Must Investment Brokers Disclose Conflicts of Interest?

In April 2018, the U.S. Securities and Exchange Commission (SEC) proposed new rules for securities brokers, which it subsequently adopted in June 2019 and went into effect in June 2020. Most notable among the new rules is Regulation Best Interest (Reg BI), which would apply to brokers when giving investment advice to retail investors.

The regulation proposes that broker-dealers “act in the best interest of their retail customers” and not place the broker’s interests ahead of the retail investor. Part of the rule requires brokers to make a full and fair disclosure of material conflicts of interest to their clients.

What Problems Did the New SEC Rule Address?

Under previous securities regulations, brokers only needed to demonstrate that their investment recommendations were suitable for their investor client. To satisfy that standard, brokers were obligated to obtain an investment profile from their customers and have a reasonable basis to believe their advice could be in the best interest of that customer. Brokers were not required to address conflicts of interest with the client.

Many industry professionals found the suitability standard of conduct inadequate when it came to protecting investors. Brokers often did not disclose commissions and fees earned from putting clients in certain investments, and clients were often in the dark regarding whether another proprietary product might serve them better.

What Does the Rule on Broker Conflicts Do?

The old rule remained in place but was expanded to include new obligations for brokers involving disclosure and mitigation of conflicts of interest. Brokers are required to give retail customers a “full and fair” disclosure of material facts relating to the scope and terms of their relationship, as well as all material conflicts of interest involved with the broker’s advice.

The new rule also requires that broker-dealers implement new written policies targeted at mitigation or elimination of “all material conflicts of interest” associated with the broker’s investment strategies. Specifically, the brokerage firm’s policies must mitigate or eliminate conflicts of interest that arise from financial incentives for the broker.

While the rule appears to bring brokers closer to a fiduciary standard of care for their clients, many industry professionals believe the rules do not go far enough and that retail investors will still get pushed into products that benefit the broker. Several of the five SEC commissioners expressed concern with the new rule, but one commissioner voted against the rules completely. Commissioner Stein released a statement, explaining, “When there is a question of where the burden of uncertainty should rest—it should rest with the more informed party—the financial professional. Unfortunately, today’s package of proposals in many ways continues to place the burden on the retail investor.”

Further among the rule changes is a restriction on brokers from labeling themselves as “advisors.” This proposal is aimed at decreasing confusion for retail investors over the various titles used by investment professionals who do not have the same fiduciary duty.

Protecting Client’s Best Interests with Legal Counsel

Retail investors with concerns about broker conduct or potential conflicts should discuss their concerns with an experienced securities attorney who can educate their clients on the broker’s obligations or pursue damages if the customer is harmed by broker conduct. For more information about this area, read our securities and corporate finance law overview.