Mark Quinn, director of regulatory affairs at Cetera Financial Group, joins us to discuss Regulation Best Interest, which federal regulators began enforcing in June 2020 to hold brokers to similar conduct standards as fiduciary advisors. Despite questions about Reg BI's strength, regulators have begun enforcing the new rule. Quinn argues the rule is about preserving investor choice as much as avoiding conflicts of interest.
Transcription:
Dan Shaw (00:08):
Hello, thank you for joining us today. I'm Dan Shaw, regulatory and compliance reporter at Financial Planning. With me is Mark Quinn, the director of regulatory affairs at Cetera Financial Group, a network of wealth management firms with more than 8,000 affiliated representatives and serving more than 1 million retail investors. He's also a legal professional with more than 25 years experience in all aspects of securities law and regulation. Cetera was among the many, many groups that submitted comments on Regulation Best Interest — or Reg BI as it's known for short — leading up to that rule's adoption by the SEC in June 2019. In a letter dated Aug. 7, 2018, Cetera CEO Robert Moore opined, "We believe that there are substantive differences between the services that are provided by broker-dealers and RIAs. That adoption of a uniform fiduciary standard that would apply equally to both types of entities would not serve the interest of the majority of retail investors."
(01:06)
So that's probably just as good of a starting point as any for our discussion today. I think that kind of touches on some of the themes that we'll get into. But yeah, welcome Mark. Thanks again for joining us. And yeah, we'll just jump right in here. Great. For anybody who's perhaps not familiar with Reg BI, what do you see as the regulation's main features and how does it differ from the rule that broker-dealers used to have to operate under, which was known as the suitability standard?
Mark Quinn (01:44):
Sure. Well, nice to see you this morning, Dan. Thank you for having me.
(01:51)
I think there are a couple of primary substantive differences between the old suitability standard and the new BI standard. The main ones really are the obligation to disclose and manage and mitigate conflicts, which was sort of present to a certain extent in the old FINRA suitability standard, but not nearly as explicit as it is in Reg BI. Also, the bigger sort of day-to-day, moment-to-moment change is the requirement in Reg BI that when a financial professional is making an investment recommendation, that they compare that recommendation to the real reasonably available alternatives. So that step, that feature, never really existed in the suitability standard. The way we tend to think about it is if there's a universe of a hundred investments that would be consistent with the objectives of the investor, the financial professional could recommend any of them and meet the suitability standard. However, under Reg BI, the requirement is to go an additional step beyond that and say, well, of this universe of a hundred investments that meet the investor's objectives or requirements, which of them is objectively better than others based on factors such as historical rate of return, level of risk and, of course, cost.
(03:25)
As the SEC has told us, continually, cost is not the only substantive difference or necessarily the most important. But Reg BI requires the financial professional to explicitly take it into account when making any investment product recommendations. So in my view, those are the big substantive changes. But Reg BI and the accompanying adopting release are 600-something pages. So obviously I've shortened it more than would otherwise be warranted.
Dan Shaw (03:58):
Yeah, yeah, right. No such thing as a two-page SEC or FINRA rule, or anything like that. Yeah. So the one other basic thing about Reg BI that we should probably establish is that it's really for the broker-dealer side of the industry. And then if you're a pure registered investment advisor, all you really need to worry about is the fiduciary standard, which is the other big rule. Why do you think it's necessary to have these two standards? Why is it necessary to have a separate standard for broker-dealers?
Mark Quinn (04:41):
Well, at the highest level, I think that the reason why different standards have to apply to the different business models is economic rather than legal or substantive. And I'll talk a little bit more about that in a minute. But if you think about the objective of the SEC in creating Best Interest, (it) was to create a standard applicable to broker-dealers that was very nearly equivalent to the standards applicable to investment advisors, except in the temporal aspect. In other words, the primary difference between the obligations of a broker-dealer and an investment advisor in making investment recommendations is that the nature of the relationship between an investment advisor and the client is designed to be ongoing. And it generally assumes that there will be ongoing monitoring and an ongoing relationship beyond just the immediate investment recommendation. So as Chair (Jay) Clayton explained it at the time, up to the moment of the investment recommendation, the SEC's view was that the obligations of investment advisors and broker-dealers were substantially equivalent.
(05:56)
It's just that at the moment of the investment recommendation, whether it was taken or ignored by the client, that the obligation of the broker dealer ends. So if you think about it, it has to do with a lot of things, primarily the economic model on which clients pay for advisory services as opposed to broker-dealer services. And broker-dealer services historically have been paid for on a transactional model, you know, pay a cost per ticket or per transaction. Or there's a commission that is somehow related to the size or value or complexity of the transaction. Whereas with advisory accounts, historically the model has been that the client pays an ongoing fee based usually on the value of the assets under management. There are models that go by the hour or by some more transitory kind of definition. But typically it's valued based on the value of the asset and the complexity of the client's circumstance.
(07:06)
So if you think about it that way, obviously the standards that apply to an ongoing relationship, which includes an obligation on the part of the financial professional to provide ongoing services, it's a different obligation and it creates different kinds of conflicts between the interests of the client and the financial professional, which, I think, is probably the main reason why it makes sense to have different standards applicable to different models. I think it, it's been suggested at times, and part of the debate or the discussion around adoption of Reg Best Interest was: Should there be a single fiduciary standard that applies to both broker-dealers and investment advisors? And, I think wisely, the SEC decided that the economic models are different enough. That didn't really make sense. But that has happened in other countries, and I think we'll talk about that a little bit more today. But there are really substantive reasons why you don't want to apply the same economic model to everyone, because it doesn't necessarily work. You have investors with small accounts or who don't have a whole lot of trading activity. The economic model that's embedded in the advisory model doesn't necessarily make sense for those clients.
Dan Shaw (08:36):
And I think one thing we should make clear, too, is (that) when we're talking about the momentary transactional nature, it's not as if the broker-dealer has no — at least according to my understanding — it's not as if they have no obligation to think about where this investor is in life or ask about whether they're planning to retire in 'X' number of years. They do have to take those things into account. So it's not as if they're living in the moment ... I want to clarify that. But there is some question, I think, about some types of investments that a broker-dealer might help a client get into, and if it's an ongoing type of investment, if the relationship continues past the initial buy-sell. But I think we'll probably talk about this later too, and that we're still waiting for final answers on some of these things with Reg BI. But I do think there is some ambiguity there. But yeah, anyway, we're not here to listen to me.
(09:45)
So what do you think about the common criticism? We're just talking about the thought that's out there that we should have one standard, but what about the common criticism that Reg BI is the weaker of the two standards? The fiduciary rule is the golden standard. And Reg BI is an also-ran.
Mark Quinn (10:07):
Well, as I mentioned a minute ago, the intention, the expressed intention of the SEC in adopting Reg Best Interest was to create as close as possible to the same standards, applicable to broker-dealers and investment advisors, with the only missing piece being the temporal element, the ongoing monitoring obligation. And as we talked about a minute ago, ongoing monitoring requires the effort and work and risk on the part of the investment advisor. So it has to be paid for. And there are a lot of what we've found ... I think my firm is relatively typical. We've been migrating slowly or sometimes more quickly from commission-based arrangements, transaction-based arrangements to advisory arrangements. And I think we could see a day in the next few years where the majority of our revenue will come from fee-based advisory arrangements as opposed to brokerage. But there are still clients or products or circumstances that lend themselves better to commission-based arrangements.
(11:18)
We mentioned a couple of them before: Clients who have small accounts who are uncomplicated, or there's a pretty good segment of the investing population that are buy-and-hold investors who don't really need ongoing advice and monitoring. And as we mentioned a minute ago, all of these services have to be paid for. And the idea was when the SEC created Reg Best Interest to design a system where the investor could choose what was best for them. There's a commercial for an insurance, auto insurance company. And they say, "Only pay for what you need." Well, I think that was kind of the idea. Some people want a higher level of ongoing service and monitoring and attention from the advisor, and that's a good thing. Or if that works for you, if that's appropriate and you're willing to pay for it, that's a good thing. But not every client does want that. And so I think the idea was to allow both standards to exist. But coming back to your original question about is the Reg BI standard weaker than the fiduciary standard, I don't really think that it is. And I think the intention was on the SEC's part to create as equal a playing field up to the moment of the investment recommendations possible. So aside from the ongoing monitoring obligation, we think of the obligations as very similar.
Dan Shaw (12:53):
Yeah, I do think one common misconception about the fiduciary standard is that it requires elimination of all conflicts of interest. And it doesn't. There are differences, I believe, between the ways that you have to disclose the conflicts of interest or the way the conflicts of interest are described, or what rises to the level of reportable conflict of interest between the two standards. And that gets into the real nitty gritty details. But at some point under fiduciary standard, if you have a conflict of interest that you can't mitigate, you can't eliminate, you just have to disclose it. And probably the most obvious conflict of interest is that if you're an advisor, you want the client to stay with you. You can't really expect, you're not going to advise the client to go to this other guy because he's a better advisor than you.
Mark Quinn (13:52):
Well, we made this comment in a couple of our comment letters, and I think it's true there. The difference is there's no such thing as any economic model where a professional provides services to a client where you don't have conflicts. Because as you said, that the interest of the professional is to provide high-quality services in a way that generates the most revenue for them. That's just a simple economic fact. So as you said, it's not that one model has conflicts and the other doesn't. Just that they're different. So the primary, original evil in a transaction-based model is the fact that the compensation payable to the financial professional is based on what product and in what quantity is purchased. So mutual funds cost X and individual equities cost Y and individual fixed-income instruments cost Z. So what the investment or the professional recommends, determines what their compensation is. Now in an advisory model, you have different sort of conflicts because the compensation doesn't vary based on what product is bought. But you, you're paying for ongoing services and monitoring whether you need them or not, or whether you want them or not. So again, all professionals, lawyers, doctors, accountants, everybody has conflicts with their clients to the extent that the professional wants to make money. So the point is disclosure and management and mitigation of the conflicts and both, each side has them. It's not that one's better than the other, it's just that they're different.
Dan Shaw (15:41):
Yeah. That's almost like no one's ever heard of a lawyer overbilling.
Mark Quinn (15:46):
Oh no, that never happens.
Dan Shaw (15:50):
It never happens. Yeah. Right. But do you think, though, that there is greater temptation on the broker side to, I mean, you do hear about churning cases much more often than you do hear of so-called reverse churn cases, which is basically the parallel to taking the money and doing nothing, whereas the churning is doing too much.
Mark Quinn (16:19):
Well, it, it's an interesting question, Dan. Maybe it was 15 or 20 years ago when I was in private practice, I got a call from a client who said they were in the middle of an SEC investigation or examination, and they were being accused of something called reverse churning. And I said, what in the world is that? How can you reverse churn?
(16:40)
Well, the suggestion at the time was, and as you mentioned, if you're an investment advisor, you get paid whether you do anything or not. So there is a temptation, or there could be a temptation under some circumstances to just get all the assets under management and do the minimum because that's how the professional in this case is compensated. That's how they maximize their revenue. Can we say that never happens? No, I don't think you can say that. Obviously there are bad apples in any barrel, but it points out the fact that there are species of conflict that apply to both models and how you monitor them, or mitigate them or best tailor them to the needs of the client is the important question. It's not that they don't exist because they do and they always will.
Dan Shaw (17:42):
Right. Okay. Well, so I think this is kind of the crux to all these questions. Reg BI is still pretty new. It's been around for almost three years, but we've only seen enforcement cases within the last few months. Really. I think we're up to five enforcement cases: four from FINRA, one from the SEC. And the general sense I get is we can't really say whether this rule is weaker or parallel to the fiduciary standard until we see some more enforcement. What do you think about the enforcement so far? Has it been slower than you expected? Do you think it's going to ramp up really quickly?
Mark Quinn (18:28):
Well, that's a really interesting question, Dan. I think you have to, before you talk about whether it's been at the pace you'd expect, you got to have some context about the radical nature of the change that Reg BI created. This is the biggest change to the legal standard, applicable to retail financial advice, certainly in my lifetime, and arguably in the last 50 or 60 years. So the fact that there haven't been a lot of enforcement actions, even given the fact that we're approaching three years since enactment, I don't think should necessarily be a surprise because I think wisely and correctly, the SEC's view from the outset was we're not going to come out of the gates on day one saying, "OK, let's bring a bunch of enforcement actions." We're going to spend the first six months trying to educate and indoctrinate the industry, if you will, about what the changes are, what they mean, how to incorporate them.
(19:30)
Because a lot of this stuff, again, as we mentioned, there's 600-page plus pages of material in the adopting release of Reg BI. It is difficult for broker-dealers and other financial professionals to incorporate all that stuff into what they're doing on a day-to-day basis. So that's a long way of saying the fact that it's taken a few years for enforcement actions to start doesn't really surprise me. And in fact, I think that's kind of par for the course. I am a little surprised on the SEC side that they've really only brought one major enforcement case that I'm aware of. It's a case called Western International Securities, and I think you mentioned it. So there are a couple of interesting things about that case. First of all, at least in my view, it is a pretty straightforward, garden-variety product failure case.
(20:25)
The firm recommended securities in a firm that went out of business and the clients lost money. OK, well, does it represent potential violations of Best Interest? Yeah. Based on the facts that are pled in the complaint, it certainly presents that potential. But this case could very easily have been brought under the old suitability standard. It is, as I mentioned, at least in my estimation, a pretty garden-variety straightforward product value case. So I think what you will see is, at least to my notion, it's probably easier for the SEC or for FINRA to establish a reg or a violation of Reg BI than it was to establish a violation of the sustainability standard simply because of the additional elements that we talked about at the beginning: the requirement to address and identify and disclose and mitigate conflicts, but also the necessity to do the comparison of the investment recommendation to the reasonably available alternatives. And you and I were talking about that offline, but I think that's something that has taken the most work on the part of the industry. And I think three years in, I think there's been a lot of progress, and I think there's much more of a consensus about what is required and how firms can meet these obligations. But that's one way of saying it takes a while for a standard to become developed and for firms to become aware of it, to know what they have to do.
Dan Shaw (22:05):
Yeah, true. And we certainly have heard from regulators that they're talking about increasing their enforcement. What are you hearing from Cetera members? Are they finding that FINRA and the SEC, when they do their compliance exams, are looking at BI much more closely?
Mark Quinn (22:28):
Well, my firm has either the good fortune or the misfortune to have four broker dealers. So we are subject to a lot of both FINRA and SEC exams, and we have been through a couple of Reg BI exams with the SEC, and there is a big component of Reg BI in the regular FINRA cycle exams. So I think what we see emerging is there is a better sense on the part of both the SEC and FINRA about what they think the standards are, what they're looking for, what they expect from firms. I think it's probably in the 18 months or approaching two years from the time we had the first one until the time the last one's concluded, I think their views about what's necessary and what firms ought to be doing are considerably more highly developed. I think you're going to start to see pretty specific findings.
(23:28)
And as we were talking about enforcement cases, the only cases that have come out of FINRA are similar to the Western International case. To me, they're kind of black-and-white, straightforward, could have been brought under an older standard. But I think what both the SEC and FINRA are signaling to us is: Why mess around with that when you've got Reg BI? It's a stringent, more stringent, more specific standard, sets a higher bar. And look, at the end of the day, they don't really want to bring enforcement actions. They want everybody to comply and do it voluntarily, but sometimes that's the way you have to make your point to the industry. This is what we expect. This is what you're going to need to do. And if you don't, then there are going to be consequences.
Dan Shaw (24:20):
Yeah. Have you heard any complaints? Oh man, these regulators are getting tough with this thing.
Mark Quinn (24:27):
Well, there are always good. That's what we do, Dan.
Dan Shaw (24:30):
Yeah, right. Yeah. How do you sort out that, yeah, this is a garden variety complaint from Oh, this is new type of thing. Yeah.
Mark Quinn (24:38):
Yeah. I look, I think every firm is a little different. The questions that we've gotten from both FINRA and the SEC and exams, I think are pretty much what we would've expected. I don't know that they have taken what I would consider unreasonable positions on anything. But this is what's going to be interesting, and we talk a lot to our colleagues about this. There are hundreds and hundreds of FINRA examiners doing examination examinations of firms. And with something that's as big and relatively revolutionary as Reg BI is, are there, are the standards going to be applied consistently across firms and across examiners? Because you've got hundreds of examiners, thousands of firms, and tens of thousands, hundreds of thousands of financial professionals with a bunch of different business models. They all do things differently. And as we were talking about before, it takes a while for consensus about what the requirements and obligations, and how they're going to be met, to emerge. I think we're getting there, but I don't know that we are there yet. So that there's some additional big work to be done on both sides.
Dan Shaw (25:57):
Yeah. Do you think it's going to take years before we really start to know, all right, this is what BI actually means practically? I mean, I think we have an idea of what it means theoretically.
Mark Quinn (26:12):
Well, in a way, I hope so, because if it does, I'll be either retired or dead and it won't be my problem. But I think, realistically, it's going to take a few more years for the parameters of all of this to emerge. And it's like anything else. When there's a new standard, both the regulatory agencies and the industry struggle for a while to figure out, OK, it says in the 10,000-foot headline we have to do this. Well, how exactly do I do that in the day-to-day operations of my firm? And remember, especially my firm has 8,000 or 9,000 financial professionals, each of them has a different clientele and different business model. They focus on different things. They do things different ways. Trying to design a model that fits all of those people and in a way that creates usable data and supervisory capability is difficult. And I think, to their credit, I think both the SEC and FINRA recognize this and are willing to give firms some time to figure it out. But that doesn't last forever. Sooner or later, the expectations and the consensus will emerge. And if you're not doing what they perceive to be what's required, then there will be enforcement and other issues. So the good times won't last forever, Dan, I'm sure of that.
Dan Shaw (27:45):
Right. Yeah. Don't assume that they will. What are some of the biggest things that firms should be doing right now in your mind to make sure that they're in compliance?
Mark Quinn (27:58):
Well, I think as we talked about at the beginning, the two big biggest substantive changes in Reg Best Interest from the old civility standard are the requirement to catalog and monitor and manage and mitigate and disclose conflicts. So I'll give you an example. There's the document called the Form CRS, which is required to be produced and delivered to clients. And the idea is you're supposed to give the client a very basic overview of the services that you provide and an extremely basic overview of the conflicts of interest that you have in managing their account. Well, it's limited to four pages, and there's only so much you can put into four pages. So most firms have developed additional supplemental conflict discoveries. My firm has, and it's about 35 pages long. Well, that sort of document didn't exist. And not only did that sort of document not exist in the prior regime, I don't think firms spent nearly as much time thinking about what are their conflicts, what do they result from, how do I manage them, how do I mitigate them, and how do I disclose them?
(29:14)
And in some cases, are they so hard to manage that I just have to stop the practice? Yeah. Now, there aren't very many things like that. I mean, the only one that the SCCs explicitly called out is a time-based sales contests where you get paid more for recommending more of a single product in a short period of time, which, clearly, that was the right step. There shouldn't be sales like that. But the truth is, I don't think most mainstream firms had arrangements like that going back 10 or 15 years. Those practices were recognized as inappropriate a long time ago, and most firms got rid of them. And frankly, the FINRA rules pretty much limited your ability to do that. So I think, as a firm, you've got to be much more focused on the conflict identification and management and mitigation than you had to be before.
(30:15)
The second big one really is the comparison, the obligation to do the comparison of reasonably available investment alternatives. And, I think, I was just at an industry conference last week and talked to a lot of my colleagues that are the firms about what they're doing. And I think the consensus has sort of emerged that you have to have a fairly well-defined and specified process that you use, that your advisors, your financial professionals, are required to use. A lot of firms up until now have said, "Well, just be more conscientious about documenting things in your notes and discussing these issues with your clients." That's a very hard thing to operationalize if you have a large number of financial professionals, as my firm does. So we've adopted a process that's actually supplied by a vendor where there's a step-by-step process that you go through, and you use this application to go to do the comparison of the available alternatives.
(31:21)
Now, is it perfect? Well, we've only been using it for six months, so I don't know that I can say that. But I will say that it creates a pretty specifically designed process, and I think that's where the expectations of the regulators are going to gravitate to. So I think if I were giving advice to a firm that was dealing with this, that's the other thing I'd be focused on. How do I manage and document this requirement to compare the reasonably available alternatives? Because there are many ways to skin a cat. If you have a small firm and only 10 advisors and they're all really doing the same things, maybe you don't have to have a process that's so specifically defined and rigorous. But if you've got a large number of advisors providing a lot of service to a different basis of clientele, in my opinion, the only way to manage it is to have a pretty tightly defined process. So those are the two things I would say.
Dan Shaw (32:27):
Yeah. Great. And all right, I guess just our last question here before we wrap up. Do you see, do you think this is pretty set for the long haul, or do you think that there's going to be modifications to it as we go along? I mean, one thing, you mentioned the form CRS — only four pages — but then you say you have to add the supplemental documents — 35 pages — which seems a little excessive to me. Is they're maybe a happy medium that can be reached here, where you're giving customers a little bit more than four pages, but not overwhelming them? That's one possibility that I see.
Mark Quinn (33:06):
That's a really interesting question, Dan, because I know you and I have discussed this before. What is the happy medium? The expression I've used is: "A friend to all is a friend to none." If you're disclosing every conceivable conflict in excruciating detail, you're going to create a 200-page document, which is not usable to investors. I think the SEC's view was to use form CRS — and they were pretty explicit about this — it's not designed to be an end-all document. It's designed to be a conversation starter and give the client the opportunity to ask questions and get into the things that are the most important. But it's not designed to be fully inclusive and cover every conflict under the sun in excruciating detail. That's what the supplemental documents are for. Yeah, I think the SEC — and again, I think this was the right approach — decided not to be overly prescriptive in saying: "What do you have to disclose and how do you have to manage and mitigate it?"
(34:18)
They said to firms: "It is up to you. This is a rules-based or a principles-based model. It's up to you to decide what's important, how you disclose it, when you disclose it, under what circumstances you disclose it." And I think that's still viable. I think that's probably the best approach because there are so many different models, so many different kinds of businesses, so many different kinds of clients. I think what we may see as time goes by is that the SEC or other regulators will identify specific issues that are common to most business models and that are, for lack of a better term, the most problematic potentially to investors. And they'll say, you need to include a discussion about this subject X. That takes time and that's going to take experience. And it'll also take work and cooperation between the various regulators, not just vendor and the SEC, but the states who obviously have an interest in this as well.
(35:25)
So I think the modifications, you got to remember that BI is relatively new. I mean, three years in the geologic time of regulation is not a very long time. Three years sounds like a long time if you're in fourth grade, but when you're dealing with stuff like this, it isn't really that long. I think the expressed intention of the SEC thus far is to go along with the current version of Reg BI, see what they come up with in examinations and enforcement, and not really go toward creating substantive provisions to the rule, at least for a while. But that may come down to what they see and: Are they seeing the same issues or violations or problems as they go through their exams and enforcement activities? And if they do, and then I think you might also see some changes. I think the other, the political dynamic, to this is what is the chair or what are the commissioners of any given mind think of as their priorities. I think Reg BI, the SEC spent a lot of time over the last few years on this, and the commissioners and the chair may think we've done everything we can do in the short run. We've got other priorities. We'll spend our time on that. We'll come back to Reg BI at such time as we feel like we need to.
Dan Shaw (36:57):
Okay. Well, I think that's a good place to wrap up here, but really appreciate your being with us today. I think it was a really thoroughgoing and interesting discussion on Regulation Best Interest, a rule that affects a large part of the industry that we cover — maybe not everyone, but a good proportion. So again, I'm Dan Shaw, regulatory and compliance reporter at Financial Planning. And with me today was Mark Quinn, the director of regulatory affairs at Cetera Financial Group, a network of wealth management firms with more than 8,000 affiliated representatives and serving more than 1 million retail customers. And that's all we have for today.
Mark Quinn (37:40):
Thank you, Dan. Take care.
