The Securities and Exchange Commission (SEC) regulations regarding broker-dealers and advisers concerning their relationship with clients. The SEC’s new regulations more clearly define the difference between a broker-dealer and an adviser, including who may include “adviser” in their title.

A recent support request required some data analysis to solve the customer’s problem. The data reminded me of a club with a similar portfolio from some years ago. The similarity was the very large number of securities held. In both cases the portfolios had approximately 100 securities. 

Research has shown the benefits of diversification plateau around 15-20 stocks in a portfolio. Adding more than 20 decreases risk very little for each stock added to the portfolio. In both cases the clubs were relying on outside advice from a broker rather than doing their own work.

The clubs could have diversified more easily and cheaply by investing in a broad-based index fund such as an S&P 500 index fund. In my opinion, the club’s best interests weren’t served by following its broker’s advice, even if the advice was given in good faith.

This brings me to new Securities and Exchange Commission regulations regarding broker-dealers and advisers concerning their relationship with clients. The SEC’s new regulations more clearly define the difference between a broker-dealer and an adviser, including who may include “adviser” in their title.

Besides defining the terms more clearly, the regulations specify the standard of care brokers and advisers should offer their clients. The current standard for broker-dealers is the suitability standard. The new standard will be the “best interests” standard. The best interests standard isn’t as high as the fiduciary standard the Obama administration’s Labor Department proposed for advisers to retirement accounts. That proposed regulation was dropped by the current administration. Investment advisers registered with the SEC currently have a fiduciary standard of care that will remain. The new rule, known as Regulation Best Interest, is long and complex. The full text runs 771 pages and is available, along with the comments, at the SEC website.

The text may be found at www.sec.gov/rules/final/2019/34-86031.pdf   
The comments may be found at www.sec.gov/comments/s7-07-18/s70718.htm

Along with new definitions and standards of care are proposed regulations on disclosures. These are separate regulations covering what broker-dealers and advisers must disclose to clients.

These regulations, known as the Form CRS Rela­tionship Summary, may be found at the SEC website at www.sec.gov/rules/final/2019/34-86032.pdf

Expect paperwork from your brokerage firm giving information on the new regulations and new disclosure forms. The rules go into effect June 30, 2020, according to an SEC news release at https://bit.ly/2XBsJBW

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This article was originally published in the October 2019 issue of BetterInvesting Magazine.

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