SIFMA: NASAA’s proposed revisions to its BD model rule conflict with Reg BI

SIFMA submits a sternly worded comment letter to NASAA on its proposed revisions to its model rule related to broker-dealer business conduct.

The Securities Industry and Financial Markets Authority (SIFMA) submitted a comment letter on Friday to the North American Securities Administrators Association, Inc. (NASAA) on proposed revisions to NASAA’s model rule related to business practices of broker-dealers.

The proposed revisions were submitted to the public for comment in early September, and the deadline for feedback was Monday, December 4.

The proposed revisions are to NASAA’s model rules on “Dishonest or Unethical Business Practices of Broker-Dealers and Agents”, also called the “Business Practices Rule”, an update NASAA believes is necessary to best reflect the SEC’s adoption in 2019 of Regulation Best Interest or “Reg BI.”

An unnecessary rewrite

“NASAA’s proposed changes would fundamentally rewrite the existing regulatory regime, including Reg BI, under which broker-dealers provide services to investors. There is a growing consensus that Reg BI is increasingly well-functioning and effective in protecting investors after more than three-years of closely-watched regulatory examinations, enforcement actions, and an ever-growing body of regulatory guidance.” Kevin M. Carroll, Deputy General Counsel of SIFMA wrote in his trade association’s letter.

“NASAA itself concedes that broker-dealer firms have demonstrated ‘helpful and steady implementation progress’ as they have ‘update[ed] their investor profile forms and enhance[ed] their policies and procedures to focus more directly on Reg BI obligations.’”

SIFMA contends the proposal conflicts with Reg BI, and it will inevitably increase costs and limit investor choice among brokerage products and services by being stricter than the SEC’s rule requires.

It also contends that the proposal is in large part federally preempted by Reg BI and the National Securities Markets Improvement Act, a law passed in 1996 that is aimed to reduce the amount of interplay between competing regulatory agencies, namely between the states and the SEC.

Conflicting provisions

The conflicts the securities industry’s membership group cites as between Reg BI and NASAA’s proposed model rule are:

  • the redefinition of what constitutes a “recommendation”;
  • the rewriting of the conflicts of interest obligation under Reg BI;
  • the treatment of “cash or non-cash compensation”;
  • the expansion of customer profile information;
  • the misstatement of the “reasonably available alternatives” obligation;
  • the treatment of “costs”;
  • the inconsistent definsion of “retail customer;” and
  • the titling provision.

In its letter, SIFMA also urges NASAA not to invite states to adopt “one, some, or all” of the subparts of its proposal.

“Doing so would likely result in an uneven patchwork of different standards across the fifty states. The corresponding negative impacts to retail investors may include greater cost, less choice, and confusion over what ‘best interest’ standard they are owed in any given state,” SIFMA says.

NASAA’s proposed model rule

NASAA, an association of state securities administrators and a vocal consumer advocacy group, says its conduct standards under its Business Practices Rule helps establish high standards of commercial honor and equitable principles of trade for broker-dealers and their agents.

It has been adopted by most US NASAA members under authority of their state laws to set forth conduct standards the violation of which may result in civil or administrative sanctions, such as fines, censures, suspensions, bars or revocations of registration.

NASAA chose to update this rule because it felt its last amendment to it — adding a failure to pay arbitration awards other monetary sanctions to the list of sanctionable conduct — did not fully account for the revisions to conduct standards embodied in the new Reg BI.

NASAA further felt its rule needing updating because it does not adequately reflect how many brokerage and advisory services have merged, plus the incredible growth within the fintech sector, especially digital investing platforms.

“NASAA’s proposed changes would fundamentally rewrite the existing regulatory regime, including Reg BI, under which broker-dealers provide services to investors.”

Kevin M. Carroll, Deputy General Counsel of SIFMA

The association contends its revisions encompass a restatement of the protections the Best Interest Rule embody, from that “best interest of the retail investor” definition to the disclosure obligations, including conflicts of interest, costs (fees, commissions, etc.) and spelling out the “care, skill and diligence” broker-dealers must have in making investment recommendations.

It defines terms such as “recommendation” and “retail investor,” and it prohibits any misleading use of the professional title “advisor” or “adviser’; not having proper licensure and using the title is considered deceptive and unethical.

This latter item is not in the SEC’s Reg BI Rule, and NASAA says it feels justified including it because it allows for exceptions where state law permits the use of these terms for such financial services professionals.

Main issues

SIFMA doesn’t approve of the definitions NASAA uses, as the bullet points above imply, and consider nearly all of them to be too expansive or outright misstatements. This even includes what it calls a shifting definition of “retail customer” in NASAA’s revised rule.

In its comment letter, SIFMA notes that broker-dealer firms have already made helpful and steady progress in implementing Reg BI into their policies and procedures (P&Ps) — a point NASAA acknowledges — by updating the P&Ps and investor profile forms to meet the rule’s obligations. It wonders why these sweeping conduct rule revisions are needed, especially ones that add new elements to the Reg BI rule with which the revisions are supposed to align.

SIFMA says a side-by-side comparison of Reg BI and NASAA’s proposed revisions showcase the numerous, significant differences between the proposal and the rule. In an appendix to its comment letter, it tracks the changes it cites in detail in a chart.

It’s final sentence sums up where we could be heading with this issue: “A court would likely find that the proposal is preempted by Reg BI.” Maybe not that likely an outcome, but it is possible that a court weighing in on the issue, might come to a similar conclusion nonetheless.

Author’s note

When the SEC introduced its Reg BI rules in June 2020, broker dealers were expected to apply a higher standard of care when providing investment recommendations to retail clients. Many had dubbed the new framework ”suitability on steroids,” given that it bulked up existing rules that required brokers to only recommend investment products that were ‘suitable’ for clients.

Consumer advocacy groups are worried some firms have not truly made the P&P adjustments (buttressed by adjustments to training and internal controls) that would support the implementation of Reg BI in their interactions with retails.

A NASAA report at the end of 2022 found that, while the firms it surveyed were engaging in slightly more pro-investor best practices and slightly fewer harmful conflicts, most had remained ”fairly stagnant” and were operating ”precisely the same under Reg BI as they had under the suitability rule.”