g., Marco Ottaviani, The Economics of limited. See Stephen Foerster et al., Retail Financial report that financial advice costs approximately Advice (Working Paper, May 2000), available at Advice: Does One Size Fit All?, 72 J. Fin. 1441 £150 per hour and that giving retirement advice http://faculty.london.edu/mottaviani/EOA.pdf (2017) (included because they capture insights into requires an average of nine hours on the part of the (included because they capture aspects of the how financial professionals may be subject to financial professional. information asymmetries between retail investors similar biases as retail investors that are not 1071 A number of studies consider advice to be a and financial professionals that are not captured by captured by the studies suggested by the credence good, which is a type of good with the studies suggested by the commenters); Miriam commenters). See Robinson (2007), supra footnote qualities that cannot be observed by the consumer Krausz & Jacob Paroush, Financial Advising in the 1054. after purchase, making it difficult to assess its Presence of Conflict of Interests, 54 J. Econ. & Bus. 1078 See Juhani T. Linnainmaa, Brian T. Melzer, utility. See, e.g., Roman Inderst, Consumer 55 (2002); Inderst & Ottaviani (2012), supra footnote & Alessandro Previtero, The Misguided Beliefs of Protection and the Role of Advice in the Market for 1050; Stoughton et al. (2011), supra footnote 1048. Financial Advisors (Kelley Sch. of Bus., Research Retail Financial Services, 167 J. Institutional & See also AARP August 2018 Letter. Paper No. 18–9, May 2018), available at http:// Theoretical Econ. 4 (2011) (which provides a review 1075 See Sendhil Mullainathan, Markus Noeth, & www.aleprevitero.com/wp-content/uploads/2018/ of investors’ ability to assess the quality of Antoinette Schoar, The Market for Financial 06/SSRN-id3101426.pdf. See also CFA August 2018 investment advice). Advice: An Audit Study (Nat’l Bureau of Econ. Letter.

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clients; they traded excessively, chased discuss evidence of potential investor Evidence suggests that there is a returns, bought expensive actively harm attributable to recommendations strong relationship between past managed funds, under-diversified their of certain investments by financial performance and subsequent fund portfolios, and earned similar net professionals, including mutual funds, flows, even when funds do not returns. Further, these financial 401(k) plans, corporate bonds, and non- persistently outperform, suggesting that professionals continued to follow traded REITs. We then discuss the investors and/or their financial similar investment strategies as those aggregate measures of investor harm professionals may engage in return- they recommended to their clients, even estimated by the CEA Study and the chasing behavior.1083 Several studies after they had left the industry, DOL RIA and the limitations of those also examine the effect of mutual fund suggesting that they believed their own estimates. costs, and find that (1) fund flows are 1079 investment advice. Directly addressing the question of negatively related to front-end loads, but c. Evidence of Potential Investor Harm whether and how brokerage customers are relatively insensitive to fund-level or advisory clients are affected by operating expenses (e.g., 12b–1 fees), A number of commenters provided conflicts of interest (e.g., through indicating that investors may be aware citations to academic studies that quantification) requires measurement of of upfront costs when selecting funds, analyze the evidence of potential the effect of advice, subject to different but may be less attuned to the effect on investor harm driven by conflicts of levels of conflict, received from broker- net returns of ongoing operating interest of financial professionals.1080 A dealers or investment advisers. Most expenses; 1084 and (2) unsophisticated number of these studies, including data currently available to researchers investors are more likely to pay higher Bergstresser et al. (2009), Del Guercio does not make distinctions between fees than sophisticated investors and are and Reuter (2014), and Christoffersen, types of firms or financial professionals, less likely to expend search costs to look Evans, and Musto (2013), underpinned and generally aggregates all firms or for lower-fee funds.1085 Retail investors, the economic analyses of the Council of financial professionals into a single however, can benefit when funds Economic Advisors 2015 Study (‘‘CEA category of financial professionals (e.g., commence operation of an institutional Study’’) and the DOL RIA assessment of ‘‘adviser’’ or ‘‘financial adviser’’). ‘‘twin’’ fund as overall expenses the aggregate harm borne by retail Further, an investor’s propensity to investors in retirement plans due to decrease and managerial effort choose a particular type of relationship conflicts of interest.1081 Below we increases, suggesting that retail may be correlated with the investor’s investors may not be able to monitor 1079 Linnainmaa et al. (2018), supra footnote skill or choice of investment and, fund managers as effectively as 1078, also suggest that conflicts of interest may not therefore, may introduce bias into institutional investors.1086 be driven by financial professionals, but instead are studies that are able to differentiate between the firm and its clients, and that firms Analyses in the CEA Study and the between types of advice relationships. DOL RIA focus on the deliberately hire financial professionals who Despite these limitations, by examining believe their misguided (and ultimately expensive) underperformance of certain broker-sold advice. In light of their findings, the authors suggest the existing academic literature, funds, potentially driven by conflicts of that regulation designed to stem conflicts of interest discussed below, we are able to gain interest and a misalignment of could be ineffective if aligning investors and qualitative insight into, and address incentives between financial financial professionals does not alter the advice that commenter concerns, about conflicts of they provide, could raise barriers to entry that could professionals and investors.1087 A interest in the market for financial reduce the amount of advice available, and may number of studies document that limit investor choice. advice and the potential harm to actively managed load mutual funds 1080 See, e.g., AARP August 2018 Letter; Better investors. Markets August 2018 Letter; CFA August 2018 purchased by investors through a Letter; EPI Letter; State Attorneys General Letter. The majority of studies to date that financial professional underperform 1081 See Letter from Linda Agerbak (Jun. 21, 2018) investigate the potential harm to (‘‘Agerbak Letter’’); Better Markets August 2018 investors arising from potential conflicts 1083 See Judith Chevalier & Glenn Ellison, Risk Letter; CFA August 2018 Letter; EPI Letter; Letter of interest have generally centered on Taking by Mutual Funds as a Response to from Public Citizen (Aug. 7, 2018) (‘‘Public Citizen Incentives, 105 J. Pol. Econ. 1167 (1997); Jonathan Letter’’); State Attorneys General Letter; Former SEC findings based on analysis of B. Berk & Richard C. Green, Mutual Fund Flows and Senior Economists Letter. See also Bergstresser et investments in mutual funds. Due to the Performance in Rational Markets, 112 J. Pol. Econ. al. (2009), supra footnote 1048; Diane Del Guercio readily available data for mutual funds, 1269 (2004); Brad M. Barber, Terrance Odean, & Lu & Jonathan Reuter, Mutual Fund Performance and the literature is rich with studies Zheng, Out of Sight, Out of Mind: The Effects of the Incentive to Generate Alpha, 69 J. Fin. 1673 Expenses on Mutual Fund Flow, 78 J. Bus. 2095 (2014); Susan E.K. Christoffersen, Richard Evans, & exploring various aspects of those (2005); Erik R. Sirri & Peter Tufano, Costly Search David K. Musto, What Do Consumers’ Fund Flows securities, including the performance of and Mutual Fund Flows, 53 J. Fin. 1589 (1998). In Maximize? Evidence from Their Brokers’ Incentives, funds, relationships between flows and the theoretical model provided by Berk and Green 68 J. Fin. 201 (2013). See Office of the President of performance or expenses, and (2004), active funds do not outperform passive the United States, Council of Economic Advisers, funds because investors compete to invest in strong The Effects of Conflicted Investment Advice on differences in performance of funds past performers (i.e., they chase returns), driving Retirement Savings (Feb. 2015), available at https:// depending on the distribution channel. these funds’ returns to the competitive level. See obamawhitehouse.archives.gov/sites/default/files/ These studies have further been used by also AARP August 2018 Letter; CFA August 2018 docs/cea_coi_report_final.pdf. See also DOL RIA, commenters and other providers of Letter. supra footnote 1002. Both the CEA Study and the 1084 DOL RIA assumed that the DOL Fiduciary Rule economic analyses to estimate the See Barber et al. (2005), supra footnote 1083. would eliminate all conflicts of interest and, magnitude of investor harm potentially 1085 See Todd Houge & Jay Wellman, The Use and therefore, all of the harms to retirement investors stemming from conflicts of interest as it Abuse of Mutual Fund Expenses, 70 J. Bus. Ethics resulting from conflicts. See also Curtis (2018) and relates to mutual fund investments.1082 23 (2007). See AARP August 2018 Letter. infra footnote 1103. By contrast, Regulation Best 1086 See Richard B. Evans & Rudiger Fahlenbrach, Interest would not require elimination or mitigation Institutional Investors and Mutual Fund of firm-level conflicts, and will require written of interest and more generally may have a deterrent Governance: Evidence from Retail-Institutional policies and procedures reasonably designed to effect. Fund Twins, 25 Rev. Fin. Stud. 3530 (2012). See eliminate or mitigate of some representative-level 1082 See CEA Study, supra footnote 1081, and AARP August 2018 Letter. The authors identify conflicts, which means that some conflicts and their DOL RIA, supra footnote 1002. See also EPI Letter; funds as ‘‘twins’’ if they share the same manager, attendant harms may remain, especially at the firm Better Markets August 2018 Letter; St. John’s U. investment objectives, fund families, and have a level. The disclosure requirements of Regulation Letter; Letter from Royce A. Charney, President, gross return correlation of 0.95 or greater. Best Interest, however, may empower some Trust Administrators (Aug. 7, 2018) (‘‘Charney 1087 See CEA Study, supra footnote 1081, and customers to push back on broker-dealer conflicts Letter’’); Agerbak Letter; CFA August 2018 Letter. DOL RIA, supra footnote 1002.

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other types of mutual funds.1088 For A number of studies, also cited by the study focuses exclusively on broker-sold example, several studies find that DOL RIA and the CEA Study, explore funds, but segments those funds into actively managed load funds the distinction between broker-sold groups that depend on the size of excess underperform a buy-and-hold strategy funds and direct-sold funds, and the loads and whether the funds are sold by by between 1.56% and 2.28% annually, effect of the distribution channel on affiliated or unaffiliated brokers.1096 while other studies show that actively fund flows and performance. When That study observes that funds with a managed load funds underperform no- examining a sample of only broker-sold one-standard deviation increase in load funds by between 1% and 1.5% per funds, one study shows that funds that excess loads are related to a reduction year.1089 This underperformance could pay higher fees to financial in future performance of between 34 bps be driven by poor market timing of professionals or charge higher excess and 49 bps in the following year. As investors (e.g., return chasing),1090 or loads generate greater fund inflows.1093 detailed in Bergstresser et al. (2009), the because increased expenditures by the Moreover, broker-sold funds, on broker-sold channel is likely to include funds on marketing and advertising average, underperform direct-sold funds funds sold through both broker-dealers successfully attract retail flows, and by between 23 bps and 255 bps per and investment advisers; however, the such expenses decrease net returns to annum, with most studies observing data provided to the authors is not investors over time.1091 Fees and average underperformance of granular enough to be able to expenses, as documented by several approximately 100 bps (1%) per distinguish the performance studies, are two of the most reliable year.1094 characteristics of the two distinct predictors of future returns, and fees Further, conflicts of interest appear to channels.1097 should reflect performance (e.g., funds depend upon the choice of investment A number of commenters stated that with high fees hypothetically should (e.g., broker-sold versus direct-sold the Proposing Release did not have better ex post performance in order funds) as well as the magnitude of the appropriately account for existing to justify the fees), as at least some costs (e.g., mutual fund loads). One economic analyses produced by the portion of the fees are dedicated to study suggests that the market for funds CEA Study and the DOL RIA to measure portfolio management; however, these is segmented: More financially the potential harm to investors from studies consistently find a negative sophisticated investors select direct-sold conflicts of interest.1098 The CEA Study relationship between fees and funds, which unbundle portfolio and the DOL RIA use the literature on performance—lower cost funds on management from advice of financial underperformance of broker-sold average are more likely to generate professionals, while less financially mutual funds as the foundation for their higher performance net of fees than high sophisticated investors purchase broker- analyses on the potential harm of retail cost funds.1092 sold funds, which combine portfolio investors, focusing on harm specifically management and advice.1095 Another directed at retirement savings. Applying 1088 See Bergstresser et al. (2009), supra footnote an estimate of approximately 1% 1048; Del Guercio & Reuter (2014), supra footnote Mutual Fund Industry, 64 J. Fin. 2153 (2009); Russel underperformance to broker-sold funds, 1081. Kinnel, Predictive Power of Fees: Why Mutual Fund which is consistent with estimates of 1089 See, e.g., Mercer Bullard, Geoffrey Friesen, & Fees Are So Important, Morningstar Manager Travis Sapp, Investor Timing and Fund Distribution Research (May 2016); William F. Sharpe, The underperformance provided by several 1099 Channels (Working Paper, 2008); Geoffrey C. Arithmetic of Investment Expenses, 69 Fin. studies, the CEA Study and the DOL Friesen & Travis R.A. Sapp, Mutual Fund Flows and Analysts J. 34 (2013). Gil-Bazo & Ruiz-Verdu (2009) Investor Returns: An Empirical Examination of find that actively managed funds with the worst and Mutual Fund Market Segmentation (Nat’l Fund Investor Timing Ability, 31 J. Banking & Fin. performance charge, on average, the highest fees. Bureau of Econ. Research, Working Paper No. 2796 (2007); Matthew R. Morey, Should You Carry See AARP August 2018 Letter; CFA August 2018 16312, Aug. 2010), available at https:// the Load? A Comprehensive Analysis of Load and Letter. www.nber.org/papers/w16312.pdf. See AARP No-Load Mutual Fund Out-of-Sample Performance, 1093 See Christoffersen et al. (2013), supra August 2018 Letter; CFA August 2018 Letter. 27 J. Banking & Fin. 1245 (2003). See also Eugene footnote 1081; Chalmers & Reuter (2015), supra Although some of the growth in direct-sold funds F. Fama & Kenneth R. French, Luck Versus Skill in footnote 1042; Jasmin Sethi, Jake Spiegel, & Aron comes from passive investing (e.g., index funds), the Cross-Section of Mutual Fund Returns, 65 J. Fin. Szapiro, Conflicts of Interest in Mutual Fund Sales: greater than 75% of the number of direct-sold funds 1915 (2010), which notes that although some active What Do the Data Tell Us?, 6 J. Retirement 46 are actively managed (as of 2012). See Jonathan managers may outperform passive benchmarks (2019). Christoffersen et al. (2013) and Sethi et al. Reuter, Revisiting the Performance of Broker-Sold while others underperform, on average, the alpha (2019) measure excess loads by first estimating the Mutual Funds (Working Paper, Nov. 2, 2015), attributable to active management will net to zero; baseline (average) load paid with regressions of available at https://www2.bc.edu/jonathan-reuter/ therefore, net of fees, on average, and the alpha loads on a number of explanatory variables, then research/brokers_revisited_201511.pdf. earned by actively managed funds will be reduced using the residuals from these regressions (excess 1096 See Christoffersen et al. (2013), supra by the aggregate amount of fees and expenses of loads) to explain fund flows and performance. See footnote 1081. active management. See also William F. Sharpe, also Morningstar Letter; Letter from Aron Szapiro, 1097 See Bergstresser et al. (2009), supra footnote The Arithmetic of Active Management, 47 Fin. Director of Policy Research, Morningstar, Inc., et al. 1048. The Bergstresser et al. study also notes that Analysts J. 7 (1991). See AARP August 2018 Letter; (Aug. 24, 2018) (‘‘Morningstar Letter Supplement’’). many funds in the direct-sold channel may be CFA August 2018 Letter. Sethi et al. (2019) find, however, that the relation recommended by fee-based advisers, whose services 1090 See, e.g., Bullard et al. (2008), supra footnote between excess loads and fund flows tapered off ‘‘are typically paid for with an advisory fee that is 1089; Friesen & Sapp (2007), supra footnote 1089. after the DOL Fiduciary Rule was adopted, outside of the fund expenses or distribution costs. 1091 One study documents that heavily advertised suggesting that the DOL Fiduciary Rule may have As a practical matter, the ‘direct’ channel may not funds outperform their benchmarks prior to the discouraged financial professionals from directing be as direct as one might imagine.’’ marketing efforts, but do not outperform their flows to funds with high excess loads. 1098 See also ARA August 2018 Letter; EPI Letter; benchmarks in the post-advertising period. These 1094 See, e.g., Bergstresser et al. (2009), supra Better Markets August 2018 Letter; St. John’s U. funds, however, attract significantly more inflows, footnote 1048; Chalmers & Reuter (2015), supra Letter; Charney Letter; Agerbak Letter; CFA August relative to a control group. See Prem C. Jain & footnote 1042; Xuanjuan Chen, Tong Yao, & Tong 2018 Letter. Joanna Shuang Wu, Truth in Mutual Fund Yu, Prudent Man or Agency Problem? On the 1099 See Bergstresser et al. (2009), supra footnote Advertising: Evidence on Future Performance and Performance of Insurance Mutual Funds, 16 J. Fin. 1048; Del Guercio & Reuter (2014), supra footnote Fund Flows, 55 J. Fin. 937 (2000). See also Nikolai Intermediation 175 (2007). See AARP August 2018 1081; Christoffersen et al. (2013), supra footnote Roussanov, Hongxun Ruan, & Yanhao Wei, Letter. 1081. A number of commenters, regarding the DOL Marketing Mutual Funds (Nat’l Bureau of Econ. 1095 See Del Guercio & Reuter (2014), supra RIA, indicated that both the CEA Study, supra Research, Working Paper No. 25056, Sept. 2018), footnote 1081. Moreover, this study finds that footnote 1081, and the DOL RIA, supra footnote available at https://www.nber.org/papers/ broker-sold actively managed funds underperform 1002, misinterpreted estimated effects described in w25056.pdf. See AARP August 2018 Letter; CFA broker-sold index funds by between 1.1% and 1.3% the Christoffersen et al. (2013) paper, and overstated August 2018 Letter; EPI Letter. per year, which the authors suggest may reflect an the potential harm associated with funds with high 1092 See Javier Gil-Bazo & Pablo Ruiz-Verdu, The agency conflict. See also Diane Del Guercio, excess loads by more than double the actual Relation Between Price and Performance in the Jonathan Reuter, & Paula A. Tkac, Broker Incentives Continued

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RIA apply different methods and Reuter (2014) sample using data from study shows that the difference between approaches to calculate the aggregate between 2003 and 2012 and tests the dollar returns and buy-and-hold returns dollar harm for retail investors in their robustness of the methodology by (‘‘performance gap’’) declined from retirement accounts.1100 Based on $1.7 examining the underperformance of 1.56% between 1991 and 2004 to 1.01% trillion invested in potentially broker-sold funds relative to direct-sold between 2007 and 2016 for a combined conflicted funds, the CEA Study funds.1104 While underperformance of sample of load and no-load funds, estimates annual harm to retirement broker-sold funds still existed, suggesting a moderation in market investors of approximately $17 depending on the methodology and timing errors in the most recent period. billion.1101 Similarly, the DOL RIA, empirical approach used, the However, the excess performance gap which estimates potential loss due to underperformance of these funds was (the difference between the performance conflicts of interest of between 50 bps reduced to between 20 bps and 70 bps, gap on load funds and no load funds) and 100 bps per year, produces ten-year with the majority of the estimation has slightly increased between 2007 and aggregate estimates of investor harm of approaches falling to between 20 bps 2016, from approximately 1% to 1.12%, between $95 billion and $189 billion and 50 bps, indicating a reduction in the indicating that, to the extent that load stemming from the underperformance of underperformance of broker-sold funds funds are sold by financial professionals broker-sold mutual funds. relative to earlier studies.1105 Another and that all inflows and outflows are The level of underperformance due to study replicates the Christoffersen et al. due solely to market timing motivations, fund selection is highly sensitive to the (2013) analysis of excess loads on investors who hold load funds are more data sample, including the sample underperformance using data from prone to market timing errors than period, as well as the methodology between 2010 and 2017, and finds that investors in no-load funds, and these employed to calculate performance. after 2010, funds with high excess loads errors are not being corrected by Many of the studies used to support the did not underperform funds with low financial professionals. The studies analyses underlying the CEA Study and excess loads, which the authors discussed above acknowledge that the DOL RIA rely on data obtained prior interpret as evidence that financial interpretation of the empirical result to 2011. However, since 2011 there have professionals have improved their that broker-sold funds underperform been a number of advances in the recommendations over time.1106 Taken direct-sold funds is subject to another market for mutual funds (e.g., shifts together, these recent studies on fund caveat because there is likely to be a from load to no-load funds and increase selection suggest that the magnitude of selection bias in the type of investor that in no-load funds without 12b–1 fees), potential investor harm likely is not as utilizes the direct-sold fund channel likely leading some of the inferences large as that estimated by the CEA Study relative to those investors who rely on drawn from those studies to be dated and the DOL RIA when more recent data financial professionals for advice and and not reflective of the current market is used to compute the recommendations about which funds to environment.1102 A number of underperformance of broker-sold purchase. A similar selection bias is commenters indicated potential flaws mutual funds. likely to exist for investors who associated with the approach and Another recent study replicates and purchase no-load funds versus those interpretation of the analyses used by extends the Friesen and Sapp (2007) that purchase load funds from financial the CEA Study and the DOL RIA.1103 and Bullard et al. (2008) analyses of professionals. For example, although One study updates the Del Guercio and market timing ability by investors in numerous studies discussed above suggest that financial advice is more estimate had the interpretation been correct. See mutual fund sales and purchases to 1107 likely to be obtained by older, more Craig M. Lewis, The Flawed Cost-Benefit Analysis newer data (2007 through 2016). The Underlying the Department of Labor’s Fiduciary financially sophisticated, and wealthier 1108 Rule (White Paper, Aug. 2017), available at https:// 1104 See Reuter (2015), supra footnote 1095. investors, Chalmers and Reuter www.sec.gov/comments/ia-bd-conduct-standards/ 1105 Reuter (2015), supra footnote 1095, states that (2015) observe that younger, less cll4-2268185-160965.pdf; Public Interest Comment ‘‘[t]hese changes suggest that the average broker- financially experienced, and less from Mark Warshawsky & Hester Peirce, George sold fund has become more competitive with the Mason University Mercatus Center (Apr. 17, 2017), wealthy investors are more likely to buy average direct-sold fund’’; however additional 1109 available at https://www.mercatus.org/system/files/ research would be required to determine if these broker-sold funds. warshawsky-dol-fiduciary-rule-pic-v1.pdf. See also changes are driven by existing fund families, new Beyond mutual funds, a nascent Curtis (2018), supra footnote 1054. fund families, or some combination of factors. literature is emerging on other securities 1100 See CEA Study, supra footnote 1081, and When performance is value-weighted, Reuter (2015) that may be prone to conflicts of interest DOL RIA, supra footnote 1002. discusses that brokers appear to direct clients 1110 1101 See CEA Study, supra footnote 1081. toward funds that pay ‘‘higher-than-average by financial professionals. Recent 1102 See ICI Letter and Section III.B.2.e.ii, supra. distribution costs.’’ 1103 See Lewis (2017), supra footnote 1099; 1106 See Sethi et al. (2019), supra footnote 1093. supra footnote 1089; Friesen & Sapp (2007), supra Warshawsky & Peirce (2017), supra footnote 1099. The authors note that the underperformance of high footnote 1089. See also Curtis (2018), supra footnote 1054. To date, excess load funds becomes statistically insignificant 1108 See supra Section III.B.3.a. only one academic study of which we are aware in the analysis only with the inclusion of prior-year 1109 See supra footnote 1042. (Curtis (2018)) has analyzed the DOL Fiduciary performance of the fund (which Christoffersen et al. 1110 Some commenters (see, e.g., CFA August Rule and the DOL RIA, and discusses issues with (2013), supra footnote 1081, include in one of their 2018 Letter; AARP August 2018 Letter; EPI Letter) the approach taken by the DOL RIA in estimating models). The authors suggest that the reduction in also provided studies about conflicts of interest in the benefits and costs of the DOL Fiduciary Rule, flows to funds with excess loads could be due in 401(k) plans which have shown that (i) plan noting that the DOL RIA likely underestimates the part to the DOL Fiduciary Rule; however, they also sponsors tilt securities toward high-cost securities potential costs of the rule. This study also indicates note that their analysis does not reveal a clear (see Ian Ayres & Quinn Curtis, Beyond that the net benefits of the DOL Fiduciary Rule are association between the DOL Fiduciary Rule and Diversification: The Pervasive Problem of Excessive expected to be close to zero because the DOL returns. The authors further cite to Holden et al. Fees and ‘‘Dominated Funds’’ in 401(k) Plans, 124 Fiduciary Rule may not completely eliminate (2018), supra footnote 955, which discusses the Yale L.J. 1476 (2015)); (ii) plans have inadequate or conflicts of interest and the actual cost of shift away from load mutual funds to no-load funds excessive investment choices (see Edwin J. Elton, investment advice at the intermediary-level was over time. See also ICI Letter; Morningstar Letter; Martin J. Gruber, & Christopher R. Blake, The excluded from the DOL RIA computation of benefit. Morningstar Letter Supplement. Adequacy of Investment Choices Offered by 401(K) Once the calculation accounted for costs of advice, 1107 See Karthik Padmanabhan, Constantijn Panis, Plans, 90 J. Pub. Econ. 1299 (2006); Sheena Sethi- Curtis (2018) estimates that the total costs attributed & Timothy Tardiff, The Ability of Investors to Time Iyengar, Gur Huberman, & Wei Jiang, How Much to conflicts of interest, including underperformance Purchases and Sales of Mutual Funds (Working Choice is Too Much? Contributions to 401(k) of some securities, is only slightly higher than the Paper, Nov. 1, 2017) (see also Department of Labor Retirement Plans, in Pension Design and Structure: costs associated with advice that is free of conflicts. April 2019 memo). See, e.g., Bullard et al. (2008), New Lessons from Behavioral Finance (Olivia S.

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studies have examined potential declining.1115 One survey paper her own.’’ 1118 Moreover, one industry conflicts of interest in markets for more concludes that although the empirical study of over 800 investors notes that complex investments, including reverse evidence is consistent with financial ‘‘96% of U.S. investors report that they convertible corporate bonds and non- professionals having conflicts of interest trust their financial professional and traded REITs. One study uses a sample that may harm consumers, ‘‘none of the 97% believe their financial professional of reverse convertible corporate bonds articles concludes that clients would has their best interest in mind.’’ 1119 that differ only in the financial have been better off by foregoing advice. Academic studies have explored the incentives provided to financial Even if people receive lower returns issue of trust and how it affects financial professionals and the coupon rate, and . . . consulting with an advisor may decisions of investors. Studies in this finds that investors are more likely to provide intangible benefits that strand of academic literature find that purchase—based on the advice given— consumers value,’’ and ‘‘it is important higher levels of trust increase investors’ the inferior bond (lower coupon, all else to bear in mind that these studies may propensity to seek investment advice equal) with the higher ‘‘kick-back’’ to have data limitations and in general and hire financial professionals,1120 the broker-dealer, which appears to be cannot account for selection issues and increase levels of stock market driven by conflicts of interest between the intangible benefits that investors participation,1121 and increase the financial professional and the receive from financial advisors.’’ 1116 willingness to take on higher-risk investors.1111 In an examination of non- investments.1122 Regarding the 4. Trust, Financial Literacy, and the traded REITs, one study documents that importance of trust in established Effectiveness of Disclosure retail investors in non-traded REITs advice relationships, some studies find underperformed by over $45 billion A number of commenters stated that that trust in financial professionals is relative to a portfolio of traded REITs, the Proposing Release did not greater when investors have lower and that nearly one-third of that sufficiently address how issues related financial literacy or when purchasing underperformance was driven by to trust in financial professionals, complex products, such as insurance upfront fees used to compensate broker- investors’ level of financial literacy or products.1123 Further, as trust in dealers.1112 sophistication, and limitations on the effectiveness of disclosure likely 1118 See Letter from Christine Lazaro, President, Finally, although a significant amount PIABA (Dec. 7, 2018) (‘‘PIABA December 2018 of empirical evidence suggests that there exacerbate the problems of information Letter’’). See also, e.g., Rhoades December 2018 may be investor harm due to conflicts of asymmetry and potential conflicts of Letter; Gross Letter; Letter from William W. interest between financial professionals interest between retail investors and McGinnis, W. McGinnis Advisors (Aug. 7, 2018) financial professionals.1117 In order to (‘‘McGinnis Letter’’); EPI Letter; Betterment Letter; and investors, because of changes to the State Attorneys General Letter; Better Markets mutual fund industry (e.g., shifts from address commenters’ concerns, we August 2018 Letter; OIAD/RAND (providing a load to no-load funds and the examined and discuss below both survey on academic literature on trust). One survey introduction of new share classes),1113 academic and industry research on how notes, however, that approximately 15% of survey trust and financial literacy could affect participants do not consult with financial increased competition,1114 and the professionals because they ‘‘don’t trust them.’’ See anticipation of regulation designed to the recommendations provided by Cetera November 2018 Letter. ameliorate potential conflicts of interest, financial professionals to retail 1119 See CCMC Letters. See also Center for Capital several new studies indicate that investors, as well as the effectiveness Markets Competitiveness, Working with Financial and limitations of disclosure in Professionals: Opinions of American Investors potential harm to investors arising from (2018), available at https://www.centerfor conflicts of interest may be ameliorating potential conflicts of capitalmarkets.com/wp-content/uploads/2018/04/ interest. CCMC_InvestorPolling_v5-1.pdf. 1120 See Jeremy Burke & Angela A. Hung, Trust Mitchell & Stephen P. Utkuss eds., 2004)); (iii) a. Trust in Investment Advice and Financial Advice (RAND Labor & Population, plans may include proprietary funds even when Working Paper No. WR–1075, Jan. 2015), available other funds perform better (see Veronika K. Pool, In seeking financial advice, a retail at https://www.dol.gov/sites/default/files/ebsa/ Clemens Sialm, & Irina Stefanescu, It Pays to Set investor places not only money but also laws-and-regulations/rules-and-regulations/ the Menu: Mutual Fund Investment Options in trust in a financial professional. proposed-regulations/1210-AB32-2/trust-and- 401(K) Plans, 71 J. Fin. 1779 (2016)); and (iv) funds Commenters stated that retail investors financial-advice.pdf. This study indicates that included in 401(k) plans underperform passive increased financial trust is associated with higher benchmarks by approximately 31 bps annually (see will follow the advice of their ‘‘trusted levels of both seeking and following investment Edwin J. Elton, Martin J. Gruber, & Christopher T. advisors,’’ because they believe advice. See also AARP August 2018 Letter; FPC Blake, How do Employer’s 401(K) Mutual Fund ‘‘financial professional[s] will place the Letter; CFA August 2018 Letter. Selections Affect Performance?, Ctr. for Retirement investor’s financial interest before his or 1121 See Luigi Guiso, Paola Sapienza, & Luigi Research at Bos. Coll., Issue in Brief No. 13–1 (Jan. Zingales, Trusting in the Stock Market, 63 J. Fin. 2013), available at https://crr.bc.edu/wp-content/ _ 2557 (2008). Guiso et al. (2008) find that higher uploads/2013/01/IB 13-1-508.pdf). 1115 See Reuter (2015), supra footnote 1042; Sethi levels of trust in financial professionals by investors 1111 See Egan (2019), supra footnote 1068. et al. (2019), supra footnote 1093. See also CFA is associated with a 50% increase in the probability 1112 See Craig McCann, Fiduciary Duty and Non- August 2018 Letter; EPI Letter; Morningstar Letter; of buying stocks and a 3.4% increase in the Traded REITs, Investments & Wealth Monitor, July/ Morningstar Letter Supplement. We include recent proportion of equity investments in the aggregate Aug. 2015, at 39, available at https://www.slcg.com/ studies provided by commenters to present the portfolio. See Rhoades December 2018 Letter. pdf/workingpapers/Fiduciary%20duty current baseline of empirical findings on potential 1122 See Nicola Gennaioli, Andrei Shleifer, & %20and%20Non-traded%20REITs.pdf. See CFA investor harm stemming from conflicts of interest. Robert Vishny, Money Doctors, 70 J. Fin. 91 (2015). August 2018 Letter. 1116 See Burke et al. (2015), supra footnote 1059. This study suggests that increased trust in financial 1113 See ICI Letter and Holden et al. (2018), supra The DOL RIA, supra footnote 1002, and some professionals by investors alleviates anxiety in footnote 951. See also Capital Group Letter; Money commenters, however, have stated that no advice is undertaking higher-risk investments (e.g., equities) Management Institute Letter; FPC Letter at footnote a better alternative to advice subject to conflicts of (included because they capture aspects of the 73. As noted above, innovations, including the interest. See also EPI Letter; Betterment Letter; benefits of higher levels of trust in financial introduction of T and clean share classes of funds PIABA Letter; CFA August 2018 Letter. The DOL professionals by retail investors that are not may reduce the expected fund underperformance RIA suggests that investors who obtain advice captured by the studies suggested by the net of costs for retail investors relative to A shares subject to conflicts of interest are worse off due to commenters). by nearly 50 basis points annually. See supra the costs associated with obtaining such advice 1123 See Thomas Pauls, Oscar Stolper, & Adreas footnote 1021 and accompanying text. See also (e.g., underperformance) than had they not sought Walter, Broad-Scope Trust and Financial Advice supra footnote 1020 and accompanying text. or received advice at all. (Working Paper, Nov. 17, 2016), available at https:// 1114 See LPL December 2018 Letter; Morgan 1117 See AARP August 2018 Letter; CFA August www.researchgate.net/publication/314235638_ Stanley Letter (which discuss the migration to open 2018 Letter; FPC Letter; Rhoades December 2018 Broad-scope_trust_and_financial_advice; David de architecture platforms). Letter; EPI Letter. Continued

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financial professionals grows, investors suitability standard, not a fiduciary A number of studies link retail may be more likely to delegate all standard.’’ 1128 investor demographic characteristics to financial literacy and document that investment decisions to the financial b. Financial Literacy and Investment financial illiteracy, although professional, irrespective of their level Advice of financial education.1124 widespread, is most significant among As discussed above, financial literacy Several commenters stated that some investors with lower levels of affects those who seek investment educational attainment, women, and financial professionals respond to the advice from financial professionals. One minorities.1133 Moreover, many studies trust that retail investors place in them commenter noted that ‘‘[a]s consumers have examined the relationship between by acting on their conflicts of interest, move closer to retirement, they may be age, cognition, and financial literacy, which could benefit the financial more vulnerable to the negative impact and have shown that older investors, on professional at the expense of the of advice that is not in their best interest average, are the least likely to be 1125 investor. In addition, some studies for three reasons: (1) The assets they financially literate, and that financial have shown that higher levels of trust by have to invest are larger; (2) they may literacy degrades as investors age.1134 A retail investors can provide incentives lack strong financial literacy skills; and number of these studies show, however, for financial professionals to provide (3) reduced cognition may affect that investors with low levels of 1129 conflicted investment advice or financial decision making.’’ A financial literacy are likely to be over- undertake actions that benefit number of studies have shown that confident in their financial abilities. For themselves at the expense of their financial literacy is significantly related example, several studies that explore customers. For example, one study to retirement planning and wealth the relationship between age and 1130 found that because investors trust their accumulation by retail investors. financial literacy show that confidence financial professionals to provide higher Generally, studies find that investors in financial decision making does not ex ante expected returns on their risky who are more financially literate or decline with age, and potentially leads investments, firms employing those sophisticated are more likely to seek to poor decisions (e.g., paying higher professionals increased fees above levels investment advice and are more likely mortgage rates).1135 Although over- that, in the author’s view, were to follow that advice than less confident investors with low levels of 1131 consistent with a competitive financially sophisticated investors. financial literacy could potentially equilibrium, resulting in lower ex post Further, one study shows that investors benefit most from seeking and following net returns to investors.1126 Further, this with lower financial literacy who do not investment advice, one study shows that study documents that, although a seek investment advice underperform over-confident investors are less likely relationship with a trusted professional investors with higher financial literacy to seek advice and perceive it as less can encourage investors to invest in who seek investment advice by more valuable.1136 than 50 bps on average, and these losses financial markets when it is efficient for One potential problem, however, for are predominantly driven by under- them to do so, in some cases financial investors with lower financial literacy is diversification of their portfolios.1132 professionals may instead provide more that they may not be able to distinguish the quality of their financial conflicted investment advice or 1128 See AARP August 2018 Letter. See also inefficient advice in order to satisfy the PIABA Letter; St. John’s U. Letter. See also Joseph professional or the advice that they 1137 desires of investors who trust them (e.g., C. Peiffer & Christine Lazaro, Major Investor Losses receive. One study documents that undertaking lottery-like behavior by Due to Conflicted Advice: Brokerage Industry small traders, relative to large 1127 Advertising Creates the Illusion of a Fiduciary Duty, institutional investors, are unable to investing in the riskiest securities). PIABA Report (Mar. 25, 2015), available at https:// Although trust in financial professionals piaba.org/sites/default/files/newsroom/2015-03/ recognize biases in recommendations can help alleviate certain behavioral PIABA%20Conflicted%20Advice%20Report.pdf. biases and encourage participation in 1129 See AARP August 2018 Letter. investors with lower financial literacy are 1130 predominantly driven by under-diversification of the securities markets, one commenter See, e.g., Jere R. Behrman et al., Financial Literacy, Schooling, and Wealth Accumulation their portfolios. stated that ‘‘[r]etail customers who place (Nat’l Bureau of Econ. Research, Working Paper No. 1133 See Lusardi & Mitchell (NBER 2011), supra their trust in salespeople that market 16452, Oct. 2010), available at https:// footnote 1131. See also Annamaria Lusardi & Olivia services as acting in their best interest www.nber.org/papers/w16452.pdf; Hans-Martin von S. Mitchell, Financial Literacy and Retirement Gaudecker, How Does Household Portfolio Planning in the United States, 10 J. Pension Econ. can end up paying excessively high Diversification Vary with Financial Literacy and & Fin. 509 (2011). See AARP August 2018 Letter. costs for higher risk or underperforming Financial Advice?, 70 J. Fin. 489 (2015) (included 1134 See Michael S. Finke, John Howe & Sandra investments that only satisfy a in response to comment letters that expressed views J. Huston, Old Age and Decline in Financial about limited financial literacy by some retail Literacy (Working Paper, Aug. 24, 2011), who investors). document that financial literacy scores decline by Meza, Bernd Irlenbusch, & Diane Reyniers, 1131 See supra Section III.B.3. See also Riccardo approximately 1% each year over the age of 60. See Disclosure, Trust and Persuasion in Insurance Calcagno & Chiara Monticone, Financial Literacy also Annamaria Lusardi, Olivia S. Mitchell, & Vilsa Markets (IZA Discussion Paper Series, No. 5060, and the Demand for Financial Advice, 50 J. Banking Curto, Financial Literacy and Financial July 2010), available at http://repec.iza.org/ & Fin. 363 (2015), who observe that investors with Sophistication Among Older Americans (Nat’l dp5060.pdf. See also OIAD/RAND, which shows lower levels of financial literacy are less likely to Bureau of Econ. Research, Working Paper No. that investors most likely in need of investor consult advisers and avoid risky assets; however, 15469, Nov. 2009), available at https:// protection (e.g., financially unsophisticated) are when they do seek advice, they generally delegate www.nber.org/papers/w15469.pdf; Keith Gamble et most likely to place their trust in financial investment decisions to their financial al., Aging and Financial Decision Making, 61 Mgmt. professionals. See also Letter from AFL–CIO et al. professionals. Lusardi & Mitchell (2011) indicate Sci. 2603 (2015). See AARP August 2018 Letter. (Dec. 7, 2018) (‘‘AFL–CIO December 2018 Letter’’). that investors who are more financially 1135 See Finke et al. (2011) and Gamble et al. 1124 See Riccardo Calcagno, Maela Giofre, & Maria sophisticated are more likely to plan for wealth (2015), supra footnote 1134. Cesira Urzi-Brancati, To Trust is Good, but to accumulation and be successful in their planning. 1136 See Marc M. Kramer, Financial Literacy, Control is Better: How Investors Discipline See Annamaria Lusardi & Olivia S. Mitchell, Overconfidence and Financial Advice Seeking Financial Advisors’ Activity, 140 J. Econ. Behav. & Financial Literacy and Planning: Implications for (Working Paper, Dec. 19, 2014), available at https:// Org. 287 (2017). See OIAD/RAND. Retirement Wellbeing (Nat’l Bureau of Econ. efmaefm.org/0EFMAMEETINGS/ 1125 See, e.g., Rhoades December 2018 Letter; EPI Research, Working Paper No. 17078, May 2011), EFMA%20ANNUAL%20MEETINGS/2015- Letter; Better Markets August 2018 Letter. available at https://www.nber.org/papers/ Amsterdam/papers/EFMA2015_0067_fullpaper.pdf. 1126 See Calcagno et al. (2017), supra footnote w17078.pdf. See AARP August 2018 Letter. 1137 See Lauren E. Willis, Against Financial- 1124. 1132 See von Gaudecker (2015), supra footnote Literacy Education, 94 Iowa L. Rev. 197 (2008). See 1127 See id. 1130. This study finds that losses borne by AARP August 2018 Letter.

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provided by securities analysts, and studies that have identified consumers and note that disclosure of therefore follow analyst characteristics that make disclosure conflicts may produce undesirable recommendations to buy and sell effective as well as limitations to the behavior by the disclosing party, or that securities without considering other effectiveness of disclosure to investors, receivers of the information provided by information produced by the in particular focusing on issues related disclosures may fail to appropriately analyst.1138 Additionally, financial to disclosure of conflicts of interest and account for the implications.1147 A literacy may influence the quality of how disclosure could inflate potential series of studies documents that advice that financial professionals are conflicts between financial consumers do not account for conflicts willing to provide their clients. Some professionals and investors. of interest revealed through disclosures, financial professionals appear to be Characteristics of effective disclosures and that such disclosures of conflicts more likely to provide superior include saliency of information, clear can have the perverse effect of information to more financially literate and concise information delivered in a increasing bias and moral licensing in investors, who may be able to discern transparent manner, and increased use the provision of advice.1148 Moral the quality of the advice, and more of visual and interactive design, among licensing arises when the discloser of likely to provide inferior and potentially others.1144 One study, examining the information ‘‘take[s] an ethical action more conflicted information to investors effect of disclosure of fees and costs for that validates [her] self-image as a good who are less financially literate.1139 mutual funds, observes that disclosures person’’ so she feels as though she ‘‘may well give [herself] permission to play c. Evidence on the Effectiveness and that prominently feature fees are more fast and loose with the rules for a Limitations of Disclosure effective than others, but do not appear to reduce the importance that investors while.’’ 1149 Disclosure may also lead to Regulation Best Interest relies in part place on other fund characteristics, such a decrease in trust of biased advice on disclosure of certain material facts to as performance or risk.1145 Other because consumers feel pressured to 1140 retail customers. A number of studies, however, have found that satisfy the discloser’s self-interest commenters, however, stated that we disclosures may be ineffective, (‘‘panhandler effect’’); 1150 however, the failed to sufficiently account for particularly if the intended audience panhandler effect can be mitigated if the limitations of disclosure in the does not read the disclosure documents disclosure is provided from an external Proposing Release of Regulation Best or does not understand the material source, the disclosure is not common 1141 Interest. One commenter stated that presented to them. One study, for knowledge between the discloser and ‘‘studies show that regulation by example, notes that as the length and the receiver of the information, the disclosure alone can actually undermine complexity of the disclosure document receiver can change his or her mind at investor protection by emboldening increases, so does the time that it takes a later date, and the receiver can change advisers to ignore the client’s best for investors to read and understand the his or her mind in private.1151 One interest once they have ‘checked the material contained within; therefore, disclosure box,’ and by rendering investors are more likely to prefer 1147 See also Relationship Summary Adopting investors even more vulnerable to Release. shorter, simpler, and more 1148 See Daylian M. Cain, George Loewenstein, & conflicted advice once they receive straightforward language in disclosures.’’ 1142 Another commenter Don A. Moore, When Sunlight Fails to Disinfect: disclosures.1146 Understanding the Perverse Effects of Disclosing asserted that the ineffectiveness of Many studies have explored the effect Conflicts of Interest, 37 J. Consumer Res. 836 (2011); disclosure arises because of investors’ of revealing conflicts of interest to Daylian M. Cain, George Loewenstein, & Don A. failure to understand the disclosure, Moore, The Dirt on Coming Clean: Perverse Effects inadequate time to read and process the of Disclosing Conflicts of Interest, 34 J. Legal Stud. 1144 See Relationship Summary Adopting Release 1 (2005); George Loewenstein, Daylian M. Cain & information, cognitive dissonance, and at Section IV, which also discusses the benefits and Sunita Sah, The Limits of Transparency: Pitfalls trust in financial professionals’ oral limitation of disclosure. See also Margaret Hagan, and Potential of Disclosing Conflicts of Interest, 101 representations over written disclosures, Designing 21st Century Disclosure Methods for Am. Econ. Rev. (Papers & Proc.) 423 (2011). These among others.1143 Below, we discuss Financial Decision Making, Stanford Law School studies also note that, although disclosure is Policy Lab (2016), available at https:// intended to help financially unsophisticated law.stanford.edu/publications/designing-21st- consumers, disclosure is most likely to be beneficial 1138 See Ulrike Malmendier & Devin century-disclosures-for-financial-decision-making/. to sophisticated users of the information. One Shanthikumar, Are Small Investors Naive About One study finds that when fund expenses are study, however, notes that disclosure can reduce Incentives?, 85 J. Fin. Econ. 457 (2007). See AARP bundled with brokerage commissions, reducing the biased advice if the disclosure acts as a deterrent August 2018 Letter. transparency of various fees and costs, investors against entering into conflicts, and may improve 1139 See Willis (2008), supra footnote 1137, and experience larger degrees of underperformance than trust in advisers. See Sunita Sah & George Calcagno & Monticone (2015), supra footnote 1131. when the fees are more transparent. See Roger M. Loewenstein, Nothing to Declare: Mandatory and See also John A. Turner, Bruce W. Klein, & Norman Edelen, Richard B. Evans, & Gregory B. Kadlec, Voluntary Disclosure Leads Advisors to Avoid P. Stein, Financial Illiteracy Meets Conflicted Disclosure and Agency Conflict: Evidence from Conflicts of Interest, 25 PSYCH. SCI. 575 (2014). See Advice: The Case of Thrift Savings Plan Rollovers Mutual Fund Commission Bundling, 103 J. Fin. also Morningstar Letter; EPI Letter; Better Markets (Working Paper, Apr. 2015), available at https:// Econ. 308 (2012). See AARP August 2018 Letter. August 2018 Letter; Warren Letter; UVA Letter; gflec.org/wp-content/uploads/2015/04/Turner- 1145 See Lucy Hayes, William Lee, & Anish AARP August 2018 Letter; Johnsen Letter. 0408Assessing-the-Standard-for-Financial- Thakrar, Now You See It: Drawing Attention to 1149 See Robert A. Prentice, Moral Equilibrium: Advice.pdf, which documents that financial Charges in the Asset Management Industry (Fin. Stock Brokers and the Limits of Disclosure, 2011 professionals often suggest rolling over from thrift Conduct Auth., Occasional Paper No. 32, Apr. Wis. L. Rev. 1059 (2011). See AARP August 2018 savings plans to more expensive plans (e.g., IRAs), 2018), available at https://www.fca.org.uk/ Letter; Better Markets August 2018 Letter; State and that such behavior is pervasive among both publication/occasional-papers/occasional-paper- Attorneys General Letter. broker-dealers and investment advisers. See AARP 32.pdf. See Morningstar Letter. See also Anagol et 1150 See Cain et al. (2011), supra footnote 1148; August 2018 Letter. al. (2015), supra footnote 1075. Sunita Sah, Prashant Malaviya, & Debora 1140 See supra Section II.C.1. 1146 See Tamar Frankel, The Failure of Investor Thompson, Conflict of Interest Disclosure as an 1141 See AARP August 2018 Letter; Better Markets Protection by Disclosure, 81 U. Cin. L. Rev. 421 Expertise Cue: Differential Effects of Automatic and August 2018 Letter; State Attorneys General Letter; (2013). See FPC. See also Omri Ben-Shahar & Carl Deliberative Processing, 147 Organizational Behav. EPI Letter; Morningstar Letter; Warren Letter; UVA E. Schneider, The Failure of Mandated Disclosure, & Hum. Decision Processes 127 (2018), whereby Letter. 159 U. Pa. L. Rev. 647 (2011), which also questions disclosures of conflicts of interest act ‘‘as a heuristic 1142 See Better Markets August 2018 Letter. See the effectiveness of disclosures and finds mandated cue to infer greater trust in advisors’ expertise.’’ infra footnote 1148 for studies submitted by this disclosures ineffective substitutes for more direct 1151 See Sunita Sah, George Loewenstein, & commenter. regulation. See AARP August 2018 Letter; Better Daylian M. Cain, The Burden of Disclosure: 1143 See State Attorneys General Letter. See also Markets August 2018 Letter; State Attorneys Increased Compliance With Distrusted Advice, 104 EPI Letter. General Letter. Continued

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study notes that, beyond conflicts best interest of the retail customer at the respect to costs to broker-dealers, there disclosures, disclosures of actual bias time the recommendation is made, is a lack of data on the extent to which lead to an improvement in performance without placing the financial or other broker-dealers with different business of portfolios relative to investors who interest of the broker-dealer ahead of the practices engage in disclosure and only receive conflict disclosures.1152 interests of the retail customer; and (2) conflict mitigation activities to comply From the perspective of the investor, address conflicts of interest by with existing requirements, and conflicts disclosures may lead to under- establishing, maintaining, and enforcing therefore how costly it would be to or over-reaction by investors. According policies and procedures reasonably comply with the proposed to one study, investors may not know designed to identify and fully and fairly requirements. Also, the final rule will how to appropriately respond to disclose material facts about conflicts of provide broker-dealers flexibility in information about conflicts (e.g., interest, and in instances where we have complying with Regulation Best estimating the effects on the quality of determined that disclosure is Interest, and, as a result, there could be advice or knowing how to search for an insufficient to reasonably address the multiple ways in which broker-dealers unbiased second opinion) and therefore conflict, to mitigate or, in certain will satisfy this obligation, although may fail to adequately adjust their instances, eliminate the conflict. As a broker-dealers must comply with each behaviors when conflicts are result, Regulation Best Interest should of the elements of the obligation. In disclosed.1153 Alternatively, some enhance the efficiency of addition, Regulation Best Interest may investors may overreact to disclosures of recommendations that broker-dealers affect broker-dealers differently conflicts of interest, and may instead provide to retail customers, help retail depending on their business model (e.g., forgo valuable investment advice.1154 customers evaluate the full service broker-dealer, broker-dealer C. Benefits and Costs recommendations received, and improve retail customer protection that uses independent contractors, 1. General when receiving recommendations from insurance-affiliated broker-dealer) and size. More generally, estimates of the In formulating Regulation Best broker-dealers. The four component obligations of Regulation Best Interest’s magnitude of such benefits and costs Interest, the Commission has considered depend on assumptions about (1) the the potential benefits of establishing a work together to enhance the current extent to which broker-dealers currently best interest standard of conduct for standard of conduct for broker-dealers engage in disclosure and conflict broker-dealers, as well as the potential and improve disclosure of material facts mitigation activities, (2) how broker- costs. relating to the scope and terms of the Regulation Best Interest enhances the relationship and conflicts of interest. dealers currently develop broker-dealer standard of conduct Both on its own and together with the recommendations for their customers, beyond existing suitability obligations, other new rules and forms we are (3) how broker-dealers choose to comply and aligns the standard of conduct with adopting,1155 we anticipate that with Regulation Best Interest, (4) retail customers’ reasonable Regulation Best Interest will reduce the whether and how broker-dealers change expectations. Under Regulation Best agency costs of the relationship between investments and share classes offered as Interest, broker-dealers and their the associated persons of the broker- a result of Regulation Best Interest, (5) associated persons will be required, dealer and their retail customers, while whether and how product among other things, to: (1) Act in the preserving access to financial advice manufacturers change their investment and choice in the scope of services and offerings as a result of Regulation Best J. Personality & Soc. Psychol. 289 (2013). See how to pay for them. Interest, (6) whether broker-dealers Morningstar Letter; Better Markets August 2018 In this section, we discuss broader restrict access to brokerage accounts by Letter; EPI Letter. themes associated with the costs and raising minimum account sizes or 1152 See Christopher Tarver Robertson, Biased benefits of Regulation Best Interest, Advice, 60 Emory L.J. 653 (2011). This study also adding additional qualification suggests that obtaining an opinion from an unbiased including general comments we requirements, (7) whether broker- adviser ‘‘is a much better remedy for biased advice received on our analysis of the costs and dealers try to shift customers to advisory than disclosure.’’ See AARP August 2018 Letter. benefits in the Proposing Release. accounts as a result of Regulation Best 1153 See Angela A. Hung, Min Gong, & Jeremy Following this more general discussion, Interest, (8) how retail customers Burke, Effective Disclosures in Financial we discuss the specific costs and Decisionmaking, RAND Labor and Population perceive the risk and return of their Report Prepared for the Department of Labor (2015), benefits associated with Regulation Best portfolios, (9) how likely retail investors available at https://www.rand.org/content/dam/ Interest’s four component obligations. are to act on a recommendation that rand/pubs/research_reports/RR1200/RR1270/ While the Commission has considered RAND_RR1270.pdf. See also AARP August 2018 complies with Regulation Best Interest, the potential benefits and costs of (10) how the risk and return of retail Letter; Better Markets August 2018 Letter; Warren Regulation Best Interest, the Letter. See also James M. Lacko & Janis K. customer portfolios change as a result of Commission notes that generally it is Pappalardo, The Effect of Mortgage Broker how they act on the recommendation, Compensation Disclosures on Consumers and difficult to quantify such benefits and and (11) how investment advisers, Competition: A Controlled Experiment, Federal costs with meaningful precision.1156 Trade Commission, Bureau of Economics Staff including dually registered advisers, Where possible, the Commission has Report (Feb. 2004), available at https://www.ftc.gov/ react to the adoption of Regulation Best provided an estimate of specific costs; sites/default/files/documents/reports/effect- Interest and the other regulatory mortgage-broker-compensation-disclosures- however, several factors make the developments, including the rules we consumers-and-competition-controlled-experiment/ quantification of many of the effects of 030123mortgagefullrpt.pdf, which documents that Regulation Best Interest difficult. With are adopting and interpretations we are when mortgage customers receive information issuing simultaneously with Regulation about mortgage broker compensation through disclosures, such disclosures lead to an increase in 1155 See, e.g., Relationship Summary Adopting Best Interest. Because many of these more expensive loans and create a bias against Release. factors are firm-specific and thus broker-sold loans, even when the broker-sold loans 1156 See supra Section III.B.3.c for discussion of inherently difficult to quantify, even if are the more cost effective option. See EPI Letter. the wide range of estimates of the potential benefits it were possible to calculate a range of 1154 See George Loewenstein, Cass R. Sunstein, & of Regulation Best Interest stemming from a potential quantitative estimates, that Russell Golman, Disclosure: Psychology Changes reduction in investor harm, and discussion Everything, 6 Ann. Rev. Econ. 391 (2014). See IRI surrounding infra footnotes 1165–1182 for other range would be so wide as to not be Letter. issues associated with these estimates. informative about the magnitude of the

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benefits or costs associated with response to the (now vacated) DOL Conflict of Interest Obligation, will be Regulation Best Interest. Fiduciary Rule that have not been maintained.1163 Broader economic forces, beyond reversed, and any practices Some commenters suggested that broker-dealer and retail customer implemented by broker-dealers to fulfill certain types of costs should remain behavioral responses to Regulation Best their obligations under existing federal outside the scope of our analysis. Some Interest, also make meaningful estimates securities laws.1158 While we stated that our analysis should not of economic impacts difficult to acknowledged in the Proposing Release consider, for example, costs to broker- develop. The market for investment that variation in the extent to which dealers resulting from lost revenues on advice and services is complex and vast, broker-dealers with different business securities they cease offering or costs and as history demonstrates, is dynamic practices already engage in disclosure associated with any potential increase and affected by market-specific facts and conflict mitigation activities makes in arbitration claims as a result of (including product developments and quantifying Regulation Best Interest’s Regulation Best Interest, except to the regulatory changes) as well as costs and benefits with meaningful extent that they are passed on to macroeconomic factors (including precision difficult, we more explicitly investors in the form of higher fees.1164 general economic conditions). For emphasize how this variation in current These commenters suggested that example, the introduction of indexation market practices affects the costs and because these types of costs are a direct to the retail investment market and the benefits of Regulation Best Interest in result of policies that make investors subsequent increase in index products the discussion that follows.1159 In better off, they should not factor into an (and providers) and reduction in the general, to the extent that broker-dealer assessment of Regulation Best Interest. costs of indexing for retail investors practices are already aligned with the The Commission has an obligation to have had substantial effects on the requirements of Regulation Best Interest, consider the economic effect of market for retail investment advice and the anticipated magnitude of both the Regulation Best Interest on affected services. The more recent introduction costs and the benefits associated with a parties, including broker-dealers, even of ETFs has had similar unanticipated given component of Regulation Best when those costs are associated with and underestimated effects, including, Interest will be correspondingly benefits to investors. However, in the in general, reducing investor costs and reduced, and vice versa. specific discussion of each rule increasing tax efficiency, as well as 1160 As discussed above, commenters component that follows, we highlight increasing the array of product offerings. noted the existence of fiduciary instances where a given cost is directly Developments such as the employer- standards in various states. One associated with a benefit to investors. driven shift from defined benefit plans commenter provided an overview of the Commenters raised several issues to defined contribution plans also have fiduciary obligations of state-registered related to the quantification of costs and had significant effects on the market for investment advisers, ‘‘typified by an benefits, or lack thereof, in the investment advice. We expect these and expectation of undivided loyalty where Proposing Release. They asserted that other factors, including factors not the adviser acts primarily for the benefit our analysis focused too much on currently identified, will continue to of its clients.’’ 1161 This commenter also Regulation Best Interest’s costs and did affect the market and, accordingly, may stated that ‘‘[s]ome states also extend not quantify any of the benefits, such as change the economic effects of the rule. these fiduciary obligations beyond the reduction in investor harm.1165 These sources of uncertainty and investment advisers to brokers, As complexity make meaningfully especially in dual-hatted scenarios,’’ discussed above, some studies present quantifying many of the costs and and that these fiduciary obligations anecdotal evidence of behavior by benefits of the rule difficult and, were extended even when broker- certain broker-dealers, such as particularly over long time periods, dealers handled non-discretionary recommending investments that are inferior to available alternatives, that is inherently speculative. accounts.1162 We recognize that there is harmful to investors.1166 A potential a. Broad Commenter Concerns With substantial variation in the sources, scope, and application of state fiduciary Respect to Costs and Benefits 1163 law. And we acknowledge that such Whether Regulation Best Interest would have We received many comments a preemptive effect on any state law would be state-level obligations for broker-dealers determined in future judicial proceedings, and regarding our analysis in the Proposing mean that they may already engage in would depend on the language and operation of the Release of the benefits and costs. In this practices under the baseline that overlap particular state law at issue. We considered whether section, we discuss comments that with certain requirements under we could determine the economic impact of address broader aspects of our analysis. possible, future state-law preemption on retail Regulation Best Interest. To the extent customers, but concluded that we cannot analyze Comments that address costs and that state-level law incorporates the economic effects of the possible preemption of benefits of more specific components of fiduciary principles similar to those state law at this point because the factors that will Regulation Best Interest are discussed in reflected in Regulation Best Interest, the shape those judicial determinations are too the corresponding sections for each rule speculative. Among the unknown factors are: (1) magnitude of the costs and benefits The final language in any proposed state legislation component that follows. discussed below that stem from the or regulation adopting a fiduciary or other standard Some commenters stated that our application of those principles to for broker-dealers; (2) whether that language would analysis in the Proposing Release did broker-dealers will be correspondingly constitute the type of law, rule, or regulation that is expressly preempted by the securities law or not properly incorporate current market reduced. However, costs and benefits practices into the baseline.1157 As impliedly preempted under principles applied by that arise from obligations under courts; and (3) whether, if there was preemption, discussed above, we have revised the Regulation Best Interest that differ from that preclusion of state law would have any positive discussion to include those practices, obligations under state law, such as the or negative effects on investors when compared which may reflect guidance by SROs with the economic effects of Regulation Best such as FINRA, requirements and Interest. 1158 See supra Section III.B.2. 1164 See AARP August 2018 Letter; EPI Letter; obligations under state laws, practices 1159 See Proposing Release at 21643. Better Markets August 2018 Letter; Cetera August implemented by broker-dealers in 1160 See supra Section III.B.2. 2018 Letter. 1161 See NASAA February 2019 Letter at 22 and 1165 See AARP August 2018 Letter; Better Markets 1157 See, e.g., CFA August 2018 Letter; CCMC footnote 40. August 2018 Letter; CFA August 2018 Letter. Letters. 1162 Id. at 23–24. 1166 See supra footnotes 1068 and 1075.

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benefit of Regulation Best Interest is However, that benchmark does not baseline that is harmful to investors, therefore a reduction in that harm, as necessarily reflect the appropriate based on our analysis, including our asserted by commenters. However, the alternative available to investors in analysis of the comments received, we anecdotal evidence of investor harm in broker-sold funds. Extrapolating from continue to believe that quantifying that these studies does not lend itself to these studies leads to the conclusion harm, and therefore quantifying the aggregation. that investors would do better investing benefits associated with reducing it, Commenters also stated that we on their own, yet there are other studies depends on many contingent factors should have incorporated the approach showing that is not the case, at least not that would render any estimates used by the DOL RIA and the CEA to for all investors.1174 We further note insufficiently precise to inform our quantify aggregate investor harm.1167 that calculating the investor harm policy choices.1179 While both of these analyses surveyed a against a benchmark that includes the With respect to the magnitude of the broad literature on the relative fees retail customers would pay for costs we assessed in the Proposing performance of broker-sold versus equivalent advice could significantly Release, some commenters asserted that direct-sold mutual funds, they both reduce the magnitude of these our analysis underestimated the costs of relied on a particular study to estimate estimates.1175 complying with Regulation Best aggregate investor harm, extrapolating Finally, while risk-adjusted returns Interest, though only a few provided the effect of ‘‘excess loads’’ on the may be useful in comparing the estimates of these costs.1180 Where performance of broker-sold funds to performance of particular mutual funds, commenters provided estimates for a total industry-wide AUM.1168 We particularly when trying to evaluate specific component of Regulation Best disagree with this approach because, as fund manager skill, they do not Interest, particularly the Disclosure noted by commenters, we believe these necessarily reflect the utility that Obligation, we discuss those estimates analyses misapplied the particular investors achieve from their when discussing that component of study’s results.1169 When the results of investments.1176 Heterogeneous Regulation Best Interest below. Based on the study are correctly applied, the investors value investments and the its experience with the DOL Rule, one aggregate estimate of investor harm services provided by financial commenter provided a broad estimate of obtained using this approach is professionals differently depending on the compliance costs associated with negligible.1170 their investment profile and the entire package of rules we proposed, Another commenter advocated a preferences, and risk-adjusted returns including Regulation Best Interest and similar approach, claiming that risk- do not necessarily represent aggregate Form CRS, indicating that the rule adjusted returns net of fees, which utility across all investors in a way that package would entail initial costs of $20 calculate the excess return of an permits us to arrive at an aggregate million and ongoing costs of $5 million investment above a benchmark that measure of investor harm. For example, per year for their firm, but that these matches the risk of the investment, are consumers invest in various forms of costs would be manageable.1181 Another the only appropriate measure of insurance products in order to hedge commenter stated that for a small whether a recommendation is in a retail their exposure to bad outcomes (e.g., broker-dealer with $500,000 in net customer’s best interest.1171 While there home insurance policies), even though capital, the compliance costs estimated are studies showing that broker-sold the expected returns on such in the Proposing Release could mutual funds underperform direct-sold investments are generally negative. The constitute 12% of that net capital, funds to varying degrees,1172 we do not relative underperformance of broker- making compliance with Regulation believe, for the reasons explained sold mutual funds also may not capture Best Interest burdensome for such below, that applying estimates of this any intangible benefits investors derive broker-dealers.1182 We acknowledge that under-performance to industry-wide from receiving tailored financial 1177 the costs of Regulation Best Interest AUM produces a meaningful estimate of advice. Alternatively, the relative could be more burdensome for small the aggregate investor harm attributable performance of mutual funds sold broker-dealers and discuss any through these two channels may reflect to recommendations made by broker- corresponding competitive effects in dealers that is sufficiently precise to other factors that are unrelated to 1178 Section III.D.1. inform our policy choices. First, as conflicts of interest. Accordingly, Although the majority of the industry discussed above, these studies do not while we do not dispute the existence studies provided by commenters necessarily cleanly distinguish under- of broker-dealer behavior under the focused on the effects of the DOL performance attributable to broker- Fiduciary Rule on broker-dealers and dealers from under-performance 1174 See supra footnotes 1045–1048. 1175 their customers, one industry survey attributable to investment advisers.1173 See also supra footnote 1103. 1176 Even in the context of evaluating fund provided information about industry Second, interpreting the relative manager skill, there is debate about whether risk- beliefs about potential effects of underperformance of broker-sold funds adjusted returns are an appropriate measure of fund proposed Regulation Best Interest.1183 as a measure of investor harm due to performance. See e.g., Vincent Glode, Why Mutual Funds ‘‘Under Perform’’, 99 J. Fin. Econ. 546 (2011); conflicts of interest implicitly evaluates 1179 Jonathan B. Berk & Jules H. van Binsbergen, See Discussion following footnote 1156 for a investor harm against a benchmark that Measuring Skill in the Mutual Fund Industry, 118 discussion of these factors. See also infra Section does not include financial advice. J. Fin. Econ. 1 (2015). III.C.7, where we have endeavored to estimate some of the potential benefits of Regulation Best Interest 1177 See, e.g., Bergstresser et al. (2009), supra based on many assumptions. 1167 footnote 1048, who note that ‘‘[o]ne possibility is See Better Markets August 2018 Letter. 1180 See Schwab Letter; ICI Letter; Letter from 1168 See supra footnotes 1081 and 1099. that brokers provide other intangible benefits, which we cannot measure’’ when interpreting the James J. Angel, Associate Professor of Finance, 1169 See, e.g., Lewis (2017), supra footnote 1099. relative performance of broker-sold versus direct- Georgetown University (Aug. 7, 2018) (‘‘Angel 1170 See id. sold mutual funds. Letter’’); LPL August 2018 Letter; NSCP Letter. 1171 1181 See EPI Letter. See also Former SEC Senior 1178 See, e.g., The DOL RIA, supra footnote 1002, See Raymond James Letter. Economists Letter, stating that risk-adjusted returns at footnote 473, noting that the relative performance 1182 See NSCP Letter. are an appropriate measure of investor harm. of broker-sold versus direct-sold funds ‘‘. . . is an 1183 See Center for Capital Markets 1172 See, e.g., Bergstresser et al. (2009), supra imperfect measure of the impact of conflicts of Competitiveness, SEC Regulation Best Interest Rule footnote 1048; Del Guercio & Reuter (2014), supra interest; other factors, aside from conflicts of Proposals: Request for Information Analysis, FTI footnote 1081. interest, affect the relative performance of mutual Consulting Report Presented to the U.S. Chamber of 1173 See supra footnote 1097. funds sold through the two distribution channels.’’ Commerce (Jul. 25, 2018), available at https://

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The survey consisted of approximately Regulation Best Interest did not meaningful precision beyond our 30 individual financial professionals ‘‘expressly define ‘financial incentive’’’ Paperwork Reduction Act estimates. across a mix of 15 companies providing for purposes of the proposed b. Broad Investor Protection Benefits financial advisory services and requirement of policies and procedures products, including broker-dealers and designed to disclose and mitigate, or As discussed above, in addition to dually registered firms, with $23 trillion eliminate, conflicts arising from any enhancements provided above and in AUM and administration and nearly financial incentives, broker-dealers beyond current requirements and 79 million investment accounts. All of could face challenges to ‘‘design and market practices, each of the component the participants surveyed stated that it maintain effective compliance programs obligations of Regulation Best Interest was unlikely that they would reconsider that appropriately address the conflicts share features with market best practices their broker-dealer registration status, inherent in their particular business under the baseline, as shaped by while nearly 40% stated that they may models’’ thereby potentially increasing FINRA’s guidance on relevant rules or alter their investment choices and 35% litigation risks.1187 Another commenter as described in its Report on Conflicts could alter the services that they offer. indicated that, with respect to of Interest. Given this overlap, FINRA, With respect to the costs of Regulation proprietary products, ‘‘[s]tate courts in in response to a congressional request, Best Interest and Form CRS, enforcement actions and in review of enumerated the ways it believes approximately 36% of respondents such actions’’ may find it difficult to Regulation Best Interest enhances stated that the implementation costs distinguish the best interest standard for existing broker-dealer obligations under could be between 1% and 5% of annual broker-dealers from a fiduciary standard current FINRA rules.1190 profits; however, nearly 80% of for investment advisers, and may cause In addition to the enhancements that respondents noted that costs are likely certain associated persons of broker- each of Regulation Best Interest’s to decline over time.1184 We note that dealers to ‘‘shy away from the risks of component obligations provide above one of the cost estimates provided by a litigation in this regulatory and beyond existing broker-dealer commenter above is consistent with this environment, causing a substantial obligations under the baseline, which range.1185 One commenter suggested market contraction away from middle we discuss below, Regulation Best that for firms that offer access to class investors.’’ 1188 Interest increases retail customer thousands of unique securities, many of In the Proposing Release, we were protections by establishing these which likely have similar strategies able to quantify costs for limited obligations under the Exchange Act so (e.g., index mutual funds or ETFs), portions of Regulation Best Interest, that the Commission may enforce them requiring broker-dealers to ‘‘consider particularly those stemming from directly and examine for compliance. reasonably available alternatives offered requirements related to document Additionally, to the extent that market by the broker-dealer as part of having a creation for purposes of the Paperwork best practices may reflect some FINRA reasonable basis for making the Reduction Act. While we have updated guidance that is not required by recommendation’’ would make it cost these estimates in Section IV.B, we FINRA’s rules, some broker-dealers may prohibitive for broker-dealers and continue to believe that it is not possible not currently implement these practices. financial professionals to evaluate the to meaningfully quantify the full costs To the extent that broker-dealers and costs associated with ‘‘every similar and benefits of Regulation Best Interest their associated persons do not investment product available through because such analysis would depend on currently implement existing best the broker-dealer’s platform.’’ 1186 Many many contingent factors that render any practices that will be codified in survey participants, although they estimate insufficiently precise to inform Regulation Best Interest, retail believed that the Commission our policy choices.1189 So while we customers will benefit because it will underestimated the aggregate costs of acknowledge, for example, that increase the implementation of these Regulation Best Interest and Form CRS, Regulation Best Interest may impose best practices throughout the industry. agreed that the benefits to investors costs that are a significant portion of the 2. Disclosure Obligation estimate of initial and ongoing costs of were likely to justify the costs. As adopted, the Disclosure Obligation Other commenters stated that a $20 million and $5 million by the of Regulation Best Interest’s requires a number of elements of the Proposing commenter cited above, we cannot broker-dealer, prior to or at the time of Release potentially could increase anticipate the associated costs for all the recommendation, to provide to the litigation exposure for some broker- firms because of the wide variation in retail customer, in writing, full and fair dealers. For example, one commenter size and scope of business practices disclosure of all material facts relating discussed that, because proposed across firms as well as the many unknown factors associated with the to the scope and terms of the relationship and all material facts www.centerforcapitalmarkets.com/wp-content/ principles-based nature of Regulation uploads/2018/08/Reg-BI-Rule-Proposal-Research_ Best Interest. In discussing Regulation relating to conflicts of interest that are _ _ 8.7.18 FTI-Updated final.pdf. See CCMC Letters. Best Interest’s component obligations associated with the recommendation. Survey participants also addressed questions below, we address any estimates Regulation Best Interest explicitly related to beliefs regarding investor protection, requires disclosure of ‘‘all material facts choices for retail customers, and the standard of provided by commenters where we can conduct for broker-dealers. and otherwise explain the specific relating to the scope and terms of the 1184 One commenter stated that the ‘‘costly’’ factors that preclude quantifying the relationship with the retail customer’’ recordkeeping requirements described in the costs of Regulation Best Interest with including: (i) That the broker, dealer, or Proposing Release ‘‘are unnecessary as self-interest such natural person is acting as a will lead firms to keep proof of compliance’’ and should be eliminated. See Angel Letter. 1187 See Primerica Letter. broker, dealer, or an associated person 1185 See supra footnote 1181. Relative to this 1188 See Letter from Douglas M. Ommen, Iowa of a broker or dealer with respect to the commenter’s 2018 fiscal year profits, its initial cost Insurance Commissioner (Aug. 6, 2018) (‘‘Iowa recommendation; (ii) the material fees estimate of $20 million would represent Insurance Commissioner Letter’’). and costs that apply to the retail approximately 2% of annual profits for this firm. 1189 See Discussion following footnote 1156 for a customer’s transactions, holdings, and See https://www.sec.gov/Archives/edgar/data/ discussion of these factors. See also infra Section 720005/000072000518000083/rjf- III.C.7, where we have endeavored to estimate some accounts; and (iii) the type and scope of 20180930x10k.htm. of the potential benefits of Regulation Best Interest 1186 See LPL December 2018 Letter. based on many assumptions. 1190 See FINRA 2018 Letter.

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services provided to the retail customer, when making a recommendation. We described in the release text, required including any material limitations on also clarify above that the use of the that a broker-dealer provide sufficient the securities or investment strategies terms ‘‘adviser’’ or ‘‘advisor’’ in a name information to enable a retail investor to involving securities that may be or title by (i) a broker-dealer that is not make an informed decision with regard recommended to the retail customer; also registered as an investment adviser, to a recommendation.1195 Therefore, we and all material facts relating to or (ii) a financial professional that is not do not expect this change to affect our conflicts of interest that are associated also a supervised person of an assessment of Regulation Best Interest’s with the recommendation. investment adviser would costs and benefits. Second, whereas the Under the baseline, some disclosure presumptively violate this particular Proposing Release’s Disclosure obligations already exist, as do an array disclosure requirement. Second, Obligation did not explicitly require a of market practices with respect to the Regulation Best Interest requires that broker-dealer to disclose particular disclosure of capacity, fees, services, any disclosure made by a broker-dealer types of material facts relating to the and conflicts of interest.1191 The be ‘‘full and fair,’’ meaning that the scope and terms of its relationship with Disclosure Obligation will enhance broker-dealer is required to provide a retail customer, Regulation Best disclosure obligations that exist under sufficient information to enable a retail Interest explicitly requires that these the baseline and bring greater alignment investor to make an informed decision material facts include the capacity in to market practices by establishing an with regard to the recommendation, which the broker-dealer is acting, fees explicit and broad disclosure even where this information is about and costs, and the type and scope of requirement under the Exchange Act aspects of the relationship between a services provided, including material that applies to all broker-dealers when retail customer and a broker-dealer that limitations on the securities or they make a recommendation to a retail may already require disclosure, investment strategies that may be customer. We expect this change to implicitly or explicitly, under the recommended. We include any improve the quality and consistency of baseline. We expect the ‘‘full and fair’’ economic effects associated with this disclosures and thus (1) reduce the requirement to benefit retail customers change in our discussion of Regulation information asymmetry that may exist in cases where it results in disclosures Best Interest’s benefits and costs. between a retail customer and her that are not currently required under Finally, while we discuss the direct broker-dealer, and (2) facilitate customer broker-dealer antifraud provisions. benefits and costs of the Disclosure comparisons of different broker-dealers Finally, Regulation Best Interest Obligation in this section, retail which we expect will, in turn, increase requires that broker-dealers provide customers, broker-dealers, investment competition among broker-dealers, these disclosures to retail customers in advisers, and their financial including with respect to fees and costs, writing at or before the time of a professionals may experience indirect as discussed below.1192 recommendation. However, we are benefits or costs due to competitive Relative to the baseline, the permitting oral disclosures prior to or at effects caused by the Disclosure Disclosure Obligation will change how the time of a recommendation and Obligation. We discuss any competitive broker-dealers disclose information to written disclosures after a effects below in Section III.D.1. their retail customers in several specific recommendation under the a. Benefits ways. First, under the baseline, a broker- circumstances outlined in Section II.C.1, dealer and its associated persons are not Oral Disclosure or Disclosure After a Regulation Best Interest requires that explicitly required to disclose that they Recommendation.1193 We focus our brokers, dealers, or natural persons are acting in a broker-dealer capacity discussion of both the benefits and costs associated with a broker-dealer disclose of the Disclosure Obligation on these that they are acting as a broker, dealer, 1191 For instance, broker-dealers are subject to a changes relative to the baseline.1194 or an associated person of a broker- number of disclosure obligations under the Regulation Best Interest’s Disclosure dealer prior to or at the time of a Exchange Act when they effect certain customer Obligation is different from the recommendation to a retail customer. transactions. These disclosure obligations include Broker-dealers are not explicitly written disclosure about capacity, compensation, Proposing Release’s Disclosure and third-party remuneration related to the Obligation in two ways. First, while the required to disclose this information transaction, and disclosures about whether the Proposing Release required that a prior to or at the time of a broker-dealer has any control, affiliation, or interest recommendation under the baseline, in the security or the issuer of the security being broker-dealer ‘‘reasonably disclose’’ material facts to retail customers, though they may disclose it to comply offered. Broker-dealers also face liability under the with other federal securities laws and antifraud provisions of the federal securities laws Regulation Best Interest requires that a for failure to provide disclosure, such as disclosure broker-dealer provide retail customers SRO rules, or because they consider it of ‘‘honest and complete information’’ or any to be a market best practice.1196 This material adverse facts or materials conflicts of with ‘‘full and fair’’ disclosure of material facts. As discussed above, this requirement is most likely to have interest, including any economic self-interest, when economic effects when retail customers recommending a security (see supra footnote 988). change from the Proposing Release does have both brokerage and advisory In addition, broker-dealers must comply with a not have a substantive effect on the number of SRO disclosure obligations—such as accounts with the same financial expected economic effect of the FINRA Rule 2124 (Net Transactions with professional, as may be the case if the Disclosure Obligation. Specifically, in Customers), FINRA Rule 2262 (Disclosure of financial professional is dually- Control Relationship with Issuer), and FINRA Rule both the Proposing Release and registered. It is designed to make all 2269 (Disclosure of Participation or Interest in Regulation Best Interest, the formulation Primary or Secondary Distribution). Finally, broker- of the Disclosure Obligation, as dealers may also adjust their practices consistent 1195 See Proposing Release at Section II.D.1.c. with existing SRO guidance on specific 1196 For example, under the baseline, broker- disclosures—such as FINRA Regulatory Notice 13– 1193 For example, when oral disclosures are used dealers may decide that disclosing the capacity in 23, Brokerage and Individual Retirement Account prior to or at the time of a recommendation, broker- which it is acting is necessary in order to meet its Fees (July 2013) on fee disclosure. See Proposing dealers must maintain a record of the fact that oral duty of fair dealing under the antifraud provisions Release at footnotes 175, 176, 177, and 192; supra disclosure was provided. See supra footnotes 301 of the federal securities laws. In addition, broker- footnotes 303 and 985–988 for a more detailed and 507–508 and surrounding discussion for more dealers must disclose whether they effected the discussion on existing disclosure practices. detail on when oral disclosure prior to or at the transaction as a principal or agent in the customer 1192 See supra footnote 1072 for a discussion of time of a recommendation and disclosure in writing confirmation statement pursuant to Exchange Act potential information asymmetries between broker- after a recommendation are permitted. Rule 10b–10, which a retail customer generally dealers and retail customers. 1194 See supra footnotes 1157–1159. receives after the trade is completed.

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retail customers aware of the capacity in To the extent that, despite the registered.1200 These benefits will be which their broker-dealer is acting when disclosures provided on Form CRS, the limited to the extent that broker-dealers a recommendation is made, which may use of the titles ‘‘adviser’’ and ‘‘advisor’’ and their financial professionals choose help the retail customer better evaluate causes investor confusion about the other names or titles that may indicate the advice they receive. For instance, nature of the relationship retail that they provide advisory services or the cost to the retail customer of acting investors have, or will have, with a use marketing materials that hold them on such advice will typically depend on broker-dealer or financial professional, out as providing advisory services but whether the advice is tied to the retail the presumption that the use of these do not trigger the presumption or customer’s brokerage or advisory titles by (i) a broker-dealer that is not preclude application of the solely account. In addition, understanding the also registered as an investment adviser, incidental prong of the broker-dealer capacity in which a financial or (ii) a financial professional that is not exception to the definition of professional is acting may provide the also a supervised person of an investment adviser.1201 retail customer with context for, and investment adviser would violate the As discussed above, under the facilitate review of, other relevant capacity disclosure requirement will baseline, broker-dealers may, in disclosures by the broker-dealer. potentially benefit investors in two Knowing that she is receiving advice practice, already disclose information ways.1198 First, certain investors may from a broker-dealer, or an associated seek an advisory relationship and would about the fees they charge, the type and person of a broker-dealer, may focus the be better off receiving advice from an scope of services they provide, and any retail customer’s attention on any investment adviser. In situations where conflicts of interest associated with their potential conflicts of interest 1202 confusion associated with titles might recommendations. However, specifically associated with receiving a Regulation Best Interest’s explicit recommendation from a broker-dealer. cause such an investor to mistakenly engage in a relationship with a broker- requirement that broker-dealers disclose For example, a disclosure that a firm is all material facts related to the scope acting in the capacity of a broker-dealer dealer or an associated person of a broker-dealer, the presumption should and terms of their relationship with a may encourage a retail customer to seek retail customer and all material facts additional information about mitigate costs the investor might incur relating to conflicts of interest that are commissions, which could give the firm associated with receiving and, or its financial professional an incentive potentially, acting on recommendations associated with a recommendation may to recommend transactions that may be from a broker-dealer, as well as costs provide retail customers with useful inconsistent with the client’s most associated with correcting this information that they may not currently efficient investment strategy, such as a mismatch by switching to an investment receive, enabling them to make more buy-and-hold strategy. adviser.1199 Second, to the extent that, informed investment decisions. The While the capacity disclosure as a result of the use of the titles magnitude and nature of this benefit requirement and the disclosures ‘‘advisor’’ or ‘‘adviser,’’ any confusion will depend on the extent to which a investors will receive in Form CRS will might remain about the capacity in broker-dealer already discloses these increase the likelihood that retail which a broker-dealer or its associated material facts and how broker-dealers customers understand the nature of person is acting, the presumption choose to disclose this information. For their relationship with a broker-dealer should alleviate that confusion and thus example, if broker-dealers choose to or financial professional, and hence increase the likelihood that retail disclose all material facts in one how this relationship might affect the customers focus their attention on any consolidated document, the disclosure recommendations retail customers potential conflicts of interest may, depending on the facts and receive, some investors may form beliefs specifically associated with receiving a circumstances of the disclosure, be more about the nature of their relationship recommendation from a broker-dealer. informative to some retail customers with a broker-dealer or financial Any benefits associated with the than disclosures that are provided professional based on their use of presumption will apply for current and across many documents. In other cases, particular names and titles such as potential retail customers of the layered disclosures may allow broker- ‘‘adviser’’ or ‘‘advisor,’’ as well as how approximately 100 broker-dealers with dealers to target their disclosures to their services are marketed. In cases retail customers that are not also where these terms are used by (i) a their particular retail customer base at investment advisers and use the terms the relevant point in time, increasing broker-dealer that is not also registered ‘‘adviser’’ or ‘‘advisor’’ in their names, as an investment adviser, or (ii) a and for current and potential retail 1200 Staff analysis found that 100 retail-facing financial professional that is not also a customers of the approximately 16% of supervised person of an investment broker-dealers as of December 2018 use either all registered representatives that use ‘‘adviser’’ or ‘‘advisor’’ in their firm names. See adviser, some retail customers may not these titles and are not dually Relationship Summary Proposal at footnote 685 for fully understand that their broker-dealer more discussion of the estimate that approximately or financial professional is not acting in 16% of all registered representatives use these titles investor’s broker-dealer or financial professional and are not dually registered. the capacity of an investment adviser, solely offers services in a broker-dealer capacity, the 1201 See supra footnotes 336–340. even though investors receive some use of the titles ‘‘adviser’’ or ‘‘advisor’’ may leave 1202 information about the capacity their her confused about the nature of the services These disclosures may stem from implicit or explicit requirements under federal securities laws. broker-dealer or financial professional is provided, despite the capacity disclosure on Form CRS. See Relationship Summary Proposal at For example, broker-dealers are explicitly required acting in on Form CRS or other footnotes 411–412. to disclose certain aspects of the fees their retail 1197 disclosures. 1198 Several commenters generally ascribed customers pay, directly and indirectly, under benefits to restricting the usage of the terms Exchange Act Rule 10b–10 (see, e.g., 913 Study at 1197 Investors may not fully understand this ‘‘adviser’’ and ‘‘advisor.’’ See supra footnotes 326– footnotes 256–259). In other cases, courts have capacity disclosure because, for example, their 330. found that broker-dealers may implicitly be financial professional is not a supervised person of 1199 See Relationship Summary Proposal at required to disclose conflicts of interest or other an investment adviser but works for a dual- footnote 674 for further discussion of the costs material facts related to the scope and terms of their registrant, and they interpret Form CRS as associated with a mismatch between an investor relationship with retail customers (see, e.g., 913 suggesting the financial professional also provides and their preferred type of investment advice Study at footnotes 249–255). See also NASD Notice both types of services. Alternatively, even if an provider. to Members 92–11.

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the likelihood that investors read these securities laws and SRO rules, they are the baseline, thereby increasing the disclosures.1203 not expressly required to provide full likelihood that retail customers have the While the Proposing Release’s and fair disclosure in the manner information they need to make a more Disclosure Obligation did not explicitly required under Regulation Best Interest. informed and efficient investment require a broker-dealer to disclose As a result, existing disclosure practices decision at the time they receive a particular types of material facts relating may not be designed to specifically help recommendation. to the scope and terms of its retail customers make informed As noted above, we are permitting relationship with a retail customer, decisions about the recommendations oral disclosure prior to or at the time of Regulation Best Interest explicitly they receive. By explicitly requiring that a recommendation and written requires that these material facts broker-dealers provide sufficient disclosure after a recommendation has include: (1) The capacity in which the information to enable retail investors to been made under the circumstances broker-dealer is acting; (2) fees and make an informed decision with regard outlined in Section II.C.1, Oral costs; and (3) the type and scope of to a recommendation, Regulation Best Disclosure or Disclosure After a services provided, including material Interest imposes a minimum standard Recommendation.1206 Because oral limitations on the securities or on disclosures that may increase the disclosure is permitted in cases where investment strategies that may be consistency of disclosure practices written disclosure prior to or at the time recommended. We generally anticipate across broker-dealers relative to the of recommendation is not feasible or greater benefits under Regulation Best baseline. This may also cause such practical, investors may benefit by Interest than under the Proposing disclosures to be more useful to retail receiving information that otherwise Release. Specifically, to the extent that customers in evaluating the advice they may not have been available to them at broker-dealers may not have disclosed receive, thereby enabling them to make the time they make an investment the types of information we are more informed decisions about the decision. In contrast, because written requiring under Regulation Best Interest, recommendations they receive. To the disclosure is permitted in instances Regulation Best Interest should increase extent that disclosure obligations under where existing regulations permit the consistency of disclosure practices the baseline already result in broker- disclosure after a recommendation, the across broker-dealers, which may make dealers providing sufficient information benefits associated with the form and it easier for investors to compare to enable a retail customer to make an timing of disclosures under Regulation disclosures from and services offered by informed decision with regard to a Best Interest may be reduced if the different broker-dealers or other firms. recommendation, the magnitude of the information in such disclosures would In addition, if some broker-dealers benefits from this component of the have been useful to investors in making would not have disclosed the specific Disclosure Obligation is likely to be an investment decision. However, for types of information required under correspondingly reduced.1205 both oral disclosure prior to or at the Regulation Best Interest, and retail Regulation Best Interest’s Disclosure time of a recommendation and written customers find that information useful, Obligation also establishes a standard disclosure after a recommendation has Regulation Best Interest may facilitate for the form and timing of disclosures been made as permitted under the more informed decisions by retail by requiring that they be made in circumstances outlined in Section II.C.1, customers when they are deciding writing prior to or at the time of a Oral Disclosure or Disclosure After a whether or not to open an account or recommendation. While broker-dealers Recommendation, retail customers will use a recommendation. For example, may already disclose information on the still receive disclosures in writing prior disclosures about the scope and terms of fees they charge, the type and scope of to a recommendation regarding the services offered by a broker-dealer or services they provide, and any conflicts circumstances under which oral about their fees and costs may facilitate of interest associated with their disclosure or disclosure after a more informed decisions by retail recommendations under the baseline, recommendation will occur and the customers as to which type of account federal securities laws and SRO rules material facts that will be disclosed is appropriate for them and whether may not explicitly specify the form and under these circumstances.1207 they should open an account with a timing of such disclosures. In cases Several commenters stated that there given broker-dealer. Alternatively, where these requirements are explicit, are limits to the effectiveness of disclosures about conflicts of interest or they may not require delivery at or prior disclosure and cited a number of studies fees and costs may facilitate more to a retail customer’s evaluation of the suggesting that disclosure alone is informed decisions by retail customers recommendations they receive and any unlikely to solve the issues surrounding, as to whether or not they should use a corresponding investment decision. In for example, the conflicts of interest recommendation of a securities contrast, while broker-dealers will have between a broker-dealer or the transaction or investment strategy. some flexibility regarding the form and associated person of a broker-dealer and Regulation Best Interest also explicitly timing of their disclosures under a retail customer.1208 Another requires that disclosures be ‘‘full and Regulation Best Interest, retail commenter cited the 2008 RAND Study, fair,’’ and thus that a broker-dealer must customers will receive standardized concluding that investors do not have provide sufficient information to enable disclosures about the fees and costs, as the education or background to a retail customer to make an informed well as any conflicts of interest, understand financial disclosures and do decision with regard to a associated with a recommendation prior not read long, formulaic documents.1209 recommendation.1204 Broker-dealers to or at the time of receiving the Other commenters claimed that may disclose, for example, certain recommendation. The Disclosure conflicts of interest associated with their Obligation should increase the 1206 See supra footnote 1193. recommendations under the baseline. consistency of disclosure practices 1207 See discussion following supra footnote 301. across broker-dealers and across 1208 See Morningstar Letter; EPI Letter; Better However, under existing federal Markets August 2018 Letter; St. John’s U. Letter; different types of information relative to Letter from Tom C.W. Lin, Professor of Law, 1203 See the discussion of layered disclosure in Temple University Beasley School of Law (Jul. 11, supra Section II.C.1.c. See also supra footnote 540 1205 See supra footnote 1191 for more on 2018) (‘‘Lin Letter’’). on the potential benefits of layered disclosure. disclosure obligations and requirements under the 1209 See Galvin Letter and discussion of 2008 1204 See discussion at supra footnotes 463–469. baseline. RAND Study.

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numerous academic studies or eliminate conflicts even in cases delivering the Relationship Summary demonstrate that disclosing conflicts of where the Conflict of Interest Obligation will not be sufficient to disclose the interest does not adequately address the does not expressly require policies and capacity in which they are acting. Thus, potential harm they cause to procedures to mitigate or eliminate such while standalone broker-dealers that investors.1210 Another commenter conflicts. Because the Disclosure deliver the Relationship Summary provided studies showing that Obligation provides broker-dealers with generally will not incur additional costs disclosure can encourage better some flexibility as to the form and to comply with this requirement of the behavior by broker-dealers, improving timing of their disclosures, the Disclosure Obligation, dual-registrants investor welfare.1211 magnitude of this benefit will depend will incur additional costs, which could As discussed above, we acknowledge on the extent to which these disclosures include the creation of disclosure studies showing disclosure can vary in are comparable across broker-dealers or materials as well as policies and its effectiveness depending on the issue to which the disclosures made by one procedures to assist their associated it is intended to address, its intended broker-dealer draw attention to practices persons in determining when they are audience, and the format in which it is at other broker-dealers that may not be acting in a broker-dealer capacity. delivered.1212 To the extent some retail in the best interest of retail customers. However, dual-registrants and their customers are not able to understand the The magnitude of the Disclosure associated persons will have some information disclosed by a broker-dealer Obligation’s benefits will depend on a flexibility with respect to the form, regarding the scope of services it number of factors, including which facts timing, or method of satisfying this provides and the conflicts of interest about the scope and terms of their requirement of the Disclosure associated with the recommendations it relationship with retail customers are Obligation when they or their associated makes, the benefits of the Disclosure material, the extent to which broker- persons make recommendations acting Obligation will not directly affect those dealers already disclose information in as brokers, dealers, or associated investors, and may not increase the a manner that is consistent with the persons of a broker or dealer.1215 efficiency of their investment decisions. Disclosure Obligation under the The presumption that the use of the However, Regulation Best Interest is not baseline, the manner in which they titles ‘‘adviser’’ and ‘‘advisor’’ would limited to disclosure; rather, the choose to disclose this information, the violate the capacity disclosure Disclosure Obligation is just one extent to which retail customers requirement may impose costs on component of Regulation Best Interest understand such disclosures and would certain broker-dealers and their that as a whole will enhance the use them in making investment financial professionals, investors, and efficiency of recommendations that decisions, and the extent to which such other affected parties. Broker-dealers broker-dealers provide to retail disclosures would improve the and their associated persons currently customers, help retail customers efficiency of retail customers’ using names and titles containing the evaluate the recommendations received, investment decisions, which varies with terms ‘‘adviser’’ and ‘‘advisor’’ will and improve retail customer protection the specific circumstances of each retail incur direct costs, including those when receiving recommendations from customer. associated with changing firm names, broker-dealers. In particular, in addition b. Costs written and/or electronic marketing to the Disclosure Obligation, both the materials, advertisements, and personal We expect broker-dealers and their Care Obligation and the Conflict of communication tools that use these financial professionals to incur costs as Interest Obligation, discussed below, are titles, among other items, as well as any designed to promote more efficient a result of Regulation Best Interest’s costs associated with voluntary outreach investment decisions by imposing Disclosure Obligation, and retail to customers to inform them of these affirmative obligations on the broker- customers may incur indirect costs as changes.1216 While commenters did not dealer that cannot be fulfilled through well. In this section, we analyze these provide specific estimates of these costs, disclosure alone, regardless of whether costs in terms of how Regulation Best they described them as ‘‘very real the retail customer fully incorporates Interest changes disclosure costs,’’ 1217 ‘‘significant costs and disclosed information into its requirements for broker-dealers relative disruption,’’ 1218 and ‘‘burdensome and investment decisions. to the baseline.

Additionally, to the extent that the The requirement that broker-dealers 1215 information disclosed by broker-dealers See supra footnote 306. or their associated persons disclose the 1216 See e.g., HD Vest Letter (stating that ‘‘[t]he as a result of Regulation Best Interest capacity in which they or their term ‘Advisor’ permeates nearly every HD Vest increases the comparability of the associated persons are acting prior to or disclosure, representative agreement, selling securities and services offered by at the time of making a recommendation agreement, client agreement, client communication, different broker-dealers, it may foster marketing piece, and website’’ and noting that may be fulfilled by delivering the broker-dealers would need to develop compliance competition between broker-dealers that Relationship Summary, depending on policies to ensure oversight of the names and titles benefits even those retail customers who the facts and circumstances.1214 For used by their financial professionals); LPL August are not able to understand the example, a standalone broker-dealer 2018 Letter (stating that ‘‘legal entities with so- information disclosed by broker- called ‘doing business as’ (d/b/a) names containing may satisfy this requirement of the the term ‘advisor’ or ‘adviser’—through which 1213 dealers. For example, if an increase Disclosure Obligation by delivering the many securities professionals operate their business in comparability promotes competition Relationship Summary to the retail practices—will be required to rename their on the basis of recommendation quality, customer, as required pursuant to Form businesses and incur significant costs and it may cause broker-dealers to mitigate disruption in updating all marketing materials with CRS. In contrast, for broker-dealers who the prior name.’’); SIFMA August 2018 Letter; are dually registered, and associated Morgan Stanley Letter. 1210 See State Treasurers Letter; Better Markets persons who are either dually registered 1217 See HD Vest Letter. August 2018 Letter; PIABA Letter. or who are not dually registered but 1218 See LPL August 2018 Letter. See also NAIFA 1211 See Morningstar Letter. only offer broker-dealer services through Letter (noting the ‘‘significant costs to update all 1212 See supra Section III.B.4.c. materials, marketing, signage, legally-required 1213 See Relationship Summary Adopting Release a firm that is dually registered, disclosure documents, etc. . . .’’); SIFMA August at footnote 1035 for similar discussion of the 2018 Letter (noting the ‘‘significant costs and potential benefits comparability can have on 1214 See supra footnotes 320–321 and surrounding burdens’’ that would be involved with ‘‘[e]xtensive competition. discussion. repapering.’’).

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costly.’’ 1219 To the extent that a broker- might be affected by the if they are not delivered by that time dealer’s company name that includes presumption.1224 under the baseline. ‘‘adviser’’ or ‘‘advisor’’ is recognized as The requirement that broker-dealers Broker-dealers may also incur costs as a brand in the market and therefore disclose material facts relating to the a result of Regulation Best Interest’s represents a valuable intangible asset to material fees and costs that apply to a requirement that they disclose material the broker-dealer, the broker-dealer may retail customer’s transactions, holdings, facts about the type and scope of also incur indirect costs if some of its and accounts may also be partially services provided to a retail customer, ‘‘brand value’’ is lost following a fulfilled by delivering the Relationship including any material limitations on 1220 company name change. Additionally Summary. Form CRS will require the securities or investment strategies to the extent that investors who have a broker-dealers to provide retail investors involving securities that may be preference for receiving advice from a a high-level summary of principal fees recommended to the retail customer. As broker-dealer or an associated person of and costs, including transaction-based discussed above, some broker-dealers a broker-dealer search exclusively for fees, as well as a narrative discussion of may be able to fulfill their obligation to disclose these material facts, such as such advice using the terms ‘‘adviser’’ other fees that retail investors will pay those related to account monitoring, or ‘‘advisor,’’ they may experience a directly or indirectly. However, while account minimums, or material reduction in the choice of service providing such high-level summaries limitations on the securities or providers available to them (e.g., they partially complies with the Disclosure 1221 investment strategies that may be might only find dual-registrants). Obligation, the Relationship Summary recommended, by complying with Form Finally, organizations that award is unlikely to provide retail customers CRS or by using disclosures included in credentials or certifications to broker- with all of the material facts about the account opening agreements or other dealers and financial professionals that fees and costs that apply to a particular include the terms ‘‘adviser’’ or customer disclosures.1227 For these recommendation.1225 As a result, ‘‘advisor’’ may lose revenues associated broker-dealers, this requirement of the Regulation Best Interest will impose with a reduction in future demand for Disclosure Obligation should not cause costs on broker-dealers associated with these credentials and certifications, or them to incur additional costs beyond assessing whether facts about the fees lose revenues associated with the an initial assessment of whether they and costs that apply to a retail maintenance of current credentials or can comply with the Disclosure customer’s transactions, holdings, and certifications by awardees.1222 Obligation using Form CRS or pre- accounts are material and delivering Relatedly, affected financial existing disclosures. In cases where a those material facts to retail customers. professionals may experience a loss broker-dealer is not able to disclose all associated with any value they currently Broker-dealers will have some material facts relating to the type and derive from the use of these credentials flexibility in how they comply with this scope of services they provide by or certifications.1223 Rather than incur requirement, which will allow them to complying with Form CRS or in any of the costs associated with tailor these disclosures to the needs of combination with existing disclosures, changing names and titles discussed their retail customers and to implement broker-dealers will incur costs above, some broker-dealers may choose them in a manner that is as cost efficient associated with assessing which facts to register as investment advisers if they as possible, given their business models. about the type and scope of services determine it will be less costly, in In addition, the Disclosure Obligation provided to retail customers are material which case these broker-dealers will may be satisfied by providing and delivering written disclosure of incur any costs associated with dual documents that broker-dealers are those material facts to retail customers. registration. The potential costs already required to produce or As discussed above, broker-dealers will associated with the presumption apply voluntarily produce under the baseline, have some flexibility in how they for the approximately 100 broker- such as prospectuses, in which case comply with this requirement, allowing dealers, as of December 2018, with retail they may only incur costs associated them to tailor these disclosures to the customers that are not also investment with determining the timing and needs of their retail customers and to advisers and use either ‘‘adviser’’ or method by which they deliver these their business models and to implement ‘‘advisor’’ in their firm names, and for disclosures.1226 For example, under the these disclosures in a cost efficient the approximately 16% of all registered baseline, broker-dealers may currently manner. representatives that use these titles and deliver prospectuses to retail customers While the Proposing Release’s after the completion of a transaction Disclosure Obligation did not explicitly 1219 See Morgan Stanley Letter. under the baseline, but would need to require broker-dealers or their 1220 Academic evidence suggest corporate brands deliver them prior to or at the time of associated persons to disclose particular are valuable intangible assets to firms. See, e.g., types of material facts relating to the Mary E. Barth et al., Brand Values and Capital a recommendation under Regulation Market Valuation, 3 Rev. Acct. Stud. 41 (1998). Best Interest, unless made under the scope and terms of their relationship 1221 The extent of this potential cost depends on circumstances outlined in Section II.C.1, with a retail customer, Regulation Best how likely it is that investors rely on the titles Oral Disclosure or Disclosure After a Interest explicitly requires that these ‘‘adviser’’ and ‘‘advisor’’ in finding a broker-dealer. Recommendation, allowing them to rely material facts include the capacity in For example, one survey suggests that 40–50% of which the broker-dealer or its associated investors find their financial professionals through on delivery of information after the fact. personal recommendations, not via searches for In cases where required disclosures are person is acting; material fees and costs; these titles (see supra footnote 946 and discussion already produced under the baseline, the type and scope of services provided, in Relationship Summary Adopting Release at broker-dealers and their associated including material limitations on the Section IV.B.2.a). securities or investment strategies that 1222 See IWI Letter (noting that ‘‘Title Restrictions, persons may still incur costs associated as proposed, have a potential to impact the long- with delivering these disclosures prior may be recommended; and all material term growth of two of the Institute’s registered to or at the time of a recommendation facts relating to conflicts of interest that marks.’’). This commenter did not provide specific are associated with a recommendation. data or estimates on the potential magnitude of this To the extent that broker-dealers are not effect. 1224 See supra footnote 1200. 1223 See NAIFA Letter. This commenter did not 1225 See the discussion following supra footnote disclosing this information or are not provide specific data or estimates on the potential 368. magnitude of this effect. 1226 See discussion at supra footnotes 495–496. 1227 See supra footnote 1203.

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disclosing it by the time of a documenting such disclosures. These of 2,101,493 hours.1231 Thus, the recommendation, broker-dealers may costs may include the time spent Disclosure Obligation will impose an incur higher costs associated with documenting such disclosures, the estimated initial aggregate cost of at disclosing these material facts under development of systems and processes least $1,508.88 million and an ongoing Regulation Best Interest compared to the necessary to document such disclosures, aggregate annual cost of at least $499.59 baseline. training associated persons to use these million on broker-dealers.1232 We note In general, for any material facts systems and processes, and supervising relating to the scope and terms of its the compliance by associated persons 1231 The estimate of the initial aggregate burden relationship with retail customers, a is based on the following calculation: 5,630 hours with this obligation. For both oral + 7,560 hours + 40,200 hours + 2,040,000 hours + broker-dealer may have to determine disclosures and written disclosures 3,780 hours + 20,100 hours + 2,040,000 hours + how to disclose those facts in a manner made after a recommendation, broker- 3,780 hours + 15,075 hours + 2,040,000 hours = that is ‘‘full and fair,’’ as required by dealers and their associated persons 6,216,125 hours. As discussed in more detail in Regulation Best Interest, which will infra Section IV.B.1, 5,630, 7,560, and 40,200 hours may incur costs associated with are estimates of the initial aggregate burden for the cause it to incur costs. Similarly, the developing initial disclosures about the preparation of disclosure of capacity, type, and requirement that broker-dealers disclose material facts subject to oral disclosures scope, for dual-registrants and small and large all material facts in writing prior to or and written disclosures after a broker-dealers, respectively. 2,040,000 hours is the estimate of the initial aggregate burden for the at the time of a recommendation may recommendation, the circumstances delivery of the disclosure of capacity, type, and also impose costs on broker-dealers. For under which such disclosures will be scope to retail customers. 3,780 and 20,100 hours example, even if a broker-dealer made, as well as costs associated with are estimates of the initial aggregate burden for the currently discloses some information preparation of disclosure of fees for small and large training financial professionals to make broker-dealers, respectively. 2,040,000 hours is the about its fees under the baseline, it may such disclosures in a manner that estimate of the initial aggregate burden for the not currently disclose that information complies with Regulation Best Interest. delivery of the disclosure of fees to retail customers. prior to the time of a recommendation, 3,780 and 15,075 hours are estimates of the initial While most of the costs associated and may incur costs updating systems aggregate burden for the preparation of disclosure with preparing and delivering of material conflicts of interest for small and large and processes to ensure the information disclosures are likely to be incurred by broker-dealers, respectively. 2,040,000 hours is the is disclosed in a manner that complies estimate of the initial aggregate burden for the with Regulation Best Interest’s broker-dealers, their associated persons delivery of the disclosure of material conflicts of requirements, including any costs may incur costs as well. For example, interest to retail customers. The estimate of the initial aggregate cost is based on the following associated with delivery of the when a financial professional is aware that the broker-dealer’s disclosure is calculation: $2.80 million + $3.80 million + $15.00 information to retail customers. million + $1.88 million + $9.99 million + $1.88 Broker-dealers may incur costs insufficient to describe ‘‘all material million + $7.49 million = $42.84 million. As facts,’’ the associated person must discussed in more detail in supra Section V.D, associated with the full and fair $2.80 million, $3.80 million, and $15.00 million are disclosure of all material facts relating supplement that disclosure, and may incur costs in developing such estimates of the initial aggregate cost for the to conflicts of interest that are preparation of disclosure of capacity, type, and associated with a recommendation. As disclosure on their own to ensure they scope, for dual-registrants and small and large are in compliance with the Disclosure broker-dealers, respectively. $1.88 million and discussed below in our analysis of the 1230 $9.99 million are estimates of the initial aggregate Conflict of Interest Obligation, broker- Obligation. The magnitude of this cost will depend on the extent to which cost for the preparation of disclosure of fees for dealers currently have obligations to small and large broker-dealers, respectively. $1.88 disclose certain material conflicts of the financial professional cannot rely on million and $7.49 million are estimates of the initial aggregate cost for the preparation of disclosure of interest under the baseline.1228 To the the disclosure made by the broker- dealer. material conflicts of interest for small and large extent that broker-dealers will be broker-dealers, respectively. The estimate of the required to disclose material facts about As discussed above, while we are ongoing aggregate burden is based on the following conflicts of interest that they do not unable to quantify the full costs of calculation: 3,941 hours + 3,024 hours + 40,200 hours + 408,000 hours + 1,512 hours + 8,040 hours currently disclose to retail customers Regulation Best Interest, including the + 816,000 hours + 756 hours + 4,020 hours + under the baseline, broker-dealers will Disclosure Obligation, we are able to 816,000 hours = 2,101,493 hours. As discussed in incur costs associated with assessing estimate some of the costs associated more detail in supra Section V.D, 3,941, 3,024, and whether facts about these conflicts are with the Disclosure Obligation, 40,200 hours are estimates of the ongoing aggregate burden for the preparation of disclosure of capacity, material and delivering those facts to specifically the costs related to type, and scope, for dual-registrants and small and retail customers. They also may incur information collection requirements as large broker-dealers, respectively. 408,000 hours is costs associated with identifying defined by the Paperwork Reduction the estimate of the ongoing aggregate burden for the Act. As discussed further below in delivery of the disclosure of capacity, type, and particular conflicts of interest to scope to retail customers. 1,512 and 8,040 hours are 1229 disclose. Section IV.B.1, the Commission estimates of the ongoing aggregate burden for the As discussed above, there are estimates that the preparation and preparation of disclosure of fees for small and large circumstances where broker-dealers and delivery of standardized language, fee broker-dealers, respectively. 816,000 hours is the schedules, and standardized conflict estimate of the ongoing aggregate burden for the their associated persons may make oral delivery of the disclosure of fees to retail customers. disclosures or written disclosures after disclosures that broker-dealers are 756 and 4,020 hours are estimates of the ongoing the time of a recommendation under the required to provide to retail customers aggregate burden for the preparation of disclosure circumstances outlined in Section II.C.1, to comply with the Disclosure of material conflicts of interest for small and large Obligation will impose on broker- broker-dealers, respectively. 816,000 hours is the Oral Disclosure or Disclosure After a estimate of the ongoing aggregate burden for the Recommendation. Where oral dealers an initial aggregate burden of delivery of the disclosure of material conflicts of disclosures are made, broker-dealers 6,216,125 hours and an additional interest to retail customers. and their associated persons may incur initial aggregate cost of $42.84 million 1232 These estimates are calculated as follows: as well as an ongoing aggregate burden (96,125 hours of in-house legal counsel) × ($415.72/ costs associated with subsequently hour for in-house counsel) + (6,120,000 hours for delivery for each customer account) × ($233.02/ 1228 See infra footnote 1261. See also supra 1230 See discussion following supra footnote 307 hour for registered representative) + (90,763 hours footnotes 985–988. for an example of a case where an associated person for outside legal counsel) × ($497/hour for outside 1229 See infra Section III.C.4 for a discussion of of a broker-dealer may be required to provide her legal counsel) = $1,508.88 million, and (35,056 costs associated with identifying conflicts of own disclosures in order to comply with the hours of in-house legal counsel) × ($415.72/hour for interest as part of the Conflict of Interest Obligation. Disclosure Obligation. Continued

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that these estimates assume broker- such disclosures satisfy the Disclosure the customer’s best interest.1239 dealers are not currently producing and Obligation. In this regard, while the However, this obligation is not delivering documents associated with commenter’s estimate may be indicative explicitly required by FINRA’s rule (or the Disclosure Obligation. To the extent for some firms, the cost per firm will its supplementary material). Under the that broker-dealers are already doing so, vary widely depending on the scope and baseline, a recommendation by a broker- these estimates may overstate the costs business model of each broker-dealer. dealer or its associated persons may be associated with the information Because Regulation Best Interest consistent with a retail customer’s best collection requirements as defined by provides broker-dealers with some interest but broker-dealers and their the Paperwork Reduction Act. flexibility regarding both the form and associated persons are not required to Several commenters stated that we timing of the Disclosure Obligation, its make recommendations in the best underestimated the compliance costs of costs are likely to be lower than a pure interest of these customers, as will be Regulation Best Interest in the point-of-sale requirement.1237 required under Regulation Best Interest. Proposing Release, particularly with Beyond the estimates provided above Relative to the baseline, the Care respect to the potential transaction- for that are derived from estimates Obligation will change how broker- based nature of the Disclosure developed for purposes of the dealers and their associated persons Obligation and the resultant record- Paperwork Reduction Act in Section make recommendations to retail making and recordkeeping IV.B.1, the Commission is unable to customers in several ways, some of requirements.1233 One commenter stated fully quantify the costs of the Disclosure which differ from the Proposing that if the Disclosure Obligation is a Obligation because the magnitude of Release. transaction-based requirement, its costs these costs depend on firm-specific First, the Care Obligation explicitly were significantly underestimated in the factors that are inherently difficult to includes cost as a factor for Proposing Release, citing an estimate quantify given the principles-based consideration when determining that an earlier proposal of a point-of-sale nature of Regulation Best Interest.1238 whether a recommendation is in a retail disclosure requirement would cost These factors include the extent to customer’s best interest. In contrast, the between $1 million and $1.2 million per which current disclosure practices Proposing Release emphasized cost as firm.1234 We first note that, given that under the baseline are different from the an important factor to consider and there are approximately 2,766 broker- requirements of the Disclosure stated that broker-dealers may be dealers with retail-facing operations, the Obligation, the manner in which broker- required to consider cost as a factor commenter’s cited estimate implies dealers choose to comply with the when making recommendations, but did initial costs of approximately $1.4 Disclosure Obligation given the not explicitly require its consideration billion and ongoing costs of flexibility it provides, how broker- when making a recommendation.1240 In approximately $1.4 billion,1235 so the dealers assess whether facts relating to addition, we clarify above in Section commenter’s implied estimate of $1.4 the scope and terms of their relationship II.C.2 that, when determining whether a billion in initial costs associated with with a retail customer are material, how recommendation is in a retail the Disclosure Obligation is consistent they determine whether their disclosure customer’s best interest with respect to with our estimate of initial costs of such material facts is full and fair, or cost or other relevant factors, broker- above.1236 Second, we note that, as the extent to which they will satisfy the dealers and their associated persons discussed in more detail above in Disclosure Obligation’s requirements by should consider reasonably available Section II.C.1.d, the Disclosure delivering the Relationship Summary or alternatives. Conversely, under FINRA Obligation only requires that certain pre-existing documents. suitability obligations, broker-dealers disclosures be made prior to or at the 3. Care Obligation and their associated persons are not time of a recommendation, and broker- required to consider reasonably dealers may use standardized Under the baseline, broker-dealers are available alternatives when determining disclosures at an earlier point than the subject to suitability obligations and whether a recommendation is suitable time of a recommendation to the extent requirements under the anti-fraud for a retail customer.1241 provisions of the federal securities laws Second, under the baseline, FINRA in-house counsel) + (2,040,000 hours for delivery and the Suitability Rule when making × rules require that a broker-dealer or for each customer account) ($233.02/hour for recommendations to retail customers. associated person who has actual or de registered representative) + (26,437 hours for in- The Care Obligation incorporates and house compliance counsel) × ($365.39/hour for facto control over a customer’s account outside legal counsel) = $499.59 million. The adds to existing suitability requirements must have a reasonable basis for hourly wages for in-house legal and compliance applicable to broker-dealers, thereby believing that a series of recommended counsel and registered representatives are obtained reducing the incidence of inefficient from SIFMA. The hourly rates for outside legal transactions, even if suitable when recommendations to retail customers. viewed in isolation, is not excessive and counsel are discussed in supra Section V.D. FINRA rules require broker-dealers 1233 See Schwab Letter; ICI Letter; Angel Letter; unsuitable for the customer when taken making recommendations to have, based Vanguard Letter; LPL August 2018 Letter; NSCP together in light of the customer’s on a particular customer’s investment Letter. investment profile. In contrast, the Care 1234 See Schwab Letter, citing April 12, 2004 profile, a reasonable basis to believe that Obligation requires that a broker-dealer comment letter from George Kramer of the the recommendation is suitable for that Securities Industry Association (‘‘SIA’’). This or its associated person has a reasonable customer. In addition, FINRA guidance estimate is based on a point-of-sale disclosure basis to believe that a series of and Commission opinions interpret requirement in proposed rule 15c2–3, for which recommended transactions is not SIA estimated that implementation costs would be suitability as prohibiting a broker-dealer in the order of $500,000 per firm, as would annual from placing its interests ahead of the excessive and is in that retail customer’s costs associated with maintaining and updated customer’s interest and requiring the best interest. This is the case at all necessary systems and procedures. See also SIFMA times—when the broker-dealer or August 2018 Letter at footnote 38 referencing the recommendations to be consistent with same estimate. associated person has actual or de facto 1235 These estimates are calculated as follows: 1237 See supra footnotes 531–533 for a discussion (2766 retail-facing broker-dealers) × ($500,000 per of layered disclosure and footnotes 541–542 for a 1239 See supra footnote 570 and 913 Study at firm in initial costs) = $1.383 billion. Implied discussion of the Disclosure Obligation’s footnote 270. ongoing costs are calculated the same way. requirements with respect to timing of disclosures. 1240 See supra footnote 572 and preceding text. 1236 See supra footnote 1232. 1238 See supra Section III.C.1. 1241 See id.

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control over a customer’s account as place the financial or other interest of of a recommendation. If this causes well as when no control exists (whether the broker-dealer or its associated broker-dealers and their associated actual or de facto). persons ahead of the interest of the persons to more carefully consider cost Finally, FINRA’s suitability standard particular retail customer. Broker- in relation to other factors, compared to applies to recommendations of rollover dealers and their associated persons can the baseline, it should reduce the decisions that involve securities comply with Regulation Best Interest as incidence of recommendations of higher transactions, but not necessarily in the a whole by complying with its four cost investments from a set of absence of a securities transaction.1242 component obligations, which now reasonably available alternatives that In addition, FINRA’s suitability explicitly include the Proposing achieve the retail customer’s objective. standard does not explicitly apply to Release’s general best interest standard If the explicit requirement to consider recommendations of account types and in elements of the Care Obligation. This the cost of a recommendation implicit hold recommendations change to the Care Obligation, as encourages broker-dealers and their resulting from agreed upon account compared to the Proposing Release, is associated persons to more carefully monitoring.1243 In contrast, Regulation intended to emphasize the importance consider cost, compared to the baseline, Best Interest explicitly applies to of determining that each the final rule makes it less likely that a account recommendations as an recommendation is in the best interest broker-dealer or its associated persons ‘‘investment strategy involving of the retail customer and that it does could have a reasonable basis to believe securities,’’ including recommendations not place the broker-dealer’s interests such investments are in the retail of securities account types, as well as ahead of the retail customer’s interest; customer’s best interest because it rollovers or transfers of assets from one however, we do not believe there will be would be difficult to have such a belief account to another. In addition, under significant economic effects associated for investments that are identical Regulation Best Interest, implicit hold with this change from the Proposing beyond their costs. Therefore, including recommendations resulting from agreed Release.1245 Second, Regulation Best cost as a required factor in Regulation upon account monitoring constitute Interest, as adopted, does not explicitly Best Interest should enhance the recommendations of ‘‘any securities require broker-dealers or their efficiency of recommendations to retail transaction or investment strategy associated persons to exercise customers relative to the baseline.1248 involving securities,’’ and are therefore ‘‘prudence’’ in making As discussed above, while a within the scope of Regulation Best recommendations. Instead they must ‘‘quantitative suitability’’ requirement Interest. Moreover, recommendations to exercise reasonable diligence, care, and applies to series of recommended open an IRA or to roll over assets into skill in making such recommendations. transactions under the baseline, it only an IRA are subject to Regulation Best While we removed the term ‘‘prudence’’ applies in cases where a broker-dealer Interest, including the Care Obligation, to address commenter concerns that it has ‘‘control’’ over a customer account. thereby requiring a broker-dealer or its might create legal confusion and Relative to the baseline, broker-dealers associated persons to have a reasonable uncertainty, this does not change the and their associated persons will be basis to believe that the IRA or IRA requirements or obligations under the required to have a reasonable basis to rollover is in the best interest of the Care Obligation as compared to the believe that any series of recommended retail customer at the time of the Proposing Release.1246 Therefore, we do transactions is in the retail customer’s recommendation, taking into not expect this change to have a best interest, not just series of consideration the retail customer’s significant economic effect, as compared recommended transactions that occur in investment profile and other relevant to the Proposing Release. an account they control. This change relative to the baseline should enhance factors, as well as the potential risks, a. Benefits rewards, and costs of the IRA or IRA investor protection by reducing the As described in the Proposing rollover compared to the retail incidence of cases where a broker-dealer Release, the Care Obligation did not customer’s existing 401(k) or other or its associated persons recommend an explicitly require broker-dealers and retirement account. We focus our excessively high rate of portfolio their associated persons to consider the discussion of both the benefits and costs turnover, or ‘‘churn,’’ for accounts that costs associated with a recommendation of the Care Obligation under Regulation they do not control. In addition, the when determining whether it was in a discussion above regarding the potential Best Interest on these changes relative to retail customer’s best interest, though benefits from the increased standard of the baseline. the Proposing Release discussed cost as Regulation Best Interest’s Care conduct required by the Care Obligation a relevant factor in making this Obligation differs from the Proposing in the context of individual determination, and noted that broker- Release’s Care Obligation in two ways recommendations also applies to series dealers might be required to consider that respond to commenter concerns but of recommended transactions. cost as a factor when making that we do not expect to have significant Enhancing the standard of conduct that 1244 recommendations under the applies to series of recommended economic effects. First, the general baseline.1247 The Care Obligation under best interest standard of conduct from transactions and reducing the incidence Regulation Best Interest includes an of recommendations that result in the Proposing Release is incorporated explicit requirement to consider the cost into Regulation Best Interest’s Care excess portfolio turnover should result Obligation, which, as adopted, also in more efficient recommendations, 1245 If anything, to the extent that broker-dealers benefiting retail customers. We are requires that a broker-dealer or its or their associated persons might have associated persons have a reasonable misunderstood the Proposing Release with respect unable to specifically quantify these basis to believe that a recommendation, to their obligation to provide recommendations that potential benefits because, in addition or series of recommendations, does not are in the best interest of retail customers, to the reasons cited above, we do not Regulation Best Interest, as adopted, emphasizes the have and cannot reasonably obtain importance of determining that each 1242 See FINRA Regulatory Notice 13–45 and recommendation is in the best interest of the retail comprehensive data on how often supra footnote 172. customer will benefit retail customers. broker-dealers, for accounts they do not 1243 See supra footnote 170. 1246 See supra footnotes 579–585 and surrounding 1244 See discussion at supra footnotes 147, 606, discussion. 1248 See discussion surrounding supra footnotes and 577–584. 1247 See supra footnote 572. 563–565.

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control, recommend series of particular account as well as the retail lost revenue is passed on to investors in transactions that result in excessive customer’s investment profile.1252 the form of higher fees, because these portfolio turnover and are therefore not Regulation Best Interest should result in types of costs are a direct result of in the best interest of their retail recommendations regarding account policies that make investors better customers. type that are in the best interest of the off.1253 As discussed above, our Regulation Best Interest applies to retail customer, particularly with economic analysis must consider the account recommendations, including respect to cost, increasing the efficiency costs Regulation Best Interest may recommendations to open an IRA or to of the account type recommendations impose on all affected parties, including participate in an IRA rollover. retail customers receive relative to the broker-dealers. However, we believe Accordingly, these types of baseline. that any loss of revenues associated recommendations are subject to the Care Finally, by clarifying that implicit with recommendations that would not Obligation (as well as the other hold recommendations resulting from satisfy the Care Obligation is components of Regulation Best Interest). agreed-upon account monitoring compensated by the corresponding Several commenters highlighted the services constitute recommendations of benefit to retail customers—namely the heightened risk of harm associated with ‘‘any securities transaction or provision of more efficient IRA and IRA rollover recommendations investment strategy involving recommendations by their financial because the amount of assets associated securities,’’ the Care Obligation will professionals.1254 In addition, even if with such recommendations can be a apply at the point in time at which their broker-dealers or their associated significant portion of a retail customer’s broker-dealer or associated person persons have a reasonable basis to net worth, and one commenter cited performs the agreed-upon monitoring, believe that a certain investment could academic and industry studies that regardless of whether the broker-dealer be in the best interest of some retail identify activities that are particularly or an associated person communicates customers, they may forgo offering or prone to conflicts of interest, including any recommendation. This should recommending the investment if, for 1249 IRA rollovers. We acknowledge the increase the efficiency of the implicit example, they think that it may increase heightened effect that recommendations hold recommendations retail customers their exposure to regulatory to open an IRA or to participate in an receive relative to the baseline. enforcement risk over their compliance IRA rollover can have on the financial with Regulation Best Interest.1255 This 1250 b. Costs well-being of retail customers. While could result in costs to both the broker- We expect broker-dealers and their FINRA’s suitability standard under the dealer and any retail customers for associated persons to incur costs as a baseline applies to rollover whom the investment would be an result of the Care Obligation, and, to the recommendations involving securities efficient investment choice. transactions, the suitability standard extent broker-dealers pass these costs on to retail customers, these customers may Because the Care Obligation holds does not necessarily apply to a rollover broker-dealers and their associated recommendation if that incur costs as well. In this section, we analyze these costs in terms of how persons to an enhanced standard of recommendation does not involve a conduct, they may incur costs securities transaction.1251 To the extent Regulation Best Interest, as adopted, changes the required standard of care associated with increased legal exposure that broker-dealers and their associated if, for example, Regulation Best Interest persons currently make broker-dealers owe their retail customers relative to the baseline. We results in increased retail customer recommendations to open an IRA or to arbitrations or litigation. For example, participate in an IRA rollover that do also highlight any changes in our one commenter stated that the lack of not involve securities transactions assessment of these costs as compared clarity in how to weight various factors under the baseline, Regulation Best to the Proposing Release. We discuss the associated with the potential risks and Interest should result in IRA and IRA costs of complying with the Care rewards of a recommendation could rollover recommendations to retail Obligation, such as those associated lead to arbitrary claims regarding other customers that are more efficient with training employees or developing alternative recommendations that, ex- because they will be in the retail policies and procedures, in Section post, would have performed better.1256 customer’s best interest regardless of III.C.5. Similarly, because the Care Obligation whether or not they involve securities To comply with the Care Obligation, also requires that a series of transactions. some broker-dealers may stop offering Regulation Best Interest also applies certain securities to retail customers, or recommended transactions be in the to other account type recommendations. their associated persons may stop best interest of a retail customer, Broker-dealers may offer different types recommending certain securities to regardless of whether a broker-dealer or of brokerage accounts that include retail customers. These decisions may an associated person controls the retail different levels of services and costs. be based on determinations that offering customer’s account, a broker-dealer The choice of account type can have a or recommending those securities could incur the same types of costs significant effect on the financial typically would not satisfy the Care associated with increased arbitration or wellbeing of a retail customer. For Obligation. To the extent that they earn litigation risk relative to the baseline. example, a recommendation to open an revenue from offering and We cannot anticipate the extent to advisory over a brokerage account, or recommending such securities, broker- which Regulation Best Interest will vice versa, can have a substantial long- dealers and their associated persons increase retail customer claims, but term effect on a retail customer’s assets. may incur costs associated with the many retail customer arbitrations are This effect may depend on the costs the determination to cease offering or already predicated in whole or in part retail customer incurs through the recommending these products. on facts alleging that a broker-dealer Commenters stated that our analysis 1249 See CFA August 2018 Letter; AARP August should not consider lost revenue as a 1253 See supra footnote 1164. 1254 2018 Letter; Morningstar Letter; CFA Institute cost of complying with Regulation Best See supra Section III.A.2 for a more detailed Letter. discussion of efficient recommendations. 1250 See supra footnotes 191–192. See also Interest, except to the extent that the 1255 See, e.g., Iowa Insurance Commissioner Fiduciary Benchmarks Letter. Letter. 1251 See supra footnote 1242. 1252 See supra footnote 191. 1256 See CCMC Letters.

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breached a fiduciary duty or its Obligation will impose on broker- its associated persons that may have an suitability obligations. Additionally, the dealers, their associated persons, or effect on the recommendations provided clarity in the rule text and this release their retail customers because the to the retail customer. This disclosure regarding the Care Obligation, as well as magnitude of these costs depends on may help the retail customer form a the other aspects of Regulation Best firm-specific factors that are inherently better assessment of the efficiency of the Interest that bring enhanced conduct difficult to quantify given the recommendation received. Moreover, and clarity (e.g., the policies and principles-based nature of Regulation reducing this information asymmetry procedures requirement and that Best Interest.1258 These factors include may discourage broker-dealers from Regulation Best Interest applies only at the extent to which broker-dealers and acting on incentives that differ from the time a recommendation is made) their associated persons currently retail customer objectives. should mitigate against an increase in engage in practices under the baseline Similarly, by addressing the effect of the likelihood and cost of such claims. that would satisfy the Care Obligation, certain conflicts of interest through The Care Obligation explicitly either of their own volition or as a result mitigation, the Conflict of Interest requires that cost be considered as a of complying with other regulations; the Obligation is intended to reduce the factor when determining whether a extent to which broker-dealers and their effect incentives created by those recommendation is in the best interest associated persons will cease conflicts may have on a of a retail customer. Several commenters recommending certain securities or recommendation provided to the retail stated that the Proposing Release’s investment strategies; the likelihood customer. Depending on how effective guidance emphasizing cost as a specific that retail customers file more the mitigation method is in reducing factor in the Care Obligation could arbitration or litigation claims; and the these incentives, the efficiency of the create uncertainty around how the cost extent to which broker-dealers pass on recommendation provided to the retail of a recommendation should be weighed any cost increases to their retail customer may increase. with other factors.1257 As discussed customers.1259 Similarly, by addressing the effect of above, the inclusion of cost as a factor certain conflicts of interest through in the Care Obligation does not require 4. Conflict of Interest Obligation elimination, the Conflict of Interest that the ‘‘least expensive’’ The Conflict of Interest Obligation Obligation is intended to neutralize the recommendation be made by a broker- under Regulation Best Interest is effect of incentives created by those dealer or its associated person; cost is intended to reduce the agency costs that conflicts may have on a one factor, but not the only relevant arise when a broker-dealer and its recommendation provided to the retail factor. Nonetheless, to the extent that associated persons provide a customer. In this case, the efficiency of the inclusion of cost as a factor in the recommendation to a retail customer by the recommendations provided to the Care Obligation increases the arbitration addressing the effect of the associated retail customer may increase. or litigation risk to which broker-dealers person’s or broker-dealer’s conflicts of The conflicts of interest that the or their associated persons are exposed, interest on the recommendation. broker-dealer or its associated persons this change could impose additional The Conflict of Interest Obligation have, and the incentives that these costs on broker-dealers. would require that broker-dealers conflicts create, arise from, among other Regulation Best Interest also expressly establish, maintain, and enforce written things, the manner in which broker- applies to account recommendations, policies and procedures that are dealers generate revenue and the including recommendations of reasonably designed to address the manner in which broker-dealers securities account types, as well as effect of the broker-dealer’s and the compensate their associated persons rollovers or transfers of assets from one associated persons’ conflicts of interest with respect to their dealings with retail account to another. We also clarify on a recommendation. At a minimum, a customers. above that implicit hold broker-dealer is required to address the The compensation arrangement recommendations resulting from agreed- effect of conflicts of interest on a between a broker-dealer and its upon account monitoring are within the recommendation. At a minimum, a associated persons may reflect the scope of Regulation Best Interest and are broker-dealer is required to address the amount of revenues that the associated therefore subject to the Care Obligation. effect of an identified conflict on a persons generate for the broker-dealer Should they choose to discontinue recommendation by disclosing the from activities performed, including offering certain services, as a result of material facts associated with that providing recommendations to retail Regulation Best Interest, broker-dealers conflict and by disclosing material customers. Such arrangements between could lose revenue associated with limitations of the menu of securities the broker-dealer and its associated making recommendations for account when the conflict stems from such persons may create incentives for the types (including IRAs). They may also limitations. In certain cases, a broker- associated person to take actions decide to cease offering monitoring dealer is required to address the effect consistent with maximizing the broker- services on retail customer accounts. of an identified conflict by either dealer’s objectives (e.g., expected However, as we discussed above with mitigating the conflict, or, in certain profits). For instance, if an associated respect to recommendations more cases, by eliminating certain sales person’s compensation from providing generally, we believe that any loss of practices. recommendations to retail customers is revenues associated with The Conflict of Interest Obligation is tied to the amount of revenues that the recommendations that would not satisfy intended to reduce the information associated person generates for the the Care Obligation is compensated by asymmetry between a retail customer broker-dealer, the associated person the corresponding benefits to retail and a broker-dealer and its associated may have an incentive to recommend persons with respect to the broker- customers associated with more securities or investment strategies that dealer’s conflicts of interest or those of efficient account recommendations. would bring more revenue to the broker- The Commission is unable to fully dealer, relative to other comparable 1258 quantify the costs that the Care See also supra Section III.C.1.a. securities or investment strategies. 1259 See discussion following infra footnote 1329 Furthermore, even if the compensation for discussion of factors affecting whether broker- 1257 See ICI Letter; CCMC Letters; LPL August dealers pass on costs to their retail customers and arrangement does not create an explicit 2018 Letter. the resultant competitive effects. incentive for the associated person, the

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broker-dealer may direct the attention of of interest, in certain circumstances.1261 a. Overarching Obligation Related to the associated person to certain Furthermore, broker-dealers are Conflicts of Interest securities. For instance, even if the generally prohibited from making an The overarching obligation of the revenues that the broker-dealer receives unsuitable recommendation to a Conflict of Interest Obligation states that when its associated persons provide customer.1262 broker-dealers must establish, maintain, recommendations to retail customers are In addition, broker-dealers may be and enforce written policies and not passed on to the associated persons, liable under the Exchange Act for failure procedures reasonably designed to the broker-dealer’s receipt of to supervise their associated persons identify and at a minimum disclose, or compensation from some securities or eliminate, all conflicts of interest their sponsors may lead the broker- when providing advice to retail 1263 associated with recommendations to dealer to emphasize to its associated customers. Broker-dealers are generally required to establish policies retail customers. persons the securities that are the source The requirement to establish written and procedures that are reasonably of such compensation. policies and procedures reasonably designed to prevent and detect The revenues that a broker-dealer designed to identify conflicts of interest violations of the federal securities laws receives when a retail customer acts on is a new requirement relative to the an investment recommendation may and regulations, as well as applicable current regulatory regime. This depend on the broker-dealer’s SRO rules. Broker-dealers are also requirement may impose costs on those compensation arrangement with the required to establish and maintain broker-dealers that currently do not product sponsor. The broker-dealer may systems for applying these procedures implement such policies and receive different compensation from (e.g., identifying and reviewing red flags procedures voluntarily. These costs different product sponsors for with respect to the recommendations stem from the resources that a broker- distributing comparable securities or provided by their associated dealer would have to expend to identify investment strategies. If the objectives of persons).1264 existing and potential conflicts of the broker-dealer are tied to the amount As discussed above, a number of interest and to design policies and of revenues it receives from studies and papers provide evidence procedures that can reasonably identify recommended securities or investment suggesting that despite the current and manage circumstances when a strategies, the broker-dealer may have regulatory regime and observations that conflict of interest arises within the an incentive to advise only, or agency costs to retail customers from broker-dealer. These circumstances predominantly, on securities or would have to take into account, among investment strategies that come with broker-dealer relationships may be trending downward, the effect of other things, how the broker-dealer attractive compensation arrangements generates revenue from providing conflicts of interest on the provision of and less so, or not at all, on other recommendations to retail customers advice remains a concern.1265 We also comparable securities or investment and how associated persons of the noted in Section III.A.2 above that, more strategies. Accordingly, the incentives broker-dealer are compensated for created by the compensation generally, the conflicts of interest of the providing recommendations. In arrangements with the product sponsors broker-dealer and its associated persons addition, these circumstances would may cause a broker-dealer to limit the and the incentives that these conflicts have to account for the limitations of the menu of securities from which the create may result in agency costs for the menu of securities from which broker- broker-dealer or its associated persons retail customers that persist despite the dealers provide recommendations. make recommendations. current regulatory regime. Furthermore, broker-dealers may incur The conflicts of interest that can arise The Conflict of Interest Obligation in costs of reviewing and updating such from the compensation arrangement Regulation Best Interest is intended to policies and procedures as new conflicts between the broker-dealer and its reduce the agency costs associated with of interest arise or as new circumstances associated persons, and from the the conflicts of interest of the broker- develop that may cause the broker- compensation arrangement between the dealers and its associated persons when dealer to identify an existing conflict of broker-dealer and the product sponsors, they provide recommendations on interest. The Commission is providing can create incentives that may affect the securities transactions and investment below a quantitative estimate of the cost broker-dealer’s or its associated persons’ to broker-dealers associated with recommendations to retail customers. In strategies to retail customers. Below we discuss the economic implications of designing and updating such policies certain circumstances, a broker-dealer’s and procedures under certain different requirements of this obligation, conflicts of interest, or its associated assumptions persons’ conflicts of interest, may result including their benefits and costs The requirement to establish policies in recommendations that are not in the relative to the current regulatory regime. and procedures reasonably designed to best interest of the retail customer.1260 identify conflicts of interest may also As discussed above, in Section III.B.2, 1261 See the Suitability Rule; see also 913 Study create benefits for retail customers. As broker-dealers are currently subject to at 55 for a detailed discussion of the broker-dealers’ disclosure obligations and liabilities under the noted above, the policies and Commission and SRO regulations and current regulatory regime. procedures would require broker- rules that govern their business conduct. 1262 See FINRA Rule 2111.03 (Recommended dealers to: (1) Identify existing conflicts For example, with respect to the Strategies). of interest and new circumstances in provision of advice, courts have found 1263 See 913 Study at 74. which an existing conflict of interest broker-dealers liable under the antifraud 1264 Id. at 75. In addition, FINRA Rule 3010 may arise, and (2) new conflicts of requires broker-dealers to establish and maintain a provisions of the federal securities laws system to supervise the activities of their associated interest and the circumstances in which for not giving ‘‘honest and complete persons that is reasonably designed to achieve they may arise. Having a process in information’’ or for not disclosing compliance with the applicable securities laws and place to identify and address the ‘‘material adverse facts of which it is regulations and FINRA rules. FINRA Rule 3120 conflicts of interest associated with a requires broker-dealers to have a system of aware’’ with regard to certain conflicts supervisory control policies and procedures that recommendation at the time the tests and verifies supervisory procedures. recommendation is made to a retail 1260 See FINRA Conflicts Report. 1265 See supra Section III.B.3.c. customer would reduce the likelihood

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that a broker-dealer may fail to disclose parties facilitates a more informed material facts disclosed may increase material facts relating to conflicts of decision. There is extensive academic the salience of the conflicts of interest interest. Thus, the process a broker- literature on the factors that contribute to retail customers as being a potential dealer develops as a result of complying to disclosure effectiveness.1267 Among factor contributing to an associated with the Conflict of Interest Obligation these factors, those associated with person’s recommendation. Salience may improve the quality of the content bounded rationality, including financial detection is a key feature of human of the disclosure of conflicts of interest literacy, are generally important.1268 In cognition allowing individuals to focus that may affect a recommendation. To particular, disclosure effectiveness their limited mental resources on a the extent such disclosure helps retail generally increases with the level of subset of the available information and customers make a better assessment of financial literacy of the transacting causing them to over-weight this the efficiency of the recommendation party.1269 It is also possible that if a information in their decision making they receive, the requirement may broker-dealer’s retail customers have processes.1272 Limited attention among benefit the retail customers. different degrees of financial literacy, individuals increases the importance of The Commission continues to believe the potential anticipated reaction of the focusing on salient disclosure signals. that it is not possible to meaningfully retail customers that are financially Research suggests that increasing signal quantify the potential costs and benefits literate to the disclosure of conflicts of salience is particularly helpful in of the Conflict of Interest Obligations interest may cause the broker-dealer to reducing limited attention of consumers because such analysis would depend on choose to eliminate certain conflicts, with lower education levels and many contingent factors that render any which, in turn, would benefit the financial literacy.1273 To the extent that estimate insufficiently precise to inform population of retail customers that are this manner of disclosure and the our policy choices.1266 For example, less financially literate. Specifically, the associated increase in salience results in such an analysis of the Conflict of requirement to establish policies and more informed decisions with respect to Interest Obligation would require strong procedures reasonably designed to, at a whether to act on a received assumptions about the circumstances minimum, disclose identified conflicts recommendation, the disclosure under which a broker-dealer may fail to of interest may have a deterrent effect requirement resulting from the Conflict identify a given conflict of interest, and on some broker-dealers to the extent of Interest Obligation will benefit retail also about the extent to which the that they anticipate that disclosing customers. disclosure of the conflicts of interest material facts about certain conflicts of It is also possible that the disclosure may enhance decision making for retail interest may be effective in dissuading of material facts about a broker-dealer’s customers. certain retail customers from seeking or conflicts of interest or those of its The requirement to establish policies accepting recommendations from their associated persons related to a and procedures reasonably designed to, associated persons in the future. As recommendation may not benefit the at a minimum, disclose identified noted above, such broker-dealers may retail customer receiving that conflicts of interest may help a retail choose to eliminate those conflicts recommendation. As noted by one customer evaluate the efficiency of the instead. commenter, the academic literature on recommendation provided by a broker- disclosure effectiveness notes that in dealer and its associated persons, and i. Disclosing Conflicts of Interest certain circumstances, disclosure of may affect the retail customer’s decision financial information may induce a of whether, and how, to act on the The requirement under the Conflict of ‘‘panhandler effect’’, whereby disclosure recommendation. As noted in Section Interest Obligation to develop increases the pressure to comply with III.A.2 above, reducing the information reasonably designed policies and the advice if the advisee (e.g., the retail asymmetry between a retail customer procedures to, at a minimum, disclose customer) feels obliged to satisfy the and a broker-dealer and its associated identified conflicts of interest would financial interest of the advice provider persons may help the retail customer obligate a broker-dealer to provide (e.g., the associated person).1274 form a better assessment of the information (e.g., material facts) about efficiency of the received its conflicts of interest and those that its account statements, and information made public recommendation. associated persons have when making a on their websites. Disclosure requirements generally are recommendation to a retail customer. As 1272 See Daniel Kahneman, Thinking, Fast and intended to reduce information discussed above, this information may Slow (2013); Susan T. Fiske & Shelley E. Taylor, Social Cognition: From Brains to Culture (3rd ed. asymmetries between transacting already be disclosed under the 2017). parties. Whether such a reduction is regulatory baseline and by broker- 1273 See, e.g., Victor Stango & Jonathan Zinman, likely to occur depends largely on the dealers that adopt best practices. Limited and Varying Consumer Attention: Evidence effectiveness of the disclosure. If the However, it is currently not clear in from Shocks to the Salience of Bank Overdraft Fees, disclosure provides new information, what form and what manner this 27 Rev. Fin. Stud. 990 (2014). 1274 See, e.g., EPI Letter at 11, noting that ‘‘[a]s the transacting parties may make more disclosure reaches the retail SEC itself noted in its analysis of one of the informed decisions than they would customer.1270 Under Regulation Best proposed regulations, disclosure may even induce without this new information, and, from Interest, the Conflict of Interest a ‘panhandler effect,’ whereby clients may go this perspective, the disclosure may be Obligation is intended to require that through with a transaction in response to social pressure to meet the professional’s financial effective. However, disclosure can be such disclosure reach the retail interests.’’ The Commenter also notes that generally effective even if no new information is customer more directly and in a more disclosure may not incentivize a financial provided, to the extent the form and timely manner.1271 In addition, the professional to change her behavior: ‘‘The SEC also manner in which a disclosure noted that disclosure could have an effect on the behavior of financial professionals through ‘moral 1267 See supra Section III.B.4.c for a detailed requirement reaches the transacting licensing’—the belief that they have already discussion of the academic literature on disclosure fulfilled their moral obligations through disclosure, effectiveness. 1266 See discussion following supra footnote 1156 and ‘strategic biasing’—the desire to compensate for 1268 for a general discussion of these factors. See also Id. an anticipated loss of profit from disclosure.’’ As infra Section III.C.7, where we have endeavored to 1269 Id. discussed above, Regulation Best Interest recognizes quantify some of the potential benefits of 1270 See e.g., 913 Study. that certain conflicts of interest cannot be Regulation Best Interest based on many 1271 Broker-dealers satisfy their current disclosure reasonably addressed with disclosure alone. See assumptions. obligations in the account opening agreement, Continued

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ii. Elimination of Conflicts of Interest b. Mitigation of Certain Incentives to the likelihood of an associated person Associated Persons placing its interest or the interest of the The policies and procedures that broker-dealer ahead of the interests of a broker-dealers will need to maintain The requirement to establish, maintain, and enforce written policies retail customer when providing and implement to comply with the and procedures reasonably designed to recommendations to retail customers. Conflict of Interest Obligation will also identify and mitigate conflicts of Another way that this requirement give them the option of addressing interest that create an incentive for the may affect the employment relationship conflicts of interest associated with associated person of the broker-dealer to between the broker-dealer and the recommendations by eliminating such place the interest of the broker-dealer or associated person is by changing the conflicts entirely, rather than just the associated person ahead of the level of effort that the associated person disclosing them to the retail customer. interest of the retail customer will likely would have to exert to ensure that all Depending on the effectiveness of the affect the relationship between the recommendations supplied to retail policies and procedures that a broker- broker-dealer and its associated persons, customers are compliant with the dealer implements to comply with the the menu of securities that the broker- Conflict of Interest Obligation. As a Conflict of Interest Obligation, conflicts dealer makes available to its associated corollary, this requirement may also of interest that are not required to be persons, and the recommendations that affect the level of effort that a supervisor eliminated and that remain may still the broker-dealer and its associated would have to exert to ensure that the have a significant effect on an associated persons provide to retail customers. In recommendations supplied by its person’s recommendation. If a broker- the employment relationship between a associated persons to a retail customer dealer considers that the effect of a broker-dealer and its associated persons, comply with the obligations of conflict of interest on the the broker-dealer generally hires and Regulation Best Interest. As discussed above in the context of recommendations of its associated compensates associated persons to the Care Obligation, an associated persons cannot be adequately addressed perform certain services (e.g., providing person would have to not only consider by the broker-dealer, as required by the recommendations on securities transactions and investment strategies to a number of factors when making a Conflict of Interest Obligation recommendation to a retail customer, (discussed further below), the broker- retail customers) using the broker- dealer’s framework (e.g., policies and but also ensure that the dealer may consider modifying its recommendation is in the best interest practices to eliminate that conflict. By procedures to ensure compliance with applicable laws and rules, supervisory of the retail customer. The eliminating a conflict, the broker-dealer systems that monitor for potential determination that a recommendation is would neutralize the effect of this violations of policies and procedures, in the retail customer’s best interest may conflict on the recommendations etc.). The compensation that the depend on the conflicts of interest that provided by the broker-dealer or its associated person receives from the exist at the time the associated person associated persons to retail customers. broker-dealer may reflect the level of makes the recommendation, and, The absence of this conflict of interest effort that the broker-dealer expects the importantly, on how the broker-dealer when the associated person is associated person to exert when complies with the requirement to considering reasonably available performing a service, given the broker- establish, maintain, and enforce policies alternatives for a recommendation to a dealer’s infrastructure. As noted above, and procedures reasonably designed to retail customer, as noted above in the the broker-dealer may also structure the identify and mitigate or eliminate discussion of the Care Obligation, associated person’s compensation to conflicts of interest that create an would likely result in an increase in the create incentives that are consistent incentive for the associated person to efficiency of the customers. As with maximizing the broker-dealer’s put the interest of the broker-dealer or discussed above in Section III.A.2, this objectives. the associated person ahead of the outcome would be consistent with the The requirement to establish, interest of the retail customer. It is goals of Regulation Best Interest by maintain, and enforce written policies possible that more effective policies and reducing the agency costs associated and procedures reasonably designed to procedures may lower the level of effort an associated person would have to with an associated person’s incentives identify and mitigate conflicts of exert to have a reasonable basis to created by these conflicts of interest, interest that create an incentive for the believe that recommendations are which would benefit the retail associated person of the broker-dealer to compliant with Regulation Best Interest, customer. put the interest of the broker-dealer or the associated person ahead of the in the sense that a supervisor or the Furthermore, the option to address interest of the retail customer may affect broker-dealer would determine whether conflicts of interest through elimination the employment relationship between the effect of the associated person’s or allows broker-dealers to reduce the the broker-dealer and the associated the broker-dealer’s conflicts of interest compliance costs associated with person in several ways. First, the is reduced to the point where the managing conflicts of interest. For requirement may change a broker- incentives created by these conflicts do example, if a broker-dealer determines it dealer’s existing policies and not have a negative effect on the is too costly to just disclose a conflict of procedures that are designed to achieve recommendations. However, the interest as required under the Conflict of compliance with the regulatory baseline potential increase in the supervisor’s Interest Obligation, the broker-dealer as well as the supervisory systems that level of effort may substitute for the could choose to eliminate the conflict. allow the broker-dealer to monitor for potential decrease in the associated On the other hand, by eliminating a potential violations by the associated person’s level of effort. conflict of interest, a broker-dealer may persons of these policies and One commenter had concerns about forgo the potential revenues associated procedures. To this end, broker-dealers the discussion in the Proposing Release with that conflict of interest. will need to consider the amount of about the effect of the compensation time and level of resources to devote to arrangements between the broker-dealer also supra Section III.B.4.c, which discusses in design and establish policies and and the associated person on the effort more detail these effects. procedures that seek to reduce the exerted by the associated person when

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providing a recommendation.1275 This persons. Specifically, some broker- In this way, complying with the Conflict commenter stated that if the dealers chose to equalize commissions of Interest Obligation would increase compensation leads to lower effort, the and deferred sales charges charged the efficiency of the recommendations associated person would not make across similar securities or investment for retail customers, relative to the recommendations that are in the retail strategies. Others chose to restrict or regulatory baseline. This, in turn, would customer’s best interest. As discussed eliminate sales quotas, contests, special reduce the agency costs associated with above, the Commission notes that the awards, and bonuses, including deferred the broker-dealer’s and its associated relationship between the effort exerted bonuses as part of the recruitment persons’ incentives that are created by to make a recommendation and the efforts.1276 It is possible that some their conflicts of interest. Lower agency efficiency of the recommendation is broker-dealers may choose to comply costs at these broker-dealers would complex, and that lower effort may not with the Conflict of Interest Obligation benefit retail customers. necessarily be inconsistent with by establishing policies and procedures One commenter noted that the size of increasing the efficiency of the that would address conflicts using these these benefits of Regulation Best Interest recommendation. or similar methods. It is also possible should be quantified relative to the Finally, the Conflict of Interest that some broker-dealers may rely on baseline that includes the current Obligation may affect the compensation existing policies and procedures that regulatory regime as well as current arrangement between the broker-dealer address conflicts through methods such practices.1277 The Commission agrees and its associated persons. Certain as compliance and supervisory systems with the commenter and notes that, as compensation arrangements may create that are consistent with the Conflict of discussed in Section III.B, broker- incentives for an associated person to Interest Obligation. dealers may already have compliance place his or her interest of the interest Some of these methods may reduce and supervisory systems in place that of the broker-dealer ahead of the interest the overall compensation of the are effective at reducing to a reasonable of the customer, and therefore create associated person from providing extent the effect of an associated conflicts of interest for the broker- recommendations (e.g., altering certain person’s conflicts of interest on the dealer’s associated persons. For bonuses). The same methods or others recommendations provided to retail example, as discussed above in Section (e.g., altering deferred recruiting customers.1278 Therefore, for the retail III.B.1.f, broker-dealers commonly bonuses) may complicate a broker- customers of these broker-dealers, the compensate their associated persons dealer’s hiring of new associated potential benefits above may be small. based on commissions and persons. However, to the extent that In contrast, for the retail customers of performance-based awards. These these methods address the conflicts of the broker-dealers that are not currently compensation arrangements create interest of a broker-dealer or those of its addressing conflicts of interest in a incentives for associated persons to associated persons in an effective manner consistent with Regulation Best recommend securities or investment manner, these methods may enhance Interest, the potential benefits above strategies that generate more the efficiency of the recommendations may be large. commissions to the broker-dealer and provided by a broker-dealer and its This commenter further stated that potentially themselves over other associated persons, and, therefore the economic analysis in the Proposing securities or investment strategies. benefit retail customers. Release did not provide a thorough The Conflict of Interest Obligation In general, if a broker-dealer discussion of the relationship between requires a broker-dealer to have policies implements policies and procedures the broker-dealer and its associated and procedures that are reasonably pursuant to the Conflict of Interest persons with a focus on the incentives designed to identify and disclose and Obligation that may result in a of the associated persons.1279 The mitigate, or eliminate, any conflicts of significant reduction in the overall Commission notes that the analysis interest associated with compensation that an associated person above about the incentives of the recommendations that create an receives from providing associated persons expands the analysis incentive for the associated person or recommendations, the associated person in the Proposing Release and establishes the firm to place the interest of the may have an incentive to register as an a clear link between compensation and associated person or the firm ahead of investment adviser, if not already incentives. the interest of the retail customer, registered as one, and provide advice As noted in the economic analysis of including conflicts of interest that arise mostly or only in an investment adviser the Proposing Release,1280 broker- from compensation arrangements capacity. dealers may also adjust their menus of between broker-dealers and their To the extent broker-dealers establish, securities in response to the associated persons. Depending on how maintain, and enforce policies and requirement to establish, maintain, and a broker-dealer complies with the procedures that are effective at reducing enforce written policies and procedures Conflict of Interest Obligation, the incentives of an associated person to reasonably designed to identify and compensation arrangements between put the interest of the broker-dealer or mitigate conflicts of interest that create broker-dealers and their associated the associated person ahead of the an incentive for the associated person to persons may change as a result of interest of the retail customer, the place his or her interest or the interest establishing these policies and Conflict of Interest Obligation would of the broker-dealer ahead of the interest procedures. For example, as discussed reduce the effect of these conflicts on of the retail customer. It is possible that above in Section III.B.2.e, in response to the recommendations provided by some broker-dealers may decide to the DOL Fiduciary Rule, which among associated persons to retail customers. expand their offerings to better comply other things, was designed to restrict with the process required pursuant to broker-dealer activities and reduce the 1276 However, we understand that following the the Conflict of Interest Obligation. For conflicts of interest of a broker-dealer decision by the Fifth Circuit to vacate the DOL instance, broker-dealers that currently and those of its associated persons, Fiduciary Rule, some broker-dealers may have reverted back to compensation arrangements that some broker-dealers altered the 1277 they had in place prior to the DOL Fiduciary Rule. See CFA August 2018 Letter. compensation for their associated For instance, as discussed in Section III.B.2.e.ii, 1278 See FINRA Conflicts Report. supra, some broker-dealers reinstated their deferred 1279 See CFA August 2018 Letter. 1275 See AARP August 2018 Letter. recruiting bonuses. 1280 See Proposing Release at 21658.

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offer advice only on a limited set of a benefit for the retail customers of these material limitations placed on securities securities (e.g., proprietary securities) broker-dealers. or investment strategies that may be would have to disclose and evaluate Broker-dealers may pass on some of recommended to a retail investor and their menu of securities to ensure that the compliance costs to their retail any conflicts of interest associated with their policies and procedures regarding customers. For instance, broker-dealers such limitations in accordance with the their limited menus of securities and the may increase their fees on the services Disclosure Obligation. It further requires disclosures of any conflicts associated that they provide to retail customers as such policies and procedures to be with such limitations do not result in part of the relationship, or may adopt reasonably designed to prevent such recommendations that place the interest new fees. Alternatively, broker-dealers limitations and associated conflicts of of the broker-dealer or its associated may seek to renegotiate their interest from causing the broker-dealer persons ahead of the retail customer’s compensation arrangements with the or its associated persons to make interest. product sponsors in the hopes of recommendations that place the interest Broker-dealers may also manage extracting greater compensation (e.g., of the broker-dealer or associated conflicts of interest by limiting their more attractive revenue-sharing persons ahead of the interest of the menu of securities on which they offer agreements), relative to current retail customer. recommendations. Broker-dealers may practices. The likelihood of a favorable As noted above, broker-dealers may prefer a limited menu of securities to outcome for the broker-dealers may limit their menus of securities in better mitigate the potential costs depend on whether product sponsors response to certain requirements of the associated with compliance of can charge their retail customers higher Conflict of Interest Obligation. The Regulation Best Interest. For instance, a fees. However, it is likely that product requirements that address limited limited menu of securities may result in sponsors are already charging fees that menus of securities are designed to help more homogenous product fees across are privately optimal (e.g., maximize ensure that these limitations and comparable securities or investment their revenue net of costs), and thus any associated conflicts of interest do not strategies, which would help reduce the deviations from these fees would lead to create incentives for the broker-dealer or effect of certain conflicts of interest on a suboptimal outcome for the product its associated persons to make the recommendations provided to retail sponsors. In other words, product recommendations that are not in the customers. Broker-dealers may also sponsors may not have an incentive to best interest of the retail customer. The respond by limiting their menus of increase their fees. second aspect of the requirement would securities because they may have A number of commenters stated that seek to ensure that the menu of conflicts of interest due to variation in policies and procedures that address securities is not limited to the point the compensation they receive from how broker-dealers manage conflicts of where it restricts a broker-dealer and its product sponsors, as discussed above. interest relating to limited menus of associated persons from complying with It is possible that complying with the securities could impose costs on a retail the Care Obligation, and in particular Conflict of Interest Obligation in this customer when all securities on the with the requirement to provide manner may result in securities menus menu have high fees or create a benefit recommendations that are in the that limit an associated person’s choices for retail customers if securities with customer’s best interest.1284 To the of investments when providing a high fees are eliminated.1283 As noted in extent these requirements reduce the recommendation to a retail the Proposing Release and above, the effect of the limitations of the menu of 1281 customer. However, as discussed Commission acknowledges the benefits securities and the associated conflicts of below, the requirements of the Conflict to the retail customers of the broker- interest on the recommendations of Interest Obligation and the Care dealers that comply with Regulation provided by a broker-dealer or its Obligation are intended to reduce the Best Interest by eliminating inferior associated persons, the Conflict of likelihood that limitations on securities securities or investment strategies. The Interest Obligation would result in menus result in recommendations that Commission also acknowledges the recommendations that are more likely to are not in the best interest of the retail 1282 potential costs of limited menus of be efficient, relative to the baseline. customer. securities by expanding the Conflict of The requirements that address It is also possible that broker-dealers Interest Obligation to include limitations of the menu of securities that limit their menus of securities in requirements that would address may have additional implications for response to the Conflict of Interest specifically limited menus of securities certain product markets, and ultimately, Obligation may eliminate securities or and by providing a detailed analysis of retail customers. To better understand investment strategies that are inferior the economic implications of these these implications we focus the relative to other securities or investment discussion on the market for mutual strategies in terms of performance and requirements, below. funds. costs. Recommendations based on c. Material Limitations on As discussed in Section III.B.3, menus of securities that do not contain Recommendations to Retail Customers academic literature has noted that in inferior securities or investment The Conflict of Interest Obligation certain product markets, such as mutual strategies are more likely to be efficient includes a requirement that specifically funds, the different distribution for the retail customer. To the extent addresses material limitations on channels that product sponsors use to broker-dealers eliminate inferior recommendations to retail customer reach the retail customer may cause investments from their securities menus (e.g., offering only proprietary or other these markets to fragment. In the market as a result of complying with the limited range of securities). This for mutual fund products, some Conflict of Interest Obligation, provision requires broker-dealers to products are sold to retail customers Regulation Best Interest would provide establish, maintain, and enforce written only through broker-dealers—the so- policies and procedures reasonably called ‘‘broker-sold’’ distribution 1281 See supra Section II.C.2. 1282 For example, if none of the securities on the designed to identify and disclose any channel—while other products are sold menu would be in the best interest of the retail customer in a given set of circumstances, the 1283 See, e.g., CFA August 2018 Letter; AARP 1284 Broker-dealers that offer a limited menu of associated person may not recommend any of the August 2018 Letter; EPI Letter; Better Markets securities may not be able to offer recommendations securities on the menu to the retail customer. August 2018 Letter. to certain clients. See also supra footnote 1282.

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directly to retail customers—the so- are comparable alternatives to a broker- As noted by one commenter, the called ‘‘direct-sold’’ distribution sold product recommended by an expense ratio for domestic equity channel.1285 The products that are sold associated person of the broker-dealer mutual funds declined from 0.86 through the broker-sold channel usually may become lower.1292 In turn, the percent in 2007 to 0.59 percent in 2017, carry higher fees relative to comparable retail customer’s demand for broker-sold a 31% reduction over the ten year products that are sold through the products may decline.1293 period.1295 This commenter further direct-sold channel.1286 Higher fees on According to economic first notes that this downward trend in the broker-sold products reflect broker- principles, when enough retail expense ratios reflects, among other dealers’ compensation for distributing customers exhibit a preference for things, a ‘‘long-running shift by the product. In general, all transactions direct-sold products over broker-sold investors toward lower-cost funds.’’ linked to the broker-sold distribution products, the aggregate demand for Because the number of low-cost funds channel are triggered by a broker-sold products should decline. To that enter the market over the period recommendation provided by an remain competitive, product sponsors 2007–2017 has increased substantially, associated person of the broker-dealer. that rely on the broker-sold channel to the assessment of this commenter would Most product sponsors currently rely on distribute their products would have to appear to be consistent with the market one of the two channels to distribute lower the fees on their products. Lower their products, but not on both.1287 mechanism being effective in the long fees on broker-sold products may result 1296 A retail customer that has an account in lower compensation for broker- run. with a broker-dealer that provides dealers and their associated persons As noted above, the effectiveness of advice is not necessarily constrained to from providing recommendations on the market mechanism may depend on accessing products only through the these products. Lower fees on broker- a number of factors, including the retail broker-sold channel. A retail customer sold products would benefit retail customer’s ability to understand the could access products from the direct- customers who access mutual fund effect of fees on the performance of a sold channel to transact on his or her products through the broker-sold product and willingness to shop around own (for example, if the broker-dealer channel. for comparable products, the product may not provide recommendations on a This market mechanism would allow sponsor’s ability to signal how its 1288 particular product). A retail retail customers’ demand to affect how broker-sold products stand out among customer who has access to products product sponsors compensate broker- comparable products, and the broker- from both distribution channels and dealers for recommending broker-sold dealer’s menu and the disclosure about who understands the effect of fees on a products. While this mechanism is potential limitations of this menu.1297 product’s performance may prefer to currently available to retail customers access a product through the broker-sold and is considered generally effective, it The Conflict of Interest Obligation channel if, for example, the combined is not clear how effective this may improve the effectiveness of this cost of identifying (e.g., search costs) mechanism is in all aspects of the market mechanism through the and accessing comparable direct-sold market, particularly in the short run.1294 requirement that broker-dealers products (e.g., product fee) is higher establish, maintain, and implement than the total cost of the broker-sold platform without a recommendation from the written policies and procedures product recommended by the associated broker-dealer and its associated persons generally reasonably designed to identify and person of the broker-dealer.1289 As more provide extensive research and analytical tools. The disclose all material limitations of Commission has recently adopted rule amendments direct-sold products enter the that address research reports that broker-dealers products that may be recommended and 1290 market, the retail customer’s cost of make available to their retail customers. See any associated conflicts of interest. This identifying 1291 direct-sold products that Covered Investment Fund Research Reports, requirement would result in disclosures Release 33–10580 (Nov 30, 2018); 83 FR 64180 that, while not necessarily new relative 1285 In this discussion, the broker-sold (Dec. 13, 2018). 1292 to the regulatory baseline, may increase distribution channel includes sales that are the See, e.g., Ali Hortacsu & Chad Sylverson, result of a recommendation provided by the broker- Product Differentiation, Search Costs, and the salience of the limitations of product dealer but may also include sales that are solicited Competition in the Mutual Fund Industry: A Case menus and the associated conflicts of by the retail customer where no advice or Study of S&P 500 Index Funds, 119 Q. J. Econ. 403 recommendation was provided by the broker-dealer (2004), who estimate an investor’s search costs for (i.e., unadvised sales). The direct-sold distribution S&P500 index funds and show that, as the number coller.tau.ac.il/sites/coller-english.tau.ac.il/files/ _ channel includes unadvised sales through broker- of S&P500 index funds increased over their sample media server/Recanati/management/conferences/ dealer open platforms as well as sales that the retail period spanning 1995 to 2000, the investor’s search finance/2017/61.pdf. This research shows that the customer solicits directly from the product sponsor. costs generally declined. The authors further show sudden entry of several low-cost index funds Investment advisers may also access products that this downward trend was driven by funds that caused direct-sold actively managed funds with through the direct-sold distribution channel. are in lower end of the search cost distribution and similar investment objectives to cut their fees by 6.4 1286 See, e.g., Del Guercio & Reuter (2014). that these funds were mostly no-load funds. These basis points. In contrast, broker-sold actively 1287 See, e.g., Del Guercio & Reuter (2014), supra no-load funds are usually available through the managed funds with similar investment objectives footnote 1081, and Reuter (2015), supra footnote direct-sold channel. as the new entrant funds increased their fees by 1095. 1293 However, a retail customer may value the 12.2 basis points. The study further shows that 1288 A retail customer could also access securities services provided by a broker-dealer that extend while some of the fee increase in the broker-sold through financial professionals that are not broker- beyond the provision of recommendations on funds is accompanied by increased levels of active dealers, including investment advisers. securities transactions and investment strategies management, most of the fee increase (more than 1289 Some broker-dealers may offer securities to and continue to maintain an account with the 60%) was passed on to broker-dealers. The author retail customers through both distribution channels, broker-dealer. To counter the potential decline in argues that the broker-sold actively managed funds but these broker-dealers provide recommendations the demand for broker-sold products, a broker- are able to increase their fees only to the extent that only on securities offered through the broker-sold dealer may respond by offering more services and they can signal to the market that they are not channel. For example, some broker-dealers with increasing the fee for the package of services or by employing strategies that mimic index funds. open platforms may only provide recommendations trying to shift the retail customer to a potentially 1295 See ICI Letter. on proprietary securities. more profitable advisory account (to the extent that 1296 Id. at 42. 1290 See, e.g., ICI Letter, which shows an the broker-dealer offers this type of accounts). 1297 As noted in supra footnote 1292, the increasing trend in the number of mutual funds 1294 Recent academic research questions the effectiveness of this market mechanism may also with no 12b-1 fees over the past 10 years. These effectiveness of the market mechanism, at least in depend on whether broker-dealers offer advisory funds are available through the direct-sold channel. the short run. See. e.g., Yang Sun, Does Competition accounts and whether these broker-dealers can 1291 Broker-dealers with open platforms that Protect Retail Investors? Role of Financial Advice convince retail customers to switch to an advisory allow retail customers to access securities on this (Working Paper, Apr. 2017), available at https:// account rather than to a self-directed account.

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interest for the retail customers.1298 The The requirement seeks to address in such conflicts, the requirement added focus on these limitations may specific firm-level conflicts—namely, should neutralize the effect of these cause some retail customers to question the conflicts associated with the conflicts on the recommendations whether the recommendations that they establishment of a product menu— provided by associated persons to retail are receiving are taking into which are likely to affect customers. The absence of these consideration a reasonable set of recommendations made to retail conflicts when the associated person is alternatives. Thus, this disclosure may customers and may result in considering reasonably available encourage retail customers to shop for recommendations that place the interest alternatives for a recommendation to a comparable products that they may of the broker-dealer or its associated retail customer, as noted in the prefer (e.g., based on cost factors) over persons ahead of the interest of the discussion of the Care Obligation, may the broker-sold products that are being retail customer. increase the efficiency of the recommended to them. This requirement may have a direct recommendation for their retail As an example, a broker-dealer that is effect on the relationship between customers. As discussed above in providing recommendations only for broker-dealers and product sponsors. To Section III.A.2, this outcome is proprietary products would have to the extent that enough broker-dealers consistent with Regulation Best Interest disclose, the material limitation that the decide to no longer offer reducing the agency costs associated products on the menu are all recommendations on certain types of with a broker-dealer’s incentives or the proprietary, and the material fact of the products that carry higher fees (i.e., incentives of its associated persons conflict of interest that the broker-dealer exclude them from the menus), the created by these conflicts of interest, and its associated persons are being aggregate demand for such products which, in turn, would benefit the retail compensated for selling these products. may decline. Product sponsors that face customer. As discussed above in Section II.C.3.f, declining demand for some of their The requirement to establish policies there are a number of other potential products may respond by lowering the and procedures reasonably designed to conflicts of interest associated with fees on these products or by repackaging eliminate certain sales practices may proprietary products. While broker- these products into new and more reduce the total compensation that a dealers may disclose this information competitive products that may again broker-dealer and its associated person under the regulatory baseline, it is not draw the interest of the broker-dealers. receives from providing clear the manner in which this d. Elimination of Certain Sales Practices recommendations to retail customers. disclosure currently reaches the retail As discussed above, to the extent that customer.1299 The new required As part of the Conflict of Interest the reduction in an associated person’s disclosure with respect to conflicts of Obligation in Regulation Best Interest, total compensation is sufficiently large, interest (under the Disclosure broker-dealers are required to establish, the associated person may have an Obligation) is intended to be more maintain, and enforce written policies incentive to register as an investment comprehensive and more specific, and and procedures reasonably designed to adviser and provide investment advice is also intended to reach the retail identify and eliminate any sales only in his or her advisory capacity. customer more directly. From this contests, sales quotas, bonuses, and Furthermore, the potential decline in perspective, the disclosure of the non-cash compensation that are based the total compensation of an associated limitations of the product menu and its on the sales of specific securities or person of the broker-dealer due to this associated conflict of interest may better specific types of securities within a inform retail customers’ choices and, limited period of time. The Commission requirement may dissuade financial therefore, may be more effective, believes that the conflicts of interest professionals from providing advice in compared to current disclosure forms of associated with these practices that may the capacity of a broker-dealer, and as the same information. While, generally, create high-pressure situations for the a result, broker-dealers may find it more the effectiveness of disclosure depends associated persons of the broker-dealer difficult to hire new associated persons, on many factors that are well known in to recommend a specific security over relative to the baseline. the academic literature, the disclosure another cannot be reasonably addressed In addition, the types of sales requirement of the Conflict of Interest through disclosure and mitigation and practices that this requirement is meant Obligation may also depend on the should be addressed through to address generally create incentives range of material facts that the broker- elimination in order to comply with the for associated persons to recommend dealer deems necessary to disclose in requirements of Regulation Best certain types of securities or investment order to be in compliance with the Interest.1301 strategies over certain time periods over obligation.1300 Relative to the regulatory baseline, other types of securities or investment The Conflict of Interest Obligation this requirement would provide benefits strategies. By requiring broker-dealers to addresses limited product menus by to retail customers. Conflicts of interest establish policies and procedures requiring that broker-dealers take that create incentives for the associated reasonably designed to eliminate certain measures through reasonably designed persons to recommend a specific sales practices that create these types of written policies and procedures to security (or specific types of securities) incentives, broker-dealers may evaluate and prevent the limitations and over another are likely to have a experience a reduction in the revenue the associated conflicts of interest from significant effect on an associated stream associated with certain securities causing associated persons of the person’s recommendation, even if such or investment strategies. Thus, through broker-dealer to make recommendations conflicts were disclosed and mitigated this requirement, Regulation Best that are inconsistent with the via policies and procedures established, Interest may impose a cost on the requirements of Regulation Best Interest. maintained and enforced by the broker- broker-dealers that currently rely on dealer. By explicitly requiring policies these types of practices in order to 1298 See supra footnote 1272 and accompanying and procedures reasonably designed to incentivize sales. On the other hand, text. retail customers who have born costs 1299 eliminate sales practices that may result See, e.g., 913 Study. associated with such practices will 1300 See supra Section III.B.4.c for a detailed discussion of the academic literature on disclosure 1301 See also the discussion in Section II.C.3.g, benefit from the cessation of these sales effectiveness. supra. practices.

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As discussed above, while we are 5. Compliance Obligation The obligation indirectly benefits unable to quantify the full costs of retail customers by ensuring that broker- The Compliance Obligation of Regulation Best Interest, including the dealers have sufficient internal controls Regulation Best Interest requires broker- Conflict of Interest Obligation, we are in place to support compliance with dealers to establish, maintain, and able to estimate some of the costs Regulation Best Interest. enforce written policies and procedures associated with the Conflict of Interest The obligation will impose reasonably designed to achieve Obligation, specifically the costs related compliance costs on broker-dealers. compliance with Regulation Best to information collection requirements However, these costs are likely to be Interest.1305 This obligation creates an as defined by the Paperwork Reduction smaller for those broker-dealers that Act. As discussed further in Section affirmative obligation under the already have effective compliance IV.B.1, the Commission believes that Exchange Act with respect to Regulation systems in place, including effective broker-dealers would update their Best Interest as a whole, while policies and procedures. policies and procedures to comply with providing sufficient flexibility to allow Broker-dealers may incur operational this requirement and would incur an broker-dealers to establish compliance costs related to training their associated initial aggregate burden of policies and procedures that persons and developing policies and accommodate a broad range of business procedures to ensure compliance with approximately 128,160 hours and an 1306 additional initial aggregate cost of models. the Care Obligation. For example, approximately $25 million, as well as an The Compliance Obligation is broker-dealers may have to provide ongoing aggregate annualized burden of designed to ensure that broker-dealers training to their employees and other approximately 27,900 hours, and an have internal controls in place to associated persons on how to make ongoing aggregate annualized cost of prevent violations of Regulation Best recommendations that do not place the approximately $2.91 million.1302 Interest. The policies and procedures interest of the broker-dealer or their Furthermore, the Commission believes required to comply with this obligation associated persons ahead of the interest that in order to identify conflicts of would allow the Commission to identify of the retail customer. In the Proposing interest and determine whether the and address potential compliance Release, these training costs were conflicts are material, broker-dealers deficiencies or failures (such as discussed as part of a separate general would incur an initial aggregate burden inadequate or inaccurate policies and best interest obligation, and our of approximately 69,150 hours and an procedures, or failure to follow the assessment of those costs has not 1310 additional initial aggregate cost of policies and procedures) early on, changed. Broker-dealers also may approximately $15.71 million as well as reducing the chance of retail customer incur costs related to training their 1307 an ongoing aggregate annualized burden harm. associated persons on how to determine of approximately 27,660 hours.1303 As discussed above in Section that they have a reasonable basis to Thus, we estimate the Conflict of III.B.2.d, under the regulatory baseline, believe that a recommendation is in a Interest Obligation of proposed broker-dealers are subject to supervisory retail customer’s best interest. This may Regulation Best Interest would impose obligations that, among other things, include training on how to evaluate the an initial aggregate cost of at least require them to establish policies and potential risks, rewards, and costs $110.73 million and an ongoing procedures reasonably designed to associated with a recommendation as aggregate annual cost of at least $20.44 prevent and detect violations of, and well as how a retail customer’s million on broker-dealers.1304 achieve compliance with, the federal investment profile affects this securities laws and regulations,1308 as determination. Additionally, broker- 1309 1302 These estimates are based on the following well as applicable SRO rules. dealers may incur costs related to calculations: 120,600 hours + 7,560 hours = 128,160 Broker-dealers would have the ability to training their associated persons on any hours; $10 million + $15 million = $25 million; and update these policies and procedures to relevant factors specific to making 24,120 hours + 3,780 hours = 27,900 hours. As recommendations regarding IRAs, IRA discussed in more detail in infra Section V.D, comply with the Compliance 120,600 hours and 7,560 hours are preliminary Obligation, rather than create new rollovers, or other account types, as well estimates for the initial aggregate burdens for large policies and procedures. as implicit hold recommendations and small broker-dealers, respectively, $10 million resulting from agreed-upon account and $15 million are preliminary estimates for the × monitoring. These training costs will be initial aggregate costs for large and small broker- in-house legal counsel) ($415.72/hour for in- house counsel) + (21,870 hours for in-house lower for broker-dealers that already dealers, respectively, and 24,120 hours and 3,780 × hours are preliminary estimates for the ongoing compliance counsel) ($365.39/hour for in-house operate in a manner that is consistent compliance counsel) + (21,870 hours for identifying aggregate burdens for large and small broker- × with the requirements of the Care dealers, respectively. conflicts of interest) ($229.74/hour for business line personnel) + (3,780 hours for review of policies Obligation and higher for those that do 1303 The estimate of the initial aggregate burden and procedures) × ($309.60/hour for compliance not. Firms may already comply with the is based on the following calculations: 13,830 hours manager) + (3,783 hours for outside legal counsel) + 55,320 hours = 69,150 hours, where, as discussed requirements of the Care Obligation, to × ($497/hour for outside legal counsel) + (3,773 in more detail in Section V.D, 13,830 hours and varying degrees, either of their own hours for outside compliance services) × ($273/hour 55,320 hours are estimates for the initial aggregate for outside compliance services) = $20.44 million. volition or because they are already burdens for identifying conflicts of interest and The hourly wages for in-house legal and subject to and comply with similar determining whether the conflicts are material for compliance counsel, registered representatives, all broker-dealers, respectively. obligations. senior business analyst, compliance manager, and 1304 These estimates are calculated as follows: As discussed above, while we are × business-line personnel are obtained from SIFMA. unable to quantify the full costs of (90,450 hours of in-house legal counsel) ($415.72/ The hourly rates for outside legal counsel, outside hour for in-house counsel) + (27,660 hours for in- Regulation Best Interest, including the × senior programmer, systems analyst or programmer house compliance counsel) ($365.39/hour for in- and outside compliance services are discussed in Compliance Obligation, we are able to house compliance counsel) + (27,660 hours for infra Section V.D. identifying conflicts of interest) × ($229.74/hour for estimate some of the costs associated 1305 These policies and procedures are in addition business line personnel) + (51,540 hours for review with the Compliance Obligation, to the policies and procedures required under the of policies and procedures) × ($309.60/hour for in- Conflict of Interest Obligation. specifically the costs related to house compliance manager) + (50,302 hours for 1306 information collection requirements as outside legal counsel) × ($497/hour for outside legal See supra Section II.C.4. counsel) + (55,317 hours for modifying existing 1307 See supra Section II.C.4. defined by the Paperwork Reduction technology) × ($284/hour for outside senior 1308 See Section 15(b)(4)(E) of the Exchange Act. programmer) = $110.73 million, and (8,040 hours of 1309 See FINRA Rule 3110 (Supervision). 1310 See Proposing Release at Section IV.C.2.a.

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Act. As discussed further in Section recordkeeping requirements on broker- and a recordkeeping obligation under IV.B.1, the Commission believes that dealers with respect to certain Rule 17a–4(e)(5) that will impose broker-dealers would update their information collected from, or provided additional compliance costs on broker- policies and procedures to comply with to, retail customers. The Commission is dealers. Currently, under Rule 17a– this requirement. We estimate that amending Rules 17a–3 and 17a–4 of the 3(a)(17), broker-dealers that make broker-dealers would incur an initial Exchange Act, which specify minimum recommendations for accounts with a aggregate burden of 524,404 hours and requirements with respect to the records natural person as customer or owner are an additional initial aggregate cost of that broker-dealers must make, and how required to create, and periodically approximately $76.3 million, as well as long those records and other documents update, specified customer account an ongoing aggregate annualized burden must be kept, respectively. We are information. However, the information of 452,524 hours, and an ongoing amending Rule 17a–3 by adding a new collection requirements of Rule 17a– aggregate annualized cost of paragraph (a)(35) that requires a record 3(a)(17) do not cover all aspects of the approximately $2.91 million.1311 Thus, of all information collected from, and ‘‘customer investment profile’’ that the Compliance Obligation of provided to, the retail customer broker-dealers may attempt to obtain to Regulation Best Interest would impose pursuant to Regulation Best Interest, as make a customer-specific suitability an initial aggregate cost of at least well as the identity of each natural determination under the Suitability $214.66 million and an ongoing person who is an associated person of Rule. aggregate annual cost of at least $110.86 a broker or dealer, if any, responsible for As noted above, the Conflict of million on broker-dealers.1312 the account. This requirement applies to Interest Obligation requires broker- dealers to establish policies and 6. Record-Making and Recordkeeping each retail customer to whom a recommendation of any securities procedures that are reasonably designed Regulation Best Interest will also transaction or investment strategy to address conflicts of interest, impose record-making and involving securities is provided. The including disclosing material facts neglect, refusal, or inability of a retail associated with the conflicts. The 1311 These estimates are based on the following customer to provide or update any disclosures will be made pursuant to the calculations: 80,400 hours + 4,536 hours + 11,064 Disclosure Obligation and are not hours + 428,404 hours= 524,404 hours; $6 million information about the customer + $7.5 million + $62.8 million = $76.3 million; and investment profile will, however, expected to trigger record-making or 24,120 hours + 428,404 hours = 452,524 hours. As excuse the broker-dealer from obtaining recordkeeping obligations outside the discussed in more detail in infra Section V.D, Disclosure Obligation. 80,400 hours, 4,536 hours, 11,064 hours and that information. Rule 17a–4(e)(5) will be amended to require that broker- The Commission is providing 428,404 hours are estimates for the initial aggregate estimates of the initial and ongoing burdens for large and small broker-dealers, dealers retain all records of the burden hours associated with the updating training module, and training, information collected from or provided respectively. In addition, $6 million, $7.5 million, record-making and recordkeeping to each retail customer pursuant to and $62.8 million are estimates for the initial obligations of the Disclosure, Care, and aggregate costs for large and small broker-dealers Regulation Best Interest for at least six Conflict of Interest Obligations, under and updating training modules, respectively. years after the earlier of the date the certain assumptions. These estimates Furthermore, 24,120 hours and 428,404 hours are account was closed or the date on which estimates for the ongoing aggregate burdens for are discussed in Section IV.B.5. Based the information was last replaced or large broker-dealers and training, respectively. on these burden hours estimates, the Finally, $2.91 million is the estimate of the ongoing updated. Commission expects that the record- aggregate cost for small broker-dealers. The requirement to create certain 1312 These estimates are calculated as follows: making and recordkeeping obligations (65,832 hours of in-house legal counsel) × ($415.72/ written records of information collected of Regulation Best Interest will impose hour for in-house counsel) + (4,536 hours for in- from or provided to a retail customer × an initial aggregate burden of 17,684,020 house compliance counsel) ($365.39/hour for in- under the Disclosure Obligation will hours and an additional initial aggregate house compliance counsel) + (10,050 hours for trigger a record-making obligation under reviewing policies and procedures) × ($446.04/hour cost of $375,732 as well as an ongoing for in-house general counsel) + (15,582 hours for paragraph (a)(35) of Rule 17a–3 and a aggregate annualized burden of reviewing policies and procedures and update recordkeeping obligation under Rule 5,520,800 hours on broker-dealers.1313 existing training systems) × ($309.60/hour for in- 17a–4(e)(5) that may impose additional house compliance manager) + (428,404 hours for training) × ($233.02/hour for registered compliance costs on broker-dealers. In 1313 These estimates are based on the representative) + (27,163 hours for outside legal cases where broker-dealers choose to Commission’s estimates, discussed in Section counsel) × ($497/hour for outside legal counsel) + meet part of the Disclosure Obligation IV.B.5, with respect to the initial and ongoing (221,127 hours for updating training module) × orally under the circumstances outlined aggregate costs and burdens imposed on broker- ($284/hour for outside senior programmer or dealers by the record-making obligation of proposed systems analyst)= $214.66 million, and (8,040 hours above in Section II.C.1, Oral Disclosure Rule 17a–3(a)(35) and the recordkeeping obligation of in-house legal counsel) × ($415.72/hour for in- or Disclosure After a Recommendation, of the proposed amendment to Rule 17a–4(e)(5) house counsel) + (8,040 hours for in-house the requirement to maintain a record of associated with all component obligations of compliance counsel) × ($365.39/hour for in-house the fact that oral disclosure was Regulation Best Interest. The estimate of the initial compliance counsel) + (8,040 hours for updating aggregate burden is based on the following policies and procedures) × ($229.74/hour for provided to the retail customer will calculation: 4,020 hours + 4,080,000 hours + business line personnel) + (8,040 hours for trigger a record-making obligation under 13,600,000 hours = 17,684,020 hours, where, as reviewing policies and procedures) × ($309.60/hour paragraph (a)(35) of Rule 17a–3 and a discussed in more detail in Section IV.B.5, 4,020 for compliance manager) + (3,783 hours for outside recordkeeping obligation under Rule hours is the estimate of amending the account legal counsel) × ($497/hour for outside legal disclosure agreement by large broker-dealers, counsel) + (3,773 hours for outside compliance 17a–4(e)(5) that may impose additional 4,080,000 hours is the estimate of the burden services) × ($273/hour for outside compliance compliance costs on broker-dealers. associated with filling out the information disclosed services) + (428,404 hours of training) × ($233.02/ Furthermore, the Care Obligation may pursuant to Regulation Best Interest in the account hour for registered representative) = $110.86 require creating new documents or disclosure agreement, and 13,600,000 hours is the million. The hourly wages for in-house legal and estimate of the burden to broker-dealers for adding compliance counsel, registered representatives, modifying existing documents to reflect new documents or modifying existing documents to senior business analyst, compliance manager, and standardized questionnaires seeking the broker-dealer’s existing retention system. business-line personnel are obtained from SIFMA. customer investment profile $375,732 is the estimate of amending the account The hourly rates for outside legal counsel, outside information. These requirements will disclosure agreement by small broker-dealers senior programmer, systems analyst or programmer pursuant to the record-making obligation of Rule and outside compliance services are discussed in also trigger a record-making obligation 17a–3(a)(35). The estimate of the ongoing annual infra Section V.D. under paragraph (a)(35) of Rule 17a–3 burden is 3,400,00 hours + 1,060,000 hours +

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After monetizing the burden hours, the differences of broker-sold and direct- translate into less severe conflicts of record-making and recordkeeping sold mutual funds. interest. Thus, a reduction in fees may obligations will impose an initial The quantification exercise below improve the efficiency of the aggregate cost of at least $4,121.73 provides an estimate for some of the recommendations that broker-dealers million and an ongoing aggregate annual potential benefits associated with make to retail customers. This potential cost of at least $1,736.52 million on Regulation Best Interest. For example, as increase in the efficiency of the broker-dealers.1314 discussed in more detail below, a recommendations received also benefits potential reduction in fees can benefit retail customers.1317 7. Approaches to Quantifying the retail customers in other ways beyond Potential Benefits reducing the total dollar amount paid The market for mutual fund products As discussed above, several for investment services. Furthermore, as may illustrate the potential for attaining commenters suggested that we quantify discussed elsewhere in this economic such a new long-run equilibrium as a the existing harm to investors under the analysis, the rule is expected to generate result of Regulation Best Interest. We baseline and the corresponding benefit other benefits for retail customers that focus on mutual funds for this analysis resulting from Regulation Best Interest. we are not able to meaningfully because of the available data for mutual We continue to believe that it is not quantify. funds, but we expect the same or similar possible to quantify, with meaningful dynamics could apply to other financial a. Benefit to Investors Due to a Potential products. As this market transitions precision, either the existing harm or Reduction in Fees the specific benefits we expect to flow toward this new long-run equilibrium, from Regulation Best Interest. Such an As discussed above, Regulation Best total fund expenses (i.e., distribution analysis, including one that would Interest may reduce the attractiveness of expenses and management fees) that are produce ranges, depends on many certain products to broker-dealers due to in excess of the marginal cost of contingent factors that render any the Care Obligation (e.g., the emphasis distributing and operating the fund may estimate insufficiently precise to inform on the need to consider cost, among be reduced in a number of ways, our policy choices.1315 Nonetheless, the other things) and the Conflict of Interest including by lowering fees, reliance on Commission has endeavored to estimate Obligation (e.g., addressing conflicts of alternative distribution channels, or some of the potential benefits that may interest, including product menu exiting the market in whole or in part result from Regulation Best Interest limitations) and/or may reduce retail (i.e., by limitations on offerings). Below using a variety of methodologies, which customers’ aggregate demand for certain we attempt to quantify the benefits are explained below in more detail products due to the Disclosure associated with this potential long-run along with certain caveats and the Obligation (e.g., due to a reduction in equilibrium in the market for mutual principal assumptions relied on. any information asymmetry with respect fund products as a result of such to fees). To the extent that Regulation Specifically, we have attempted to reduction in fees, relative to the Best Interest produces these effects on estimate the benefit that may result from baseline, assuming all funds reduced certain products, the affected product a reduction in fees due to increased fees to marginal costs. To this end, we sponsors may react by lowering the fees competition; we also consider the start with the current distribution of fees that they charge retail customers on potential benefit arising from a of funds within each Center for these products to be more competitive, reduction in the relative performance Research in Security Prices (CRSP) or by repackaging these products into 1318 new products that are more objective class. We focus on funds 1,060,000 hours = 5,520,800 hours where 3,400,00 competitively priced. The increased that have reported this information in hours is the estimate of complying with the competition generated by the lower fees 2018 in CRSP. We perform the analysis recordkeeping obligation of the amendment to Rule using total fees (i.e., fund expense 17a–4(e)(5) and 1,060,000 hours are estimates of for affected products may further both the record-making and recordkeeping incentivize other product sponsors (i.e., ratios). As an alternative, we also obligations associated with oral disclosure. those not directly affected by Regulation perform the analysis using the 1314 These estimates are calculated as follows: component of the total fees that are (2,010 hours of in-house legal counsel) × ($415.72/ Best Interest) to lower their fees as 1316 allocated toward distribution and hour for in-house counsel) + (17,680,000 hours for well. Alternatively, a product entering and adding new or modifying existing sponsor may preempt the potential documents in each customer account) × ($233.02/ decline in the aggregate demand for its 1317 For purposes of this analysis, we assume that hour for registered representative) + (2,010 hours product sponsors respond to competitive pressures for in-house compliance counsel) × ($365.39/hour products by lowering the fees before by lowering their fees. However, competition may for in-house compliance counsel) + (756 hours for other sponsors do. affect quality in addition to price. For example, outside legal counsel) × ($497/hour for outside legal For the purposes of calculation, we product sponsors may choose to offer higher quality counsel) = $4,121.73 million, and (3,400,000 hours assume that this potential competition products which may be costlier to produce (e.g., × for recordkeeping) ($365.39/hour for in-house in prices results in a new long-run because they must hire more skilled managers or compliance counsel) + (1,060,000 hours for record- apply more costly technology) and as such require making associated with oral disclosure) × ($233.02/ equilibrium in this product market, in higher fees. Alternatively, product sponsors may hour for registered representative) + (1,060,000 which product sponsors charge fees that lower fees by reducing the quality of their product hours for record-keeping associated with oral are close to or equal to their marginal (e.g., hiring fewer skilled managers) and, as a result, × disclosure) ($233.02/hour for registered costs. Lower fees translate into direct offering lower fee products that may produce lower representative) = $1,736.52 million. The hourly average returns. Competition along both of these wages for in-house legal and compliance counsel savings to retail customers. If a portion dimensions may allow retail customers to choose and registered representatives are obtained from of fees collected from retail customers different combinations of quality and price, SIFMA. The hourly rates for outside legal counsel serves to compensate broker-dealers for depending on their individual preferences. are discussed in infra Section IV.B.5. selling certain investment products, 1318 Calculated based on data from the Center for 1315 See supra footnote 1156 and subsequent text Research in Security Prices (CRSP), University of for a discussion of these factors. For these reasons then lowering those fees could also Chicago Booth School of Business. Funds with and because we believe that quantification of the different objectives may incur different marginal costs and benefits of the alternatives discussed in 1316 A product sponsor that does not lower its fees costs due to the frequency of trading in the markets infra Section III.E would require still further on a given product may risk experiencing low retail that are reflective of the objective of the fund, assumptions, lead to additional imprecision, and customer aggregate demand or low demand from advertising to reach a certain clientele, distribution yield less meaningful results, we have not included broker-dealers as a result of Regulation Best costs, etc. The CRSP Mutual Fund dataset includes quantified estimates of the economic effects of these Interest. To stay competitive this product sponsor a breakdown of mutual funds by their objective alternatives. may have to lower the fees on its product. types.

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marketing expenses, and that we can the net benefit of the new equilibrium conflicts of interest as they pertain to observe, namely 12b–1 fees.1319 as the difference between the two mutual funds, we use estimates of the We estimate the marginal cost of present values of declining perpetuities difference in net returns (gross returns distributing and operating a non-index that pay the dollar value associated with on a fund’s performance less fees and fund in a given CRSP objective class excess fees under the baseline other expenses associated with the (i.e., strategy) as the minimum total fee equilibrium and the new equilibrium, fund) between broker-sold funds and of the funds in that class, after respectively, for each of the three funds that are direct-sold from Reuter excluding index funds. Similarly, we scenarios. When using the total fees, we (2015).1324 We then apply this estimate the marginal cost of operating obtain an expected net benefit of $35.21 difference to the aggregate market an index fund in a given CRSP objective billion in the moderate decay scenario, capitalization of load funds, which we class as the minimum total fee of the $59.15 billion in the accelerated decay assume are sold with a recommendation index funds in that class. We then scenario, and $76.49 billion in the rapid from a broker-dealer because we cannot calculate the maximum ‘‘excess fee’’ for decay scenario. Similarly, when using identify the channel through which a fund (index or non-index) as the 12b–1 fees only, we obtain an expected mutual funds are sold or whether each difference between the actual total fee of net benefit of $14.10 billion in moderate sale through the broker-sold channel the fund and the marginal cost of the decay scenario, $23.69 billion in the involves a recommendation. To the CRSP objective class that contains the accelerated decay scenario, and $30.63 extent that no-load funds are also sold fund. By construction, the excess fee billion in the rapid decay scenario. by broker-dealers, this assumption may cannot be negative. cause us to underestimate the portion of We obtain an aggregate amount of b. Benefits to Investors Due to a mutual fund AUM that are sold with a reduced fees of approximatively $22.2 Potential Reduction in the Relative recommendation from a broker- billion for non-index funds and $1.4 Underperformance of Broker-Versus dealer.1325 Because the data in Reuter billion for index funds annually at the Direct Sold Mutual Funds (2015) ends in 2012, for the purposes of new potential equilibrium.1320 The Another way to estimate the potential this approach we assume that the aggregate amount of saved fees across benefits of Regulation Best Interest is to relative underperformance of broker- index and non-index funds becomes use aspects of the approach used in the sold funds, and hence our application of approximatively $23.6 billion. CEA Study and the DOL RIA, as this underperformance to load funds as Similarly, if we focus on 12b–1 fees suggested by several commenters.1322 a proxy for funds sold with a only, the aggregate amount of saved fees Specifically, we rely on academic recommendation from a broker-dealer, are $9.13 billion for non-index funds literature claiming that, to varying remains unchanged from 2012.1326 and $0.32 billion for index funds, or degrees, broker-sold mutual funds Reuter (2015) employs a variety of $9.45 billion across both index and non- underperform direct-sold mutual funds methods in computing the difference in index funds. and assume that underperformance net returns between broker-sold and Using certain assumptions to reflects agency costs associated with the direct-sold actively managed funds, calculate the present value of this conflicts of interest that may be present including different ways of computing potential fee reduction,1321 we calculate in recommendations provided by net returns (e.g., net return, net return broker-dealers. Although this literature plus 12b–1 fees, net alphas, and 1319 12b–1 fees are paid out of fund assets to cover addresses only a portion of the AUM ordinary least-squares and weighted the costs of marketing and selling fund shares. affected by Regulation Best Interest, we least-squares regression methods), ‘‘Distribution fees’’ include fees to compensate different samples (e.g. ‘‘non-specialized brokers and others who sell fund shares, and to pay use methods from these studies to for advertising and printing and mailing estimate the monetary effect the final domestic equity’’), and different prospectuses to new investors. ‘‘Shareholder service rule might produce by reducing the weighting schemes (e.g. equally fees’’ are fees that cover the cost of responding to effect that conflicts of interest have on weighted or value weighted returns). investor inquiries and providing investors with Reuter concludes by noting that the information. This analysis excludes loads because, the recommendations provided by unlike 12b–1 fees, loads cannot be separately broker-dealers. performance difference between broker- broken out. Total AUM of load and no-load long- sold and direct-sold actively managed 1320 We calculate the dollar value associated with term mutual funds in the U.S. as of the mutual funds is likely to fall between these excess fees by multiplying the excess fees of end of 2018 are approximately $12.4 0.20% and 0.47%, depending whether a fund with total net assets (TNA) of the fund and or not 12b–1 fees are included in the then aggregating across funds. This amount trillion, with $10.4 trillion attributable represents the capital that would be reallocated to no-load funds and $2.1 trillion estimation. Given that the towards more efficient funds and can be thought of attributable to load funds.1323 To underperformance only affects broker- as ‘‘fees saved’’ by retail customer as this product estimate the monetary effect of potential sold funds, and applying these market shifts from the baseline equilibrium to the underperformance estimates to load new equilibrium. 1321 First, we note that expense ratios for equity is at least as large as the one observed in the post- funds, the estimated monetized mutual funds have declined at a rate of about 3% 2011 period is not unreasonable. Under this underperformance of broker-sold funds per year since 2000. This rate doubles to 6% if we assumption, we consider three scenarios: (1) focus on the period following FINRA’s adoption of Moderate decay at 6%; (2) accelerated decay at 9%; 1324 See Reuter (2015), supra footnote 1095. In the Suitability Rule in 2011. We assume that under and (3) rapid decay at 12%. The half-life for each contrast to the DOL RIA, we do not base our the current equilibrium, or ‘‘baseline equilibrium,’’ of these scenarios is 11.5 years, 7.7 years, and 5.8 analysis on excess loads, as estimated in excess fees—as defined above—would continue to years, respectively. Finally, we assume that the Christoffersen et al. (2013), supra footnote 1081. decline at the rate of 3% per year. This rate of decay opportunity cost of the excess fees is equal to the Prior commenters noted that the average excess corresponds to a half-life of approximatively 23 expected rate of return on the value-weighted load, by definition, is zero and would likely yield years. We further assume that as the product market market portfolio, as defined in CRSP, as these fees a much lower estimate of aggregate harm, than the shifts towards the new equilibrium, excess fees encumber capital that would have otherwise been estimate published by the CEA and include in the decline at a rate that is at least as high as the post- invested in efficient funds. To estimate the DOL RIA. See, e.g., Lewis (2017), supra footnote 2011 rate. Because Regulation Best Interest expected return on the market portfolio, we assume 1099. See also supra footnotes 1169 and 1170. enhances the broker-dealer standard of conduct that the discount rate is the geometric average of the 1325 Brokers may still be compensated for selling established by the Suitability Rule—particularly annual rate of return on the market portfolio over no-load funds by 12b–1 fees, revenue sharing, or with respect to the disclosure, mitigation, or the period 1927–2018, namely 9.76%. other arrangements. elimination of conflicts of interest, which is not 1322 See supra footnote 1167. 1326 See supra footnote 1102 for discussion of addressed by the Suitability Rule—and the federal 1323 See Investment Company Institute 2019 Fact how trends in the relative performance of load securities laws, we believe that a rate of decay that Book, Figure 6.12. funds may have changed in more recent years.

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ranges from $4.1 billion per year to $9.7 Taking into account these caveats,1329 provides a recommendation to a retail billion per year. to the extent that Regulation Best customer that may not be fully As discussed elsewhere in this Interest mitigates, and in the limit, addressed by the regulatory baseline. release, we expect Regulation Best eliminates the adverse effects of Regulation Best Interest is intended to Interest will reduce the severity of conflicts of interest on broker-dealers’ reduce agency costs and other costs by conflicts of interest that may contribute recommendations, we estimate that the enhancing the standard of conduct of to the underperformance between benefits attributable to Regulation Best broker-dealers, increasing the broker-sold and direct-sold mutual Interest could be as large as $4.1 billion effectiveness of disclosure to allow per year to $9.7 billion per year when retail customers to make a more funds. However, the range noted above estimated assuming that the relative informed decision with respect to the most likely overestimates the expected underperformance of broker-sold recommendation they receive and by reduction in harm associated with mutual funds estimated in the academic requiring broker-dealers to implement broker-sold mutual funds due to literature reflects conflicts of interest policies and procedures reasonably Regulation Best Interest for a number of that will eventually be eliminated. designed to reduce the effect of conflicts reasons. First, as discussed by As with our other estimates of the of interest on recommendations to retail Bergstresser et al. (2009), broker-sold benefits above, we assume that there is customers. Specifically, the Disclosure funds can be sold by both broker-dealers already a decreasing trend in the Obligation and Conflict of Interest and investment advisers (e.g., dually underperformance gap under the Obligation require broker-dealers to registered investment advisers), and the baseline that is consistent with the disclose information that, while not data these studies relied upon is not decreasing trend in mutual fund necessarily new in all instances, will sufficiently granular to identify the expense ratios of 3%, and that reach retail customers more directly and fraction of broker-sold funds sold by Regulation Best Interest will accelerate more timely than under the regulatory each type of financial professional.1327 this trend to a decay rate under three baseline. In addition, the disclosed Because Regulation Best Interest applies scenarios: (1) Moderate decay at 6%; (2) information would raise a retail to registered broker-dealers, this range accelerated decay at 9%; and (3) rapid customer’s salience of fees, scope of the would need to be narrowed to reflect the decay at 12%. Similarly, we assume a relationship, conflicts of interest, and proportion of broker-sold funds sold by discount rate of 9.76% as above to value limitations of the menu of securities registered broker-dealers. these cash flows. Under these from which the retail customer receives Second, the estimated range fully assumptions, the present value of the recommendations as potential factors attributes the differences between potential benefits of Regulation Best affecting the recommendations of a direct-sold funds and broker-sold funds Interest in the mutual fund sector, broker-dealer or its associated persons. to conflicts of interest between retail relative to the baseline, from limiting or The content and form of disclosure may customers and broker-dealers. This eliminating the adverse effects of help some retail customers make more might over-estimate the benefits of conflicts of interest could be as large as informed decisions with regards to Regulation Best Interest because there approximately $6.8 to $16 billion in the whether to act on a recommendation might be other unobservable systematic moderate decay scenario, $11.4 to $26.7 provided by an associated person of the differences between investors who billion in the accelerated decay broker-dealer. Regulation Best Interest choose direct-sold funds versus those scenario, and $14.7 to $34.5 billion in may also reduce the agency costs faced who choose to employ a financial the rapid decay scenario. by these retail customers. Finally, we can obtain an approximate The Conflict of Interest Obligation professional. For example, retail estimate of the present value of the costs also requires broker-dealers to customers that buy broker-sold funds associated with Regulation Best Interest implement policies and procedures to might be willing to pay more for those using the costs estimated in Section IV reduce the effect of conflicts of interest funds if they receive intangible benefits for purposes of the Paperwork and securities menu limitations on from a broker-dealer’s recommendation Reduction Act, which imply aggregate recommendations to retail customers. that are not reflected in the relative initial costs of approximately $5.96 For broker-dealers that implement more performance between funds sold billion and ongoing costs of $2.37 effective policies and procedures, the through these two channels. billion. Assuming the initial costs are obligation may increase the efficiency of Furthermore, not all sales in the broker- incurred one year from the rule’s the recommendations for their retail sold channel are triggered by enactment, and using a discount rate of customers. As a result, Regulation Best recommendations provided by broker- 9.76% as above, the present value of Interest may reduce the agency costs dealers or their associated persons. For these costs is approximately $27.5 faced by these retail customers. example, customer-directed transactions billion. Note that this cost estimate The Care Obligation requires a broker- may not involve a recommendation at cannot be directly compared with the dealer and its associated persons to have all. benefit estimates above as the benefits a reasonable basis to believe that a Third, measuring a fund’s estimates are with respect to mutual recommendation provided to a retail performance using its net return relative funds only. customer is in the customer’s best interest. This reasonable basis should to a benchmark might not be the most D. Efficiency, Competition, and Capital include factors similar to those accurate measure of a fund manager’s Formation skill or the value created by a fund to identified by the Suitability Rule of the an investor.1328 Therefore, estimating As discussed above, Regulation Best current regulatory regime as well as investor harm assuming this definition Interest is designed to address the additional factors. For example, relative of the value created by a fund might agency costs that arise when an to the regulatory baseline, the Care potentially overstate or understate this associated person of the broker-dealer Obligation requires that a broker-dealer harm. and its associated persons consider 1329 See supra footnotes 1172–1178 for further costs, among other factors, and establish discussion of the limitations that apply in using the 1327 See Bergstresser et al. (2009), supra footnote relative underperformance of broker-sold mutual a direct link between the attributes of a 1048. funds as an estimate of investor harm and, security or investment strategy and the 1328 See supra footnote 1176. therefore, the benefits of Regulation Best Interest. retail customer’s best interest. By

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requiring consideration of costs and by competing broker-dealer, investment their broker-dealer business under including an explicit link between the adviser, or other financial services Regulation Best Interest to be lower than investment-related factors and the best provider. If broker-dealers are unable to the profitability of their advisory interest, the obligation may increase the pass costs through to customers, it is business. efficiency of the recommendations for possible that some of the broker-dealers Similar concern over costs of the retail customer. As a result, that face high compliance costs may complying with Regulation Best Interest Regulation Best Interest may reduce the decide to exit the market for investment may deter some broker-dealers from agency costs faced by these retail advice in the capacity of a broker-dealer. entering the market for investment customers. The potential competitive effects advice. Higher entry costs may have Through these effects, as discussed associated with compliance costs could long-run competitive effects on prices below, Regulation Best Interest may be further exacerbated by how broker- paid by retail customers, as incumbents have an effect on competition, capital dealers choose to comply with the adjust their strategic behavior to reflect formation, and efficiency. component obligations of Regulation a lower threat of competition from new Best Interest. As discussed in Section entrants, relative to the baseline.1333 1. Competition III.C.4, broker-dealers are given Regulation Best Interest may also Regulation Best Interest may have flexibility when addressing conflicts of encourage competition for retail competitive effects for the market for interest through policies and customers to the extent that the investment advice and may affect how procedures. Because Regulation Best Disclosure Obligation increases the broker-dealers compete with each for Interest and the component obligations retail customers’ salience to variables retail customers. As discussed in are generally principles-based, a broker- such as fees and conflicts of interest that Section III.C, the brokerage industry dealer would have to determine what would facilitate comparability across currently recognizes that broker-dealers constitutes effective means of broker-dealers. For example, retail and their associated persons may have addressing a given conflict of interest, customers may form preferences over conflicts of interest that create and how it should relate to the size and some or all of the disclosed variables, incentives for broker-dealers or their complexity of a broker-dealer’s business such as fees, securities or service associated persons to make model. For a broker-dealer that is dually offerings, and range of conflicts of recommendations that, while suitable registered or for a broker-dealer that is interest, and may choose one broker- for their retail customers, may not be in affiliated with an investment adviser, dealer over another or over an the best interest of (and may not be the the overall costs of complying with investment adviser based on these most efficient recommendations for) Regulation Best Interest may encourage preferences. In turn, if firms anticipate such customers. As noted above in the broker-dealer to exit the market for that there is a possibility that retail Section III.B.2.c, a FINRA survey providing investment advice in the customers may use the disclosed suggested that broker-dealers currently capacity of a broker-dealer and, instead, variables for comparability purposes, employ different methods for managing provide advice only in the capacity of broker-dealers may compete over some conflicts of interest, with some methods an investment adviser. Whereas broker- or all of these variables to attract more being more effective than others at dealers have explicit requirements to retail customers. This potential reducing the effect of conflicts of establish written policies and competition may result in greater interest on recommendations. These procedures reasonably designed to securities or service offerings, or lower methods generally depend on the size disclose, mitigate or eliminate identified fees for retail customers. and complexity of a broker-dealer’s conflicts of interest that create an Regulation Best Interest may also business model. Against this backdrop, incentive for the associated persons to affect how broker-dealers compete with the cost of complying with Regulation place their interest ahead of the retail each other when negotiating with Best Interest, scaled by the size and customer, the fiduciary standard for investment sponsors for access to complexity of a broker-dealer’s business investment advisers relies on full and securities. The findings of the activities, may be higher for broker- fair disclosure and informed consent to aforementioned FINRA survey suggest dealers that currently employ less address conflicts of interest.1331 that broker-dealers may face different effective methods for managing conflicts Investment advisers must also adopt degrees of competition when negotiating of interest. and implement written policies and with product sponsors for access to Relative to broker-dealers that face procedures reasonably designed to certain securities. For instance, the lower compliance costs, broker-dealers prevent violations of the Advisers Act, survey observed that some product that face higher compliance costs may including violations related to sponsors rate the broker-dealers that are be at a disadvantage when competing undisclosed conflicts of interest.1332 interested in distributing their securities for retail customers and may not be able More generally, compliance costs may based on criteria such as product to fully pass on these costs to their retail drive such firms to no longer offer expertise and experience, the quality of customers. For example, the advice in the capacity of a broker-dealer the control environment, and the presumption related to the titles if firms anticipate the profitability of strength of their sales practices. Broker- ‘‘adviser’’ and ‘‘advisor’’ may impose dealers that have higher ratings, based higher costs on broker-dealers that use on these criteria may be given access to 1331 As discussed in supra Section I.C, some these terms in their names or titles, but broker-dealer commenters also expressed the view a broader range of securities, including that are not dual-registrants.1330 The that by requiring mitigation of financial incentives, more complex securities. In contrast, extent to which broker-dealers are able Regulation Best Interest would require more of broker-dealers that have lower ratings to pass on costs to their retail customers broker-dealers than what is required of investment may be given access to a narrower range advisers under their fiduciary duty, which could depends on a number of factors that create a competitive issue for broker-dealers that of securities. To the extent Regulation include the availability of close could further encourage migration from the broker- Best Interest has the effect of increasing substitutes for the services provided by dealer to investment adviser model and result in a and homogenizing the product expertise broker-dealers and the cost to retail loss of choice for retail customers. Because of this and experience (e.g., the Care competitive issue, dually registered financial customers of switching accounts to a professionals could be incentivized to recommend Obligation) and the quality of the advisory accounts through compensation. 1330 See supra footnotes 1216–1220. 1332 See Advisers Act Rule 206(4)–7. 1333 See, e.g., Mas-Colell et al. (1995).

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control environment (e.g., the Conflict cost of entry in the market for As discussed above in Section III.C.4, of Interest Obligation) across the investment advice in the capacity of a depending on the effectiveness of complying broker-dealers, the final rule broker-dealer relative to the baseline, as disclosure and the effectiveness of may increase the competition across discussed above. policies and procedures that address firms when negotiating with product The Disclosure Obligation may also limitations of the menu of securities sponsors. This increased competition encourage competition for retail (e.g., Disclosure and Conflict of Interest may allow product sponsors to customers across broker-dealers and Obligations), Regulation Best Interest economize on the distribution costs, and investment advisers. As noted above, may reduce the aggregate demand for may result in lower fees for retail the Disclosure Obligation would require certain sponsors’ securities. To remain customers. broker-dealers to make full and fair competitive, product sponsors that face Regulation Best Interest may also have disclosure of all material facts relating decreased demand as a result of competitive effects for the market for to the scope and terms of the Regulation Best Interest may reprice investment advice, more generally. relationship with the retail customer their securities (e.g., by offering Regulation Best Interest may affect how and all material facts relating to different share classes), lower their fees, broker-dealers compete with firms that conflicts of interest that are associated or seek alternative distribution channels provide advice in a capacity other than with a recommendation. Investment that are not affected by Regulation Best as a broker-dealer, such as an advisers are also required to provide full Interest. For example, product sponsors investment adviser. Under the and fair disclosure of material facts may choose to distribute their securities regulatory baseline, investment advisers about similar elements under the through investment advisers or through owe a fiduciary duty to their clients. current regulatory regime. To the extent commercial banks to the extent that the Some commenters describe this that the Disclosure Obligation raises the banks can engage in limited broker- standard of conduct as a ‘‘higher’’ salience of variables that may facilitate dealer activity, subject to certain standard compared to the standard of comparison across broker-dealers and conditions, without having to register as conduct applies to broker-dealers under investment advisers, Regulation Best broker-dealers.1335 Finally, product the regulatory baseline.1334 Interest may encourage competition sponsors may choose to distribute their For some retail customers the duty between broker-dealers and investment securities directly to retail investors owed to them by their firm or financial advisers. rather than indirectly, through broker- professional may be a determining Regulation Best Interest may also have dealers. The potential competitive effect factor when deciding which type of firm competitive effects for financial of Regulation Best Interest on product or financial professional they want to professionals that offer investment sponsors may manifest itself in lower use. As previously noted, key elements advice in a capacity other than that of product fees for retail customers. of the standard of conduct that applies a broker-dealer (e.g., investment to broker-dealers, at the time a advisers and other financial 2. Capital Formation and Efficiency recommendation is made, under professionals that are not registered Regulation Best Interest is designed to Regulation Best Interest will be with the Commission, such as insurance reduce the agency and other costs to substantially similar to key elements of companies, banks, and trust companies). retail customers associated with the standard of conduct that applies to As discussed above in Section III.C.4, obtaining recommendations from investment advisers pursuant to their depending on the effectiveness of broker-dealers. As discussed above, to fiduciary duty under the Advisers Act. disclosure and the effectiveness of reduce these costs, Regulation Best As such, the standard of conduct under policies and procedures that address Interest would impose obligations on Regulation Best Interest may make securities menu limitations (e.g., the broker-dealers that are designed to Disclosure Obligation and Conflict of broker-dealers more attractive to certain increase the efficiency of the Interest Obligation), Regulation Best retail customers who seek recommendations to retail customers Interest may reduce the retail customers’ recommendations for securities relative to the recommendations that aggregate demand for certain securities transactions or investment strategies in broker-dealers and their associated that are distributed by broker-dealers a more cost effective manner, but worry persons provide to retail customers and securities on which broker-dealers about the duties owed to them by their under the regulatory baseline. or their associated persons provide financial professional. As a result, To the extent retail customers receive recommendations. Instead, retail Regulation Best Interest may increase recommendations that are more efficient customers may access some of these or the competition between broker-dealers relative to the baseline, Regulation Best comparable securities from other and investment advisers for retail financial professionals. For example, a Interest would increase the efficiency of customers interested in obtaining retail customer may access certain the portfolio allocation that a retail investment advice. In competing for securities offered by broker-dealers customer makes as a result of the business, broker-dealers and investment through corporate fiduciaries such as recommendation received. As discussed advisers may lower their fees, resulting commercial banks or trust companies. above in Sections III.A.2 and III.C, this in retail customers paying less for Alternatively, a retail customer may would occur when a retail customer obtaining investment advice. To the open an advisory account and access increases the allocative efficiency of his extent that this potential lower cost securities that are comparable to those or her portfolio when the causes an increase in the demand for offered by the broker-dealer. To the recommendation leads to a reallocation investment advice in the capacity of a extent that Regulation Best Interest of resources across time and market and broker-dealer, this positive competitive causes a potential reduction in the retail economic conditions that generate a effect may offset some of the negative customers’ aggregate demand for higher net benefit to the retail customer, potential competitive effects of securities offered by broker-dealers, relative to the baseline. Thus, to the Regulation Best Interest, such as higher retail customers’ aggregate demand may extent that Regulation Best Interest increase for securities offered by non- 1334 See Letter from Ken Fisher, Fisher 1335 See Exchange Act Sections 3(a)(4)(B) and Investments (Jul. 31, 2018) (‘‘Fisher Letter’’); PIABA broker-dealers. Regulation Best Interest 3(a)(5)(B) and rules thereunder (providing banks Letter; FPC Letter; NASAA August 2018 Letter; U. may also affect how product sponsors exceptions from ‘‘broker’’ and ‘‘dealer’’ status for of Miami Letter; Rhoades August 2018 Letter. compete for flows from retail customers. specified securities activities).

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increases the efficiency of the associated dealers under the Exchange Act that is same standard of care and loyalty persons’ recommendations to retail intended to address the agency costs regardless of what type of financial customers, the final rule would have a that retail customers face when professional they engage.1338 As positive effect on the retail customers’ obtaining recommendations of securities discussed above and in detail further allocative efficiency. transactions and investment strategies below we believe, in practice, that such Regulation Best Interest may also from broker-dealers and their associated uniformity would be difficult to increase the efficiency of the persons. This new standard is intended implement and disruptive to pursue as recommendations involving rollovers or to enhance investor protection, while a result of various factors, including the transfers of assets from retirement preserving, to the extent possible, retail key differences in the ways broker- accounts to other taxable or non-taxable investor access (in terms of choice and dealers and investment advisers engage accounts, relative to the baseline. As cost) to differing types of investment with retail clients. Achieving such noted above, the incentives associated services and securities. As noted above, uniformity could require narrowing the with this type of recommendation are the Commission considered several type and scope of services permitted to particularly acute because of the size of reasonable alternative policy choices, be provided by various types of the transaction and the importance to including (1) applying the fiduciary financial professionals. If we were to the retail customer (e.g., given that the standard under the Advisers Act to pursue such an approach, it could amount of assets associated with such broker-dealers, and (2) adopting a reduce retail customers’ confusion with recommendations can be a significant ‘‘new’’ uniform fiduciary standard of respect to the duties owed to them by portion of a retail customer’s net worth). conduct applicable to both broker- the broker-dealers and investment The potential increase in the efficiency dealers and investment advisers, such as advisers and could reduce potential of this type of recommendation may that recommended by the staff in the costs to some investors associated with improve the allocative efficiency of 913 Study. The Commission also choosing a type of relationship that is assets held in retirement accounts, and considered adopting similar standards not well suited to them, because under may encourage retail customers to to those the DOL had provided under its a uniform standard, retail customers of consider a rollover or transfer of assets fiduciary rule to broker-dealers and each type of financial professional recommendation to potentially increase investment advisers.1336 We examine would be subject to the same standard the efficiency of their retirement asset the effects of these primary alternatives, of conduct. allocation. as well as several other alternatives that However, this uniformity could come Similarly, Regulation Best Interest we considered both in the Proposing at a cost to both investors and financial may increase the efficiency of the Release and in response to comments. service providers. Such an approach recommendations regarding account could result in a standard of conduct for types. As discussed above, currently, a 1. Fiduciary Standard for Broker-Dealers broker-dealers that is not appropriately dual-registrant may have an incentive to As discussed in the Proposing Release tailored to the structure and recommend the account type that and as raised by commenters, instead of characteristics of the broker-dealer benefits the dual-registrant at the adopting our approach in Regulation model (i.e., transaction specific expense of the retail customer. The Best Interest, the Commission could recommendations and compensation), potential increase in the efficiency of have alternatively imposed a form of and might not properly take into this type of recommendation under fiduciary standard on broker-dealers account, or build upon, existing Regulation Best Interest relative to a providing recommendations to retail obligations that apply to broker-dealers, similar recommendation that the dual- customers. The Commission recognized including under FINRA rules.1339 A registrant may provide under the that fiduciary standards vary among potential implication of this paradigm baseline may improve the allocative investment advisers, banks acting as shift would be that broker-dealers efficiency of the retail customer’s assets trustees or fiduciaries, or ERISA plan would face significant compliance costs, held in this account. providers, but fiduciaries are generally at least in the short run, relative to the The possibility that Regulation Best required to act in the best interest of regulatory baseline. Potentially higher Interest may increase the efficiency of their clients.1337 compliance costs could increase the the recommendations provided by the Under any of the options considered, incentive to offer investment advice in associated persons of the broker-dealer the Commission would have to craft a the capacity of investment adviser and may enhance the attractiveness of mechanism to apply a uniform standard could decrease the incentive to offer broker-dealer services for those of conduct to all financial professionals investment advice in the capacity of investors who currently do not invest regardless of how they engage with their broker-dealer. To the extent broker- through broker-dealers. Although there retail customers. This approach was dealers act on the increased incentives are costs associated with these advocated by certain commenters, many and decide to participate in the market requirements, the protections deriving of whom asserted that it would reduce for investment advice only in the from these requirements may benefit retail investor confusion as it would capacity of investment advisers, retail investors, issuers, and intermediaries by ensure that investors are provided the customers could experience an increase helping to create a marketplace where a in the cost of obtaining investment higher number of retail customers invest 1336 We had additionally discussed in the advice, relative to the baseline. Proposing Release an alternative of a principles- through broker-dealers, relative to the based best interest standard. See Proposing Release Furthermore, as noted above, the current regulatory regime. If retail at 21663. Some of the economic effects of this potential exit of broker-dealers from the customers are more willing to alternative would be similar to the economic effects market for investment advice in the participate in the securities markets of any of the fiduciary alternatives, which would broker-dealer capacity could limit how also be principles-based. through broker-dealers, Regulation Best 1337 See Proposing Release at footnotes 328–329. retail customers would access certain Interest would have a positive effect on For example, an investment adviser’s fiduciary duty securities or investment strategies and capital formation. under the Advisers Act comprises a duty of care how they would pay for investment and a duty of loyalty. This combination of care and advice, which, in turn, could increase E. Reasonable Alternatives loyalty obligations has been characterized as requiring the investment adviser to act in the ‘‘best Regulation Best Interest establishes a interest’’ of its client at all times. See Fiduciary 1338 See, e.g., Better Markets Letter at 24. new standard of conduct for broker- Interpretation. 1339 See also 913 Study at 139–143.

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their costs of obtaining investment of the retail investor.1343 Both standards Regulation Best Interest only applies at advice, relative to the baseline.1340 To provide methods for addressing the time of a recommendation of any the extent broker-dealers decide to conflicts of interest, although the securities transaction or investment continue to participate in the market for mechanics of those methods and their strategy by a broker-dealer to its retail investment advice in the capacity of outcomes may be different,1344 and both customers.1349 Where application of the broker-dealers, they could pass on standards require full and fair Advisers Act fiduciary standard to increased compliance costs, in full or in disclosure of material facts that affect broker-dealers would impose on broker- part, to their retail customers. As a the relationship, including costs. Both dealers obligations similar to those of result, retail customers could experience standards allow each type of financial Regulation Best Interest, we anticipate an increase in the cost of obtaining professional to agree to provide account similar economic effects; in contrast, investment advice, relative to the monitoring services to retail investor where this alternative would result in baseline. The potential increase in the accounts, although continuous different obligations, it would generate cost of accessing investment advice monitoring is embedded in the economic effects distinct from those of could push some retail customers regulatory regime and market practices Regulation Best Interest. outside the market for investment for investment advisers, whereas a i. Fiduciary Standard Under the advice from Commission-registered broker-dealer may agree to provide Advisers Act Relative to the Baseline broker-dealers and investment account monitoring services only to the advisers.1341 extent that it is solely incidental to the Relative to the regulatory baseline, the We discuss each of the three options primary brokerage business.1345 fiduciary standard of this alternative for applying a uniform fiduciary We recognize that there are certain applied to broker-dealers could benefit standard in more detail below. We notable differences between the retail customers in some circumstances compare each of the three alternatives Advisers Act fiduciary standard and the by extending the obligations of all firms against the regulatory baseline, which is Regulation Best Interest standard we are and financial professionals to act in the the current broker-dealer regulatory adopting. In particular, the investment best interest of retail customers (and to regime. In addition, we briefly discuss adviser fiduciary duty is generally not place the interest of the firm or the the differences between the standard of principles-based, in keeping with the interest of the financial professionals conduct imposed by Regulation Best regulatory tradition and market ahead of those of the retail customers) Interest and the fiduciary standard practices for advisers,1346 whereas to aspects of the relationship other than under the Advisers Act. As discussed Regulation Best Interest, while also providing personalized investment above in Section I, we believe that our largely principles-based, establishes advice through recommendations. For approach in adopting Regulation Best minimum, obligations that are generally example, retail customers might benefit Interest will best achieve the more prescriptive than the fiduciary if broker-dealers were required (as Commission’s important goals of obligations under Advisers Act. Further, advisers are under their current enhancing retail investor protection and advisers are able to address conflicts of fiduciary standard) to disclose any decision making, while preserving, to interest through full and fair disclosure material conflicts related to their the extent possible, retail investor and informed consent,1347 while broker- execution of trades for retail customers access (in terms of choice and cost) to dealers must have policies and in the case when the broker-dealer has differing types of investment services procedures that are reasonably designed not provided a recommendation and securities. to identify and disclose and mitigate, or regarding the transaction (e.g., self- eliminate, any conflicts of interest directed trade). In addition, under the a. Fiduciary Standard Under the associated with recommendations that fiduciary standard that applies to Advisers Act Applied to Broker-Dealers create an incentive for the broker-dealer investment advisers, if an investment A number of commenters discussed or its associated persons to place the adviser cannot fully and fairly disclose the viability of this alternative and interest of the broker-dealer or its a material conflict of interest to a client stated that it would provide superior associated persons ahead of the interest such that the client could reasonably be investor protection benefits relative to of the retail customer. With regard to the expected to provide informed consent, the standard that the Commission substance of both standards, the the investment adviser would be proposed.1342 At the outset, we note investment adviser fiduciary duty expected to either eliminate the conflict that, at the time a recommendation is generally is broader and applies to the or adequately mitigate (i.e., modify its made, key elements of the standard of entire relationship between adviser and practices to reduce) the conflict to the conduct that applies to broker-dealers client, including providing non- point where full and fair disclosure of under Regulation Best Interest will be securities advice,1348 whereas the conflict to the client and informed substantially similar to key elements of the standard of conduct that applies to 1343 See supra Section I.A. advice on annuity products to a client with an investment advisers pursuant to their 1344 Whereas, pursuant to Regulation Best advisory retirement account. fiduciary duty under the Advisers Act. Interest, broker-dealers are required to (i) to 1349 However, under the current legal and establish written policies and procedures regulatory regime, broker-dealers are subject to Both standards of conduct require that, reasonably designed to identify and at a minimum, other rules that apply outside the context of a when making a recommendation or disclose, or eliminate, all conflicts of interest; and recommendation, including rules regarding how providing advice, firms and financial (ii) to establish written policies and procedures broker-dealers market securities and services professionals act in the best interest of reasonably designed to mitigate or eliminate (communications with the public), how they identified conflicts of interest, the fiduciary execute trades (best execution), and the fees that the retail investor and not place the standard for investment adviser relies on full and they charge (fair and reasonable compensation financial professionals’ interests ahead fair disclosure and informed consent. obligations). Moreover, broker-dealers always a have a duty of fair dealing with their retail 1345 See Solely Incidental Interpretation. See also customers under SRO rules. In addition, broker- 1340 supra Section II.B.2.b. See supra Section III.D.1. dealers are subject to a number of obligations that 1346 1341 See supra Section I.A for a discussion of See Fiduciary Interpretation. attach when a broker-dealer makes a access to investment advice in the context of the 1347 See id. recommendation to a customer, as well as general DOL Fiduciary Rule. 1348 For example, an investment adviser may and specific requirements aimed at addressing 1342 See Betterment Letter; Warren Letter; Fein consider both securities annuity products (e.g., certain conflicts of interest, including requirements Letter; State Treasurers Letter; AARP August 2018 variable annuities) and non-securities annuity to eliminate, mitigate, or disclose certain conflicts Letter; ACLI Letter; Schwab Letter. products (e.g., fixed annuities) when providing of interest. See Proposing Release Section I.A.1.

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consent is possible.1350 To the extent alternative were to create situations broker-dealers decide to continue to that this approach of addressing where the compensation to a broker- participate in the market for investment conflicts of interest would extend to the dealer for providing a recommendation advice in the capacity of broker-dealers, fiduciary standard in this alternative, a in a commission-based brokerage they may pass on the increased broker-dealer would also have to account would be less than the compliance costs, in full or in part, to eliminate or modify a conflict of interest compensation under a fee-based their retail customers in the form of to the point where full and fair advisory account and/or where the higher prices for services rendered. In disclosure and informed consent is perceived regulatory burden for an particular, retail customers may possible. The potential reduction in the investment adviser is lower, relative to experience an increase in the cost of effect of conflicts of interest on the baseline, a broker-dealer’s incentive obtaining investment advice, relative to recommendations and the potential to offer advice in the capacity of the baseline. reduction in the information asymmetry investment adviser would likely It is also possible that the fiduciary between a retail customer and a broker- increase, relative to the baseline.1352 standard of this alternative may result in dealer would likely increase the To the extent broker-dealers act on the a different menu of choices that allows efficiency of the recommendation increased incentives and decide to retail customers to access investment provided by the firm to the retail participate in the market for investment advice in a more cost-efficient manner customer, relative to the baseline. Thus, advice only in the capacity of relative to the baseline. For example, if this alternative may reduce the agency investment advisers—for example, dual- more financial professionals decide to costs of the relationship between a registrants may prefer to offer participate in the market for investment broker-dealer and a retail customer, investment advice only in the capacity advice in the capacity of investment which would benefit retail customers, of investment adviser—retail customers advisers, competitive pressure may relative to the baseline. may experience an increase in the cost result in investment advisers providing However, any such benefits would of obtaining investment advice, relative better pricing and/or more choices of come at a cost. As an initial matter, the to the baseline. Furthermore, as noted accessing investment advice for retail fiduciary standard under this alternative above, the potential exit of broker- customers. is a principles-based regime and shaped dealers from the market for investment To the extent that the cost of by decades of case law specific to advice in the capacity of broker-dealer accessing investment advice increases investment advisory model. In contrast, may limit how retail customers can under the fiduciary standard of this the standard of conduct that applies to access certain securities or investment alternative, some retail customers may broker-dealers under the baseline is strategies and how they can pay for be pushed outside the market for more prescriptive, and governed by investment advice, which, in turn, may investment advice. For example, detailed SRO rules. Therefore, if this further increase the cost of obtaining currently, a retail customer that prefers investment advice, relative to the to receive recommendations from a alternative were adopted, broker-dealers 1353 would face increased compliance costs baseline. Alternatively, to the extent broker-dealer or its associated persons resulting from having to conform their to implement a buy-and-hold strategy is due to firms exiting the market. The paper also may find a brokerage account to be advice models to a regulatory regime observes that a state-level obligation on broker- that was not formed for a transaction- dealers may cause a compositional shift in the pool better suited to his or her needs based model governed by detailed SRO of variable annuities sold by broker-dealers toward compared to an advisory account.1354 rules. annuities that offer a larger and more diverse set of Under the fiduciary standard in this investment options, which, in certain alternative, this retail customer may The potential increased compliance circumstances, may also generate higher expected costs associated with applying the returns for retail customers. The paper also observes have to pay more for the broker-dealer fiduciary standard in this alternative to that under certain circumstances a state-level services that come with his or her broker-dealers would likely increase the obligation on broker-dealers may increase the account, including obtaining investment quality of the variable annuities sold by broker- broker-dealers’ incentives to offer dealers. ‘‘Quality’’ is defined by the authors as ‘‘the advice, relative to the baseline. If this investment advice in the capacity of return on variable annuities assuming optimal increase in the cost for broker-dealer investment adviser and may decrease allocation.’’ The authors interpret these results as services outweighs the benefits of the suggesting that a state-level obligation on broker- potential improved efficiency of the their incentive to continue offering dealers may (i) cause some broker-dealers to exit the investment advice in the capacity of market, and (ii) cause a compositional shift in the recommendations provided by the broker-dealer dealer (on a transaction- variable annuities sold by the broker-dealers that do by-transaction basis), relative to the not exit the market toward annuities of higher 1354 For example, Del Guercio & Reuter (2014), 1351 quality as defined in the paper. However, the supra footnote 1081, document (Table 1 on page baseline. For example, if this limitations of the data sample and of the empirical 1682) that retail customers can access index funds methodology make it difficult to (i) generalize these through both broker-dealers (i.e., the broker-sold 1350 See Fiduciary Interpretation. results to the entire market of annuities sold by channel, as discussed above) and directly from the 1351 See Vivek Bhattacharya, Gaston Illanes, & broker-dealers, (ii) extrapolate these results to the fund sponsor (i.e., the direct-sold channel). Manisha Padi, Fiduciary Duty and the Market for entire universe of securities that broker-dealers offer Furthermore, in their sample, the average expense Financial Advice (Working Paper, Apr. 2019) for a advice on, (iii) extrapolate the results to the ratio for an index fund is 0.86 if sold through the recent paper providing an empirical analysis on the population of broker-dealers not captured by the broker-sold channel and 0.44 if sold through the effect of state-level standards of conduct on the data sample, or (iv) use the results as a basis for direct channel. Assuming that a retail customer is structure of the market for investment advice in the comparing the investor protections offered by state- interested in implementing a buy-and-hold strategy context of variable annuities. The study finds level standards of conduct, SRO rules, existing using index funds that carry no loads, the cost to differences in broker-dealer behavior when federal standards of conduct, and Regulation Best the retail customer of implementing this strategy comparing states with and without a fiduciary Interest. See also supra footnote 1163 and through a broker-dealer would be on average 86 obligation for broker-dealers. The states with the surrounding discussion noting that there is basis points of the assets invested per year. In obligation are associated with fewer variable substantial variation in the sources, scope, and contrast, the cost to the retail customer of annuity sales and are also associated with some application of state fiduciary law. implementing the same strategy through an broker-dealers exiting the industry. Specifically, the 1352 Broker-dealers that choose to deregister investment adviser would be on average 44 basis paper observes, among other things, that a state- would eliminate the costs of complying with FINRA points plus the investment adviser’s AUM-based fee level obligation reduces the number of broker- rules, which are broader than retail customer sales per year. Assuming that in the investment adviser’s dealers that are not dually registered by about 16% practice obligations, and submitting to FINRA fee is 100 basis points of AUM per year, the cost but has no meaningful effect on the number of dual- examinations as well as compliance with other to the retail customer of implementing his or her registrants. The authors argue that this specific rules, which do not apply to advisers. strategy with an investment adviser would be on compositional shift in the number of broker-dealers 1353 See supra Section III.D.1. average 144 basis points.

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broker-dealer for this retail customer, as by the 913 study could be implemented, provided by broker-dealers and their noted above, the retail customer may the fiduciary standard under this associated persons under the new prefer to switch to a more-limited alternative could have imposed any or fiduciary standard of this alternative brokerage account that does not come all of the following requirements: (1) would benefit retail customers, relative with personalized investment advice Eliminate or disclose conflicts of to the baseline. (e.g., an execution-only brokerage interest; (2) prohibit certain conflicts of Similarly, the new fiduciary standard account).1355 Alternatively, and as noted interest by requiring firms to mitigate of this alternative applied to investment by one commenter, the retail customer conflicts through specific action, or to advisers may create benefits for their may switch to a light version of an impose specific disclosure and consent clients, relative to the baseline. advisory account that implements requirements; and (3) specify the basis Requirements (1) and (2) would enhance automated investment strategies tailored a broker-dealer or investment adviser the obligations of the investment around a retail customer’s goals.1356 has in making a recommendation to a advisers under the current fiduciary However, this type of advisory account retail customer by referring to and standard that applies to investment may not offer the flexibility of expanding upon broker-dealers’ existing advisers by requiring investment personalized investment advice to the suitability requirements. advisers to take actions to mitigate or evolving needs of the customer and may Some of the benefits of the investment eliminate certain conflicts of interest. To not be as responsive to market advisers’ fiduciary standard of the the extent that these requirements movements not anticipated by the previous alternative would carry over to reduce of the effect of the conflicts of automated investment strategies. the new uniform standard of this interest on the recommendation alternative. In particular, relative to the provided by an investment adviser or its b. Uniform Fiduciary Standard Under baseline, the new fiduciary standard of associated persons and reduce the 913(g) this alternative applied to broker-dealers information asymmetry between retail Another alternative approach to the could benefit retail customers in some customers and investment advisers, the standard of conduct imposed by circumstances by extending the new fiduciary standard under this Regulation Best interest is a ‘‘new’’ obligations of all firms and financial alternative may increase the efficiency uniform fiduciary standard of conduct professionals to act in the best interest of the recommendations made by applicable to both broker-dealers and of retail customers (and to not place the investment advisers and their associated investment advisers, such as that interest of the firm or those of the persons, relative to the baseline. recommended by the staff in the 913 financial professionals ahead of the The new fiduciary duty of this Study.1357 The fiduciary standard under interest of the retail customer) to aspects alternative may also result in increased this alternative would require firms ‘‘to of the relationship other than providing competition across financial act in the best interest of the customer personalized investment advice through professionals for retail customers or without regard to the financial or other recommendations. clients, relative to the baseline. This interest of the broker, dealer, or In addition, the new fiduciary potential increase in competition, investment adviser providing the standard of this alternative applied to relative to the baseline, may benefit advice.’’ Based on the Commission broker-dealers may create additional retail customers of broker-dealers and staff’s recommendations about ways in benefits for their retail customers, clients of investment advisers in the which the fiduciary standard proposed relative to the baseline. For example, form of lower prices for investment requirements (1) and (2) may enhance advice. 1355 Relative to a brokerage account that offers the obligations under the baseline by Turning to the potential costs personalized investment advice, execution-only requiring broker-dealers to disclose imposed by this alternative, we note brokerage accounts may also come with enhanced research tools, more investment choices, and, conflicts of interest and to take actions that some of the costs of the investment potentially, other forms of impersonal advice. to mitigate or eliminate certain conflicts advisers’ fiduciary standard of the 1356 See, e.g., CFA August 2018 Letter at 79, of interest. To the extent that these previous alternative carry over to the noting that ‘‘[f]or example, Vanguard charges 0.30% requirements reduce of the effect of the new fiduciary standard of this for its Personal Advisor Services, Schwab charges conflicts of interest on the alternative. As noted above, this 0.28% for its Intelligent Advisory Services, and Betterment charges 0.25% for its Digital offering recommendation provided by a broker- alternative would impose a new and 0.40% for its Premium offering.’’ dealer or its associated persons and regulatory paradigm on broker-dealers 1357 One of the staff’s primary recommendations reduce the information asymmetry relative to the baseline. The fiduciary was that the Commission engage in rulemaking to between retail customers and broker- standard of this alternative would be adopt and implement a uniform fiduciary standard of conduct for broker-dealers and investment dealers, the new fiduciary standard of principles-based and shaped by advisers when providing personalized investment this alternative may increase, relative to common law. In contrast, the standard advice about securities to retail customers. The the baseline, the efficiency of the of conduct that applies to broker-dealers staff’s recommended standard would require firms recommendations made by broker- under the baseline is more prescriptive ‘‘to act in the best interest of the customer without regard to the financial or other interest of the dealers and their associated persons. and governed by detailed SRO rules. A broker, dealer, or investment adviser providing the Furthermore, requirement (3) may paradigm shift from the standards of advice.’’ The staff made a number of specific enhance the existing suitability conduct under the current baseline to recommendations for implementing the uniform requirements that apply to broker- the uniform standard in this alternative fiduciary standard of conduct, including that the Commission should: (1) Require firms to eliminate dealers and, to the extent that this may increase compliance costs relative or disclose conflicts of interest; (2) consider requirement results in recommendations to the baseline.1358 whether rulemaking would be appropriate to that are better aligned with the Furthermore, the potential increased prohibit certain conflicts, to require firms to objectives of the retail customers, the compliance costs associated with mitigate conflicts through specific action, or to impose specific disclosure and consent new fiduciary standard of conduct of applying the fiduciary standard of this requirements; and (3) consider specifying uniform this alternative may further increase, alternative to broker-dealers may standards for the duty of care owed to retail relative to the baseline, the efficiency of increase, relative to the baseline, a customers, such as specifying what basis a broker- the recommendations provided by broker-dealer’s incentives to offer dealer or investment adviser should have in making a recommendation to a retail customer by referring broker-dealers and their associated investment advice in the capacity of an to and expanding upon broker-dealers’ existing persons. The potential increase in the suitability requirements. See 913 Study. efficiency of the recommendations 1358 See also 913 Study at 156–159.

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investment adviser and may decrease the baseline. For example, if more may not be able to afford the additional their incentive to offer investment financial professionals decide to cost and may be pushed outside the advice in the capacity of broker-dealer. participate in the market for investment market for investment advice, relative to For example, if this alternative creates advice as investment advisers, the baseline. As noted above, the situations where the compensation to a competitive pressure may result in options available to these clients may broker-dealer for providing a better pricing and/or greater choice in not offer the flexibility of tailored recommendation in a commission-based accessing investment advice for retail investment advice that may benefit a brokerage account would be less than customers and clients that choose to use client with evolving needs. the compensation under a fee-based an investment adviser. c. Fiduciary Standard Under the DOL advisory account while the perceived However, to the extent that the cost of Rule and BIC Exemption regulatory burden is equal to that of an accessing investment advice increases investment adviser, a broker-dealer’s under the new fiduciary standard of this A third alternative approach to incentive to offer advice in the capacity alternative, some retail customers may addressing the agency costs associated of investment adviser may increase, be pushed outside the market for with obtaining advice from broker- relative to the baseline.1359 investment advice, relative to the dealers is a fiduciary standard coupled To the extent broker-dealers act on the baseline. For example, currently, a retail with a series of disclosures and other increased incentives and decide to customer who prefers to receive requirements akin to the full participate in the market for investment recommendations from a broker-dealer complement of conditions of the DOL’s advice only in the capacity of or its associated persons to implement BIC Exemption adopted in connection investment advisers—for example, dual- a buy-and-hold strategy may find a with the DOL Fiduciary Rule. This registrants may prefer to offer brokerage account to be better suited to alternative would mirror the key investment advice only in the capacity his or her needs than an advisory conditions that apply to an ‘‘adviser’’ of investment adviser—retail customers account. Under the new fiduciary under the BIC Exemption.1364 This may experience an increase in the cost standard of this alternative, this retail alternative approach would apply to of obtaining investment advice, relative customer may have to pay more for the broker-dealers when providing to the baseline. Alternatively, to the broker-dealer services that come with recommendations to retail customer for extent broker-dealers decide to continue his or her account, including obtaining all types of retail accounts rather than to participate in the market for investment advice, relative to the retirement accounts only. At least one investment advice in the capacity of baseline. If, from the perspective of a commenter signaled support for this broker-dealers, they may pass on the retail customer, this increase in the cost alternative.1365 increased compliance costs, in full or in for broker-dealer services outweighs the Unlike other alternatives considered part, to their retail customers in the expected benefits of the potential in this section, or Regulation Best form of higher prices for services improved efficiency of the Interest, this alternative can be rendered, relative to the baseline. In recommendations provided by the analyzed, at least in part, based upon its particular, retail customers may broker-dealer, the retail customer may previous adoption by the DOL and experience an increase in the cost of prefer to switch to a more limited partial implementation. Because this obtaining investment advice, relative to brokerage account that does not come alternative was already partly the baseline.1360 with personalized investment advice implemented, the market for investment Similarly, the new fiduciary standard (e.g., an execution-only brokerage advice, the securities market, and, of this alternative may also impose account).1362 ultimately investors have had an additional compliance costs for Alternatively, and as noted by one opportunity to partially adjust to it. investment advisers relative to the commenter, the retail customer may Section III.B.2.e.ii summarizes the baseline.1361 For example, to the extent switch to an advisory account that evidence about the response of firms, that investment advisers currently implements automated investment investors and product markets in provide investment advice to their strategies.1363 However, this type of response to the DOL Fiduciary Rule. clients in a manner that is not fully advisory account may not offer the The requirements of the standard of consistent with the requirements (2) and flexibility of personalized investment conduct in this alternative would (3), investment advisers may incur advice to the evolving needs of the enhance the obligations under the compliance costs in adhering to these customer, the level of contact a retail baseline by requiring broker-dealers to potentially more stringent requirements. customer seeks from a relationship with adhere to the impartial conduct Investment advisers would likely pass a financial professional, and may not be standard, which included requirements on the potential increase in the costs of as responsive to market movements not to act in their retail customers’ best complying with the new fiduciary anticipated by the automated interest, disclose material conflicts of standard of this alternative to their investment strategies. interest and designate a person clients. In turn, under the new fiduciary Similarly, under the new fiduciary responsible for addressing material standard of this alternative, clients may standard of this alternative, clients of conflicts of interest and monitoring the experience an increase in the cost of investment advisers may experience an adherence of the associated persons of obtaining investment advice, relative to increase in the cost of obtaining the broker-dealer to the impartial the baseline. investment advice. Some of these clients conduct standard. To the extent that It is also possible that the new fiduciary standard of this alternative 1362 Relative to a brokerage account that offers 1364 For a discussion of key conditions of the BIC personalized investment advice, execution-only Exemption, see Section I.A.2 of the Proposing may result in a different menu of brokerage accounts may also come with enhanced Release at 21581. As discussed above, the DOL choices that allows retail customers and research tools, more investment choices, and, Fiduciary Rule—including the BIC Exemption—was clients to access investment advice in a potentially, other forms of impersonal advice. vacated by the United States Court of Appeals for more cost-efficient manner relative to 1363 See, e.g., CFA August 2018 Letter at 79, the Fifth Circuit on March 15, 2018, although some noting that ‘‘[f]or example, Vanguard charges 0.30% firms may continue to seek comply with certain of for its Personal Advisor Services, Schwab charges its conditions under a DOL temporary enforcement 1359 See supra footnote 1351. 0.28% for its Intelligent Advisory Services, and policy. See also supra Section III.B.2.e. See also 1360 See also 913 Study at 159–162. Betterment charges 0.25% for its Digital offering supra footnote 32. 1361 See id. at 159. and 0.40% for its Premium offering.’’ 1365 See Galvin Letter.

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these requirements reduce the effect of cases some broker-dealers have either hold investments. As discussed in the conflicts of interest on the eliminated or reduced access to Section III.B.2.e.ii, one study provided recommendation provided by a broker- brokerage advice services. Other studies an estimate for this potential cost.1369 dealer or its associated persons and observe that some broker-dealers However, as discussed above, the reduce the information asymmetry migrated toward fee-based advisory estimates provided by various studies, between retail customers and broker- services or limited brokerage services including this one, or by commenters dealers, the new standard of conduct in (i.e., no provision of advice) and, in the are generally subject to assumptions or this alternative would increase the process, offered their retail customers methodological limitations which may efficiency of the recommendations made the option to shift from commission- affect the inferences based on such by broker-dealers and their associated based brokerage accounts to fee-based estimates. persons, relative to the regulatory accounts, automated investment In addition to the evidence discussed baseline. Furthermore, the requirement accounts or self-directed accounts. above, there are other potential to act in the retail customers’ best Some of their customers chose to not economic implications of this interest would enhance the existing move to a fee-based account. alternative. For instance, this alternative suitability standard that applies to Certain studies provide evidence may exclude from the market for broker-dealers and, to the extent that the suggesting that some broker-dealers investment advice those retail new standard of conduct of this adjusted the range of their offerings.1366 customers that have account balances alternative would result in Specifically, according to these studies, that are below the account minimum for recommendations that are better aligned some of the respondents reduced or typical advisory accounts. The with the objectives of the retail eliminated access to certain assets or investment advisory industry might customers, this new standard would share classes, such as certain mutual adjust to a lack of supply by further increase the efficiency of the funds or mutual fund share classes, and accommodating lower account balances. recommendations provided by broker- or annuity securities offered. However, because investment advisers dealers and their associated persons, Finally, there is some anecdotal have a fiduciary duty to all their clients, relative to the regulatory baseline. The evidence that suggests that certain firms and because they have limited time and potential increase in the efficiency of changed the compensation structure for resources, there is likely a limit to how the recommendations provided by their associated persons.1367 much an investment adviser can lower broker-dealers and their associated Specifically, some firms equalize his or her account minimum to persons under the new standard in this commissions and deferred sales charges accommodate more advisory clients. alternative would benefit retail across similar securities, while other Similarly, the product market may customers, relative to the baseline. firms banned sales quotas, contests, and adjust by innovating new products to This alternative may also affect certain bonuses. accommodate retail customers with product markets. As discussed above in To the extent that the fiduciary account balances that are below the Section III.B.2.ii, certain product standard in this alternative would result typical advisory account minimum. For sponsors introduced new products in in similar responses by broker-dealers, example, hybrid products that the market for mutual funds, such as the alternative would impose cost on implement automated investment clean and T shares that were designed retail customers relative to the baseline. strategies tailored to a retail customer’s to facilitate compliance with various For example, switching a retail goals may substitute for the services of anticipated regulations, including the customer from a commission-based an investment adviser for customers DOL Fiduciary Rule. In certain brokerage account to a different type of with lower account balances. circumstances, these products may account, such as fee-based advisory come with lower fees for retail account, may leave a customer worse off 2. Prescribed Format for Disclosure customers. To the extent that this in certain circumstances. For instance, a Although Regulation Best Interest alternative would enhance this trend in retail customer who is a buy-and-hold specifies the required content of product innovation, retail customers investor may overpay for the advice disclosure necessary to meet a broker- may benefit from this trend. typically associated with this type of dealer’s Disclosure Obligation, it does However this alternative would also investment strategy if the retail not prescribe a specific format for that impose costs on broker-dealers and customer were to shift from a brokerage disclosure. As an alternative, and as retail customers. account to a fee-based account.1368 As suggested by commenters,1370 we Compliance costs would include costs another example, a retail customer associated with the contract provision, would lose access to occasional 1369 See SIFMA Study. and the disclosure, policies and personalized advice if he or she were to 1370 See, e.g., LPL August 2018 Letter that notes procedure, and record-making and shift from his or her brokerage account that ‘‘all investors should be provided with general recordkeeping requirements. It is disclosures somewhat akin to those contained in to a self-directed account. Form ADV Part 2A—e.g., which set forth the ranges possible that broker-dealers would pass The cost to retail customers from of remuneration payable to a broker-dealer in on these direct compliance costs, in part switching to a suboptimal account is connection with its recommendations of different or in full, to retail customers. particularly important in the context of products . . . [W]e believe that detailed product- In addition to these costs, this specific disclosures should be required prior to or IRA brokerage accounts, because of the at the time of a recommendation only in instances alternative would likely cause some larger size of these accounts and the where the remuneration associated with the broker-dealers to change their current importance of these accounts for retail recommendation exceeds the previously disclosed practices, which, in turn, may impose investors to meet their retirement needs. range or where the recommendation implicates a further costs on them or their retail conflict of interest that has not previously been These costs may also be higher for IRA disclosed. In all other cases, a broker-dealer should customers. As discussed above in brokerage accounts than for other be permitted to satisfy its Disclosure Obligation by Section III.B.2.e.ii some studies find account types to the extent that these directing an investor in writing to review the evidence suggesting that firms have accounts include long-term, buy-and- recommended product’s offering documents and adjusted their practices, at least in the providing hyperlinks to those documents (or providing a hyperlink to a central page on the short-run, in response to the DOL 1366 See supra Section III.B.2.e.ii. broker-dealer’s website that contains hyperlinks to fiduciary Rule. In particular, certain of 1367 See id. the product documents), either prior to the these studies observe that in certain 1368 See supra footnote 1354. Continued

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considered requiring broker-dealers to form that, while comprehensive in advice from broker-dealers. As a result, use a specific form similar to, for terms of capturing the diversity of the Commission believes both specific example, Form ADV. business practices that broker-dealers disclosure and mitigation requirements Because this alternative would still employ, remains easy to understand for are needed to address those conflicts. impose all the obligations of Regulation retail customers. In general, given that Also, we noted above that sales contests, Best Interest, all the benefits and the there is a wide variety of business sales quotas, bonuses, and non-cash costs identified in Regulation Best models and practices, there is value in compensation that are based on the Interest would carry over to this providing broker-dealers with flexibility sales of specific securities within a alternative as well. However, by to enable them to better tailor disclosure limited period of time create high- changing the way broker-dealers would and information that their retail pressure situations for associated meet the Disclosure Obligation, this customers can understand and may be persons to increase the sales of specific alternative may create additional more likely to read at relevant points in securities by compromising the best benefits and impose additional costs. time, rather than, for example, interest of their customers; the The requirement to use a form similar mandating a standardized all-inclusive Commission does not believe such to Form ADV to meet the Disclosure (and likely lengthy) disclosure. conflicts of interest can be reasonably Obligation would put more structure on Depending on the specific form that is mitigated, let alone disclosed, in a the disclosure of material facts relating eventually mandated, some firms may manner that adequately prevents harm to the scope and terms of the incur more costs than others. To the to retail customers and, accordingly, relationship with the retail customer extent firms pass on those costs to retail believes that these conflicts must be and material facts relating to conflicts of customers, the alternative would impose eliminated in their entirety. interest that are associated with a a cost on retail customers. Finally, as we discussed earlier, recommendation. This added structure commenters noted that there are limits 3. Disclosure-Only would facilitate retail customers’ to the effectiveness of disclosure and comparison of multiple broker-dealers, Another potential alternative to cited a number of studies suggesting which would benefit retail customers. addressing the agency costs of obtaining that disclosure alone is unlikely to solve For example, the evidence provided by advice from broker-dealers is a the issues surrounding, for example, the the investor testing surveys suggests that disclosure-only alternative, which conflicts of interest between a broker- retail customers form preference over would require that broker-dealers satisfy dealer (or their associated persons) and various variables that are being only the Disclosure Obligation of a retail customer.1372 disclosed.1371 On the backdrop of this Regulation Best Interest. In other words, evidence, the structured disclosure broker-dealers would be required to IV. Paperwork Reduction Act provided by a specific form may provide the retail customer, in writing, Certain provisions of Regulation Best enhance a retail customer’s ability to full and fair disclosure of all material Interest and the rule amendments that select a broker-dealer in a manner facts relating to the scope of the we are adopting today contain consistent with his or her preferences. relationship with the retail customer ‘‘collection of information’’ In addition, the structured disclosure and all material facts relating to the requirements within the meaning of the provided by a form may allow a third conflicts of interest associated with the Paperwork Reduction Act of 1995 party to collect the information recommendations to the retail customer, (‘‘PRA’’).1373 The Commission disclosed by firms, process it, and prior to or at the time of the submitted Regulation Best Interest and present it to retail customers in a way recommendation. However, this the rule amendments to the Office of that would make it easier for the retail alternative would not impose either the Management and Budget (‘‘OMB’’) for customer to select a broker-dealer. To Care Obligation or the Conflict of review and approval in accordance with the extent the format of disclosure Interest Obligation. the PRA.1374 The Commission’s earlier under this alternative would result in As discussed in Sections III.C.2 and PRA assessments have been revised to this potential outcome, the alternative III.C.4, there may be substantial overlap reflect the modifications to the rule and would further benefit retail customers. between the disclosure requirements of amendments from the Proposing However, the requirement to use a Regulation Best Interest and the Release, as well as additional form similar to Form ADV to meet the disclosure requirements under the information and data provided to the Disclosure Obligation may also impose regulatory baseline. From this Commission by commenters. An agency costs on broker-dealers, at least in the perspective, relative to the regulatory may not conduct or sponsor, and a short run, to the extent that this form of baseline, the cost of this alternative to person is not required to respond to, a disclosure is different from the form of the broker-dealers may be small, at least collection of information unless it disclosure that firms employ currently for some broker-dealers. However, as displays a currently valid OMB control to satisfy their disclosure obligations pointed out above, a disclosure-only number. The titles and OMB control and liabilities under the baseline. In alternative is not likely to address the numbers for the collections of general it may be difficult to design a agency costs associated with obtaining information are: recommendation via a general Form ADV Part 2A- document would also be useful for the small bd that 1372 See supra footnote 1208 and accompanying like disclosure document or shortly thereafter via a cannot afford the legal assistance needed to text. See also supra Section III.B.4.c for a discussion trade confirmation.’’ See also Morningstar Letter, evaluate this 1,000 page proposal and draft of the literature on the effectiveness of disclosure. noting ‘‘publicly available disclosures with a appropriate documents. [. . .] The Commission 1373 44 U.S.C. 3501 et seq. standard taxonomy work best because they should therefore reconsider the impact of its 1374 See 44 U.S.C. 3507(d); 5 CFR 1320.11. empower third parties such as ‘fintech’ and ‘reg- proposal on small investors and small bd’s with the tech’ firms to analyze and contextualize critical 1375 assumption that retirement accounts are See 17 CFR 240.17a–3. The addition of information and amplify a call to action for significantly more important than regular brokerage paragraph (a)(35) to Rule 17a–3 would amend the ordinary investors.’’ See also Letter from Peter J. existing PRA for Rule 17a–3. Chepucavage (May 31, 2018) (‘‘Chepucavage accounts especially for small and elderly investors. 1376 See 17 CFR 240.17a–4. The amendment to Letter’’), noting that ‘‘[c]osts for the small bd’s A standard disclosure for small firms would reduce however can be reduced with a commission costs for the firms and their customers.’’ Rule 17a–4(e)(5) would amend the existing PRA for approved standard disclosure which would add 1371 See Relationship Summary Adopting Release Rule 17a–4. certainty and ought to be considered especially for for a discussion of the evidence provided by the the small investor. [. . .] A standard disclosure investor testing surveys.

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OMB control Rule Rule title No.

Rule 15l–1 ...... Regulation Best Interest. Rule 17a–3 ...... Records to be made by certain exchange members, brokers and dealers 1375 ...... 3235–0033 Rule 17a–4 ...... Records to be preserved by certain exchange members, brokers and dealers 1376 ...... 3235–0279

Regulation Best Interest enhances the Best Interest that had not been A. Respondents Subject to Regulation broker-dealer standard of conduct identified in the Proposing Release. Best Interest and Amendments to Rule beyond existing suitability obligations, As discussed in Sections I, II, and III, 17a–3(a)(35) and Rule 17a–4(e)(5) and aligns the standard of conduct with we received comments that addressed 1. Broker-Dealers retail customers’ reasonable whether we could minimize the burden expectations by requiring broker- of the proposed collections of Regulation Best Interest imposes a dealers, among other things, to: (1) information. We received several best interest obligation on a broker- Comply with specific obligations to comments suggesting that our estimated dealer when making recommendations make recommendations that are in the of any securities transaction or burdens and costs for the rule as a best interest of the retail customer, and investment strategy involving securities whole were too low.1379 In addition, the that do not place the broker-dealer’s to retail customers. Except where noted, Commission received some comments interests ahead of the interests of the we have assumed that a dually specifically addressing the costs to retail customer; and (2) address conflicts registered firm, already subject to the smaller broker-dealers.1380 Also, as of interest by fully and fairly disclosing Advisers Act, would be subject to new, material facts about conflicts of interest, discussed in the Economic Analysis distinct burdens under Regulation Best and in instances where we believe section above, we received comments Interest. regarding the potential costs and disclosure is insufficient to reasonably As of December 31, 2018, 3,764 burdens of proposed Regulation Best address the conflict, establish, maintain broker-dealers were registered with the Interest on broker-dealers.1381 In and enforce policies and procedures Commission, either as standalone response, we have modified several reasonably designed to mitigate or, in broker-dealers or as dually registered substantive requirements to the rule by, certain instances, eliminate the conflict. entities.1383 Based on data obtained Generally, in crafting Regulation Best among other things, providing more from Form BR, the Commission believes Interest, we aimed to provide broker- specificity in the rule text in the that approximately 73.5% of this dealers flexibility in determining how to Disclosure and Conflict of Interest population, or 2,766 broker-dealers, satisfy the component obligations. For Obligations, which we believe will have retail customers and therefore purposes of this analysis, we have made mitigate some of these burdens and would be subject to Regulation Best assumptions regarding how a broker- costs relative to the Proposing Interest and the amendments under 1382 dealer would comply with the Release. At the same time, certain Rules 17a–3(a)(35) and 17a–4(e)(5).1384 obligations of Regulation Best Interest, modifications, such as maintaining a Further, based on FOCUS Report as well as the amendments under Rule written record of oral disclosure, data,1385 the Commission estimates that 17a–3(a)(35) and Rule 17a–4(e)(5). resulted in new burdens and costs, as of December 31, 2018, approximately In the Proposing Release, we relative to those addressed in the 985 broker-dealers may be deemed requested comment on the matters Proposing Release, which are reflected small entities under the Regulatory discussed in the PRA, including our below. Flexibility Act.1386 Of these, estimates for the new and recurring burdens and associated costs described 1379 See, e.g., NSCP Letter; see also CCMC Letters 1383 The Commission estimated the number of in connection with Regulation Best (costs to implement the proposal were respondents in the Proposing Release as of Interest and the amendments under underestimated and greater than 40% of firms December 31, 2017. The Commission is updating its surveyed anticipate having to spend a moderate or estimated number of broker-dealers to reflect the Rule 17a–3(a)(35) and Rule 17a– substantial amount to implement Regulation Best number of broker-dealers registered with the 4(e)(5).1377 In particular, we sought Interest and Form CRS); Raymond James Letter Commission as of December 31, 2018. comment on estimates as to: (1) The (noting the significant implementation costs of 1384 As of December 31, 2018, 3,764 broker- number of natural persons who are Regulation Best Interest and Form CRS for the dealers filed Form BD. Retail sales by broker-dealers industry); SIFMA August 2018 Letter (stating that were obtained from Form BR. As discussed above associated persons; (2) the number of implementation costs of Regulation Best Interest in Section III.B.1.a, the number of broker-dealers broker-dealers that make securities- and Form CRS would be significant). that serve retail customers (i.e., 2,766) likely related recommendations to retail 1380 See, e.g., Chepucavage Letter (finding that the overstates the number of broker-dealers that will be customers; (3) the number of natural estimates in the proposal are severely understated subject to Regulation Best Interest, because not all unless they are excluding time needed for review broker-dealers that serve retail investors provide persons who are associated persons that of the proposal and final rule and suggesting the recommendations to retail investors. We do not make securities-related Commission reconsider the impact on small have reliable data to determine the precise number recommendations to retail customers; investors and small broker-dealers); NSCP Letter of broker-dealers that provide recommendations, and (4) any other costs or burdens 1378 (requesting the Commission to consider the and as a result, we have assumed, for purposes of financial and operational impacts of the proposed this analysis that 2,766 broker-dealers will be associated with proposed Regulation rule, particularly on small firms, and to minimize subject to Regulation Best Interest. those impacts, given that small firms do not have 1385 FOCUS Reports, or ‘‘Financial and 1377 The Proposing Release proposed to add new compliance departments adequate to deal with Operational Combined Uniform Single’’ Reports, paragraph (a)(25) of Rule 17a–3. As noted above, we increasing regulatory demands). See also, e.g., Iowa are monthly, quarterly, and annual reports that are adopting the provision substantially as Insurance Commissioner Letter; Letter from David broker-dealers are generally required to file with the proposed but redesignating it as new paragraph S. Addington, National Federation of Independent Commission and/or SROs pursuant to Exchange Act (a)(35) of Rule 17a–3. See supra footnote 820 and Business (May 30, 2018) (‘‘NFIB Letter’’). Rule 17a–5. See 17 CFR 240.17a–5. accompanying text. 1381 See supra Section III. 1386 See infra Section V for an explanation of 1378 Throughout the PRA analysis in the 1382 Throughout this PRA analysis, the burdens which brokers-dealers, subject to Regulation Best Proposing Release, the burdens on in-house on in-house personnel are measured in terms of Interest, are ‘‘small entities,’’ for purposes of the personnel were measured in terms of burden hours, burden hours, and external costs are expressed in Regulatory Flexibility Act analysis. and external costs were expressed in dollar terms. dollar terms. Continued

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approximately 756 have retail transaction or investment strategy customer, in writing, all material facts business.1387 Therefore, we estimate involving securities to a retail customer relating to the scope and terms of the that 2,010 broker-dealers would qualify to act in the best interest of the retail relationship with the retail customer as large broker-dealers with retail customer at the time the would facilitate the retail customer’s customers for purposes of this recommendation is made, without understanding of the nature of his or her analysis.1388 placing the financial or other interest of account, the broker-dealer’s fees and the broker-dealer ahead of the interest of costs, as well as the nature of services 2. Natural Persons Who Are Associated the retail customer. As discussed above, that the broker-dealer provides, as well Persons of Broker-Dealers Regulation Best Interest specifically as any limitations to those services. It As with broker-dealers, Regulation provides that this best interest would also provide retail customers Best Interest imposes a best interest obligation shall be satisfied if the with information to better understand obligation on natural persons who are broker-dealer complies with the specific the differences among certain financial associated persons of broker-dealers Disclosure, Care, Conflict of Interest, service providers, such as broker- when making recommendations of any and Compliance Obligations. dealers, investment advisers, and dually securities transaction or investment Rule 17a–3 requires a broker-dealer to registered firms and dually registered strategy involving securities to retail make and keep current certain records. financial professionals. In addition, the customers. The Commission is amending this rule obligation to disclose all material facts The Commission believes that by adding new paragraph (a)(35) to relating to conflicts of interest that are approximately 428,404 natural persons impose new record-making obligations associated with a recommendation would qualify as retail-facing, registered on broker-dealers subject to Regulation would raise retail customers’ awareness representatives at standalone broker- Best Interest. Rule 17a–4 requires a of the potential effects of conflicts of dealers or dually registered firms,1389 broker-dealer to preserve certain records interest, and increase the likelihood that and would therefore be subject to if it makes or receives them. The broker-dealers would make Regulation Best Interest.1390 Commission is amending Rule 17a– recommendations that are in the retail B. Summary of Collections of 4(e)(5) to impose new record retention customer’s best interest. Information obligations on broker-dealers subject to We are explicitly requiring in the rule Regulation Best Interest. text of Regulation Best Interest, items Regulation Best Interest requires The obligations arising under that the Proposing Release had only broker-dealers and their associated Regulation Best Interest and the provided as examples of ‘‘material facts 1391 persons when making a amendments under Rule 17a–3(a)(35) relating to the scope and terms of the recommendation of any securities and Rule 17a–4(e)(5) would give rise to relationship with the retail customer’’ distinct collections of information and that must be disclosed, namely: (1) That The Commission’s estimate is obtained from associated costs and burdens for broker- the broker, dealer or such natural person Form BD filings. Although Form BD filings are updated on a more frequent basis than annually, dealers subject to the rules. The is acting as a broker, dealer or an FOCUS data, which also informs this baseline with collections of information associated associated person of a broker-dealer respect to broker-dealers, is only sparsely updated with Regulation Best Interest and rule with respect to the recommendation; (2) throughout the year. Moreover, instead, broker- amendments are described below. dealers tend to make their most complete updates the material fees and costs that apply to in the fourth calendar quarter of each year. 1. Disclosure Obligation the retail customer’s transactions, Therefore, in order to minimize discrepancies in the holdings, and accounts; and (3) the type broker-dealer data between Form BD and FOCUS The Disclosure Obligation under and scope of services provided to the data, we have normalized all of the data to the most Regulation Best Interest requires a recently complete FOCUS data, which is for retail customer, including: any material December 2018. broker, dealer, or natural person who is limitations on the securities or 1387 Id. an associated person of a broker or investment strategies involving 1388 This calculation was made as follows: (2,766 dealer, prior to or at the time of securities that may be recommended to total retail broker-dealers)¥(756 total small retail recommending a securities transaction the retail customer. We generally broker-dealers) = 2,010 large retail broker-dealers. or strategy involving securities to a believe the proposed burdens and costs 1389 See supra Section III.B.1 at Table 5. This retail customer, to provide the retail estimate is based on the following calculation: identified in the Proposing Release were (504,005 total licensed representatives (including customer, in writing, full and fair accurate but have updated estimates to representatives of investment advisers)) × (15% (the disclosure of: (1) All material facts reflect changes in the number of broker- percentage of total licensed representatives who are relating to the scope and terms of the dealers and costs of certain services standalone investment adviser representatives)) = relationship with the retail customer, approximately 75,601 representatives at standalone since the last estimate. The collections investment advisers. To isolate the number of including (a) that the broker, dealer, or of information associated with the representatives at standalone broker-dealers and such natural person is acting as a Disclosure Obligation, as well as the dually registered firms, we have subtracted 75,601 broker, dealer, or an associated person from 504,005, for a total of 428,404 retail-facing, associated record-making and licensed representatives at standalone broker- of a broker or dealer with respect to the recordkeeping obligations are addressed dealers or dually registered firms. recommendation, (b) the fees and costs below. 1390 Unless otherwise noted, for purposes of the that apply to the retail customer’s PRA, we use the term ‘‘registered representatives’’ transactions, holdings, and accounts, a. Obligation To Provide to the Retail to refer to associated persons of broker-dealers who and (c) the type and scope of services Customer Full and Fair Disclosure, in are registered, have series 6 or 7 licenses, and are Writing, of all Material Facts Relating to retail-facing, and we use the term ‘‘dually registered provided to the retail customer, representatives of broker-dealers’’ to refer to including any material limitations on the Scope and Terms of the Relationship registered representatives who are dually registered the securities or investment strategies With the Retail Customer and are associated persons of a standalone broker- dealer (who may be associated with an unaffiliated involving securities that may be The Commission assumes for investment adviser) or a dually registered broker- recommended to the retail customer; purposes of this analysis that broker- dealer. and (2) all material facts relating to dealers would meet the obligation to 1391 However, in certain instances, as described conflicts of interest that are associated disclose to the retail customer, in more fully below, the Commission assumes that with the recommendation. The writing, the material facts related to the broker-dealers will undertake certain Disclosure Obligations on behalf of their registered Commission believes that requiring scope and terms of the relationship with representatives. See, e.g., infra footnote 1396. broker-dealers to disclose to a retail the retail customer through a

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combination of delivery of the limitations on the securities or which they are acting through the Relationship Summary, creating account investment strategies that may be delivery to retail customers of the disclosures to include standardized recommended to the retail customer, we Relationship Summary, in accordance language related to capacity and type assume for purposes of this PRA with the rules and guidance set forth in and scope of services, and the analysis that a broker-dealer would the Relationship Summary Adopting development of fee schedules. satisfy the Disclosure Obligation by Release. Additionally, although we including this information in the understand that many dual-registrants (1) Disclosure of Capacity account disclosure provided to the retail and standalone broker-dealers, as a As discussed above, the Commission customer at the beginning of the matter of best practice, already disclose believes that a standalone broker-dealer relationship, as described above. The the capacity in which they are acting as would be able to satisfy its obligation to broker-dealer would need to deliver an well as the and type and scope of disclose that it is acting in a broker- amended account disclosure to the retail services they offer to retail customers, dealer capacity by providing the retail customer in the case of any material for purposes of this analysis, we assume customer with the Relationship changes made to the type and scope of that dual-registrants would create new Summary in the manner prescribed by services or provide an oral update, account disclosure related to capacity the rules and guidance in the under the circumstances outlined in and all broker-dealers would create or Relationship Summary Adopting Section II.C.1. update account disclosure related to Release.1392 type and scope of services specifically b. Obligation To Provide to the Retail We assume, for purposes of this PRA for purposes of compliance with Customer Full and Fair Disclosure, in analysis, that a dually registered broker- Regulation Best Interest. The Writing, of All Material Facts Relating to dealer would satisfy its obligation to Commission assumes that broker- Conflicts of Interest That are Associated disclose it is acting in a broker-dealer dealers would provide the account With the Recommendation capacity by creating an account disclosure to each retail customer disclosure with standardized language, Regulation Best Interest requires a account, regardless of whether the retail and by providing it to the retail broker-dealer to provide the retail customer has multiple accounts with customer at the beginning of the customer, in writing, full and fair the broker-dealer. relationship. The account disclosure disclosure of all material facts relating While the Commission recognizes that would set forth when the broker-dealer to conflicts of interest that are the Disclosure Obligation applies to the would be acting in a broker-dealer associated with a recommendation. broker-dealer entity and its associated capacity, and the method the broker- As discussed above, we assume that persons, we do not expect associated dealer planned to use to clarify its broker-dealers will satisfy the obligation persons to incur any initial or ongoing capacity at the time of the to disclose all material facts relating to burdens with respect to the scope and recommendation. We understand that conflicts of interest through the use of: terms of the relationship, as we assume many broker-dealers already include (1) A standardized, written disclosure for purposes of this analysis that this such information in account document provided to all retail information would be addressed by the disclosures. customers and (2) supplemental broker-dealer entity’s account disclosure provided to certain retail disclosure.1394 With regard to disclosure (2) Disclosure of Fees and Costs and customers for recommendations of Type and Scope of Services, Including of the capacity in which the associated specific products. person is acting, the Commission Any Material Limitations on the We assume for purposes of this believes that dually registered Securities or Investment Strategies That analysis that delivery of written representatives of broker-dealers will may be Recommended disclosure will occur at the beginning of incur initial and ongoing burdens.1395 While many broker-dealers provide a relationship, such as together with the Following is a discussion of the fee information to retail customers in a account opening agreement. For existing estimated initial and ongoing burdens fee schedule, the Commission believes retail customers, the disclosure will and costs. that to comply with the Disclosure need to occur ‘‘prior to or at the time’’ Obligation broker-dealers will either of a recommendation. Subsequent i. Initial Costs and Burdens amend their existing schedules or disclosures may be delivered or the Because, as noted above, standalone develop a new standardized fee broker-dealer may provide an oral broker-dealers will satisfy the obligation schedule to disclose the fees and costs update, under the circumstances to disclose the capacity in which they applicable to retail customers’ outlined in Section II.C.1, in the event are acting through the delivery to retail transactions, holdings, and accounts. of a material change or if the broker- customers of the Relationship Summary, This fee schedule would be delivered to dealer determines additional disclosure we estimate zero burden hours for retail customers at the beginning of a is needed for certain types of products. standalone broker-dealers to disclose relationship. If, at the time the The corresponding estimated total the capacity in which they are acting. recommendation is made, the disclosure annual reporting costs and burdens are made to the retail customer is not addressed below.1393 1394 A broker-dealer or an associated person may satisfy the Disclosure Obligation by using oral current or does not contain all material c. Estimated Costs and Burdens disclosure if it has previously provided written facts regarding the fees and costs of the (1) Disclosure of Capacity, Type and disclosure to the retail customer beforehand as well particular recommendation, the broker- as the method it planned to use to clarify the dealer would need to deliver an Scope of Services disclosure at the time of the recommendation. In Standalone broker-dealers will satisfy addition, a record of the fact of such oral disclosure amended fee schedule or provide an having been made must be created and retained. We oral update, under the circumstances the obligation to disclose the capacity in assume that any disclosure required of a registered outlined in Section II.C.1. representative will be made orally, and that any With respect to disclosure of the type 1393 The costs and burdens arising from the ongoing costs and burdens will be associated with and scope of services provided by the obligation to identify all material conflicts of the record-making memorializing the fact of the oral interest that are associated with the disclosure. See Section IV.B.5 (discussing the costs broker-dealer, including any material recommendation are addressed below, in the and burdens associated with record-making). context of the Conflict of Interest Obligation, in 1395 See supra Section IV.B.5 (discussing the costs 1392 See Relationship Summary Adopting Release. Section V.B.1. and burdens associated with record-making).

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We estimate that a dually registered firm that they provide. We expect that the burden hours 1412 for delivery of the will incur an initial internal burden of associated costs and burdens will differ account disclosure document.1413 Based 10 hours for in-house counsel and in- between small and large broker-dealers, on FOCUS data, we estimate that the house compliance 1396 to draft language as large broker-dealers generally offer 2,766 broker-dealers that report retail regarding the capacity in which they are more products and services and activity have approximately 139 million acting for inclusion in the standardized therefore will need to evaluate a larger customer accounts, and that account disclosure that is delivered to number of products and services. approximately 73.5%, or 102 million, of 1397 the retail customer. Given these assumptions, we estimate those accounts belong to retail 1414 In addition, we estimate that dual- that a small broker-dealer will incur an customers. We therefore estimate registrants will incur an estimated internal initial burden of 10 hours for that broker-dealers will have an external cost of $4,970 for the assistance in-house counsel and in-house aggregate initial burden of 2,040,000 of outside counsel in the preparation 1415 compliance to draft this standardized hours, or approximately 738 hours and review of standardized language language.1403 In addition, a small per broker-dealer for the first year after regarding capacity.1398 For the 1416 broker-dealer will incur an estimated Regulation Best Interest is in effect. estimated 563 dually registered firms We estimate a total initial aggregate external cost of $4,970 for the assistance with retail business,1399 we project an burden for all broker-dealers to develop of outside counsel in the preparation aggregate initial burden of 5,630 and deliver to retail customers account and review of this standardized hours,1400 and $2.8 million in aggregate disclosures relating to capacity and type language.1404 For the estimated 756 initial costs relating to disclosure of the 1405 and scope of services of 2,093,390 capacity in which they are acting.1401 small broker-dealers, we project an burden hours.1417 We estimate a total Similarly, to comply with Regulation aggregate initial burden of 7,560 1406 initial aggregate cost of $21.6 Best Interest, we believe that broker- hours, and aggregate initial costs of 1418 1407 million. dealers 1402 will draft standardized $3.8 million. language for inclusion in the account Given the broader array of products 1412 This is the same estimate the Commission disclosure to provide the retail customer and services offered, we estimate that a makes in the Relationship Summary Adopting with more specific information large broker-dealer will incur an Release. It is also the same estimate the Commission made in the Amendments to Form ADV Adopting regarding the type and scope of services internal burden of twenty hours to draft Release, and for which we received no comment. this standardized language.1408 A large See Amendments to Form ADV, 17 CFR parts 275 1396 The ten hour estimate includes five hours for broker-dealer will also incur an and 279 at 49259. We expect that delivery in-house counsel to draft and review the estimated cost of $7,470 for the requirements will be performed by a general clerk. standardized language, and five hours for The general clerk’s time is included in the initial consultation and review of compliance personnel. assistance of outside counsel in the burden estimate. 1397 As discussed above, the following estimates preparation and review of this 1413 As noted above, for new retail customers, we include the costs and burdens that broker-dealers standardized language.1409 For the expect delivery to occur at the beginning of the would incur in drafting standardized account estimated 2,010 large retail broker- relationship; for existing customers, we expect disclosure language related to the scope and terms delivery to occur prior to or at the time of a of the relationship on behalf of their dually dealers, we estimate an aggregate initial recommendation. 1410 registered representatives. For purposes of this burden of 40,200 hours and $15 1414 We have revised our estimates from the analysis, the Commission assumes that broker- million in aggregate initial costs.1411 Proposing Release to reflect the updated FOCUS dealers will undertake these tasks on behalf of their Report data. Therefore, the 2,766 broker-dealers registered representatives. See Section IV.B.5 We estimate that all broker-dealers (including dual-registrants) with retail customers (discussing the costs and burdens associated with will each incur approximately 0.02 report 139 million customer accounts. See Section record-making). III.B.1.a, at Table 1, Panel B. Assuming the amount 1398 Data from the Securities Industry Financial of retail customer accounts is proportionate to the 1403 The 10-hour estimate includes 5 hours for in- Markets Association’s Management & Professional percentage of broker-dealers that have retail house counsel to draft and review the standardized Earnings in the Securities Industry 2013 (‘‘SIFMA customers, or 73.5% of broker-dealers, then the language, and 5 hours for consultation and review Management and Professional Earnings Report’’), number of retail customer accounts would be 73.5% by in-house compliance. modified by Commission staff to account for an of 139 million accounts = 102 million retail 1404 1,800-hour work-year and inflation, and multiplied This estimate is based on the following customer accounts. This number likely overstates calculation: (10 hours for outside counsel review/ by 5.35 (professionals) or 2.93 (office) to account for × the number of deliveries to be made due to the bonuses, firm size, employee benefits, and drafting) ($497/hour for outside counsel services) double-counting of deliveries to be made by dual- overhead, suggests that costs for this position is = $4,970 in initial outside counsel costs. registrants to a certain extent, and the fact that one $497 per hour. The SIFMA Management and 1405 See supra footnote 1384 and accompanying customer may own more than one account. Professional Earnings Report was updated in 2019 text. 1415 These estimates are based on the following to reflect inflation. The numbers in the report are 1406 This estimate is based on the following calculations: (0.02 hours per customer account × × higher than the numbers we used in the Proposing calculation: (756 small broker-dealers) (10 hours (102 million retail customer accounts) = 2,040,000 Release. This estimate is based on the following per small broker-dealer) = 7,560 initial aggregate aggregate burden hours. Conversely, (2,040,000 calculation: (10 hours for outside counsel review/ burden hours. hours)/(2,766 broker-dealers) = approximately 738 drafting) × ($497/hour for outside counsel services) 1407 This estimate is based on the following burden hours per broker-dealer for the first year = $4,970 in initial outside counsel costs. calculation: (756 small broker-dealers) × ($4,970 in after Regulation Best Interest is in effect. 1399 See supra Section III.B.1.a, at Table 1, Panel external cost per small broker-dealer) = $3.8 million 1416 We estimate that broker-dealers will not incur B. The number of dually registered broker-dealers in aggregate initial outside counsel costs. any incremental postage costs because we assume includes broker-dealers that are also Commission- 1408 The 20-hour estimate includes 10 hours for that they will make such deliveries with another and state-licensed investment advisers. in-house counsel to draft and review the mailing the broker-dealer was already delivering to 1400 This estimate is based on the following standardized language, and 10 hours for retail customers. calculation: (563 dually registered retail firms) × (10 consultation and review by in-house compliance. 1417 This estimate is based on the following hours) = 5,630 initial aggregate burden hours. 1409 This estimate is based on the following calculation: (5,630 aggregate initial burden hours 1401 This estimate is based on the following calculation: (15 hours for outside counsel review/ for dual-registrants) + (7,560 aggregate initial calculation: (563 dually registered retail firms) × drafting) × ($497/hour for outside counsel services) burden hours for small broker-dealers) + (40,200 ($4,970 in external cost per firm) = $2.8 million in = $7,455 in initial outside counsel costs. burden hours for large broker-dealers) + (2,040,000 aggregate initial costs. 1410 This estimate is based on the following aggregate initial burden hours for all broker-dealers 1402 In the Proposing Release, we inadvertently calculation: (2,010 large broker-dealers) × (20 to deliver the account disclosures) = 2,093,390 total referred to ‘‘standalone broker-dealers’’ in this burden hours) = 40,200 aggregate initial burden aggregate initial burden hours. discussion, but our subsequent references and hours. 1418 This estimate is based on the following estimates reflected our intent to capture initial costs 1411 This estimate is based on the following calculation: ($2.8 million in initial aggregate costs and burdens relating to disclosure of type and scope calculation: (2,010 large broker-dealers) × ($7,455 for dual-registrants) + ($3.8 million in initial of services on all broker-dealers (distinguishing initial outside counsel costs) = $15 million in aggregate costs for small broker-dealers) + ($15 between small and large). aggregate initial costs. million in initial aggregate costs for large broker-

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ii. Ongoing Costs and Burdens With respect to small broker-dealers, offerings vary greatly by broker-dealer, For purposes of this analysis, we we estimate an internal burden of two and therefore the costs and burdens assume that broker-dealers will review hours for in-house compliance and associated with updating the account and amend the standardized language in business-line personnel to review and disclosure might also vary. update changes in types or scope of the account disclosure, on average, once (2) Disclosure of Fees and Costs a year.1419 Further, we assume that services, and another two burden hours The Commission assumes for broker-dealers will not incur outside annually for in-house counsel to amend purposes of this analysis that a broker- costs in connection with updating the account disclosure to disclose dealer will disclose its fees and costs account disclosures, as in-house material changes to type and scope of through a standardized fee schedule, personnel will be more knowledgeable services—for a total of four burden delivered to the retail customer at the about changes in capacity, and the type hours. The estimated ongoing aggregate beginning of the relationship, or, for and scope of services offered by the burden for small broker-dealers to existing retail customers, prior to or at broker-dealer. Additionally, with amend account disclosures to reflect the time of a recommendation and, as respect to standalone broker-dealers, changes in type and scope of services is 1422 discussed below, will amend such fee because they will meet their obligation therefore 3,024 hours per year. schedules in the event of material to disclose capacity by delivering the We estimate that large broker-dealers changes. Although we understand that Relationship Summary, and will be would incur ten burden hours annually many broker-dealers already provide fee subject to requirements to amend the for in-house compliance and business- schedules to retail customers, we are Relationship Summary consistent with line personnel to review and update assuming for purposes of this analysis Form CRS, we estimate zero burden changes the type and scope of services, that a fee schedule would be created hours annually for ongoing costs and another ten burden hours annually specifically for purposes of compliance relating to disclosure of capacity under for in-house counsel to amend the with Regulation Best Interest.1426 While the Disclosure Obligation. account disclosure to disclose material We estimate that each dually changes to the type and scope of the Commission recognizes that the fee registered broker-dealer will incur services, for a total of twenty burden disclosure included in Disclosure approximately five burden hours hours. We therefore believe the ongoing, Obligation applies to the broker-dealer annually for in-house compliance and aggregate burden is 40,200 hours per entity and its associated persons, we do 1423 business-line personnel to review year for large broker-dealers. not expect any burdens or costs on changes in the dual-registrant’s With respect to delivery of the associated persons related to the fees capacity,1420 and another two burden amended account agreements in the and costs as this information would be hours annually for in-house counsel to event of material changes to the capacity addressed in the broker-dealer entity’s amend the account disclosure to disclosure or disclosure related to type fee schedule. and scope of services, we estimate that disclose material changes to the dual- i. Initial Costs and Burdens registrant’s capacity, for a total of seven this would take place among 20% of a broker-dealer’s retail customer accounts We assume that, for purposes of this burden hours. The estimated ongoing analysis, the associated costs and aggregate burden to amend dual- annually. We therefore estimate broker- dealers to incur a total annual aggregate burdens will differ between small and registrants’ account disclosures to large broker-dealers, as large broker- reflect changes in capacity is therefore burden of 408,000 hours, or 148 hours 1424 dealers generally offer more products 3,941 hours per year.1421 per year per broker-dealer. The total ongoing aggregate burden for and services and therefore will need to all broker-dealers to review, amend, and evaluate a wider range of fees in their dealers) = $21.6 million in total initial aggregate costs. deliver updated account disclosures to fee schedules. As stated above, while we 1419 We believe this annual timeframe is reflect changes in capacity, type and anticipate that many broker-dealers may consistent with other obligations imposed on scope of services would be 455,165 already create fee schedules, we believe broker-dealers. For example, FINRA rules set an burden hours per year.1425 that small broker-dealers will initially annual supervisory review as a minimum threshold spend five hours for in-house for broker-dealers, for example, in FINRA Rules The Commission acknowledges that 3110 (requiring an annual review of the businesses the types of services and product compliance and large broker-dealers in which the broker-dealer engages), 3120 (requiring will spend ten hours for in-house an annual report detailing a broker-dealer’s system firm per year) × (563 dually registered broker- compliance to internally create a new of supervisory controls, including compliance dealers) = 3,941 ongoing aggregate burden hours per fee schedule in consideration of the efforts in the areas of antifraud and sales practices); year. and 3130 (requiring each broker-dealer’s CEO or 1422 This estimate is based on the following requirements of Regulation Best Interest. equivalent officer to certify annually to the calculation: (4 burden hours per broker-dealer per We additionally estimate a one-time reasonable design of the policies and procedures for year) × (756 small broker-dealers) = 3,024 ongoing external cost of $2,485 for small broker- compliance with relevant regulatory requirements). aggregate burden hours per year. dealers 1427 and $4,970 for larger broker- 1420 In the Proposing Release, we referred to 1423 This estimate is based on the following capacity and type and scope of services, however, calculation: (20 burden hours per broker-dealer per dealers for outside counsel to review the 1428 we captured the ongoing costs and burdens relating year) × (2,010 large broker-dealers) = 40,200 fee schedule. We therefore estimate to disclosure of type and scope of services in the ongoing aggregate burden hours per year. the initial aggregate burden for small paragraphs that followed, where we inadvertently 1424 (20%) × (102 million retail customer broker-dealers to be 3,780 burden referred to ‘‘small standalone broker-dealers’’ and accounts) × (.02 hours for delivery to each customer ‘‘large standalone broker-dealers,’’ but where our account) = 408,000 aggregate burden hours. 1426 calculations reflected the burdens on all ‘‘small Conversely, 408,000 aggregate burden hours/2,766 Our estimates may be higher than actual, broker-dealers’’ and all ‘‘large broker-dealers.’’ See broker-dealers = 148 burden hours per year per since firms may be able to use or simply update Proposing Release, footnotes 600–601. We believe it broker-dealer. existing disclosures depending on the facts and is appropriate to distinguish between standalone 1425 This estimate is based on the following circumstances. and dually registered broker-dealers in assessing the calculation: (3,941 ongoing aggregate burden hours 1427 This cost estimate is based on the following costs and burdens relating to disclosure of capacity, for dually registered broker-dealers) + (3,024 calculation: (5 hours of review) × ($497/hour for and to distinguish between small and large firms in ongoing aggregate burden hours for small broker- outside counsel services) = $2,485 outside counsel assessing the costs and burdens relating to dealers) + (40,200 ongoing aggregate burden hours costs. disclosure of type and scope of services, as reflected for large broker-dealers) + (408,000 ongoing 1428 This cost estimate is based on the following in this section. aggregate burden hours for delivery of amended calculation: (10 hours of review) × ($497/hour for 1421 This estimate is based on the following account disclosures) = 455,165 total ongoing outside counsel services) = $4,970 outside counsel calculation: (7 burden hours per dually registered aggregate burden hours per year. costs.

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hours,1429 and the initial aggregate cost once a year. With respect to small (3) Disclosure of All Material Facts to be $1.88 million.1430 We estimate the broker-dealers, we estimate that Relating to Conflicts of Interest aggregate burden for large broker-dealers reviewing and updating the fee schedule Associated With the Recommendation to be 20,100 burden hours,1431 and the will require approximately two hours aggregate cost to be $9.99 million.1432 for in-house compliance per year, and Regulation Best Interest requires Similar to delivery of the account for large broker-dealers, we estimate that broker-dealers to provide a retail disclosure regarding capacity and type the recurring, annual burden to review customer, in writing, full and fair and scope of services, we estimate the and update the fee schedule will be four disclosure of all material facts relating burden for broker-dealers to make the hours for in-house compliance for each to conflicts of interest that are initial delivery of the fee schedule to large broker-dealer. Based on these associated with the recommendation. new retail customers, at the beginning of estimates, we estimate the recurring, Because the Disclosure Obligation the relationship, and existing retail aggregate, annualized burden will be applies to both the broker-dealer entity customers, prior to or at the time of a 1,512 hours for small broker-dealers 1438 and its associated persons, the recommendation, will require and 8,040 hours for large broker- Commission expects that the broker- approximately 0.02 hours to deliver to dealers.1439 We do not anticipate that dealer entity and its associated persons each retail customer.1433 As stated small or large broker-dealers will incur will incur initial and ongoing burdens. above, we estimate that the 2,766 outside legal, compliance, or consulting However, as with the disclosure of the broker-dealers that report retail activity fees in connection with updating their capacity in which they are acting and have approximately 139 million standardized fee schedule since in- type and scope of services, we assume customer accounts, and that house personnel would be more for purposes of this analysis that the approximately 73.5%, or 102 million, of knowledgeable about these facts, and we broker-dealer entities will incur the those accounts belong to retail therefore do not expect external costs costs and burdens of disclosing material customers.1434 We therefore estimate associated with updating the fee conflicts of interest on behalf of their that broker-dealers will have an schedule. associated persons.1443 aggregate initial burden of 2,040,000 hours, or approximately 738 hours per With respect to delivery of the i. Initial Costs and Burdens broker-dealer for the first year after amended fee schedule in the event of a Regulation Best Interest is in effect.1435 material change, we estimate that this The Disclosure Obligation provides The total aggregate initial burden for would take place among 40% of a broker-dealers with the flexibility to broker-dealers is therefore estimated at broker-dealer’s retail customer accounts choose the form and manner of conflict 2,063,880 1436 hours, and the total annually, and that broker-dealers will disclosure. However, we believe that aggregate initial cost is estimated at require approximately 0.02 hours to many or most broker-dealers will $11.87 million.1437 deliver the amended fee schedule to develop a standardized conflict each retail customer.1440 We therefore disclosure document and deliver it to ii. Ongoing Costs and Burdens estimate broker-dealers would incur a their retail customers.1444 We also For purposes of this PRA analysis, we total annual aggregate burden of 816,000 assume for purposes of this PRA assume that broker-dealers will review hours, or 295 hours per broker- analysis that broker-dealers will update and amend the fee schedule on average, dealer.1441 and deliver the standardized conflict The total ongoing aggregate burden for disclosure document yearly on an 1429 This estimate is based on the following all broker-dealers to review, amend, and ongoing basis, following the broker- calculation: (5 burden hours of review per small dealer’s annual conflicts review process. broker-dealer) × (756 small broker-dealers) = 3,780 deliver updated account disclosures to aggregate initial burden hours. reflect changes in fees and costs would For purposes of this PRA analysis, we 1430 This estimate is based on the following be 825,552 burden hours per year.1442 assume that a standardized conflict calculation: ($2,485 for outside counsel costs per disclosure document will be developed small broker-dealer) × (756 small broker-dealers) = The Commission acknowledges that $1.88 million in aggregate initial outside costs. the type of fee schedule may vary by in-house counsel and reviewed by 1431 This estimate is based on the following greatly by broker-dealer, and therefore outside counsel. For small broker- calculation: (10 burden hours of review per large that the costs or burdens associated with dealers, we estimate it will take in- broker-dealer) × (2,010 large broker-dealers) = updating the standardized fee schedule house counsel, on average, five burden 20,100 aggregate initial burden hours. hours to create the standardized conflict 1432 This estimate is based on the following might similarly vary. calculation: ($4,970 for outside counsel costs per disclosure document and outside large broker-dealer) × (2,010 large broker-dealers) = 1438 This estimate is based on the following counsel five hours to review and revise $9.99 million in aggregate initial costs. calculation: (2 burden hours per broker-dealer) × the document. We estimate that the 1433 See supra footnote 1411. (756 small broker-dealers) = 1,512 aggregate burden initial aggregate burden for the 1434 See supra footnote 1412. hours per broker-dealer per year. development of a standardized 1435 This estimate is based on the following 1439 This estimate is based on the following calculation: (102 million retail customer accounts) calculation: (4 burden hours per broker-dealer) × disclosure document, based on an × (.02 hours for delivery to each customer account) (2,010 large broker-dealers) = 8,040 aggregate estimated 756 small broker-dealers, will = 2,040,000 aggregate burden hours. Conversely, burden hours per broker-dealer per year. be 3,780 burden hours.1445 We (2,040,000 aggregate burden hours)/(2,766 broker- 1440 See supra footnote 1411. additionally estimate an initial cost of dealers) = 738 burden hours per broker-dealer for 1441 This estimate is based on the following the first year after Regulation Best Interest is in calculation: (40% of 102 million retail customer effect. accounts) × (.02 hours) = 816,000 aggregate burden 1443 See Section IV.B.5 (discussing the costs and 1436 This estimate is based on the following hours. Conversely, (816,000 aggregate burden burdens associated with record-making, including calculations: (3,780 aggregate burden hours for hours)/(2,766 broker-dealers) = 295 burden hours for associated persons of a broker-dealer). small broker-dealers) + (20,100 burden hours for per broker-dealer per year. 1444 As noted above, we assume that delivery for large broker-dealers) + (2,040,000 burden hours for 1442 This estimate is based on the following new customers will occur at the beginning of the delivery) = 2,063,880 total aggregate initial burden calculation: (1,512 ongoing aggregate burden hours relationship, and that delivery for existing hours. for small broker-dealers) + (8,040 ongoing aggregate customers will occur prior to or at the time a 1437 This estimate is based on the following burden hours for large broker-dealers) + (816,000 recommendation is made. calculation: ($1.88 million for small broker-dealer ongoing aggregate burden hours for delivery of 1445 This estimate is based on the following costs) + ($9.99 million large broker-dealer costs) = amended account disclosures) = 825,552 total calculation: (5 hours) × (756 small broker-dealers) $11.87 million in total initial aggregate costs. ongoing aggregate burden hours per year. = 3,780 aggregate initial burden hours.

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$2,485 per small broker-dealer,1446 and The total aggregate initial burden for document to each retail customer.1457 an aggregate initial cost of $1.88 million broker-dealers is therefore estimated at We therefore estimate that broker- for all small broker-dealers.1447 2,058,855 1453 hours, and the total dealers will incur an ongoing, aggregate We expect the development and aggregate initial cost is estimated at annual burden of 816,000 hours, or 295 review of the standardized conflict $9.37 million.1454 burden hours per broker-dealer.1458 The disclosure document to take longer for total aggregate ongoing burden for large broker-dealers because, as ii. Ongoing Costs and Burdens broker-dealers is therefore estimated at discussed above, we believe large We believe that broker-dealers will 820,776 hours.1459 broker-dealers generally offer more incur ongoing annual burdens and costs Based on the calculation describe products and services and employ more to update the disclosure document to above, we estimate that broker-dealers individuals, and therefore will need to include newly identified conflicts. We will incur an aggregate total initial disclose a larger number of conflicts. We assume for purposes of this analysis that burden of 6,216,125 hours 1460 and a estimate that for large broker-dealers, it broker-dealers will update their conflict total initial cost of $42.84 million,1461 as will take 7.5 burden hours for in-house disclosure document annually, after well as an aggregate total ongoing counsel to create the standardized conducting an annual conflicts review. annual burden of 2,101,493 hours 1462 to conflict disclosure document, and We estimate that the conflicts comply with the Disclosure Obligation. outside counsel will take another 7.5 disclosures will be updated internally 2. Care Obligation hours to review and revise the by both small and large broker-dealers. disclosure document. As a result, we We estimate that in-house counsel at The Care Obligation requires a broker- estimate the initial aggregate burden, a small broker-dealer will require dealer to have a reasonable basis to based on an estimated 2,010 large approximately one hour per year to believe, based on its understanding of broker-dealers, to be approximately update the standardized conflict the potential risks, rewards, and costs of 15,075 burden hours.1448 We disclosure document, for an ongoing the recommended security or additionally estimate initial costs of aggregate, annual burden of investment strategy involving securities, $3,728 per broker-dealer,1449 and an approximately 756 hours.1455 For large aggregate initial cost for large broker- broker-dealers, we estimate that the 1457 See supra footnote 1411. The Commission estimates that broker-dealers will update their dealers of approximately $7.49 ongoing, aggregate annual burden would disclosures of fees and costs and material facts 1450 million. be two hours for each broker-dealer: relating to conflicts of interest that are associated We assume that broker-dealers will One hour for in-house compliance and with their recommendation more frequently than deliver the standardized conflict one hour for in-house counsel for legal disclosure related to capacity or type and scope of disclosure document to new retail services. personnel. We therefore estimate the 1458 This estimate is based on the following customers at the inception of the ongoing, aggregate burden for large calculation: (40% of 102 million retail customer relationship, and to existing retail broker-dealers to be approximately accounts) × (.02 hours) = 816,000 aggregate burden customers prior to or at the time of a 4,020 burden hours.1456 We do not hours per year. Conversely, (816,000 aggregate recommendation. We estimate that anticipate that small or large broker- burden hours)/(2,766 broker-dealers) = 295 hours broker-dealers will require per broker-dealer per year. dealers will incur outside legal, 1459 This estimate is based on the following approximately 0.02 hours to deliver the compliance, or consulting fees in calculations: (756 aggregate burden hours for small standardized conflict disclosure connection with updating their broker-dealers) + (4,020 aggregate burden hours for document to each retail customer.1451 large broker-dealers) + (816,000 aggregate burden standardized conflict disclosure hours for delivery) = 820,776 total aggregate We therefore estimate that broker- document, since in-house personnel ongoing burden hours. dealers will incur an aggregate initial would presumably be more 1460 This estimate is based on the following burden of 2,040,000 hours, or knowledgeable about conflicts of calculation: (2,093,390 aggregate initial burden approximately 738 hours per broker- interest. hours for initial compliance with disclosure of dealer for delivery of the standardized capacity and type and scope of services) + With respect to ongoing delivery of (2,063,880 aggregate initial burden hours for initial conflict disclosure document the first the updated conflict disclosure compliance with disclosure of fees and costs) + year after Regulation Best Interest is in document, we estimate that this will (2,058,855 aggregate initial burden hours for initial effect.1452 take place among 40% of a broker- compliance with disclosure of all material facts regarding disclosure of conflicts of interest dealer’s retail customer accounts associated with the recommendation) = 6,216,125 1446 This estimate is based on the following annually, and that broker-dealers will total aggregate initial burden hours for compliance calculation: ($497/hour) × (5 hours) = $2,485 in with the Disclosure Obligation. initial costs. require approximately 0.02 hours to 1461 This estimate is based on the following 1447 This estimate is based on the following deliver the updated conflict disclosure calculation: ($21.6 million aggregate initial cost for calculation: ($497/hour × 5 hours) × (756 small compliance with disclosure of capacity and type broker-dealers) = $1.88 million in aggregate initial (2,040,000 hours)/(2,766 broker-dealers) = 738 and scope of services) + ($11.87 million aggregate costs. burden hours per broker-dealer. initial cost for compliance with disclosure of fees 1448 This estimate is based on the following 1453 This estimate is based on the following × and costs) + ($9.37 aggregate initial cost for calculation: (7.5 hours 2,010 large broker-dealers) calculations: (3,780 aggregate burden hours for compliance with disclosure of all material facts = 15,075 aggregate initial burden hours. small broker-dealers) + (15,075 burden hours for regarding disclosure of conflicts of interest 1449 This estimate is based on the following large broker-dealers) + (2,040,000 burden hours for associated with the recommendation) = $42.84 × calculation: ($497/hour) (7.5 hours) = $3,728 in delivery) = 2,058,855 total aggregate initial burden million total aggregate initial cost for compliance initial costs per broker-dealer. hours. with the Disclosure Obligation. 1450 This estimate is based on the following 1454 This estimate is based on the following 1462 This estimate is based on the following × × calculation: ($497/hour) (7.5 hours) 2,010 large calculation: ($1.88 million for small broker-dealer calculation: (455,165 aggregate annual burden hours broker-dealers) = $7.49 million in aggregate costs. costs) + ($7.49 million large broker-dealer costs) = for ongoing compliance with disclosure of capacity 1451 See supra footnote 1411. For purposes of this $9.37 million in total aggregate initial costs. and type and scope of services) + (825,552 aggregate PRA analysis, we have assumed any initial 1455 This estimate is based on the following annual burden hours for ongoing compliance with disclosures made by the broker-dealer related to calculation: (1 hour per broker-dealer) × (756 small disclosure of fees and costs) + (820,776 aggregate material conflicts of interest will be delivered broker-dealers) = 756 aggregate burden hours per annual burden hours for ongoing compliance with together. year. disclosure of all material facts regarding disclosure 1452 These estimates are based on the following 1456 This estimate is based on the following of conflicts of interest associated with the calculations: (0.02 hours per customer account × calculation: (2 hours per broker-dealer) × (2,010 recommendation) = 2,101,493 total aggregate 102 million retail customer accounts) = 2,040,000 large broker-dealers) = 4,020 aggregate burden hours burden hours per year for ongoing compliance with aggregate initial burden hours. Conversely, per year. the Disclosure Obligation.

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and in light of the retail customer’s for its business, for identifying conflicts purposes of this analysis, the associated investment profile, that the of interest, and then determining costs and burdens would differ between recommendation is in the best interest whether to eliminate, or disclose and/or small and large broker-dealers, as large of the particular retail customer and mitigate the conflict and the appropriate broker-dealers generally offer more does not place the broker-dealer’s means of eliminating, disclosing and/or products and services and therefore interest ahead of the retail customer’s mitigating the conflict. In addition, would need to evaluate and address a interest. However, any PRA burdens or establishing and maintaining written greater number of potential conflicts of costs associated with the Care policies and procedures would interest. As discussed above, we Obligation are duplicative of costs generally (1) assist a broker-dealer in estimate that 2,010 broker-dealers associated with other obligations in supervising its associated persons and would qualify as large broker-dealers for Regulation Best Interest, including the assessing compliance with the Conflict purposes of this analysis and 756 would Disclosure Obligation and the Record- of Interest Obligation; and (2) assist the qualify as small broker-dealers that have Making Obligation under Rule 17a– Commission and SRO staff in retail business.1468 3(a)(35) and Recordkeeping Obligation connection with examinations and In the Proposing Release, we under Rule 17a–4(e)(5). investigations.1465 estimated that a large broker-dealer In light of the modifications to several would incur a one-time internal burden 3. Conflict of Interest Obligation substantive requirements of the rule of 60 hours for in-house legal and in- The Conflict of Interest Obligation relative to the Proposing Release, house compliance counsel to update creates an overarching obligation to including the Conflict of Interest existing policies and procedures to require broker-dealers 1463 to establish Obligation, as discussed in more detail comply with Regulation Best written policies and procedures above, we believe these changes will Interest.1469 We also estimated a cost of reasonably designed to identify and at a allow broker-dealers’ to more easily $4,720 for outside counsel to review minimum disclose, pursuant to the incorporate the requirements of updated policies and procedures on Disclosure Obligation, or eliminate all Regulation Best Interest into existing behalf of a large broker-dealer, with an conflicts of interest associated with a supervisory and compliance systems aggregate initial burden of 123,300 recommendation. More specifically, and streamline compliance with burden hours and aggregate initial cost broker-dealers are specifically required Regulation Best Interest.1466 Therefore, of $9.70 million for large broker- to establish, maintain, and enforce we generally believe our proposed dealers.1470 written policies and procedures burdens and costs are accurate but have In the Proposing Release, we assumed reasonably designed to: (i) Identify and updated estimates to reflect changes in that small broker-dealers would mitigate any conflicts of interest the number of broker-dealers and costs primarily rely on outside counsel to associated with recommendations that of certain services since the last estimate update existing policies and procedures, create an incentive for a natural person in the Proposing Release. as small broker-dealers generally have who is an associated person of a broker Following is a detailed discussion of fewer in-house legal and compliance or dealer to place the interest of the the estimated costs and burdens personnel. Given that smaller broker- broker or dealer, or such natural person associated with the Conflict of Interest dealers generally have fewer conflicts of making the recommendation, ahead of Obligation. interest, we estimated that 40 hours of the interest of the retail customer; (ii) outside legal counsel services would be a. Written Policies and Procedures (A) identify and disclose any material required, for a one-time cost of $18,800 limitations placed on the securities or i. Initial Costs and Burdens per small broker-dealer, and an investment strategies involving We believe that most broker-dealers aggregate cost of $15.1 million for all securities that may be recommended to have policies and procedures in place to small broker-dealers, and we also a retail customer and any conflicts of address conflicts of interest, but do not expected that in-house compliance interest associated with such necessarily have written policies and personnel would require 10 hours to limitations, in accordance with the procedures regarding the identification review and approve the updated Disclosure Obligation, and (B) prevent and management of conflicts as required policies and procedures, for an such limitations and associated conflicts by Regulation Best Interest. To comply aggregate burden of 8,020 hours.1471 of interest from causing the broker, with the Conflict of Interest Obligation, Therefore, we estimated the total initial dealer, or a natural person who is an we believe that broker-dealers would aggregate burden to be 131,320 hours associated person of the broker or dealer utilize a combination of in-house and and the total initial aggregate cost to be to make recommendations that place the outside legal and compliance counsel to $24.8 million.1472 interest of the broker, dealer, or such update existing policies and We believe our estimates are generally natural person ahead of the interest of procedures.1467 We assume that, for accurate in light of the increased the retail customer; and (iii) identify specificity in Regulation Best Interest as and eliminate sales contests, bonuses, 1465 See Section II.C.3.a. to how a broker-dealer must address and non-cash compensation that are Any written policies and procedures developed specified conflicts of interest but due to based on the sales of specific securities pursuant to Regulation Best Interest would be changes in the number of broker-dealers or specific types of securities within a required to be retained pursuant to Exchange Act and cost estimates for certain services, 1464 Rule 17a–4(e)(7), which requires broker-dealers to limited period of time. retain compliance, supervisory, and procedures we are revising our burden and cost Written policies and procedures manuals (and any updates, modifications, and estimates.1473 developed pursuant to the Conflict of revisions thereto) describing the policies and procedures of the broker-dealer with respect to Interest Obligation of Regulation Best 1468 See footnote 1387 and accompanying text. compliance with applicable laws and rules, and 1469 Interest would help a broker-dealer to supervision of the activities of each associated, for See Proposing Release at 21666. develop a process reasonably designed a specified period of time. The record retention 1470 Id. requirements of Rule 17a–4(e)(7) include any 1471 Id. 1463 As discussed above, the Conflict of Interest written policies and procedures that broker-dealers 1472 Id. Obligation and Compliance Obligation apply solely may produce pursuant to the Conflict of Interest 1473 We have revised our cost estimates to reflect to the broker or dealer entity, and not to the Obligation of Regulation Best Interest. the updated SIFMA Management and Professional associated persons of a broker or dealer. 1466 See Section II.C.3. Earnings Report which was updated in 2019 to 1464 Rule 15l–1 under the Exchange Act. 1467 See footnote 1381 and accompanying text. reflect inflation. Therefore, the hourly rates used

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For purposes of Regulation Best updated policies and procedures, for an turnover would incur an annual internal Interest as adopted, we estimate that a aggregate burden of 7,560 hours.1480 burden of 12 hours to review and large broker-dealer would incur an Therefore, we estimate the total initial update existing policies and procedures: initial burden of 50 hours for in-house aggregate burden to be 128,160 Four hours for in-house counsel, four counsel and in-house compliance to hours 1481 and the total initial aggregate hours for in-house compliance, and four update existing policies and procedures cost to be approximately $25.0 hours for business-line personnel to to comply with Regulation Best Interest million.1482 identify new conflicts. We therefore and an initial burden of 5 hours for estimate an ongoing, aggregate burden ii. Ongoing Costs and Burdens general counsel and 5 hours for a Chief for large broker-dealers of Compliance Officer to review and For purposes of this analysis, we approximately 24,120 hours.1486 approve the updated policies and assume that small and large broker- Because we assume that large broker- procedures, for a total of 60 burden dealers would review and update dealers would rely on internal hours.1474 We also estimate ten hours of policies and procedures on an annual personnel to update policies and outside counsel services will be basis to accommodate the addition of, procedures on an ongoing basis, we do required at a cost of $4,970 to review for example, new products or services, not believe large broker-dealers would updated policies and procedures on new business lines, and/or new incur ongoing external costs. behalf of a large broker-dealer.1475 We personnel. We also assume that broker- We assume for purposes of this therefore estimate the aggregate initial dealers would review and update their analysis that small broker-dealers, burden for large broker-dealers to be of policies and procedures for compliance generally have fewer and less complex 120,600 burden hours 1476 and initial with the Conflict of Interest Obligation products and lower rates of hiring. We aggregate cost of approximately $10.0 on an annual basis, and in-house also assume they would primarily rely million for large broker-dealers.1477 personnel would perform the review For small broker-dealers, we believe on outside legal counsel and outside and make any updates. compliance consultants for review and that they would primarily rely on In the Proposing Release, we update of their policies and procedures, outside counsel to update existing estimated that large broker-dealers with final review and approval from an policies and procedures, as small would incur an annual internal burden in-house compliance manager. We broker-dealers generally have fewer in- of 12 hours to review and update estimate that outside legal counsel house legal and compliance personnel. existing policies and procedures to would require approximately five hours Given that smaller broker-dealers identify new conflicts for an ongoing, per year to update policies and generally have fewer conflicts of aggregate burden of 24,660 hours with procedures, for an annual cost of $2,485 interest, we estimate that 40 hours of no ongoing costs as they would rely on for each small broker-dealer.1487 The outside legal counsel would be required internal personnel.1483 We assumed projected aggregate, annual ongoing cost to update existing policies and small broker-dealers would rely on for outside legal counsel to update procedures, for a one-time cost of outside legal counsel and compliance 1478 policies and procedures for small $19,880 per small broker-dealer, and consultants to review and update broker-dealers would be $1.88 million an aggregate cost of $15.0 million for all policies and procedures, with final 1479 per year.1488 In addition, we expect that small broker-dealers. We also expect review and approval from in-house small broker-dealers would require five that in-house compliance would require compliance 1484 with an aggregate, hours of outside compliance services 10 hours to review and approve the annual ongoing cost of $3.08 million per per year to update their policies and year.1485 In addition to these costs, we procedures, for an ongoing cost of here for certain services, for example, outside legal believed that small broker-dealers counsel and outside compliance costs, are higher $1,365 per year,1489 and an aggregate would incur an internal an ongoing, than the numbers in the Proposing Release. ongoing cost of $1.03 million.1490 The 1474 aggregate burden of 28,670 hours. While This estimate is based on the following total aggregate, ongoing cost for small calculation: (50 hours of review for in-house the Commission believes our time counsel and in-house compliance counsel) + (5 estimates from the Proposing Release hours of review for general counsel) + (5 hours of 1486 This estimate is based on the following review for Chief Compliance Officer) = 60 initial are generally accurate, we have revised calculation: (12 burden hours per large broker- burden hours per large broker-dealer. our burdens and estimates to account dealer) × (2,010 large broker-dealers) = 24,120 1475 Data from the SIFMA Management and for changes in both the number of aggregate ongoing burden hours. Professional Earnings Report suggests that the broker-dealers and external costs of 1487 This estimate is based on the following average hourly rate for legal services is $497/hour. services. calculation: (5 hours per small broker-dealer) × This cost estimate is therefore based on the ($497/hour for outside counsel services) = $2,485 in following calculation: (10 hours of review) × ($497/ We estimate that large broker-dealers, outside counsel costs. hour for outside counsel services) = $4,970 in which generally have more numerous 1488 This estimate is based on the following outside counsel costs per large broker-dealer. and complex products and services, as calculation: ($2,485 in outside counsel costs per 1476 This estimate is based on the following well as and higher rates of hiring and small broker-dealer) × (756 small broker-dealers) = calculation: (60 burden hours of review per large $1.88 million in aggregate, ongoing outside legal broker-dealer) × (2,010 large broker-dealers) = costs per year. 1480 This estimate is based on the following 120,600 aggregate burden hours for large broker- 1489 We believe that performance of this function calculation: (10 burden hours) × (756 small broker- dealers. will most likely be equally allocated between a dealers) = 7,560 aggregate burden hours. 1477 This estimate is based on the following senior compliance examiner and a compliance 1481 calculation: ($4,970 for outside counsel costs per This estimate is based on the following manager. Data from the SIFMA Management and large broker-dealer) × (2,010 large broker-dealers) = calculation: (120,600 aggregate burden hours for Professional Earnings Report suggests that costs for approximately $10.0 million in outside counsel large broker-dealers) + (7,560 aggregate burden these positions are $237 and $309 per hour, costs for large broker-dealers. hours for small broker-dealers) = 128,160 total respectively for an average of $273 per hour. This 1478 This cost estimate is based on the following aggregate burden hours. cost estimate is based on the following calculation: calculation: (40 hours of review) × ($497/hour for 1482 This estimate is based on the following (5 hours of review) × ($273/hour for outside outside counsel services) = $19,880 in outside calculation: ($10 million in aggregate costs for large compliance services) = $1,365 in outside counsel costs per small broker-dealer. broker-dealers) + ($15.0 million in aggregate costs compliance service costs. 1479 This cost estimate is based on the following for small broker-dealers) = $25.0 million total 1490 This estimate is based on the following calculation: ($19,880 for outside attorney costs per aggregate costs. calculation: ($1,365 in outside compliance costs per small broker-dealer) × (756 small broker-dealers) = 1483 Proposing Release at 21667. small broker-dealer) × (756 small broker-dealers) = approximately $15.0 million in outside counsel 1484 Id. $1.03 million in aggregate, ongoing outside costs for small broker-dealers. 1485 Id. compliance costs per year.

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broker-dealers is therefore projected at broker-dealer, but we expected that an incentive to an associated person to $2.91 million per year.1491 modification of a broker-dealer’s place the interest of the broker-dealer or In addition to the costs described existing technology would initially natural person making the above, we additionally believe small require the retention of an outside recommendation ahead of the interest of broker-dealers would incur an internal programmer as well as coordination the retail customer, a material limitation burden of approximately 5 hours for an between the programmer and the on the product menu, or a sales practice in-house compliance manager to review broker-dealer’s in-house compliance that is based on the sales of specific and approve the updated policies and manager. The costs and burdens for this securities or specific types of securities procedures per year. The ongoing, process were estimated to be $15.43 within a limited period of time and (2) aggregate burden for small broker- million and 14,285 burden hours.1496 In determine whether and how the conflict dealers would be 3,780 hours for in- addition to these costs and burdens, we would be disclosed, disclosed and house compliance manager review.1492 expected that a broker-dealer would mitigated, or eliminated in accordance We therefore estimate the total spend time to determine whether the with the Conflict of Interest Obligation. ongoing aggregate ongoing burden to be conflict of interest identified were In order to complete this process, we 27,900 hours per year 1493 and the total material and would have required an believe a broker-dealer, on average, ongoing aggregate cost to be $2.91 additional 14,285 burden hours for all would require approximately 20 million per year.1494 broker-dealers for an aggregate burden hours 1502 of review per broker- The Commission acknowledges that of 28,570 hours for identification of dealer,1503 for an aggregate of 55,320 policies and procedures may vary conflicts of interest.1497 burden hours for all broker-dealers.1504 greatly by broker-dealer, given the As stated above, we believe the We therefore estimate the total initial differences in size and the complexity of process would be largely the same as set aggregate burden for identification and broker-dealer business models. forth in the Proposing Release but have management of conflicts of interest is Accordingly, we expect that the need to revised our estimates and costs below to 69,150 hours.1505 update policies and procedures might account for changes in the number of also vary greatly. broker-dealers and external costs as well ii. Ongoing Costs and Burdens b. Identification and Management of as to account for some changes to the To maintain compliance with the Conflicts of Interest structure of the Conflict of Interest Conflict of Interest Obligation, we Obligation. assume for purposes of this analysis that With respect to identifying and To comply with the Conflict of a broker-dealer would seek to identify determining whether a conflict of Interest Obligation, we expect that additional conflicts of interest as its interest exists in connection with a broker-dealers will modify existing business evolves. As noted above, the recommendation and whether it needs technology through the work of an Commission recognizes that broker- to be addressed through disclosure, outside programmer which would dealers vary in the types of services and mitigation and/or elimination, a broker- require, on average, an estimated 20 product offerings and therefore vary in dealer would first need to establish hours, for an estimated cost per broker- the types of conflicts of interest that mechanisms to proactively and dealer of $5,680.1498 We additionally exist within and across broker- systematically identify conflicts of continue to estimate (as was set forth in dealers.1506 interest in its business on an ongoing or the Proposing Release) that coordination However, for purposes of the PRA periodic basis.1495 For purposes of this between the programmer and the analysis in the Proposing Release, we analysis, we assume that most broker- broker-dealer’s compliance manager assumed that broker-dealers would, at a dealers already have an existing would involve five burden hours.1499 minimum, engage in a material conflicts technological infrastructure in place, The aggregate initial costs and burdens identification process on an annual and we assume it would need to be for the modification of existing basis, and we estimated that in the modified to comply with the Conflict of technology to identify conflicts of aggregate broker-dealers would spend Interest Obligation. interest would therefore be $15.71 approximately 28,570 hours each to 1500 1507 i. Initial Costs and Burdens million, and 13,830 burden complete this process per year. hours.1501 Similar to the Proposing Release, we As stated in the Proposing Release, we As a result of the changes made to the believe that for purposes of this believed that costs and burdens may rule text of the Conflict of Interest analysis, broker-dealers would, through vary greatly depending on the size of the Obligation, we believe that broker- the help of the business line and dealers would incur burdens to: (1) compliance personnel, spend on average 1491 This estimate is based on the following Identify conflicts of interest and 10 hours 1508 to perform an annual calculation: ($1.88 million for outside legal counsel costs) + ($1.03 million for outside compliance costs) determine whether the conflict involves = $2.91 million total aggregate ongoing costs per 1502 In light of the changes made to the rule text year. 1496 Proposing Release at 21667. of the Conflict of Interest Obligation and the 1492 This estimate is based on the following 1497 Id. comments received, we have increased our estimate to 20 burden hours per broker-dealer. calculation: (5 hours compliance manager review 1498 Data from the SIFMA Management and 1503 per small broker-dealer) × (756 small broker- Professional Earnings Report suggests that the This burden estimate consists of 10 hours for dealers) = 3,780 aggregate ongoing burden hours per average hourly rate for technology services in the review by business line personnel, and 10 hours for year. securities industry is $284. This cost estimate is review by in-house compliance manager. 1493 This estimate is based on the following based on the following calculation: (20 hours of 1504 This burden estimate is based on the × calculation: (24,120 aggregate ongoing burden hours review) × ($284/hour for technology services) = following calculation: (20 burden hours) (2,766 for large broker-dealers) + (3,780 aggregate ongoing $5,680. broker-dealers) = 55,320 aggregate burden hours. burden hours for small broker-dealers) = 27,900 1499 1505 This burden estimate is based on the total aggregate ongoing burden hours per year. 1500 This cost estimate is based on the following following calculation: (13,830 burden hours for 1494 This estimate is based on the following calculation: ($5,680 in outside programmer costs modification of technology) + (55,320 burden hours calculation: ($2.91 million per year in total per broker-dealer) × (2,766 broker-dealers) = $15.71 for evaluation of managing conflicts) = 69,150 total aggregate ongoing costs for small broker-dealers) + million in aggregate outside programmer costs. aggregate burden hours. ($0 projected ongoing costs for large broker-dealers) 1501 This burden estimate is based on the 1506 See supra Section II.C.3. = $2.91 million per year in total aggregate ongoing following calculation: (5 burden hours for in-house 1507 See Proposing Release at 21668. costs. compliance manager) × (2,766 broker-dealers) = 1508 This burden estimate consists of five hours 1495 See supra Section III.C.3. 13,830 aggregate burden hours. for review by business line personnel, and five

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conflicts review using the modified 4. Compliance Obligation analysis, the associated costs and 1509 technology infrastructure. Therefore, As discussed above, in response to burdens would differ between small and the Commission estimates that the comments that we should require large broker-dealers, as large broker- aggregate ongoing burden for an annual policies and procedures to comply with dealers generally offer more products conflicts review, based on an estimated Regulation Best Interest as a whole, we and services and employ more 2,766 retail broker-dealers, would be are adopting the Compliance individuals and therefore would need to approximately 27,660 burden hours per Obligation.1515 The Compliance evaluate and update a greater number of 1510 year. Because we assume that Obligation requires that the broker- systems. As discussed above, we broker-dealers would use in-house dealer 1516 establish, maintain and estimate that 2,010 broker-dealers personnel to identify and evaluate new, enforce written policies and procedures would qualify as large broker-dealers for potential conflicts, we continue to reasonably designed to achieve purposes of this analysis and 756 would believe they would not incur additional compliance with Regulation Best qualify as small broker-dealers that have 1519 ongoing external costs. Interest. This Compliance Obligation retail business. For purposes of this analysis we c. Training creates an explicit obligation under the Exchange Act with respect to Regulation estimate that a large broker-dealer As discussed in the Proposing Best Interest as a whole. Similar to the would incur a one-time average internal Release, we expect that broker-dealers policies and procedures requirement of burden of 30 hours for in-house legal would develop training programs to the Conflict of Interest Obligation, personnel and in-house compliance comply with Regulation Best Interest, broker-dealers will have flexibility to counsel to update existing policies and including the Conflict of Interest design policies and procedures that are procedures to comply with the Obligation. However, we believe that reasonable for the scope, size and risks Compliance Obligation and a one-time any burdens and costs associated with associated with the operations of the burden of five hours for general counsel a training program would fall under the firm and the types of business in which and five hours for a Chief Compliance new Compliance Obligation as it would the broker-dealer engages. Because we Officer to review and approve the be developed to comply with Regulation did not include the Compliance updated policies and procedures, for a Best Interest as a whole, including each 1520 Obligation in the Proposing Release, we total of 40 burden hours. We also of the component obligations. did not previously include costs and estimate six hours of outside counsel In total, to comply with the Conflict services a cost of $2,982 for outside of Interest Obligation, the Commission burdens associated with the Compliance Obligation, but we have provided a counsel to review updated policies and estimates that the total initial burdens procedures on behalf of a large broker- 1511 detailed explanation of these costs and and costs to be 197,310 hours and 1517 dealer.1521 We therefore estimate the 1512 burdens below. $40.71 million, and the total aggregate burden for large broker-dealers ongoing burdens and costs to be 55,560 a. Written Policies and Procedures to be of 80,400 burden hours 1522 and 1513 hours per year and $2.91 million i. Initial Costs and Burdens aggregate cost of $6.0 million for large 1514 per year. 1523 While the Compliance Obligation broker-dealers. creates an explicit requirement under For small broker-dealers, we believe hours for review by an in-house compliance that they would primarily rely on manager. the Exchange Act, we believe that outside counsel to update existing 1509 FINRA rules set an annual supervisory broker-dealers would likely establish review as a minimum threshold for broker-dealers. policies and procedures to comply with policies and procedures, as small See, e.g., FINRA Rules 3110 (requiring an annual Regulation Best Interest pursuant to broker-dealers generally have fewer in- review of the businesses in which the broker-dealer house legal and compliance personnel. engages); 3120 (requiring an annual report detailing Section 15(b)(4)(E) and SRO rules by a broker-dealer’s system of supervisory controls, adjusting their current systems of We estimate that only 20 hours of including compliance efforts in the areas of supervision and compliance, as opposed outside legal counsel services would be antifraud and sales practices); and 3130 (requiring to creating new systems. While broker- required, for a one-time cost of $9,940 each broker-dealer’s CEO or equivalent officer to per small broker-dealer,1524 and an certify annually to the reasonable design of the dealers must already have policies and policies and procedures for compliance with procedures in place to address other aggregate cost of $7.5 million for all relevant regulatory requirements). Commission and SRO rules, they would 1519 1510 This estimate is based on the following need to update their systems of See supra footnote 1387 and accompanying calculation: (10 hours per retail broker-dealer) × text. (2,766 retail broker-dealers) = 27,660 aggregate supervision and compliance to account 1520 This estimate is based on the following burden hours per year. for Regulation Best Interest. calculation: (30 hours of review for in-house legal 1511 This estimate is based on the following To comply with the Compliance and in-house compliance) + (5 hours of review for calculation: (128,160 initial burden hours for Obligation, we believe that broker- general counsel) + (5 hours of review for Chief policies and procedures) + (69,150 initial burden dealers would employ a combination of Compliance Officer) = 40 burden hours. hours for identification and management of 1521 Data from the SIFMA Management and conflicts of interest) = 197,310 initial burden hours in-house and outside legal and Professional Earnings Report suggests that the to comply with the Conflict of Interest Obligation. compliance counsel to update existing average hourly rate for legal services is $497/hour. 1512 This estimate is based on the following policies and procedures to account for This cost estimate is therefore based on the calculation: ($25.0 million initial costs for policies the Disclosure and Care Obligations.1518 following calculation: (6 hours of review) × ($497/ and procedures) + ($15.71 million initial costs for We assume that, for purposes of this hour for outside counsel services) = $2,982 in identification and management of conflicts of outside counsel costs. interest) = $40.71 million initial total costs to 1522 This estimate is based on the following comply with the Conflict of Interest Obligation. identification and management of conflicts of calculation: (40 burden hours of review per large 1513 This estimate is based on the following interest) = $2.91 million aggregate ongoing total broker-dealer) × (2,010 large broker-dealers) = calculation: (27,900 ongoing burden hours for costs per year to comply with the Conflict of 80,400 aggregate burden hours. policies and procedures) + (27,660 ongoing burden Interest Obligation. 1523 This estimate is based on the following hours for identification and management of 1515 Section II.C.4. calculation: ($2,982 for outside counsel costs per conflicts of interest) = 55,560 aggregate ongoing 1516 See supra footnote 1462 and accompanying large broker-dealer) × (2,010 large broker-dealers) = burden hours per year to comply with Conflict of text. $6.0 million in outside counsel costs. Interest Obligation. 1517 We note that any burdens and costs to 1524 This cost estimate is based on the following 1514 This estimate is based on the following comply with the Conflict of Interest Obligation are calculation: (20 hours of review) × ($497/hour for calculation: ($2.91 million ongoing costs for included in the estimates in Section IV.B.3 above. outside counsel services) = $9,940 in outside policies and procedures) + ($0 ongoing costs for 1518 Id. counsel costs.

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small broker-dealers.1525 We also expect generally have fewer and less complex ongoing costs and burdens associated that in-house compliance personnel products, and lower rates of hiring and with such a training program are would require 6 hours to review and turnover, would mostly rely on outside estimated below. approve the updated policies and legal counsel and compliance i. Initial Costs and Burdens procedures, for an aggregate burden of consultants for review and update of 4,536 hours.1526 Therefore, we estimate their policies and procedures, with final We believe that broker-dealers would the total initial aggregate burden to be review and approval from an in-house likely use a computerized training 84,936 hours 1527 and the total initial compliance manager. We estimate that model to train their associated persons aggregate cost to be $13.5 million.1528 outside counsel would require regarding the policies and procedures approximately five hours per year to pertaining to Regulation Best Interest. ii. Ongoing Costs and Burdens update policies and procedures, for an We estimate that a broker-dealer would For purposes of this analysis, we annual cost of $2,485 for each small retain an outside systems analyst, assume that small and large broker- broker-dealer.1530 The projected outside programmer, and an outside dealers would review and update aggregate, annual ongoing cost for programmer analyst to create the policies and procedures on a periodic outside legal counsel to update policies training module, at 20 hours, 40 hours, basis to accommodate the addition of, and procedures for small broker-dealers and 20 hours, respectively. The total among other things, new products or would be $1.88 million.1531 In addition, cost to develop the training module services, new business lines, and/or we expect that small broker-dealers would be approximately $20,920,1535 for new personnel. We also assume that would require five hours of outside an aggregate initial cost of $62.8 broker-dealers would review and update compliance services per year to update million.1536 their policies and procedures for their policies and procedures, for an Additionally, we expect that the compliance with Regulation Best ongoing cost of $1,365 per year,1532 and training module would require the Interest on an annual basis, and for an aggregate ongoing cost of $1.03 approval of the Chief Compliance purposes of this analysis, we assume million.1533 The Commission estimates Officer, as well as in-house counsel, they would perform the review and the total aggregate, ongoing cost for each of whom would require update using in-house personnel. Under small broker-dealers is therefore $2.91 approximately 2 hours to review and the Compliance Obligation, we do not million per year.1534 approve the training module. The initial aggregate burden for broker-dealers is believe that broker-dealers would incur b. Training any costs or burdens associated with therefore estimated at 11,064 burden compliance with the Conflict of Interest Pursuant to the Compliance hours.1537 Obligation, as those are included in the Obligation’s requirement to ‘‘maintain In addition, broker-dealers would discussion above, but would for ongoing and enforce’’ written policies and incur an initial cost for associated compliance with the Disclosure and procedures, we additionally believe persons to undergo training through the Care Obligations. broker-dealers will develop training training module. We estimate the For large broker-dealers with more programs that promote compliance with training time at one hour per associated numerous and complex products and Regulation Best Interest. We believe that person, for an aggregate burden of services, as well as higher rates of hiring a training program would cover 428,404 burden hours, or an initial and turnover, we estimate that each compliance with Regulation Best burden of 154.9 hours per broker- broker-dealer would annually incur an Interest as a whole and would therefore dealer.1538 We estimate the total initial cover the Disclosure, Care and Conflict internal burden of 12 hours to review aggregate burden to approve the training of Interest Obligations. The initial and and update existing policies and module and implement the training procedures: four hours for legal program would be 439,486 burden 1530 Data from the SIFMA Management and hours.1539 personnel, four hours for compliance Professional Earnings Report suggests that the personnel, and four hours for business- average hourly rate for legal services is $497/hour. line personnel. We therefore estimate an This estimate is therefore based on the following 1535 Data from the SIFMA Management and × Professional Earnings Report suggests that the ongoing, aggregate burden for large calculation: (5 hours per small broker-dealer) ($497/hour for outside counsel services) = $2,485 in average hourly rate in the securities industry is broker-dealers of approximately 24,120 outside counsel costs per year. $263 for a systems analyst, $271 for a programmer, hours per year.1529 1531 This estimate is based on the following and $241 for a programmer analyst.. This cost calculation: ($2,485 in outside counsel costs per estimate is based on the following calculation: ((20 We assume for purposes of this × small broker-dealer) × (756 small broker-dealers) = hours for a systems analyst) ($263/hour)) + ((40 analysis that small broker-dealers, who × $1.88 million in aggregate, ongoing legal costs per hours of labor for a programmer) ($271/hour)) + year. ((20 hours of labor for a programmer analyst) × 1525 This cost estimate is based on the following 1532 We believe that performance of this function ($241/hour)) = $20,920 in external technology costs calculation: ($9,940 for outside counsel costs per will most likely be equally allocated between a per broker-dealer. × small broker-dealer) (756 small broker-dealers) = senior compliance examiner and a compliance 1536 This estimate is based on the following $7.5 million in outside counsel costs. manager. Data from the SIFMA Management and calculation: (2,766 broker-dealers) × ($20,920in 1526 This estimate is based on the following Professional Earnings Report suggests that costs for external technology costs per broker-dealer) = $57.9 calculation: (6 burden hours) × (756 small broker- these positions are $237 and $309 per hour, million in aggregate costs for technology services. dealers) = 4,536 initial aggregate burden hours. respectively for an average of $273 per hour. This 1537 This estimate is based on the following 1527 This estimate is based on the following estimate is therefore based on the following calculation: (2,766 broker-dealers) × (4 burden calculation: (80,400 aggregate burden hours for calculation: (5 hours per small broker-dealer) × hours per broker-dealer) = 11,064 burden hours. large broker-dealers) + (4,536 aggregate burden ($273/hour for outside counsel services) = $1,365 in 1538 This estimate is based on the following hours for small broker-dealers) = 84,936 total initial outside compliance service costs per year. calculation: (1 burden hour) × (428,404 registered aggregate burden hours. 1533 This estimate is based on the following representatives at standalone or dually registered 1528 This estimate is based on the following calculation: ($1,365 in outside compliance costs per broker-dealers) = 428,404 aggregate burden hours. calculation: ($6 million in aggregate costs for large small broker-dealer) × (756 small broker-dealers) = Conversely, (428,404 aggregate burden hours)/ broker-dealers) + ($7.5 million in aggregate costs for $1.03 million in aggregate, ongoing outside (2,766 retail broker-dealers) = 154.9 initial burden small broker-dealers) = $13.5 million total initial compliance costs per year. hours per broker-dealer per year. aggregate costs. 1534 This estimate is based on the following 1539 This estimate is based on the following 1529 This estimate is based on the following calculation: ($1.88 million for outside legal counsel calculation: (428,404 burden hours for training of calculation: (12 burden hours per large broker- costs) + ($1.03 million for outside compliance costs) registered representatives) + (11,064 burden hours dealer) × (2,010 large broker-dealers) = 24,120 = $2.91 million total aggregate ongoing costs per to approve training program) = 439,468 total aggregate ongoing burden hours per year. year. aggregate burden hours per year.

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ii. Ongoing Costs and Burdens Release. However, while we understand In addition, we continue to believe that We believe that, as a matter of best commenters’ concerns that the estimates broker-dealers likely make records of practice, broker-dealers would likely are lower than what would actually be the ‘‘identity of each natural person who require registered representatives to required to comply with Regulation Best is an associated person, if any, repeat the training module for Interest, we believe the estimates are responsible for the account.’’ However, Regulation Best Interest on an annual generally accurate in light of the we are assuming, for purposes of basis. The ongoing aggregate cost for the increased specificity in Regulation Best compliance with Rule 17a–3(a)(35), that one-hour training would be 428,404 Interest on how to comply with the broker-dealers will need to create a component obligations, including the record, or modify an existing record, to burden hours per year, or 154.9 burden 1545 hours per broker-dealer per year.1540 Disclosure Obligation. The record- identify the associated person, if any, In total, to comply with the making and recordkeeping costs and responsible for the account in the Compliance Obligation, the Commission burdens associated with the context of Regulation Best Interest. In estimates the total initial burdens and amendments to Rule 17a–3(a)(35) and addition, in cases where broker-dealers costs to be 524,414 hours 1541 and $71.4 Rule 17a–4(e)(5) are addressed below. choose to meet part of the Disclosure Obligation orally under the million,1542 and the total ongoing a. Record-Making Obligation circumstances outlined in Section II.C.1, burdens and costs to be 463,588 We are amending Rule 17a–3 by hours 1543 and $2.91 million.1544 Oral Disclosure or Disclosure After a adding a new paragraph (a)(35) that Recommendation, we believe the 5. Record-Making and Recordkeeping requires a record of all information requirement to maintain a record of the Obligations collected from, and provided to, the fact that oral disclosure was provided to retail customer pursuant to Regulation The record-making and recordkeeping the retail customer will trigger a record- Best Interest, as well as the identity of obligations will impose record-making making obligation under paragraph each natural person who is an and recordkeeping requirements on (a)(35) of Rule 17a–3 and a associated person of a broker or dealer, broker-dealers with respect to certain recordkeeping obligation under if any, responsible for the account.1546 information collected from, or provided paragraph (e)(5) of Rule 17a–4 that may This requirement applies with respect to to, retail customers. Specifically, the impose additional compliance costs and each retail customer to whom a Commission is amending Rules 17a–3 burdens on broker-dealers. recommendation of any securities and 17a–4 of the Exchange Act, which transaction or investment strategy i. Initial Costs and Burdens set forth minimum requirements with involving securities is provided. The In the Proposing Release, we assumed respect to the records that broker- neglect, refusal, or inability of a retail that broker-dealers would satisfy the dealers must make, and how long those customer to provide or update any such record-making requirement of the records and other documents must be information will, however, excuse the proposed amendment to Rule 17a– kept, respectively. Records made and broker-dealer from obtaining that 3(a)(25) by amending an existing retained in accordance with the information. account disclosure document to include amendments to Rule 17a–3(a)(35) and We indicated in the Proposing the ‘‘identity of each natural person who 17a–4(e)(5) will (1) assist a broker-dealer Release, and we continue to believe that is an associated person, if any, in supervising and assessing internal broker-dealers currently make records of responsible for the account.’’ We compliance with Regulation Best relevant customer investment profile estimated that the inclusion of this Interest; and (2) assist the Commission information, and we therefore assume information in an account disclosure and SRO staff in connection with that no additional record-making document would require an examinations and investigations. obligations would arise as a result of approximate total aggregate initial Due to changes in the number of broker-dealers’ or their registered burden of 3,808,000 hours, or broker-dealers and costs estimated for representatives’ collection of approximately 1,333 hours per broker- certain services, we are revising our information from retail customers.1547 dealer for the first year after Regulation estimates from those in the Proposing Best Interest is in effect.1548 1545 See, e.g., Raymond James Letter; CCMC As discussed above, we continue to 1540 This estimate is based on the following Letters; SIFMA August 2018 Letter. believe that broker-dealers will satisfy calculation: (1 burden hour) × (428,404 registered 1546 As indicated in the Proposing Release, we the record-making requirements of the representatives at standalone or dually registered understand that broker-dealers likely make such broker-dealers) = 428,404 burden hours. records in the ordinary course of their business amendment to Rule 17a–3(a)(35) by Conversely, (428,404 aggregate burden hours) / pursuant to Exchange Act Rules 17a–3(a)(6) and (7). amending an existing account (2,766 retail broker-dealers) = 154.9 initial burden We continue to believe, for purposes of compliance disclosure document to include the hours per broker-dealer. with Rule 17a–3(a)(35), that broker-dealers would ‘‘identity of each natural person who is 1541 This estimate is based on the following need to create a record, or modify an existing calculation: (84,946 initial burden hours for policies record, to identify the associated person, if any, an associated person, if any, responsible and procedures) + (439,468 initial burden hours responsible for the account in the context of for the account.’’ We believe that the training) = 524,414 initial burden hours to comply Regulation Best Interest. See Proposing Release at inclusion of this information in an with the Compliance Obligation. 21673. account disclosure document will 1542 This estimate is based on the following 1547 The PRA burdens and costs arising from the require, on average, approximately 1 calculation: ($13.5 million initial costs for policies requirement that a record be made of all and procedures) + ($57.9 million initial costs for information provided to the retail customer are training) = $71.4 million initial total costs to accounted for in Regulation Best Interest and the analysis of that information and any resulting comply with the Compliance Obligation. Relationship Summary Adopting Release. With recommendations will need to adhere to the 1543 This estimate is based on the following respect to the requirement that a record be made of enhanced best interest standard of Regulation Best calculation: (24,120 ongoing burden hours for all information from the retail customer, we believe Interest. See supra Section II.C.2. policies and procedures) + (439,468 ongoing burden that Rule 17a–3(a)(35) will not impose any new 1548 These estimates were based on the following hours for training) = 463,588 ongoing burden hours substantive burdens on broker-dealers. As calculations: (0.04 hours per customer account) × to comply with Compliance Obligation. discussed above, we continue to believe that the (95.2 million retail customer accounts) = 3,808,000 1544 This estimate is based on the following obligation to exercise reasonable diligence, care, aggregate burden hours. Conversely, (3,808,000 calculation: ($2.91 million ongoing costs for and skill will not require a broker-dealer to collect aggregate burden hours)/(2,857 broker-dealers) = policies and procedures) + ($0 million ongoing additional information from the retail customer 1,333 hours per broker dealer for the first year after costs for training) = $2.91 million ongoing costs to beyond that currently collected in the ordinary Regulation Best Interest is in effect. See Proposing comply with the Compliance Obligation. course of business even though a broker-dealer’s Release at 21673.

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hour per year for outside legal counsel believe that there are no ongoing costs i. Initial Costs and Burdens at small broker-dealers, at an updated and burdens associated with this record- We believe that, to reduce costs and average rate of $497/hour, for an average making requirement of the amendment for ease of compliance, broker-dealers annual cost of $497 for each small to Rule 17a–3(a)(35). will utilize their existing recordkeeping broker-dealer to update an account With respect to memorializing oral systems in order to retain the forgoing disclosure document. The projected disclosures in cases where broker- records made pursuant to Regulation aggregate initial cost for small broker- dealers choose to meet part of the Best Interest, and as required to be kept dealers is therefore estimated to be Disclosure Obligation orally under the under the amendment to Rule 17a– 1549 $375,732 per year. For broker- circumstances outlined in Section II.C.1, 4(e)(5). As noted above, broker-dealers dealers that are not small entities, we Oral Disclosure or Disclosure After a currently are subject to recordkeeping estimate that the initial burden will be Recommendation, we estimate that this obligations pursuant to Rule 17a–4, 2 hours for each broker-dealer: 1 hour would take place among 52% of a which require, for example, broker- for compliance personnel and 1 hour for broker-dealer’s retail customer accounts dealers to ‘‘preserve for a period of not legal personnel. We therefore estimate (and thus 52% of a registered less than six years, the first two years in the aggregate initial burden for broker- representative’s retail customer 1555 an easily accessible place, all records dealers that are not small entities to be accounts) annually. We therefore required to be made pursuant to’’ Rule 1550 approximately 4,020 burden hours. estimate broker-dealers to incur a total 17a–3(a)(1), (a)(2), (a)(3), (a)(5), (a)(21), Finally, we estimate it will require an annual aggregate burden of 1.06 million (a)(22), and analogous records created additional 0.04 hours for the registered hours, or 383.5 burden hours per year 1556 pursuant to paragraph 17a–3(f). Thus, representative responsible for the per broker-dealer. for example, broker-dealers are already information (or other clerical personnel) b. Recordkeeping Obligation required to maintain documents such as to fill out that information in the account blotters and ledgers for six account disclosure document, for an We are amending Rule 17a–4(e)(5) to require that broker-dealers retain all years. approximate total aggregate initial We continue to believe that broker- records of the information collected burden of 4,080,000 hours, or dealers will utilize their existing from or provided to each retail customer approximately 1,475 hours per broker- recordkeeping systems to include any pursuant to Regulation Best Interest for dealer for the first year after Regulation additional or amended records required 1551 at least six years after the earlier of the Best Interest is in effect. Because we by Regulation Best Interest or pursuant date the account was closed or the date have already included the costs and to the amendment to Rule 17a–4(e)(5), on which the information was last burdens associated with the creation of and would similarly utilize their replaced or updated. We assume that, a record to memorialize an oral existing recordkeeping systems to for purposes of this analysis, the disclosure, and the delivery of the account for any differences in the following records would likely be amended account disclosure document retention period. Thus, where broker- retained pursuant to amended Rule 17a– discussed above, they are not included dealers currently retain documents on 1552 3(a)(35): (1) Existing account disclosure in this section of the analysis. an electronic database to satisfy existing documents; (2) comprehensive fee The total aggregate initial burden for Rule 17a–4 or otherwise, we continue to schedules; (3) disclosures identifying broker-dealers is therefore estimated at expect broker-dealers to maintain any 4,084,020 hours,1553 and the total material conflicts; and (4) memorialized oral disclosures under the additional documents required by aggregate initial cost is estimated at Regulation Best Interest or the $375,732.1554 circumstances outlined in Section II.C.1, Oral Disclosure or Disclosure After a amendment to Rule 17a–4(e)(5) by the ii. Ongoing Costs and Burdens Recommendation.1557 same means. Likewise, where broker- We do not believe that the identity of dealers maintain documents required by existing Rule 17a–4 by paper, we would the registered representative responsible 1555 We believe (and our experience indicates) for the retail customer’s account will that broker-dealers will use oral disclosure rarely, expect broker-dealers to continue to do change. Accordingly, we continue to and primarily when making disclosures regarding a so. change in capacity. We do not have reliable data to Based on our belief that broker- determine the precise number of retail customers dealers will rely on existing 1549 This estimate is based on the following that have both a brokerage and an advisory account calculation: (1 hour per small broker-dealer) × (756 with a dually registered associated person. As infrastructures to satisfy the small broker-dealers) × ($497/hour) = $375,732 in indicated above, approximately 52% of registered recordkeeping obligations of Regulation aggregate costs per year. representatives were dually registered as Best Interest and the amendment to Rule 1550 This estimate is based on the following investment adviser representatives at the end of 17–a(4)(e)(5), we believe the burden for calculation: (2 burden hours per broker-dealer) × 2018. See supra footnote 945 and accompanying (2,010 large broker-dealers) = 4,020 aggregate text. As a result, we have assumed for purposes of broker-dealers to add new documents or burden hours per year. this analysis that this will take place among 52% 1551 These estimates are based on the following of all retail customer accounts at broker-dealers reflected as Rule 17a–3(a)(35)): (1) A standardized calculations: (0.04 hours per customer account) × annually. This estimate is likely over inclusive, as Relationship Summary document; (2) existing (102 million retail customer accounts) = 4,080,000 it includes all retail customer accounts at all broker- account disclosure documents; (3) a comprehensive aggregate burden hours. Conversely, (4,080,000 dealers (as opposed to only retail customer accounts fee schedule; and (4) disclosures identifying burden hours)/(2,766 broker-dealers) = 1,475 hours where the retail customer has both a brokerage and material conflicts. However, in calculating the per broker-dealer for the first year after Regulation advisory account with a dually registered financial estimated burden for broker-dealers to add new Best Interest is in effect. professional), and under inclusive, as it assumes documents or modify existing documents to the 1552 See supra Section IV.B.1. that such an oral disclosure will happen annually broker-dealer’s existing retention system, we 1553 This estimate is based on the following (as opposed to multiple times a year). erroneously assumed a broker-dealer would upload calculation: (0 aggregate burden hours for small 1556 (52%) × (102 million retail customer or file five account documents, as opposed to the broker-dealers) + (4,020 burden hours for large accounts) × (0.02 hours for recording each oral four account documents identified in the Proposing broker-dealers) + (4,080,000 burden hours for disclosure relating to a retail customer’s account) = Release. See Proposing Release at 21673–21674. In personnel to fill out information in the account 1,060,800 aggregate burden hours. Conversely, addition, while the burden for broker-dealers to disclosure document) = 4,080,000 initial burden 1,060,800 aggregate burden hours/2,766 broker- retain a standardized relationship summary was hours. dealers = 383.5 burden hours per broker-dealer per included in the Regulation Best Interest Proposing 1554 This estimate is based on the following year. Release, it is excluded here because its associated calculation: ($375,732 for small broker-dealer costs) 1557 In the Proposing Release, we identified four burden is reflected in the Relationship Summary + ($0 for large broker-dealer costs) = ($375,732 in records that would likely need to be retained Proposal and Relationship Summary Adopting total aggregate initial costs). pursuant to amended Rule 17a–3(a)(25) (now Release.

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modify existing documents to the (‘‘FRFA’’) in accordance with the recommendation, a broker-dealer must broker-dealer’s existing retention system provisions of the Regulatory Flexibility disclose, in writing,1562 material facts will be approximately 13.6 million Act (‘‘RFA’’) 1560 relating to Regulation about the scope and terms of its burden hours for all broker-dealers, Best Interest. An Initial Regulatory relationship with the customer. This assuming a broker-dealer will need to Flexibility Analysis (‘‘IRFA’’) was includes a disclosure that the broker- upload or file each of the four account prepared in accordance with the RFA dealer or associated person is acting in documents discussed above for each and included in the Proposing a broker-dealer capacity; the material retail customer account.1558 We do not Release.1561 fees and costs the customer will incur; believe there will be additional and the type and scope of the services A. Need for and Objectives of the Rule substantive internal or external costs to be provided, including any material relating to the uploading or filing of the Broker-dealers play an important role limitations on the recommendations documents. In addition, because we in helping Americans organize their that could be made to the retail have already included the costs and financial lives, accumulate and manage customer. Moreover, the broker-dealer burdens associated with the delivery of retirement savings, and invest toward must disclose all material facts relating the amended account opening other important long-term goals, such as to conflicts of interest associated with agreement and other documents above, buying a house or funding a child’s the recommendation that might incline we do not include them in this section college education. a broker-dealer to make a of the analysis. As discussed in Section I, concerns recommendation that is not exist regarding: (1) The potential harm disinterested, including, for example, ii. Ongoing Costs and Burdens to retail customers resulting from proprietary products, payments from We estimate that the approximate broker-dealer recommendations third parties, and compensation ongoing burden associated with the provided in the presence of conflicts of arrangements. recordkeeping requirement of the interest and (2) the insufficiency of Second, as described in Section II.C.2, amendment to Rule 17a–4(e)(5) is 4.46 existing broker-dealer regulatory under the Care Obligation, a broker- million burden hours per year.1559 We requirements to address these conflicts dealer must exercise reasonable do not believe that the ongoing costs when broker-dealers make diligence, care, and skill when making associated with ensuring compliance recommendations to retail customers. a recommendation to a retail customer. with the retention schedule would More specifically, there are concerns The broker-dealer must understand change from the current costs of that existing requirements do not potential risks, rewards, and costs ensuring compliance with existing Rule require a broker-dealer’s associated with the recommendation. 17a–4 and as outlined above. recommendations to be in the retail The broker-dealer must then consider customer’s best interest. those risks, rewards, and costs in light V. Final Regulatory Flexibility Act As a result, we are adopting of the retail customer’s investment Analysis Regulation Best Interest, which creates profile and have a reasonable basis to The Commission has prepared this an enhanced standard of conduct believe that the recommendation is in Final Regulatory Flexibility Analysis applicable to broker-dealers at the time the customer’s best interest and does not they recommend to a retail customer a place the broker-dealer’s interest ahead 1558 This estimate is based on the following securities transaction or investment of the retail customer’s interest. When calculation: (4 documents per customer account) × strategy involving securities. This recommending a series of transactions, × (102 million retail customer accounts) (2 minutes includes recommendations of account the broker-dealer must have a per document)/60 minutes = 13,600,000 aggregate burden hours. As indicated above, the following types and rollovers or transfers of assets reasonable basis to believe that the records would likely need to be retained: (1) and also covers implicit hold transactions taken together are not Existing account disclosure documents; (2) recommendations, resulting from excessive, even if each is in the retail comprehensive fee schedules; (3) disclosures agreed-upon account monitoring. When customer’s best interest when viewed in identifying material conflicts; and (4) memorialized oral disclosures under the circumstances outlined making a recommendation, a broker- isolation. in Section II.C.1, Disclosure Obligation, Oral dealer must act in the retail customer’s Third, as described in Section II.C.3, Disclosure or Disclosure After a Recommendation. best interest and cannot place its own under the Conflict of Interest Obligation, 1559 This estimate is based on the percentage of interests ahead of the customer’s a broker-dealer must establish, account records we expect would be updated each maintain, and enforce reasonably year as described in Section IV.B.1, supra, and the interests. This General Obligation is following calculation: (40% of fee schedules × 102 satisfied only if the broker-dealer designed written policies and million retail customer accounts) × (2 minutes per complies with four specified component procedures addressing conflicts of document) + (40% of conflict disclosure forms × obligations: (1) Disclosure Obligation, interest associated with its 102 million retail customer accounts) × (2 minutes recommendations to retail customers. per document) + (20% of account opening (2) Care Obligation, (3) Conflict of documents × 102 million retail customer accounts) Interest Obligation, and (4) Compliance These policies and procedures must be × (2 minutes per document) = 204 million minutes/ Obligation. In addition, the Commission reasonably designed to identify all such 60 minutes = 3.4 million aggregate ongoing burden is amending Rules 17a–3 and 17a–4 of conflicts and at a minimum disclose or hours. In addition, with respect to ongoing eliminate them. Additionally, the memorialization of the updated oral disclosures, we the Exchange Act, which set forth estimate that this will take place among 52% of a minimum requirements with respect to policies and procedures must be broker-dealer’s retail customer accounts annually. the records that broker-dealers must reasonably designed to mitigate We therefore estimate that broker-dealers will incur make, and how long those records and conflicts of interests that create an an aggregate ongoing burden of 1.06 million hours incentive for an associated person of the per year (calculated as follows: (52% of updated other documents must be kept, oral disclosures x 102 million retail customer respectively. broker-dealer to place its interests or the accounts) × (1.2 minutes per document) = 63.6 First, as described in Section II.C.1, million minutes/60 minutes = 1.06 million under the Disclosure Obligation, before 1562 As discussed above, there are circumstances aggregate ongoing burden hours); or 383.5 burden or at the time of making a where broker-dealers and their associated persons hours per broker-dealer (1.06 million hours/2,766 may make oral disclosures or written disclosures broker-dealers = 383.5). 3.4 million burden hours after the time of a recommendation under the per year + 1.06 million burden hours per year = 1560 5 U.S.C. 603. circumstances outlined in Section II.C.1, Disclosure 4,460,000 total aggregate ongoing burden hours per 1561 See Proposing Release, supra footnote 7, at Obligation, Oral Disclosure or Disclosure After a year. Section VII. Recommendation.

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interest of the firm ahead of the retail Analysis, that discuss the costs and ‘‘suitable’’ with ‘‘best interest’’ could customer’s interest. Moreover, when a burdens on all broker-dealers. create legal risk and cause smaller and broker-dealer places material limitations mid-sized professional firms to leave the B. Significant Issues Raised by Public on recommendations that may be made market.1567 As noted above in Section Comments to a retail customer (e.g., offering only III, we acknowledge that the costs of the proprietary or other limited range of The Commission is sensitive to the rule could be more burdensome for products), the policies and procedures burdens that the new rule may have on small firms and discuss any must be reasonably designed to disclose small entities. In the Proposing Release, corresponding competitive effects in the limitations and associated conflicts we requested comment on matters Section III.D.1.1568 Further, as described and to prevent the limitations from discussed in the IRFA. In particular, we above, we acknowledge the requests by causing the associated person or broker- sought comments on the number of commenters for further clarity on what dealer to place the associated person’s small entities that may be affected by it means to ‘‘act in the best interest’’ of or broker-dealer’s interests ahead of the proposed Regulation Best Interest, and the retail customer, and particularly customer’s interest. Finally, the policies whether proposed Regulation Best what it means to make a and procedures must be reasonably Interest would have an effect on small recommendation in a retail customer’s designed to identify and eliminate sales entities that had not been considered. ‘‘best interest’’ under the Care contests, sales quotas, bonuses, and We requested that commenters describe Obligation. Consequently, in Section non-cash compensation that are based the nature of any impact on small II.A, and in the detailed discussion of on the sale of specific securities or entities and provide empirical data to each of the Disclosure, Care, Conflict of specific types of securities within a support the extent of such impact. We Interest, and Compliance Obligations in limited period of time. also requested comment on the Section II.C, we have provided further Fourth, as described in Section II.C.4, proposed compliance burdens and the clarity on how a broker-dealer can under the Compliance Obligation, a effects these burdens would have on comply with Regulation Best Interest. broker-dealer must also establish, smaller entities. However, with respect to the comment maintain, and enforce written policies As discussed in the Economic concerning the term ‘‘suitable,’’ we are and procedures reasonably designed to Analysis and PRA Analysis above, we adopting a ‘‘best interest’’ standard as achieve compliance with Regulation received comments regarding the proposed—which enhances the broker- Best Interest as a whole. Thus, a broker- potential costs and burdens of the dealer standard of conduct beyond dealer’s policies and procedures must proposal on broker-dealers, including existing suitability obligations—in light address not only conflicts of interest but those that are small entities.1564 of our goal to enhance retail investor also compliance with its Disclosure and Additionally, the Commission received protection and decision making. Care Obligations under Regulation Best some comments specifically addressing Another commenter stated that costs Interest. the costs to smaller broker-dealers. for small broker-dealers could be The enhancements contained in One commenter stated that for a small reduced if the Commission approved a Regulation Best Interest will improve firm with $500,000 in net capital, a standard disclosure, which would add investor protection by enhancing the compliance cost of $60,000 1565 could certainty and reduce costs for small 1569 quality of broker-dealer constitute 12% of that net capital, firms and their customers. We recommendations to retail customers making compliance with the rule 1567 and reducing the potential harm to retail burdensome for such firms and See Iowa Insurance Commissioner Letter (‘‘Striking ‘‘suitability,’’ and its history and legal customers that may be caused by potentially forcing many small firms to precedence, will usher in an age of legal and conflicts of interest. Regulation Best hire additional compliance marketing confusion. Additionally, smaller and Interest will complement the related personnel.1566 Another commenter mid-sized professional firms, to avoid the risks of rules, interpretations, and guidance that this confusion and the resulting litigation, will raised concerns that replacing the term leave the market, and the larger firms will remain, the Commission is concurrently increasing market concentration. A decision to issuing.1563 Individually and 1564 See supra Sections III and IV. replace the term ‘‘suitable’’ in the text of traditional collectively, these actions are designed 1565 See NSCP Letter (‘‘Consider the estimated suitability rules with the phrase ‘‘best interest’’ will to help retail customers better $60,000 in additional compliance costs referenced disrupt the market, decrease competition, increase in the Release which would represent 12% of net the price of services out of the reach of thousands understand and compare the services capital of a $500,000 firm.’’) of middle class Americans, and significantly reduce offered by broker-dealers and 1566 See id (‘‘Several small firms estimate that consumer options for selecting valuable investment advisers and make an they incur approximately $80,000 in compliance professional services.’’) But see NAIFA Letter informed choice of the relationship best costs to meet basic ongoing regulatory (‘‘NAIFA supports a best interest standard of conduct for securities-licensed firms and suited to their needs and circumstances, requirements. Notably, this amount does not include expenses associated with new rules, individuals, and we appreciate the SEC’s provide clarity with respect to the regulatory changes, regulatory exams or running a considerable efforts to establish such a standard standards of conduct applicable to compliance department. In isolation, it may seem without imposing unduly prescriptive or investment advisers and broker-dealers, that this single proposal by one regulatory agency burdensome implementation or compliance requirements. The SEC’s general approach, we and foster greater consistency in the would have manageable marginal impact on costs. But in fact, it would be one of many changes (and believe, will preserve choices for consumers at all level of protections provided by each importantly, a major change) that smaller firms income levels and account sizes—and should not regime, particularly at the point in time must address. Many small firms do not have large unnecessarily increase costs for consumers or that a recommendation is made. Compliance Departments adequate to shoulder businesses.’’) All of these requirements are these ever increasing regulatory demands. In fact, 1568 See also infra Section V.E., noting that we many small firm Compliance Departments are believe that Regulation Best Interest will result in discussed in detail in Section II above. comprised of just one or two persons.’’). See also, multiple investor protection benefits, and these The costs and burdens of these generally, NFIB Letter (‘‘America’s small and benefits should apply to retail customers of smaller requirements on small broker-dealers independent businesses in the financial industry entities as well as retail customers of large broker- are discussed below as well as above in cannot afford the army of lawyers and clerks dealers. needed to comply with the welter of complex rules 1569 See Chepucavage Letter (‘‘Costs for the small our Economic Analysis and PRA issued or proposed by the U.S. Department of Labor bd’s however can be reduced with a commission (DOL) (Reference 1 above), the U.S. Securities and approved standard disclosure which would add 1563 See Relationship Summary Adopting Release; Exchange Commission (SEC) (Reference 2 above), certainty and ought to be considered especially for Fiduciary Interpretation; Solely Incidental and the several states to govern the duties of the small investor. [. . .] A standard disclosure Interpretation. financial businesses toward their retail customers.’’) document would also be useful for the small bd that

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considered, as an alternative to the December 31, 2018, approximately including any material limitations on Disclosure Obligation, mandating a 2,766 retail broker-dealers will be the securities or investment strategies standardized disclosure.1570 However, subject to Regulation Best Interest and involving securities that may be as described in Section II.C.1, after the amendments to Rules 17a–3 and recommended to the retail customer; careful consideration of the comments 17a–4.1573 Based on FOCUS Report and (2) all material facts relating to concerning the proposed Disclosure data,1574 the Commission estimated that conflicts of interest that are associated Obligation, we have decided not to as of December 31, 2018, approximately with the recommendation. The require any standard written disclosures 756 of those retail broker-dealers might estimated costs and burdens incurred by under Regulation Best Interest at this be deemed small entities for purposes of small entities in relation to this time. We recognize the wide variety of this analysis.1575 For purposes of this Disclosure Obligation are discussed in business models and practices and we RFA analysis, we refer to broker-dealers detail below.1578 continue to believe it is important to that might be deemed small entities provide broker-dealers with flexibility under the RFA as ‘‘small entities,’’ and a. Obligation To Provide to the Retail to enable them to better tailor disclosure we continue to use the term ‘‘broker- Customer Full and Fair Disclosure, in and information that their retail dealers’’ to refer to broker-dealers Writing, of All Material Facts Relating to customers can understand and may be generally, as the term is used elsewhere the Scope and Terms of the Relationship more likely to read at relevant points in in this release.1576 Of these 756 small With the Retail Customer time, rather than, for example, entities, the Commission estimates that The Commission assumes for mandating a standardized all-inclusive 623 are standalone broker-dealers and purposes of this analysis that small (and likely lengthy) disclosure. 133 are dually registered as investment entities would meet the obligation to The vast majority of commenters advisers.1577 disclose to the retail customer, in supported the Commission’s rulemaking writing, the material facts related to the efforts to address the standards of D. Projected Reporting, Recordkeeping, and Other Compliance Requirements scope and terms of the relationship with conduct that apply to broker-dealers the retail customer through a when making recommendations, but The new requirements impose certain combination of delivery of the nearly all commenters suggested reporting and compliance requirements Relationship Summary,1579 creating modifications to proposed Regulation on certain broker-dealers, including account disclosures to include Best Interest. These suggestions touch those that are small entities. The new standardized language related to the on almost every aspect of the proposal, requirements are summarized in this capacity in which they are acting and as summarized in Section I.C above and FRFA (Section V.A. above). All of these type and scope of services, and the as discussed in more detail, along with requirements are also discussed in development of fee schedules. explanations of modifications made in detail, in Section II above, and these light of the comments, throughout the requirements as well as the costs and b. Estimated Costs and Burdens release. burdens on broker-dealers, including In addition to the costs described those that are small entities, are C. Small Entities Subject to the Rule below, additional costs associated with discussed above in Sections III and IV Regulation Best Interest are described For purposes of a Commission (the Economic Analysis and PRA above in Section III.C.1580 rulemaking in connection with the RFA, Analysis) and below. a broker-dealer will be deemed a small (1) Disclosure of Capacity, Type and 1. Disclosure Obligation entity if it: (i) Had total capital (net Scope of Services worth plus subordinated liabilities) of The Disclosure Obligation under As explained above, standalone Regulation Best Interest requires a less than $500,000 on the date in the broker-dealers that are small entities broker-dealer or its associated persons, prior fiscal year as of which its audited will satisfy the obligation to disclose the prior to or at the time of recommending financial statements were prepared capacity in which they acting through a securities transaction or strategy pursuant to Rule 17a–5(d) under the the delivery to the retail customer of the 1571 involving securities to a retail customer, Exchange Act, or, if not required to Relationship Summary, and to provide the retail customer, in file such statements, had total capital accordingly, we estimate zero burden writing, full and fair disclosure of: (1) (net worth plus subordinated liabilities) hours for standalone broker-dealers that All material facts relating to the scope of less than $500,000 on the last are small entities to disclose the and terms of the relationship with the business day of the preceding fiscal year capacity in which they are acting. retail customer, including: (a) That the (or in the time that it has been in We estimate that a dually registered broker, dealer, or such natural person is business, if shorter); and (ii) is not firm that is a small entity will incur an affiliated with any person (other than a acting as a broker, dealer, or an associated person of a broker or dealer initial internal burden of 10 hours for natural person) that is not a small in-house counsel and in-house business or small organization.1572 with respect to the recommendation, (b) the fees and costs that apply to the retail compliance to draft language regarding As discussed in Section IV above, the the capacity in which it is acting for Commission estimates that as of customer’s transactions, holdings, and accounts, and (c) the type and scope of inclusion in the standardized account services provided to the retail customer, disclosure that is delivered to the retail cannot afford the legal assistance needed to 1581 evaluate this 1,000 page proposal and draft customer. In addition, we estimate appropriate documents. [. . .] The Commission 1573 As noted above, this estimate likely should therefore reconsider the impact of its overstates the number that would be impacted by 1578 For a discussion of additional costs and proposal on small investors and small bd’s with the Regulation Best Interest. See supra Section III.C.1.a. burdens as well as monetized burdens, related to assumption that retirement accounts are 1574 See supra footnote 1384. the Disclosure Obligation, see supra Section significantly more important than regular brokerage 1575 See supra footnote 1386. III.C.2.b. accounts especially for small and elderly investors. 1576 Consistent with the PRA, unless otherwise 1579 See Exchange Act Rule 17a–14 and A standard disclosure for small firms would reduce notes, we use the terms ‘‘registered representative’’ Relationship Summary Adopting Release, supra costs for the firms and their customers.’’) and ‘‘dually registered representative of a broker- footnote 12. 1570 See supra Section III.E and infra Section V.E. dealer’’ herein. 1580 See Sections III.C.2.b, III.C.3.b, III.C.4, III.C.5, 1571 17 CFR 240.17a–5(d). 1577 These estimate are based on FOCUS Report and III.C.6. 1572 See 17 CFR 240.0–10(c). Data, see supra footnote 1384 1581 See supra footnotes 1395–1396.

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that dual-registrants that are small hours 1593 per small entity for the first With respect to delivery of the entities will incur an estimated external year after Regulation Best Interest is in amended account agreements in the cost of $4,970 for the assistance of effect for delivery of the account event of material changes to the capacity outside counsel in the preparation and disclosure document.1594 disclosure or disclosure related to type review of standardized language We therefore estimate a total initial and scope of services, we estimate that regarding capacity.1582 For the aggregate burden for small entities to this would take place among 20% of a estimated 133 dually registered broker- develop and deliver to retail customers small entity’s retail customer accounts dealers that are small entities, we account disclosures relating to the annually. We therefore estimate small project an aggregate initial burden of capacity in which they are acting and entities to incur a total annual aggregate 1,330 hours,1583 and $661,010 in type and scope of services of 7,666 burden of 21 hours, or 0.03 hours per aggregate initial costs for drafting burden hours.1595 small entity per year.1599 language regarding capacity.1584 In terms of ongoing costs, we estimate The total ongoing aggregate burden for Similarly, to comply with Regulation that each dually registered broker-dealer small entities to review, amend, and Best Interest, we believe that small that is a small entity will incur deliver updated account disclosures to entities will draft standardized language approximately 5 burden hours annually reflect changes in capacity, type and for inclusion in the account disclosure for in-house compliance and business- scope of services would be 3,444 burden to provide the retail customer with more line personnel to review changes in the hours per year.1600 specific information regarding the type dual-registrant’s capacity, and another 2 The Commission acknowledges that and scope of services that they provide. burden hours annually for in-house the types of services and product We estimate that a small entity will counsel to amend the account offerings vary greatly by broker-dealer, incur an internal initial burden of 10 disclosure to disclose material changes and therefore the costs or burdens hours for in-house counsel and in-house to the dual-registrant’s capacity, for a associated with updating the account compliance to draft this standardized total of 7 burden hours. The estimated disclosure might also vary. ongoing aggregate burden to amend language.1585 In addition, a small entity (2) Disclosure of Fees and Costs will incur an estimated external cost of account disclosures of dual-registrants that are small entities to reflect changes As stated above, while we anticipate $4,970 for the assistance of outside that many small entities may already counsel in the preparation and review of in capacity is therefore 931 hours per 1596 create fee schedules, we believe that this standardized language.1586 For the year. With respect to small entities, we small entities will initially spend 5 estimated 756 small entities,1587 we estimate an internal burden of 2 hours hours to internally create a new fee project an aggregate initial burden of for in-house compliance and business- schedule in consideration of the 7,560 hours,1588 and aggregate initial line personnel to review and update requirements of Regulation Best Interest. costs of $3.8 million for drafting changes in types or scope of We additionally estimate a one-time language regarding type and scope of services,1597 and another 2 burden external cost of $2,485 for small services.1589 hours annually for in-house counsel to entities.1601 We therefore estimate the We estimate that small entities will amend the account disclosure to initial aggregate burden for small each incur approximately 0.02 burden entities to be 3,780 burden hours,1602 1590 disclose material changes to type and hours for delivery of the account and the initial aggregate cost to be $1.88 1591 scope of services—for a total of 4 burden disclosure document. Based on hours per year. The estimated ongoing million.1603 FOCUS data, we believe that the 756 aggregate burden for standalone broker- Similar to delivery of the account small entities have a total of 5,281 dealers that are small entities to amend disclosure regarding capacity and type customer accounts, and that account disclosures to reflect changes in and scope of services, we estimate the approximately all of those accounts burden for small entities to make the 1592 type and scope of services is therefore belong to retail customers. We 2,492 hours per year.1598 initial delivery of the fee schedule to therefore estimate that small entities new retail customers, at the inception of will have an aggregate initial burden of 1593 These estimates are based on the following the relationship, and existing retail 106 hours, or approximately 0.14 calculations: (0.02 hours per customer account × customers, prior to or at the time of a (5,281 retail customer accounts) = 106 aggregate recommendation, will require 1582 See supra footnote 1397. burden hours. Conversely, (106 hours) / (756 small entities) = approximately 0.14 burden hours per approximately 0.02 hours to deliver to 1583 See supra footnote 1395. This estimate is small entity for the first year after Regulation Best each retail customer.1604 We therefore based on the following calculation: (133 dually Interest is in effect. registered retail firms that are small entities) × (10 estimate that small entities will have an 1594 hours) = 1,330 initial aggregate burden hours.) The See supra footnote 1415. aggregate initial burden of 106 hours, or professional skills associated with the estimated 1595 This estimate is based on the following calculation: (1,330 aggregate initial burden hours burden hours are specified in Section IV above. entities) = 2,492 ongoing aggregate burden hours 1584 This estimate is based on the following for dually registered broker-dealers that are small entities) + (6,230 aggregate initial burden hours for per year. calculation: (133 dually registered retail firms that 1599 × × × standalone broker-dealers that are small entities) + (20%) (5,281 retail customer accounts) are small entities) ($4,970 in external cost per (0.02 hours for delivery to each customer account) firm) = $661,010 in aggregate initial costs. (106 aggregate initial burden hours for small entities to deliver the account disclosures) = 7,666 total = 21 aggregate burden hours per year. Conversely, 1585 See supra footnote 1402. aggregate initial burden hours. 21 aggregate burden hours/756 small entities = 0.03 1586 See supra footnote 1403. 1596 This estimate is based on the following burden hours per small entity per year. 1587 See supra footnote 1385 and accompanying calculation: (7 burden hours per dually registered 1600 This estimate is based on the following text. firm per year) × 133 dually registered broker-dealers calculation: (931 ongoing aggregate burden hours 1588 See supra footnote 1405. that are small entities) = 931 ongoing aggregate for dually registered broker-dealers that are small 1589 See supra footnote 1406. burden hours per year. entities) + (2,492 ongoing aggregate burden hours 1590 See supra footnote 1411. 1597 As noted above, we estimate zero burden for standalone broker-dealers that are small entities) 1591 See supra footnote 1412. hours annually for standalone broker-dealers that + (21 ongoing aggregate burden hours for delivery of amended account disclosures) = 3,444 total 1592 This estimate may overstate the number of are small entities relating to disclosure of capacity ongoing aggregate burden hours per year. retail customer accounts at small entities and/or under the Disclosure Obligation. See supra Section 1601 may overstate the number of deliveries to be made IV.B.1.a.ii. See supra footnote 1426. due to the double-counting of deliveries to be made 1598 This estimate is based on the following 1602 See supra footnote 1428. by dual-registrants to a certain extent, and the fact calculation: (4 burden hours per small entity per 1603 See supra footnote 1429. that one customer may own more than one account. year) × (623 standalone broker-dealers that are small 1604 See supra footnote 1411.

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approximately 0.14 hours per small disclosure document, based on an With respect to ongoing delivery of entity for the first year after Regulation estimated 756 small entities, will be the updated conflict disclosure Best Interest is in effect.1605 3,780 burden hours.1609 We additionally document, we estimate that this will With respect to small entities, we estimate an initial cost of $2,485 per take place among 40% of a small estimate that reviewing and updating small entity,1610 and an aggregate initial entity’s retail customer accounts the fee schedule will require cost of $1.88 million for all small annually, and that small entities will approximately 2 hours per year. Based broker-dealers.1611 require approximately 0.02 hours to on these estimates, we estimate the We assume that small entities will deliver the updated conflict disclosure 1617 recurring, aggregate, annualized burden deliver the standardized conflict document to each retail customer. will be 1,512 hours for small disclosure document to new retail We therefore estimate that small entities 1606 entities. We do not anticipate that customers at the inception of the will incur an aggregate ongoing burden small entities will incur outside legal, relationship, and to existing retail of 42 hours, or 0.06 burden hours per 1618 compliance, or consulting fees in customers prior to or at the time of a small entity per year. connection with updating their recommendation. We estimate that 2. Care Obligation standardized fee schedule since in- small entities will require house personnel would be more approximately 0.02 hours to deliver the As discussed above in Section IV.B.2, knowledgeable about these facts, and we standardized conflict disclosure we believe that any burdens or costs therefore do not expect external costs document to each retail customer.1612 associated with the Care Obligation are associated with updating the fee We therefore estimate that small entities accounted for in other obligations under schedule. will incur an aggregate initial burden of Regulation Best Interest, including the With respect to delivery of the 106 hours, or approximately 0.14 hours Disclosure Obligation and the Record- amended fee schedule in the event of a per small entity for delivery of the making Obligation under Rule 17a– material change, we estimate that this standardized conflict disclosure 3(a)(35) and Recordkeeping Obligation would take place among 40% of a small document the first year after Regulation under Rule 17a–4(e)(5). Other costs entity’s retail customer accounts Best Interest is in effect.1613 applicable to broker-dealers, including annually, and that small entities will Accordingly, the total aggregate initial small entities, associated with the Care require approximately 0.02 hours to burden for small entities is estimated at Obligation are discussed above in deliver the amended fee schedule to 3,886 hours,1614 and the total aggregate Section III.C.3.b. each retail customer. We therefore initial cost is estimated at $1.88 3. Conflict of Interest Obligation estimate small entities would incur a million.1615 total annual aggregate burden of 42 As described more fully above in hours, or 0.06 hours per small We believe that small entities will Section IV.B.3, the Conflict of Interest entity.1607 incur ongoing annual burdens and costs Obligation would generally include the The Commission acknowledges that to update the disclosure document to obligation to: (1) Update written policies the type of fee schedule may vary include newly identified conflicts. We and procedures to comply with greatly by small entity and therefore that estimate that in-house counsel at a small Regulation Best Interest and (2) the costs or burdens associated with entity will require approximately 1 hour establish mechanisms to proactively and updating the standardized fee schedule per year to update the standardized systematically identify and manage might similarly vary. conflict disclosure document, for an conflicts of interest in its business on an ongoing aggregate burden of ongoing or periodic basis.1619 (3) Disclosure of All Material Facts approximately 756 hours per year.1616 Relating to Conflicts of Interest We do not anticipate that small entities a. Written Policies and Procedures Associated With the Recommendation will incur outside legal, compliance, or i. Initial Costs and Burdens consulting fees in connection with We believe that many or most small To initially comply with this updating their standardized conflict entities will develop a standardized obligation, we believe that small entities disclosure document, since in-house conflict disclosure document and would primarily rely on outside counsel 1608 personnel would presumably be more deliver it to their retail customers. to update existing policies and knowledgeable about conflicts of For small entities, we estimate it will procedures, as small broker-dealers interest. take in-house counsel, on average, 5 generally have fewer in-house legal and burden hours to create the standardized compliance personnel. We estimate that 1609 conflict disclosure document and See supra footnote 1444. 40 hours of outside legal counsel 1610 See supra footnote 1445. outside counsel 5 hours to review and services would be required, for a one- revise the document. We estimate that 1611 See supra footnote 1446. 1612 time initial cost of $19,880 per small the initial aggregate burden for the See supra footnote 1411. For purposes of this analysis, we have assumed any initial disclosures entity,1620 and an aggregate initial cost development of a standardized made by the small entities related to material of $15.0 million for all small conflicts of interest will be delivered together. entities.1621 We also expect that in- 1605 This estimate is based on the following 1613 These estimates are based on the following calculation: (5,281 retail customer accounts) × (0.02 calculations: (0.02 hours per customer account × hours for delivery to each customer account) = 106 5,281 retail customer accounts) = 106 aggregate 1617 See supra footnote 1455. aggregate burden hours. Conversely, (106 aggregate burden hours. Conversely, (106 hours)/(756 small 1618 This estimate is based on the following burden hours) / (756 small entities) = 0.14 burden entities) = 0.14 burden hours per small entity for calculation: (40% of 5,281 retail customer accounts) hours per small entity for the first year after the first year after Regulation Best Interest is in × (0.02 hours) = 42 aggregate burden hours. Regulation Best Interest is in effect. effect. Conversely, (42 aggregate burden hours per year)/ 1606 See supra footnote 1437. 1614 This estimate is based on the following (756 small entities) = 0.06 hours per small entity 1607 This estimate is based on the following calculation: (3,780 aggregate initial burden hours per year. calculation: (40% of 5,281 retail customer accounts) for the development of a standardized conflict 1619 See supra Section IV.B.3. For a discussion of × (0.02 hours) = 42 aggregate burden hours. disclosure document) + (106 burden hours for additional costs and burdens, as well as monetized Conversely, (42 aggregate burden hours)/(756 small delivery of the standardized conflict disclosure burdens, related to the Conflict of Interest entities) = 0.06 burden hours per small entity per document) = 3,886 aggregate initial burden hours. Obligation, see supra Section III.C.4. year. 1615 See supra footnote 1429. 1620 See supra footnote 1477. 1608 See supra footnote 1443. 1616 See supra footnote 1453. 1621 See supra footnote 1478.

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house compliance would require 10 therefore be $4.29 million,1632 and 3,780 a whole, including each of the hours to review and approve the burden hours.1633 component obligations. updated policies and procedures, for an As a result of the changes made to the In total, to comply with the Conflict initial aggregate burden of 7,560 rule text of the Conflict of Interest of Interest Obligation, the Commission hours.1622 Therefore, we estimate the Obligation of Regulation Best Interest, estimates that the total initial burdens total initial aggregate burden for small we believe that small entities would and costs for small entities to be 135,720 entities to be 128,160 hours 1623 and the incur burdens to determine how to hours 1640 and $29.29 million 1641 and total initial aggregate cost to be $25.0 manage the conflict of interest. We the total ongoing burdens and costs for million.1624 believe that small entities would require small entities to be 11,340 hours 1642 approximately 20 hours per small and $2.91 million.1643 We believe that the related ongoing entity,1634 for an aggregate of 15,120 costs for small entities (relating to initial burden hours for all small 4. Compliance Obligation outside counsel reviewing and updating entities.1635 The total initial aggregate As discussed above, in response to policies and procedures on a periodic burden for small entities for comments that we should require basis) would be $2,485 annually for policies and procedures to comply with 1625 identification and management of each small entity, and the projected conflicts of interest is therefore 18,900 the rule as a whole, we are adopting the aggregate, annual ongoing cost for small initial burden hours.1636 Compliance Obligation.1644 Because we entities (relating to outside legal To maintain compliance with the did not include the Compliance 1626 counsel) would be $1.88 million. In Conflict of Interest Obligation, we Obligation in the Proposing Release, we addition, we expect that small entities believe that for purposes of this did not include costs and burdens would require five hours of outside analysis, small entities would, through associated with the Compliance compliance services per year to update the help of the business line and Obligation, but have provided a detailed their policies and procedures, for an compliance personnel, spend on average explanation in Section IV.B.4 above, ongoing cost of $1,365 per year per 10 hours 1637 to perform an annual and a summary below. small entity,1627 and an aggregate conflicts review using the modified To comply with the Compliance ongoing cost of $1.03 million per technology infrastructure.1638 Therefore, Obligation, we believe that small year.1628 The total aggregate, ongoing the aggregate ongoing burden for an entities would primarily rely on outside cost for small entities is therefore annual conflicts review, based on an counsel to update existing policies and projected at $2.91 million per year.1629 estimated 756 small entities, would be procedures, and that 20 hours of outside In addition to the costs described approximately 7,560 burden hours per legal counsel services would be above, we additionally believe small year.1639 Because we assume that small required, for a one-time cost of $9,940 broker-dealers would incur an internal entities would use in-house personnel per small entity,1645 and an aggregate burden of approximately five hours for to identify and evaluate new, potential initial cost of $7.5 million for all small an in-house compliance manager to conflicts, we continue to believe they entities.1646 We also expect that in- review and approve the updated would not incur additional ongoing house compliance personnel would policies and procedures per year. The costs. require 6 hours to review and approve ongoing, aggregate burden for small c. Training the updated policies and procedures, for broker-dealers would be 3,780 hours for an aggregate initial burden of 4,536 in-house compliance manager review As discussed in the Proposing hours.1647 per year.1630 Release, we expect that small entities In terms of ongoing costs, we assume would develop training programs to for purposes of this analysis that small b. Identification and Management of comply with Regulation Best Interest, entities would mostly rely on outside Conflicts of Interest including the Conflict of Interest legal counsel and compliance Obligation. However, we believe that consultants for review and update of To comply with Regulation Best any burdens and costs associated with their policies and procedures, with final Interest, we expect that small entities a training program would fall under the review and approval from an in-house would modify existing technology new Compliance Obligation as it would compliance manager. We estimate that through an outside programmer which be developed to comply with the rule as outside counsel would require would require, on average, an estimated approximately five hours per year to 20 hours, for an estimated initial cost 1632 This cost estimate is based on the following update policies and procedures, for an per small entity of $5,680.1631 We calculation: ($5,680 in outside programmer costs additionally continue to project that per broker-dealer) × (756 small entities) = $4.29 million in aggregate initial outside programmer 1640 This estimate is based on the following coordination between the programmer costs. calculation: (128,160 burden hours for written and the small entity’s compliance 1633 This burden estimate is based on the policies and procedures) + (7,560 burden hours for manager would involve five initial following calculation: (5 burden hours) × (756 small identification and management of conflicts of burden hours. The aggregate initial costs entities) = 3,780 aggregate initial burden hours. interest) = 135,720 hours. 1641 and burdens for small entities for the 1634 See supra footnotes 1501 and 1502. This estimate is based on the following 1635 This burden estimate is based on the calculation: ($25 million initial aggregate costs modification of existing technology to following calculation: (20 burden hours) × (756 relating to written policies and procedures) + ($4.29 identify conflicts of interest would small entities) = 15,120 aggregate initial burden million initial aggregate costs for modification of hours. existing technology to identify conflicts of interest) = $29.29 million initial aggregate costs. 1622 See supra footnote 1479. 1636 This burden estimate is based on the 1642 This estimate is based on the following 1623 See supra footnote 1480. following calculation: (3,780 burden hours for modification of technology) + (15,120 burden hours calculation: (3,780 burden hours for reviewing and 1624 See supra footnote 1481. for evaluation of managing conflicts) = 18,900 total approving the updated policies and procedures) + 1625 See supra footnote 1486. aggregate initial burden hours. (7,560 burden hours for annual conflicts review) = 1626 See supra footnote 1487. 1637 See supra footnote 1507. 11,340 initial aggregate burden hours. 1627 1643 See supra footnote 1488. 1638 See supra footnote 1508. See supra footnote 1629. 1628 1644 See supra footnote 1489. 1639 This estimate is based on the following Section II.C.4. 1629 See supra footnote 1490. calculation: (10 hours of labor per small entity per 1645 See supra footnote 1523. 1630 See supra footnote 1491. year) × (756 small entities) = 7,560 aggregate burden 1646 See supra footnote 1524. 1631 See supra footnote 1497. hours per year. 1647 See supra footnote 1525.

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annual cost of $2,485 for each small approve the training module and projected initial, aggregate cost for small entity.1648 The projected aggregate, implement the training program would entities is therefore estimated to be annual ongoing cost for outside legal be 8,118 initial burden hours.1657 $375,732.1664 Finally, we estimate it counsel to update policies and For purposes of this analysis, we will require an additional 0.04 hours for procedures for small entities would be assume that small entities would likely the registered representative responsible $1.88 million per year.1649 In addition, require registered representatives to for the information (or other clerical we expect that a small entity would repeat the training module for personnel) to fill out that information in require five hours of outside compliance Regulation Best Interest on an annual the account disclosure document, for an services per year to update its policies basis. The ongoing aggregate cost for the approximate total aggregate initial and procedures, for an ongoing cost of one-hour training would be 5,094 burden of 211 hours, or approximately $1,365 per year,1650 and an aggregate burden hours per year, or 6.7 burden 0.28 hours per small entity for the first ongoing cost of $1.03 million per hours per small entity per year.1658 year after the rule is in effect.1665 year.1651 The total aggregate, ongoing In total, for small entities to comply Because we have already included the cost for small entities is therefore with the Compliance Obligation, the costs and burdens associated with the projected at $2.91 million per year.1652 Commission estimates the total initial creation of a record to memorialize an burdens and costs to be 12,654 a. Training oral disclosure, and the delivery of the hours 1659 and $23.31 million,1660 and amended account disclosure document Pursuant to the obligation to the total ongoing burdens and costs to in Section V.D.1., we need not include ‘‘maintain and enforce’’ written policies be 5,094 hours 1661 and $2.91 them in this section of the analysis. and procedures, we additionally believe million.1662 We do not believe that the identity of small entities will develop training 5. Record-Making and Recordkeeping the registered representative responsible programs that promote compliance with Obligations for the retail customer’s account will Regulation Best Interest. change. Accordingly, we continue We estimate that a small entity would The record-making and recordkeeping believe that there are no ongoing costs retain an outside systems analyst, obligations will impose record-making and burdens associated with this record- outside programmer, and an outside and recordkeeping requirements on making requirement of the amendment programmer analyst to create a training broker-dealers with respect to certain to Rule 17a–3(a)(35). With respect to module, at 20 hours, 40 hours, and 20 information collected from, or provided memorializing oral disclosures, we hours, respectively. The total cost to to, retail customers. estimate that this would take place develop the training module would be a. Record-Making Obligation among 52% of a small entity’s retail approximately $20,920 per small customers (and thus 52% of a registered 1653 As discussed above, we continue to entity, for an aggregate initial cost to representative’s retail customer 1654 believe that small entities will satisfy small entities of $17.18 million. accounts) annually.1666 We therefore Additionally, we expect that the the record-making requirements of the estimate that small entities will incur a training module would require the amendment to Rule 17a–3(a)(35) by total annual aggregate ongoing burden of approval of the Chief Compliance amending an existing account 55 hours or 0.07 hours per small entity Officer, as well as in-house counsel, disclosure document to include certain per year.1667 each of whom would require information.1663 We believe that the approximately 2 hours to review and inclusion of this information in an b. Recordkeeping Obligation account disclosure document will approve the training module. The initial For purposes of this analysis, we require, on average, approximately 1 aggregate burden for small entities is assume the following records would hour per year for outside counsel at therefore estimated at 3,024 initial likely be retained pursuant to amended 1655 small entities, at an updated average burden hours. Rule 17a–3(a)(35): (1) Existing account rate of $497/hour, for an annual cost of In addition, small entities would disclosure documents; (2) $497 for each small entity to update an incur an initial cost for registered comprehensive fee schedules; (3) representatives to undergo training account disclosure document. The disclosures identifying material through the training module. We conflicts; and (4) memorialized oral estimate the training time at one hour 1657 This estimate is based on the following disclosures under the circumstances per associated person, for an aggregate calculation: (5,094 burden hours for training of registered representatives) + (3,024 burden hours to outlined in Section II.C.1, Oral initial burden of 5,094 burden hours, or approve training program) = 8,118 total aggregate Disclosure or Disclosure After a an initial burden of 6.7 hours per small initial burden hours. 1656 1658 Recommendation. entity. The total aggregate burden to See supra footnote 1656. Based on our belief that small entities 1659 This estimate is based on the following will rely on existing infrastructures to 1648 See supra footnote 1529. calculation: (4,536 initial burden hours for policies and procedures) + (8,118 initial burden hours 1649 See supra footnote 1530. satisfy the recordkeeping obligations of training) = 12,654 initial burden hours to comply 1650 Regulation Best Interest and the See supra footnote 1531. with Compliance Obligation. 1651 amendment to Rule 17–a(4)(e)(5), we See supra footnote 1532. 1660 This estimate is based on the following 1652 See supra footnote 1533. calculation: ($7.5 million initial costs for policies 1653 See supra footnote 1534. and procedures) + ($15.81 million initial costs for 1664 See supra footnote 1548. 1654 This estimate is based on the following training) = $23.31 million initial total costs to 1665 These estimates are based on the following calculation: (756 small entities) × ($20,920 initial comply with Compliance Obligation. calculations: (0.04 hours per customer account) × costs per broker-dealer) = $15.81 million in 1661 This estimate is based on the following (5,281 retail customer accounts at small entities) = aggregate initial costs for technology services. calculation: (0 ongoing burden hours for policies 211 aggregate initial burden hours. Conversely, (211 1655 This estimate is based on the following and procedures) + (5,094 ongoing burden hours for burden hours)/(756 small entities) = 0.28 initial calculation: (756 small entities) × (4 initial burden training) = 5,094 ongoing burden hours to comply burden hours per broker-dealer. hours per small entity) = 3,024 initial burden hours. with Compliance Obligation. 1666 See supra footnote 1554. 1656 This estimate is based on the following 1662 This estimate is based on the following 1667 (52%) × (5,281 retail customer accounts at calculation: (1 burden hour) × (5,094 registered calculation: ($2.91 million ongoing costs for small entities) × (0.02 hours for recording each oral representatives at small entities) = 5,094 aggregate policies and procedures) + ($0 ongoing costs for disclosure relating to a retail customer’s account) = initial burden hours. Conversely, (5,094 aggregate training) = $2.91 million ongoing total costs to 55 aggregate burden hours per year. Conversely, 55 burden hours)/(756 small entities) = 6.7 initial comply with Compliance Obligation. aggregate burden hours/756 small entities = 0.07 burden hours per broker-dealer. 1663 See supra Section IV.B.5.a.i. ongoing burden hours per small entity per year.

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believe the burden for small entities to requirements or timetables that take into amendments to Rules 17a–3 and 17a– add new documents or modify existing account the resources available to small 4(e)(5). documents to the small entity’s existing entities; (2) the clarification, Moreover, we continue to believe that retention system will be approximately consolidation, or simplification of providing an exemption or different 704 burden hours for small entities, compliance and reporting requirements requirements for small entities would be assuming a small entity will need to for small entities; (3) the use of inconsistent with our goal of facilitating upload or file each of the four account performance rather than design more consistent regulation, in documents discussed above for each standards; and (4) an exemption from recognition of the importance for both retail customer account.1668 We do not coverage of the new requirements, or investors and broker-dealers of having believe there will be additional internal any part thereof, for such small entities. the applicable standards for brokerage or external costs relating to the Regarding the first alternative, the recommendations be clear, uploading or filing of the documents. In Commission does not believe that we understandable, and as consistent as addition, because we have already could effectively achieve our stated possible across a brokerage relationship included the costs and burdens objectives by establishing different (i.e., whether for retirement or non- associated with the delivery of the requirements applicable to broker- retirement purposes) and better aligned amended account opening agreement dealers of different sizes. We considered with other advice relationships (e.g., a and other documents in Section V.D.1 adopting tiered compliance dates so that relationship with an investment above, we do not include them in this smaller broker-dealers would have had adviser). Further, as discussed above, section of the analysis. more time to comply. However, as broker-dealers are subject to regulation We estimate that the approximate discussed in Section II.E above, we under the Exchange Act and the rules of ongoing burden associated with the believe the operational capability each SRO of which the broker-dealer is recordkeeping requirement of the needed to develop processes to comply a member, including a number of amendment to Rule 17a–4(e)(5) is 231 with Regulation Best Interest is obligations that attach when a broker- burden hours per year.1669 We do not sufficiently established by firms of all dealer makes a recommendation to a believe that the ongoing costs associated sizes and resources. The Commission customer, as well as general and specific with ensuring compliance with the has determined, in light of the requirements aimed at addressing retention schedule would change from importance of the protections afforded certain conflicts of interest. We note that the current costs of ensuring compliance by Regulation Best Interest to retail these existing requirements do not with existing Rule 17a–4 and as customers, that a Compliance Date of generally distinguish between small outlined above. one year after the Effective Date is an entities and other broker-dealers. appropriate timeframe for firms to For the same reasons as described in E. Agency Action To Minimize Effect on conduct the requisite operational the Proposing Release, we still do not Small Entities changes to their systems to establish believe that additional clarification, The RFA directs the Commission to internal processes to comply with consolidation, or simplification of consider significant alternatives that Regulation Best Interest. Further, as compliance and reporting requirements would accomplish the stated objective, discussed above in Section III, each of would be appropriate for small entities. while minimizing any significant the component obligations in Regulation We note, however, in crafting adverse impact on small entities. As Best Interest shares features with Regulation Best Interest, we generally described in the Proposing Release we existing market best practices, as shaped aimed to provide broker-dealers considered the following alternatives for by FINRA’s guidance on relevant rules flexibility in determining how to satisfy small entities in relation to the new or as described in its Report on Conflicts the component obligations. We continue requirements: (1) The establishment of of Interest.1670 To the extent that broker- to believe that this flexibility reflects a differing compliance or reporting dealer (and small entity) practices are general performance-based approach, already aligned with the requirements of rather than design-based approach. 1668 This estimate is based on the following Regulation Best Interest, the anticipated As discussed in the Economic calculation: (4 documents per customer account) × Analysis in Section III.E above, the (5,281 retail customer accounts at small entities) × magnitude of the costs associated with (2 minutes per document)/60 minutes = 704 a given component of the rule will be Commission also considered a number aggregate burden hours. correspondingly reduced.1671 of alternatives as they affect all firms, 1669 This estimate is based on the percentage of As discussed above, we believe that including small entities. Specifically, account records we expect would be updated each Regulation Best Interest will result in the Commission considered three year as described in Section IV.B.1, supra, and the different options for imposing a following calculation: ((40% of fee schedules × important investor protection benefits, 5,281 retail customer accounts at small entities) × and these benefits apply to retail fiduciary standard on broker-dealers: (1) (2 minutes per document) + (40% of conflict customers of smaller entities as well as Applying the fiduciary standard under disclosure forms × 5,281 retail customer accounts the Advisers Act to broker-dealers; (2) × retail customers of large broker-dealers. at small entities) (2 minutes per document) + adopting a ‘‘new’’ uniform fiduciary (20% of account opening documents × 5,281 retail For example, a primary objective of this customer accounts at small entities) × (2 minutes rulemaking is to enhance the quality of standard of conduct applicable to both per document)) = 10,560 minutes/60 minutes = 176 recommendations provided by broker- broker-dealers and investment advisers, aggregate ongoing burden hours. In addition, with dealers to retail customers, by such as that recommended by the staff respect to ongoing memorialization of the updated oral disclosures, we estimate that this will take establishing under the Exchange Act a in the 913 Study, and, or (3) adopting place among 52% of a small entity’s retail customer ‘‘best interest’’ obligation. We do not similar standards to what the DOL had accounts annually. We therefore estimate that small believe that the interest of investors who provided under its fiduciary rule to entities will incur an aggregate ongoing burden of are retail customers would be served by broker-dealers and investment advisers. 55 hours, or 0.07 burden hours per broker-dealer (calculated as follows: (52% of updated oral establishing differing compliance or The Commission further considered disclosures × 5,281 retail customer accounts at reporting requirements or timetables for requiring broker-dealers to use a specific small entities) × (1.2 minutes per document) = 3,295 broker-dealers that are small entities form for disclosure, similar to, for minutes/60 minutes = 55 aggregate ongoing burden under Regulation Best Interest and the example, Form ADV Part II in lieu of the hours (or 55 aggregate burden hours/756 small entities = 0.07 burden hours per small entity)). 176 flexible approach of the Disclosure hours + 55 hours = 231 total aggregate ongoing 1670 See supra Section III.C.1.b. Obligation, or in the alternative, burden hours. 1671 See supra text following footnote 1159. developing a disclosure-only standard,

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which would require that broker-dealers 1350; and Pub. L. 111–203, 939A, 124 Stat. basis to believe that the satisfy only the Disclosure Obligation of 1887 (2010); and secs. 503 and 602, Pub. L. recommendation could be in the best the final rule. 112–106, 126 Stat. 326 (2012), unless interest of at least some retail customers; We acknowledge certain commenters otherwise noted. (B) Have a reasonable basis to believe urged the Commission to take additional * * * * * that the recommendation is in the best or different regulatory actions than the Section 240.15l–1 is also issued under Pub. interest of a particular retail customer approach we have adopted, including L. 111–203, sec. 913, 124 Stat. 1376, 1827 based on that retail customer’s the alternatives discussed above. We do (2010). investment profile and the potential not believe that any rulemaking * * * * * risks, rewards, and costs associated with governing retail investor-advice ■ 2. Add § 240.15l–1 to read as follows: the recommendation and does not place relationships can solve for every issue the financial or other interest of the § 240.15l–1 Regulation Best Interest. presented. After careful consideration of broker, dealer, or such natural person the comments and additional (a) Best interest obligation. (1) A ahead of the interest of the retail information we have received, we broker, dealer, or a natural person who customer; believe that Regulation Best Interest, as is an associated person of a broker or (C) Have a reasonable basis to believe modified, appropriately balances the dealer, when making a recommendation that a series of recommended concerns of the various commenters in of any securities transaction or transactions, even if in the retail a way that will best achieve the investment strategy involving securities customer’s best interest when viewed in Commission’s important goals of (including account recommendations) to isolation, is not excessive and is in the enhancing retail investor protection and a retail customer, shall act in the best retail customer’s best interest when decision making, while preserving, to interest of the retail customer at the time taken together in light of the retail the extent possible, retail investor the recommendation is made, without customer’s investment profile and does access (in terms of choice and cost) to placing the financial or other interest of not place the financial or other interest differing types of investment services the broker, dealer, or natural person of the broker, dealer, or such natural and products. who is an associated person of a broker person making the series of or dealer making the recommendation recommendations ahead of the interest VI. Statutory Authority and Text of the ahead of the interest of the retail of the retail customer. Rule customer. (iii) Conflict of interest obligation. The Pursuant to Dodd-Frank Wall Street (2) The best interest obligation in broker or dealer establishes, maintains, Reform and Consumer Protection Act paragraph (a)(1) of this section shall be and enforces written policies and Section 913(f), Public Law 111–203, 124 satisfied if: procedures reasonably designed to: Stat. 1376, 1827 (2010), and Exchange (i) Disclosure obligation. The broker, (A) Identify and at a minimum Act sections 3, 10, 15, 15(c)(6), 15(l), 17, dealer, or natural person who is an disclose, in accordance with paragraph 23 and 36 thereof, 15 U.S.C. 78c, 78j, associated person of a broker or dealer, (a)(2)(i) of this section, or eliminate, all 78o, 78o(c)(6), 78o(l), 78q, 78w and prior to or at the time of the conflicts of interest associated with such 78mm, the Commission is adopting recommendation, provides the retail recommendations; § 240.15l–1 and adopting amendments customer, in writing, full and fair (B) Identify and mitigate any conflicts to § 240.17a–3 by adding new paragraph disclosure of: of interest associated with such (a)(25), and to revise § 240.17a–4(e)(5) of (A) All material facts relating to the recommendations that create an Title 17 of the Code of Federal scope and terms of the relationship with incentive for a natural person who is an Regulations in the manner set forth the retail customer, including: associated person of a broker or dealer below. (1) That the broker, dealer, or such to place the interest of the broker, natural person is acting as a broker, dealer, or such natural person ahead of List of Subjects in 17 CFR Part 240 dealer, or an associated person of a the interest of the retail customer; Brokers, Reporting and recordkeeping broker or dealer with respect to the (C)(1) Identify and disclose any requirements, Securities. recommendation; material limitations placed on the (2) The material fees and costs that securities or investment strategies Text of the Rule apply to the retail customer’s involving securities that may be In accordance with the foregoing, transactions, holdings, and accounts; recommended to a retail customer and Title 17, Chapter II of the Code of and any conflicts of interest associated with Federal Regulations is amended as (3) The type and scope of services such limitations, in accordance with follows: provided to the retail customer, subparagraph (a)(2)(i), and including any material limitations on (2) Prevent such limitations and PART 240—GENERAL RULES AND the securities or investment strategies associated conflicts of interest from REGULATIONS, SECURITIES involving securities that may be causing the broker, dealer, or a natural EXCHANGE ACT OF 1934 recommended to the retail customer; person who is an associated person of and the broker or dealer to make ■ 1. The authority citation for part 240 (B) All material facts relating to recommendations that place the interest is amended by adding sectional conflicts of interest that are associated of the broker, dealer, or such natural authorities for section 240.15l–1 to read with the recommendation. person ahead of the interest of the retail as follows: (ii) Care obligation. The broker, customer; and Authority: 15 U.S.C. 77c, 77d, 77g, 77j, dealer, or natural person who is an (D) Identify and eliminate any sales 77s, 77z–2, 77z–3, 77eee, 77ggg, 77nnn, associated person of a broker or dealer, contests, sales quotas, bonuses, and 77sss, 77ttt, 78c, 78c–3, 78c–5, 78d, 78e, 78f, in making the recommendation, non-cash compensation that are based 78g, 78i, 78j, 78j–1, 78k, 78k–1, 78l, 78m, 78n, 78n–1, 78o, 78o–4, 78o–10, 78p, 78q, exercises reasonable diligence, care, and on the sales of specific securities or 78q–1, 78s, 78u–5, 78w, 78x, 78ll, 78mm, skill to: specific types of securities within a 80a–20, 80a–23, 80a–29, 80a–37, 80b–3, 80b– (A) Understand the potential risks, limited period of time. 4, 80b–11, 7201 et seq.; and 8302; 7 U.S.C. rewards, and costs associated with the (iv) Compliance obligation. In 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. recommendation, and have a reasonable addition to the policies and procedures

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required by paragraph (a)(2)(iii) of this person from obtaining that required reference Investor.gov/CRS, a page on section, the broker or dealer establishes, information. the Commission’s investor education maintains, and enforces written policies * * * * * website, Investor.gov, which offers and procedures reasonably designed to ■ 4. Amend § 240.17a–4 by revising educational information to investors achieve compliance with Regulation paragraph (e)(5) to read as follows: about investment advisers, broker- Best Interest. dealers, and individual financial (b) Definitions. Unless otherwise § 240.17a–4 Records to be preserved by professionals and other materials. Retail provided, all terms used in this rule certain exchange members, brokers and investors will receive a relationship shall have the same meaning as in the dealers. summary at the beginning of a Securities Exchange Act of 1934. In * * * * * relationship with a firm, addition, the following definitions shall (e) * * * communications of updated information apply for purposes of this section: (5) All account record information following a material change to the (1) Retail customer means a natural required pursuant to § 240.17a–3(a)(17) relationship summary, and an updated person, or the legal representative of and all records required pursuant to relationship summary upon certain such natural person, who: § 240.17a–3(a)(35), in each case until at events. The relationship summary is (i) Receives a recommendation of any least six years after the earlier of the subject to Commission filing and securities transaction or investment date the account was closed or the date recordkeeping requirements. on which the information was collected, strategy involving securities from a DATES: broker, dealer, or a natural person who provided, replaced, or updated. Effective dates: The rules and form are is an associated person of a broker or * * * * * effective September 10, 2019. dealer; and By the Commission. Compliance dates: The applicable (ii) Uses the recommendation Dated: June 5, 2019. compliance dates are discussed in primarily for personal, family, or Vanessa Countryman, section II.D. household purposes. Acting Secretary. FOR FURTHER INFORMATION CONTACT: : (2) Retail customer investment profile [FR Doc. 2019–12164 Filed 7–11–19; 8:45 am] Gena Lai, James McGinnis, Elizabeth includes, but is not limited to, the retail Miller, Sirimal R. Mukerjee, Olawale´ BILLING CODE 8011–01–P customer’s age, other investments, Oriola, Alexis Palascak, Benjamin financial situation and needs, tax status, Tecmire, Roberta Ufford, Jennifer Porter investment objectives, investment SECURITIES AND EXCHANGE (Branch Chief), Investment Adviser experience, investment time horizon, COMMISSION Regulation Office at (202) 551–6787 or liquidity needs, risk tolerance, and any [email protected]; Benjamin Kalish and other information the retail customer 17 CFR Parts 200, 240, 249, 275, and Parisa Haghshenas (Branch Chief), Chief may disclose to the broker, dealer, or a 279 Counsel’s Office at (202) 551–6825 or natural person who is an associated [email protected], Division of Investment person of a broker or dealer in [Release Nos. 34–86032; IA–5247; File No. S7–08–18] Management; Alicia Goldin, Emily connection with a recommendation. Westerberg Russell, Lourdes Gonzalez (3) Conflict of interest means an RIN 3235–AL27 (Assistant Chief Counsel), Office of interest that might incline a broker, Chief Counsel, Division of Trading and dealer, or a natural person who is an Form CRS Relationship Summary; Markets, at (202) 551–5550 or associated person of a broker or dealer Amendments to Form ADV [email protected], Securities —consciously or unconsciously—to AGENCY: Securities and Exchange and Exchange Commission, 100 F Street make a recommendation that is not Commission. NE, Washington, DC 20549. disinterested. ACTION: Final rule. SUPPLEMENTARY INFORMATION: The ■ 3. Amend § 240.17a–3 by adding Commission is adopting new rule 17 reserved paragraphs (a)(24) through (34) SUMMARY: The Securities and Exchange CFR 275.204–5 [rule 204–5] under the and paragraph (a)(35) to read as follows: Commission (the ‘‘Commission’’ or the Investment Advisers Act of 1940 [15 ‘‘SEC’’) is adopting new rules and forms U.S.C. 80b] 1 and is adopting § 240.17a–3 Records to be made by certain as well as amendments to its rules and amendments to Form ADV to add a new exchange members, brokers and dealers. forms, under both the Investment Part 3: Form CRS [17 CFR 279.1] under (a) * * * Advisers Act of 1940 (‘‘Advisers Act’’) the Advisers Act. The Commission is (24)–(34) [Reserved]. and the Securities Exchange Act of 1934 also adopting amendments to rules 17 (35) For each retail customer to whom (‘‘Exchange Act’’) to require registered CFR 275.203–1 [rule 203–1], 17 CFR a recommendation of any securities investment advisers and registered 275.204–1 [rule 204–1], and 17 CFR transaction or investment strategy broker-dealers (together, ‘‘firms’’) to 275.204–2 [rule 204–2] under the involving securities is or will be provide a brief relationship summary to Advisers Act. The Commission is provided: retail investors. The relationship adopting new rule 17 CFR 240.17a–14 (i) A record of all information summary is intended to inform retail [rule 17a–14] 2 under the Securities collected from and provided to the retail investors about: The types of client and customer pursuant to § 240.15l–1, as customer relationships and services the 1 15 U.S.C. 80b. Unless otherwise noted, when we well as the identity of each natural firm offers; the fees, costs, conflicts of refer to the Advisers Act, or any paragraph of the person who is an associated person, if interest, and required standard of Advisers Act, we are referring to 15 U.S.C. 80b, at which the Advisers Act is codified, and when we any, responsible for the account. conduct associated with those refer to rules under the Advisers Act, or any (ii) For purposes of this paragraph relationships and services; whether the paragraph of these rules, we are referring to Title (a)(35), the neglect, refusal, or inability firm and its financial professionals 17, part 275 of the Code of Federal Regulations [17 of the retail customer to provide or currently have reportable legal or CFR 275], in which these rules are published. 2 15 U.S.C. 78a. Unless otherwise noted, when we update any information described in disciplinary history; and how to obtain refer to the Exchange Act, or any paragraph of the paragraph (a)(35)(i) of this section shall additional information about the firm. Exchange Act, we are referring to 15 U.S.C. 78a, at excuse the broker, dealer, or associated The relationship summary will also which the Exchange Act is codified, and when we

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