theory, to include such an explicit provision in the contract between
the customer and the broker-dealer to this effect, it would be
difficult for the customer to confirm the broker-dealer's actual
understanding. The inability of the customer to confirm the broker-
dealer's actual understanding limits the usefulness of such a provision
in ameliorating the agency conflict between the customer and the
broker-dealer.
    Another factor that determines the effectiveness of explicit
contracting and monitoring by the principal is the ability of the
principal to accurately measure and assess the actions of the
agent.\375\ For example, customers may expect advice that is tailored
to their specific investment objectives, financial situation, and
needs. Contracts between customers and broker-dealers could include
explicit provisions to this effect. However, customers may lack the
knowledge required to assess whether a recommendation is appropriate
for their needs, given their particular situation. As a result, while
such an explicit provision could be included in a contract between a
retail customer and a broker-dealer, it would be of limited value in
ameliorating the agency conflict between the two.
---------------------------------------------------------------------------

    \375\ See Frank H. Easterbrook and Daniel R. Fischel, ``Contract
and Fiduciary Duty,'' Journal of Law & Economics (1993, vol. 36, p.
426) (``Contract and Fiduciary Duty'').
---------------------------------------------------------------------------

    Finally, we note that beyond the agency costs described above,
there are costs associated with specifying the contractual terms
themselves. Specifying contractual terms potentially involves
forecasting all future states of the world that are relevant to the
contractual relationship and specifying the parties' obligations in
each of those states. In environments as complex as financial markets,
the ability to forecast future states may be especially difficult.
Further, even if financial firms and retail customers were able to
forecast all future states of the world relevant to their relationship,
the process of contractually specifying each state and the financial
firm's obligation to a retail customer in each of those states could be
very costly.\376\
---------------------------------------------------------------------------

    \376\ See Frank H. Easterbrook and Daniel R. Fischel, ``The
Economic Structure of Corporate Law'' (1991, p. 90). See also
``Contract and Fiduciary Duty.'' The authors note that parties to
the contract are likely not able to see future possibilities well
enough to specify all contingencies ahead of time.
---------------------------------------------------------------------------

    As an alternative to explicit contracting and monitoring by
principals, agents can expend resources (i.e., ``bonding costs'') to
guarantee their fulfillment of contractual terms or to ensure that the
principal will be compensated if the agents fail to meet their
obligations.\377\ As we noted above, customers would like broker-
dealers to understand the potential risks and rewards associated with a
recommended transaction or strategy. For example, and if consistent
with applicable legal limitations, the contract between the customer
and broker-dealer could include a provision in which the broker-dealer
agrees to compensate the retail customer if the broker-dealer does not
have the level of understanding promised under the contract.
Unfortunately, factors that limit the effectiveness of explicit
contracting and monitoring by principals also tend to limit the
effectiveness of explicit contracting and bonding by agents. For
example, a broker-dealer's actual level of understanding is difficult
to confirm. The difficulty in confirming a broker-dealer's
understanding would cause any promise to compensate the customer if the
broker-dealer did not understand the potential risks and rewards
associated with a recommended transaction or strategy to be of limited
value.
---------------------------------------------------------------------------

    \377\ For example, agents might bond themselves by purchasing
insurance policies that pay the principal in the case of theft. See
James A. Brickley, Clifford W. Smith, Jr., Jerold L. Zimmerman,
``Managerial Economics and Organizational Architecture'' (2004, p.
265). The agent is willing to incur bonding costs to increase the
amount paid to the agent by the principal for the agent's services.
---------------------------------------------------------------------------

    In situations where the costs of explicit contracting and
monitoring and bonding are large, or where the cost of writing and
enforcing contracts is large, a legal or regulatory standard of conduct
can serve as an alternative mechanism for ameliorating agency
costs.\378\ Under a legal or regulatory standard of conduct, agents are
obligated to act in the principal's interest with the standard of
conduct defining how that obligation is to be met. For example, as
noted above, retail customers would like broker-dealers to understand
the potential risks and rewards associated with a recommended
transaction or strategy as well as for the broker-dealer to tailor
recommendations to the retail customer's specific investment
objectives, financial situation, and needs. It would be difficult to
stipulate those requirements in an explicit contract between a broker-
dealer and a retail customer because such contract would be difficult
to monitor and enforce. In particular, under private contracting,
deterring broker-dealers from not acting in the retail customer's
interest could be difficult. A standard of conduct that requires
broker-dealers to act in the retail customer's best interest provides
an alternative mechanism that is designed to result in the broker-
dealer providing services at a level of quality

that better matches the expectations of its retail customers. In
particular, broker-dealers would face regulatory liability if they
failed to meet their obligation to act in the retail customer's
interest under the standard of conduct. Relative to private
contracting, a standard of conduct may be more effective in deterring
broker-dealers from acting in their own interest rather than the retail
customer's interest.
---------------------------------------------------------------------------

    \378\ In a world of scarce information and high transactions
costs, regulation can promote the efficiency of contracting between
parties by prescribing the outcomes the parties themselves would
have reached had information been plentiful and negotiations
costless. See ``Contract and Fiduciary Duty'' and R. H. Coase, ``The
Problem of Social Cost,'' Journal of Law & Economics (1960, vol. 3,
pp. 1-44).
---------------------------------------------------------------------------

    Regulation Best Interest would create a minimum professional
standard of conduct for broker-dealers under the Exchange Act that is
designed to ameliorate the agency costs associated with conflicts
between broker-dealers and their retail customers. It would also
articulate the role of regulators in enforcing such standard of
conduct. As a result, the firm's legal and regulatory obligations would
be designed to result in the firm providing advice at a level of
quality that better matches the expectations of its retail customers.
    In the absence of some form of amelioration, the agency conflicts
between broker-dealers and retail customers may influence the advice
that retail customers obtain in a number of ways. In the narrow context
of a choice between two products with similar expected returns and risk
profiles, but with different commissions, an agency conflict leaves the
retail customer no worse off in terms of investment outcomes except to
the extent that higher commissions result in total returns that are
lower on one product than on the other. Under other circumstances,
however, an agency conflict may impose greater or different costs on
retail customers and, more generally, on financial markets.
    For example, a financial firm that is able to systematically choose
a higher fee product to recommend to its retail customers may
rationally respond by constructing a menu of offerings that permit it
to choose to recommend products that yield the firm higher expected
payoffs. However, such menus may restrict retail customer access to
financial products that are equally suitable but that could provide
retail customers with better risk-return profiles. Agency conflicts
that arise from material conflicts of interest may similarly cause
financial firms to limit the choices available to retail customers.
Financial firms may have incentives to prefer proprietary products or
products of affiliates over more conventional products that may be
equally suitable for the retail customers, but potentially more
beneficial for the firms.
    Furthermore, the ability of financial firms to act on conflicts may
have repercussions for retail customer welfare if it erodes retail
customer trust in financial markets or the market for financial advice.
As noted in the Relationship Summary Proposal, evidence suggests a
relatively low level of financial literacy among retail customers.\379\
Retail customers who are aware that financial firms are likely to be
conflicted may choose not to seek advice even when conflicted advice
would make them better off than no advice at all. If the presence of
conflicts of interest reduces retail customer trust, retail customers,
out of abundance of caution may forgo valuable investment
opportunities.\380\ By contrast, disclosure of conflicts of interest
and disclosure of measures taken to mitigate conflicts of interest
could have the opposite effect by bolstering investor trust.
---------------------------------------------------------------------------

    \379\ See Relationship Summary Proposal. See, e.g., Staff of the
Securities and Exchange Commission, Study Regarding Financial
Literacy Among Investors As Required by Section 917 of the Dodd-
Frank Wall Street Reform and Consumer Protection Act (Aug. 2012), at
iv, v, xiv, 37, 73, 121-23 and 131-32, available at https://www.sec.gov/news/studies/2012/917-financial-literacy-study-part1.pdf
(``917 Financial Literacy Study'')
    \380\ See Ko, K. Jeremy, ``Economics Note: Investor
Confidence,'' Oct. 2017, available at https://www.sec.gov/files/investor_confidence_noteOct2017.pdf.
---------------------------------------------------------------------------

b. Effects of the Best Interest Standard on the Agency Relationship
    As discussed above, there are significant investor protections
offered by a best interest standard of conduct approach to addressing
the principal-agent issue. However, it is important to note that both
parties potentially benefit from the reduction of agency costs. As an
initial matter, both retail customers and financial firms enter into an
agency relationship only when both sides expect the relationship will
make them better off. Generally, both parties enter into a contracting
relationship when the retail customer values the financial firm's
services at a value that is greater than the minimum price at which the
financial firm is willing to supply them (the financial professional's
``reservation price'').\381\ The difference between the retail
customer's willingness to pay and the financial firm's reservation
price represents the ``gains from trade'' associated with the
contracting relationship. How these gains from trade are shared between
the retail customer and the broker-dealer depends on a variety of
factors, including the competitiveness of the market for financial
advice, and the ability of broker-dealers to exploit their
informational advantage over retail customers.
---------------------------------------------------------------------------

    \381\ See James A. Brickley, Clifford W. Smith, Jr., Jerold L.
Zimmerman, ``Managerial Economics and Organizational Architecture''
(2004, p. 45).
---------------------------------------------------------------------------

    To make this concrete, consider a situation where a principal
values the agent's services at $10,000 and the minimum price at which
the agent is willing to provide the service is $5,000.\382\ The
difference between the principal's valuation of the agent's services
and the minimum price at which the agent is willing to supply the
services represents potential gains from trade to be shared between the
two parties. In this case, the gains from trade would be $5,000
(=$10,000-$5,000).\383\
---------------------------------------------------------------------------

    \382\ These numbers are provided only as an illustrative example
and are not meant to convey the costs of financial services.
    \383\ See supra note 380.
---------------------------------------------------------------------------

    Suppose, however, that the principal recognizes that the agent's
preferences are not perfectly aligned with her own and that given the
difference in preferences the principal revises her expectation of the
agent's behavior, and therefore the valuation of the agent's services,
to $7,000. The potential gains from trade have been reduced from $5,000
to $2,000. The $3,000 reduction in gains from trade is a real cost of
the agency conflict between the two parties.\384\ If gains from trade
are shared between both parties, both parties have an incentive to
ameliorate the agency conflict so as to maximize the potential gains
from trade to be shared between the two.
---------------------------------------------------------------------------

    \384\ From the example, it should be clear that agency costs
can, potentially, rise to such a level that the gains from trade are
completely wiped out and trade does not occur.
---------------------------------------------------------------------------

    Suppose further that the two parties could agree to a contract with
explicit provisions that would ameliorate the agency conflict to such a
degree that the principal would believe the agent's services to be
worth $9,000. Further, suppose that the contract has associated costs
of $500.\385\ It would be in both parties' interests to use the
contract because it would increase the gains from trade to be shared
between the two from $2,000 to $3,500 (=$9,000-$5,000-$500).
---------------------------------------------------------------------------

    \385\ That is, the sum of the monitoring, bonding, and contract
specifications costs is $500.
---------------------------------------------------------------------------

    However, contracts may be inefficient under certain circumstances.
For example, suppose there existed additional contract provisions that
could further ameliorate the agency conflict to a degree that the
principal would believe that the agent's services to be worth an
additional $500, or $9,500 in total (=$9,000 + $500), but that those
provisions cost $750 to implement. In this case, it would not be in the
parties' interests to engage in those additional contracting provisions

because it would result in a reduction in gains from trade from $3,500
to $3,250 (=$9,500-$5,000-$500-$750).
    Importantly, this example does not reflect the types of factors
that can impact how these gains from trade will be shared. For example,
broker-dealers may have an informational advantage that could allow
them to maintain a large share of the gains of trade that flow from
their relationship with retail customers. We understand that retail
customers generally do not know the structure of mutual fund fees or
how much is remitted back to broker-dealers recommending those funds.
The proposed rule would no longer make it possible for the broker-
dealer to make a recommendation solely based on the portion of fees
that flow back to the broker-dealer, thereby reducing the share of the
gains from trade that broker-dealers are currently able to retain. In
response, broker-dealers may try to recoup this loss by increasing the
fees for recommendations to retail customers. Fees that broker-dealers
charge to retail customers, unlike the compensation that broker-dealers
extract from product sponsors, are generally required to be disclosed.
To the extent that retail customers are sensitive to fee increases
(e.g., may switch to another, lower-cost broker-dealer) broker-dealers
may not be able to reverse the loss in gains from trade through a fee
increase. Thus, the degree of competition among broker-dealers may
limit the extent to which a broker-dealer can recoup these losses. As a
result, if the market for broker-dealer advice is sufficiently
competitive, the gains from trade that result from the proposed rule
would mostly flow to retail customers.
    Therefore, a standard of conduct may be an efficient alternative to
the costly explicit contracting illustrated above. We acknowledge,
however, that standards also can be costly. In the analysis that
follows in Section C below, we characterize the benefits and costs
associated with the proposed best interest standard of conduct and
their resulting effect on the gains from trade to be shared between
broker-dealers and their retail customers.

B. Economic Baseline

1. Market for Advice Services \386\
---------------------------------------------------------------------------

    \386\ In addition to broker-dealers and Commission-registered
investment advisers discussed below in the baseline, there are a
number of other entities, such as state registered investment
advisers, commercial banks, and insurance companies, which also
provide financial advice services to retail customers. A number of
broker-dealers (see infra note 391) have non-securities businesses,
such as insurance or tax services; however, the Commission is unable
to estimate the number of other entities that are likely to provide
financial advice to retail customers. As of January 2018, there were
approximately 17,800 state-registered investment advisers, of which
145 are also registered with the Commission, as reported on Form ADV
Item 2.A. The Department of Labor in its Regulatory Impact Analysis
identifies approximately 398 life insurance companies that could
provide advice to retirement investors. See infra note 453.
---------------------------------------------------------------------------

a. Broker-Dealers
    The Commission analyzed the effect of proposed Regulation Best
Interest on the market for broker-dealer services. For simplification,
the Commission presents its analysis as if the market for broker-dealer
services encompasses one broad market with multiple segments, even
though, in terms of competition, it may be more realistic to think of
it as numerous interrelated markets. The market for broker-dealer
services covers many different markets for a variety of services,
including, but not limited to, managing orders for customers and
routing them to various trading venues; providing advice to retail
customers on an episodic, periodic, or ongoing basis; holding retail
customers' funds and securities; handling clearance and settlement of
trades; intermediating between retail customers and carrying/clearing
brokers; dealing in government bonds; privately placing securities; and
effecting transactions in mutual funds that involve transferring funds
directly to the issuer. Some broker-dealers may specialize in just one
narrowly defined service, while others may provide a wide variety of
services.
    As of December 2017, there were approximately 3,841 registered
broker-dealers with over 130 million customer accounts. In total, these
broker-dealers have close to $4 trillion in total assets, which are
total broker-dealer assets as reported on Form X-17a-5.\387\ More than
two-thirds of all brokerage assets and close to one-third of all
customer accounts are held by the 16 largest broker-dealers, as shown
in Table 1, Panel A.\388\ Of the broker-dealers registered with the
Commission as of December 2017, 366 broker-dealers were dually-
registered as investment advisers; \389\ however, these firms hold
nearly 90 million (68% of) customer accounts.\390\ Approximately 546
broker-dealers (14%) reported at least one type of non-brokerage
business, including insurance, retirement planning, mergers &
acquisitions, and real estate, among others.\391\ Approximately 74% of
registered broker-dealers report retail customer activity.\392\
---------------------------------------------------------------------------

    \387\ Assets are estimated by Total Assets (allowable and non-
allowable) from Part II of the FOCUS filings (Form X-17A-5 Part II,
available at https://www.sec.gov/files/formx-17a-5_2.pdf) and
correspond to balance sheet total assets for the broker-dealer. The
Commission does not have an estimate of the total amount of customer
assets for broker-dealers. We estimate broker-dealer size from the
total balance sheet assets as described above.
    \388\ Approximately $3.91 trillion of total assets of broker-
dealers (98%) are at firms with total assets in excess of $1
billion. Of the 30 dual registrants in the group of broker-dealers
with total assets in excess of $1 billion, total assets for these
dual registrants are $2.46 trillion (62%) of aggregate broker-dealer
assets. Of the remaining 88 firms, 81 have affiliated investment
advisers.
    \389\ Because this number does not include the number of broker-
dealers who are also registered as state investment advisers, it
undercounts the full number of broker-dealers that operate in both
capacities. Further, not all firms that are dually-registered as an
investment adviser and a broker-dealer offer both brokerage and
advisory accounts to retail investors--for example, some dual
registrants offer advisory accounts to retail investors but offer
brokerage services, such as underwriting services, only to
institutional customers. For purposes of the discussion of the
baseline in this economic analysis, a dual registrant is any firm
that is dually-registered with the Commission as an investment
adviser and a broker-dealer. For the purposes of proposed Regulation
Best Interest, however, we propose to define dual registrant as a
firm that is dually-registered as a broker-dealer and an investment
adviser and offers services to retail investors as both a broker-
dealer and investment adviser.
    \390\ Some broker-dealers may be affiliated with investment
advisers without being dually-registered. From Question 10 on Form
BD, 2,145 broker-dealers (55.8%) report that directly or indirectly,
they either control, are controlled by, or under common control with
an entity that is engaged in the securities or investment advisory
business. Comparatively, 2,478 (19.57% of) SEC-registered investment
advisers report an affiliate that is a broker-dealer in Section 7A
of Schedule D of Form ADV, including 1,916 SEC-registered investment
advisers that report an affiliate that is a registered broker-
dealer. Approximately 75% of total assets under management of
investment advisers is managed by these 2,478 investment advisers.
    \391\ We examined Form BD filings to identify broker-dealers
reporting non-securities business. For the 546 broker-dealers
reporting such business, staff analyzed the narrative descriptions
of these businesses on Form BD, and identified the most common types
of businesses: Insurance (208), management/financial/other
consulting (101), advisory/retirement planning (80), mergers &
acquisitions (71), foreign exchange/swaps/other derivatives (31),
real estate/property management (31), tax services (15), and other
(141). Note that a broker-dealer may have more than one line of non-
securities business.
    \392\ The value of customer accounts is not available from FOCUS
data for broker-dealers. Therefore, to obtain estimates of firm size
for broker-dealers, we rely on the value of broker-dealers' total
assets as obtained from FOCUS reports. Retail sales activity is
identified from Form BR, which categorizes retail activity broadly
(by marking the ``sales'' box) or narrowly (by marking the
``retail'' or ``institutional'' boxes as types of sales activity).
We use the broad definition of sales as we preliminarily believe
that many firms will just mark ``sales'' if they have both retail
and institutional activity. However, we note that this may capture
some broker-dealers that do not have retail activity, although we
are unable to estimate that frequency. We request comment on whether
firms that intermediate both retail and institutional customer
activity generally market only ``sales'' on Form BR.
---------------------------------------------------------------------------

    Panel B of Table 1 limits the broker-dealers to those that report
some retail customer activity. As of December 2017,

there were approximately 2,857 broker-dealers that served retail
customers, with over $3.6 trillion in assets (90 of total broker-dealer
assets) and almost 128 million (96 of) customer accounts.\393\ Of those
broker-dealers serving retail customers, 360 are dually-registered as
investment advisers.\394\
---------------------------------------------------------------------------

    \393\ Total assets and customer accounts for broker-dealers that
serve retail customers also include institutional accounts. Data
available from Form BD and FOCUS data is not sufficiently granular
to identify the percentage of retail and institutional accounts at
firms.
    \394\ Of the 36 dual registrants in the group of retail broker-
dealers with total assets in excess of $500 million, total assets
for these dual registrants are $2.19 trillion (60%) of aggregate
retail broker-dealer assets. Of the remaining 72 retail broker-
dealers, 67 have affiliated investment advisers.
---------------------------------------------------------------------------

---------------------------------------------------------------------------

    \395\ The data is obtained from FOCUS filings as of December
2017. Note that there may be a double-counting of customer accounts
among in particular the larger broker-dealers as they may report
introducing broker-dealer accounts as well in their role as clearing
broker-dealers.
    \396\ In addition to the approximately 130 million individual
accounts at broker-dealers, there are approximately 293,000 omnibus
accounts (0.2% of total accounts at broker-dealers), with total
assets of $23.1 billion, across all 3,841 broker-dealers, of which
approximately 99% are held at broker-dealers with greater than $1
billion in total assets. See also supra note 388. Omnibus accounts
reported in FOCUS data are the accounts of non-carrying broker-
dealers with carrying broker-dealers. These accounts may have
securities of multiple customers (of the non-carrying firm), or
securities that are proprietary assets of the non-carrying broker-
dealer. We are unable to determine, from the data available, how
many customer accounts non-carrying broker-dealers may have. The
data does not allow the Commission to parse the total assets in
those accounts to determine to whom such assets belong. Therefore,
our estimate may be underinclusive of all customer accounts held at
broker-dealers.
    \397\ ``Customer Accounts'' includes both broker-dealer and
investment adviser accounts for dual registrants.

                      Table 1, Panel A--Registered Broker-Dealers as of December 2017 \395\
                        Cumulative Broker-Dealer Total Assets and Customer Accounts \396\
----------------------------------------------------------------------------------------------------------------
                                                                                Cumulative
                                                   Total number   Number of dual-   Cumulative       number of
      Size of broker-dealer (total assets)            of BDs      registered BDs   total assets      customer
                                                                                (billion)    accounts \397\
----------------------------------------------------------------------------------------------------------------
> $50 billion...................................              16              10          $2,717      40,969,187
$1 billion to $50 billion.......................             102              20           1,196      81,611,933
$500 million to $1 billion......................              38               7              26       4,599,330
$100 million to $500 million....................             118              26              26       1,957,981
$10 million to $100 million.....................             482              94              17       2,970,133
$1 million to $10 million.......................           1,035             141               4         233,946
< $1 million....................................           2,055              68               1           5,588
                                                 ---------------------------------------------------------------
    Total.......................................           3,841             366           3,987     132,348,098
----------------------------------------------------------------------------------------------------------------

                     Table 1, Panel B--Registered Retail Broker-Dealers as of December 2017
                           Cumulative Broker-Dealer Total Assets and Customer Accounts
----------------------------------------------------------------------------------------------------------------
                                                                                Cumulative
                                                   Total number   Number of dual-   Cumulative       number of
      Size of broker-dealer (total assets)            of BDs      registered BDs   total assets      customer
                                                                                (billion)       accounts
----------------------------------------------------------------------------------------------------------------
> $50 billion...................................              15              10          $2,647      40,964,945
$1 billion to $50 billion.......................              70              19             923      77,667,615
$500 million to $1 billion......................              23               7              16       4,547,574
$100 million to $500 million....................              93              25              20       1,957,981
$10 million to $100 million.....................             372              94              14       2,566,203
$1 million to $10 million.......................             815             139               3         216,158
< $1 million....................................           1,469              66              .4           5,588
                                                 ---------------------------------------------------------------
    Total.......................................           2,857             360           3,624     127,926,064
----------------------------------------------------------------------------------------------------------------

    As shown in the table below, based on responses to Form BD, broker-
dealers' most significant business lines include private placements of
securities (61.4 of broker-dealers), retail sales of mutual funds
(54.2), acting as a broker or dealer retailing corporate equity
securities over the counter (51.2), acting as a broker or dealer
retailing corporate debt securities (46.6), acting as a broker or
dealer selling variable contracts, such as life insurance or annuities
(39.5), acting as a broker of municipal debt/bonds or U.S. government
securities (39.0 and 36.7, respectively), acting as an underwriter or
selling group participant of corporate securities (30.0), investment
advisory services (24.2), among others.\398\
---------------------------------------------------------------------------

    \398\ Form BD requires applicants to identify the types of
business engaged in (or to be engaged in) that accounts for 1% or
more of the applicant's annual revenue from the securities or
investment advisory business. Table 2 provides an overview of the
types of businesses listed on Form BD, as well as the frequency of
participation in those businesses by registered broker-dealers as of
December 2017.

   Table 2--Retail Broker-Dealer Lines of Business as of December 2017
------------------------------------------------------------------------
                                                       Total
                                         -------------------------------
            Line of business                 Number of
                                          broker-dealers      Percent
------------------------------------------------------------------------
Private Placements of Securities........           1,755            61.4

Mutual Fund Retailer....................           1,549            54.2
Broker or Dealer Retailing:
    Corporate Equity Securities OTC.....           1,462            51.2
    Corporate Debt Securities...........           1,331            46.6
    Variable Contracts..................           1,129            39.5
Municipal Debt/Bonds--Broker............           1,115            39.0
U.S. Government Securities Broker.......           1,049            36.7
Put and Call Broker or Dealer or Options             999            35.0
 Writer.................................
Underwriter or Selling Group                         857            30.0
 Participant--Corporate Securities......
Non-Exchange Member Arranging for                    797            27.9
 Transactions in Listed Securities by
 Exchange Member........................
Investment Advisory Services............             691            24.2
Broker or Dealer Selling Tax Shelters or             626            21.9
 Limited Partnerships--Primary Market...
Trading Securities for Own Account......             613            21.5
Municipal Debt/Bonds--Dealer............             489            17.1
U.S. Government Securities--Dealer......             347            12.1
Solicitor of Time Deposits in a                      317            11.1
 Financial Institution..................
Underwriter--Mutual Funds...............             232             8.1
Broker or Dealer Selling Interests in                232             8.1
 Mortgages or Other Receivables.........
Broker or Dealer Selling Oil and Gas                 207             7.2
 Interests..............................
Broker or Dealer Making Inter-Dealer                 205             7.2
 Markets in Corporate Securities OTC....
Broker or Dealer Involved in Networking,             202             7.1
 Kiosk, or Similar Arrangements (Banks,
 Savings Banks, Credit Unions)..........
Internet and Online Trading Accounts....             200             7.0
Exchange Member Engaged in Exchange                  175             6.1
 Commission Business Other than Floor
 Activities.............................
Broker or Dealer Selling Tax Shelters or             163             5.7
 Limited Partnerships--Secondary Market.
Commodities.............................             159             5.6
Executing Broker........................             111             3.9
Day Trading Accounts....................              92             3.2
Broker or Dealer Involved in Networking,              90             3.2
 Kiosk, or Similar Arrangements
 (Insurance Company or Agency)..........
Real Estate Syndicator..................              89             3.1
Broker or Dealer Selling Securities of                76             2.7
 Non-Profit Organizations...............
Exchange Member Engaged in Floor                      63             2.2
 Activities.............................
Broker or Dealer Selling Securities of                47             1.6
 Only One Issuer or Associate Issuers...
Prime Broker............................              21             0.7
Crowdfunding FINRA Rule 4518(a).........              18             0.6
Clearing Broker in a Prime Broker.......              14             0.5
Funding Portal..........................               8             0.3
Crowdfunding FINRA Rule 4518(b).........               3             0.1
Number of Retail-Facing Broker-Dealers..           2,857  ..............
------------------------------------------------------------------------

b. Investment Advisers
    Proposed Regulation Best Interest could affect, indirectly, other
providers of investment advice, such as investment advisers, because
the proposed rule could impact the competitive landscape in the market
for the provision of financial advice.\399\ This section first
discusses Commission-registered investment advisers, followed by a
discussion of state-registered investment advisers.
---------------------------------------------------------------------------

    \399\ In addition to the Commission-registered and state-
registered investment advisers, which are the focus of this section,
the proposed rule could also affect banks, trust companies,
insurance companies, and other providers of investment advice.
---------------------------------------------------------------------------

    As of December 2017, there were 12,659 investment advisers
registered with the Commission. The majority of Commission-registered
investment advisers report that they provide portfolio management
services for individuals and small businesses.\400\
---------------------------------------------------------------------------

    \400\ Of the 12,659 SEC-registered investment advisers, 7,979
(64%) report in Item 5.G.(2) of Form ADV that they provide portfolio
management services for individuals and/or small businesses. In
addition, there are approximately 17,800 state-registered investment
advisers, of which 145 are also registered with the Commission.
Approximately 13,800 state-registered investment advisers are retail
facing (see Item 5.D. of Form ADV).
---------------------------------------------------------------------------

    Of all SEC-registered investment advisers, 366 identified
themselves as dually-registered broker-dealers.\401\ Further, 2,478
investment advisers (20%) reported an affiliate that is a broker-
dealer, including 1,916 investment advisers (15%) that reported an SEC-
registered broker-dealer affiliate.\402\ As shown in Panel A of Table 3
below, in aggregate, investment advisers have over $72 trillion in
assets under management (``AUM''). A substantial percentage of AUM at
investment advisers is held by institutional clients, such as
investment companies, pooled investment vehicles, and pension or
profit-sharing plans; therefore, although the dollar value of AUM for
investment advisers and of customer assets in broker-dealer accounts is
comparable, the total number of accounts for investment advisers is
only 27% of the number of customer accounts for broker-dealers.
---------------------------------------------------------------------------

    \401\ See supra note 389.
    \402\ Form ADV Item 7.A.1.
---------------------------------------------------------------------------

    Based on staff analysis of Form ADV data, approximately 60% of
investment advisers (7,600) have some portion of their business
dedicated to individual clients, including both high net worth and non-
high net worth individual clients,\403\ as shown in Panel B of Table

3.\404\ In total, these firms have approximately $32 trillion of assets
under management.\405\ Approximately 6,600 registered investment
advisers (52%) serve 29 million non-high net worth individual clients
and have approximately $5.33 trillion in assets under management, while
nearly 7,400 registered investment advisers (58%) serve approximately
4.8 million high net worth individual clients with $6.56 trillion in
assets under management.\406\
---------------------------------------------------------------------------

    \403\ We note that the data on individual clients obtained from
Form ADV may not be exactly the same as who would be a ``retail
customer'' as defined in proposed Regulation Best Interest because
the data obtained from Form ADV is limited to individuals and does
not involve any test of use for personal, family, or household
purposes.
    \404\ We use the responses to Items 5(D)(a)(1), 5(D)(a)(3),
5(D)(b)(1), and 5(D)(b)(3) of Part 1A of Form ADV. If at least one
of these responses was filled out as greater than 0, the firm is
considered as providing business to retail investors. Form ADV Part
1A.
    \405\ The aggregate AUM reported for these investment advisers
that have retail investors includes both retail AUM as well as any
institutional AUM also held at these advisers.
    \406\ Estimates are based on IARD system data as of December 31,
2017. The AUM reported here is specifically that of non-high net
worth individual clients. Of the 7,600 investment advisers serving
individual clients, 360 are also registered as broker-dealers.

                   Table 3, Panel A--Registered Investment Advisers (RIAs) as of December 2017
                            Cumulative RIA Assets Under Management (AUM) and Accounts
----------------------------------------------------------------------------------------------------------------
                                                                  Number of dual-                   Cumulative
        Size of investment adviser (AUM)          Number of RIAs    registered    Cumulative AUM     number of
                                                                       RIAs          (billion)       accounts
----------------------------------------------------------------------------------------------------------------
> $50 billion...................................             246              15         $48,221      17,392,968
$1 billion to $50 billion.......................           3,238             115          21,766      11,560,805
$500 million to $1 billion......................           1,554              53           1,090       2,678,084
$100 million to $500 million....................           5,568             129           1,303       3,942,639
$10 million to $100 million.....................           1,103              24              59         198,659
$1 million to $10 million.......................             172               2               1           5,852
< $1 million....................................             778              28             .02          31,291
                                                 ---------------------------------------------------------------
    Total.......................................          12,659             366          72,439      35,810,298
----------------------------------------------------------------------------------------------------------------

               Table 3, Panel B--Retail Registered Investment Advisers (RIAs) as of December 2017
                            Cumulative RIA Assets Under Management (AUM) and Accounts
----------------------------------------------------------------------------------------------------------------
                                                                  Number of dual-                   Cumulative
        Size of investment adviser (AUM)          Number of RIAs    registered    Cumulative AUM     number of
                                                                       RIAs          (billion)       accounts
----------------------------------------------------------------------------------------------------------------
> $50 billion...................................             106              15         $22,788      16,638,548
$1 billion to $50 billion.......................           1,427             114           8,472      10,822,275
$500 million to $1 billion......................             934              52             652       2,602,220
$100 million to $500 million....................           4,114             126             917       3,814,900
$10 million to $100 million.....................             711              24              40         231,663
$1 million to $10 million.......................              98               1              .4           5,804
< $1 million....................................             198              29             .02          31,271
                                                 ---------------------------------------------------------------
    Total.......................................           7,588             361          32,870      34,146,681
----------------------------------------------------------------------------------------------------------------

    As an alternative to registering with the Commission, smaller
investment advisers could register with state regulators.\407\ As of
December 2017, there were 17,635 state registered investment
advisers,\408\ of which 145 are also registered with the Commission. Of
the state-registered investment advisers, 236 are dually-registered as
broker-dealers, while 5% (920) report a broker-dealer affiliate. In
aggregate, state-registered investment advisers have approximately $341
billion in AUM. Eighty-two percent of state-registered investment
advisers report that they provide portfolio management services for
individuals and small businesses, compared to just 64% for Commission-
registered investment advisers.
---------------------------------------------------------------------------

    \407\ Pursuant to the Dodd-Frank Act, Item 2.A. of Part 1A of
Form ADV requires an investment adviser to register with the SEC if
it (i) is a large adviser that has $100 million or more of
regulatory assets under management (or $90 million or more if an
adviser is filing its most recent annual updating amendment and is
already registered with the SEC); (ii) is a mid-sized adviser that
does not meet the criteria for state registration or is not subject
to examination; (iii) meets the requirements for one or more of the
revised exemptive rules under section 203A discussed below; (iv) is
an adviser (or subadviser) to a registered investment company; (v)
is an adviser to a business development company and has at least $25
million of regulatory assets under management; or (vi) received an
order permitting the adviser to register with the Commission.
Although the statutory threshold is $100 million, the SEC raised the
threshold to $110 million for those investment advisers that do not
already file with the SEC.
    \408\ There are 79 investment advisers with latest reported
Regulatory Assets Under Management in excess of $110 million but are
not listed as registered with the SEC. For the purposes of this
rulemaking, these are considered erroneous submissions.
---------------------------------------------------------------------------

    Approximately 77% of state-registered investment advisers (13,470)
have some portion of their business dedicated to retail investors,\409\
and in aggregate, these firms have approximately $308 billion in
AUM.\410\ Approximately 12,700 (72%) state-registered advisers serve
616,000 non-high net worth retail clients and have approximately $125
billion in AUM, while over 11,000 (63%) state-registered advisers serve
approximately 194,000 high net worth retail clients with $138 billion
in AUM.\411\
---------------------------------------------------------------------------

    \409\ We use the responses to Items 5.D.(a)(1), 5.D.(a)(3),
5.D.(b)(1), and 5.D.(b)(3) of Part 1A of Form ADV. If at least one
of these responses was filled out as greater than 0, the firm is
considered as providing business to retail investors. Form ADV Part
1A.
    \410\ The aggregate AUM reported for these investment advisers
that have retail investors includes both retail AUM as well as any
institutional AUM also held at these advisers.
    \411\ Estimates are based on IARD system data as of December 31,
2017. The AUM reported here is specifically that of non-high net
worth investors. Of the 13,471 investment advisers serving retail
investors, 144 may also be dually-registered as broker-dealers.

---------------------------------------------------------------------------

c. Trends in the Relative Numbers of Providers of Financial Services
    Over time, the relative numbers of broker-dealers and Commission-
registered investment advisers have changed. Figure 1 presented below
shows the time series trend in the relative numbers of broker-dealers
and Commission-registered investment advisers between 2005 and 2017.
Over the last 13 years, the number of broker-dealers has declined from
over 6,000 in 2005 to less than 4,000 in 2017, while the number of
investment advisers has increased from approximately 9,000 in 2005 to
over 12,000 in 2017. This change in the relative numbers of broker-
dealers and investment advisers over time likely affects the
competition for advice and potentially reduces the choices available to
retail customers on how to receive or pay for such advice, the nature
of the advice, and the attendant conflicts of interest.
[GRAPHIC] [TIFF OMITTED] TP09MY18.000

    Increases in the number of investment advisers and decreases in the
number of broker-dealers could have occurred for a number of reasons,
including anticipation of possible regulatory changes to the industry,
other regulatory restrictions, technological innovation (i.e., robo-
advisers and online trading platforms), product proliferations (e.g.,
index mutual funds and exchange-traded products), and industry
consolidation driven by economic and market conditions, particularly
among broker-dealers.\412\ Commission staff has observed the transition
by broker-dealers from traditional brokerage services to providing also
investment advisory services (often under an investment adviser
registration, whether federal or state), and many firms have been more
focused on offering fee-based accounts than accounts that charge
commissions.\413\ Broker-dealers have indicated that the following
factors have contributed to this migration: Provision of stability or
increase in profitability,\414\ perceived lower

regulatory burden, and provisions of more or better services to retail
customers.
---------------------------------------------------------------------------

    \412\ See Hester Peirce, ``Dwindling numbers in the financial
industry,'' Brookings Center on Markets and Regulation, May 15, 2017
(``Brookings Report''), available at https://www.brookings.edu/research/dwindling-numbers-in-the-financial-industry/ (noting that
``SEC restrictions have increased by almost thirty percent [since
2000],'' and that regulations post-2010 were driven in large part by
the Dodd-Frank Act). Further, the Brookings Report observation of
increased regulatory restrictions on broker-dealers only reflects
CFTC or SEC regulatory actions, but does not include regulation by
FINRA, NFA, the MSRB, or other SROs.
    \413\ The Brookings Report also discusses the shift from broker-
dealer to investment advisory business models for retail investors,
in part due to the Department of Labor's fiduciary rule (page 7).
See also the RAND Study, supra note 28, which documents a shift from
transaction-based to fee-based accounts prior to recent regulatory
changes. Declining transaction-based revenue due to declining
commission rates and competition from discount brokerage firms has
made offering fee-based products and services more attractive.
Although discount brokerage firms generally provide execution-only
services and do not compete directly in the advice market with full
service broker-dealers and investment advisers, entry by discount
brokers has contributed to lower commission rates throughout the
broker-dealer industry. Further, fee-based activity generates a
steady stream of revenue regardless of the customer trading
activity, unlike commission-based accounts.
    \414\ Commission staff examined a sample of recent Form 10-K or
Form 10-Q filings of large broker-dealers, many of which are dually-
registered as investment advisers, that have a large fraction of
retail customer accounts to identify relevant broker-dealers. See,
e.g., Edward Jones 9/30/2017 Form 10-Q, available at https://www.sec.gov/Archives/edgar/data/815917/000156459017023050/ck0000815917-10q_20170929.htm; Raymond James 9/30/2017 Form 10-K,
available at https://www.sec.gov/Archives/edgar/data/720005/000072000517000089/rjf-20170930x10k.htm; Stifle 12/31/2016 Form 10-
K, available at https://www.sec.gov/Archives/edgar/data/720672/000156459017022758/sf-10q_20170930.htm; Wells Fargo 9/30/2017 10-Q,
available at https://www.sec.gov/Archives/edgar/data/72971/000007297117000466/wfc-09302017x10q.htm; and Ameriprise 12/31/2016
Form 10-K, available at https://www.sec.gov/Archives/edgar/data/820027/000082002717000007/ameriprisefinancial12312016.htm. We note
that discussions in Form 10-K and 10-Q filings of this sample of
broker-dealers may not be representative of other large broker-
dealers or of small to mid-size broker-dealers. Some firms have also
reported record profits as a result of moving clients into fee-based
accounts, and cite that it provides ``stability and high returns.''
See ``Morgan Stanley Wealth Management fees climb to all-time
high,'' Bloomberg, Jan. 18, 2018, available at https://www.bloomberg.com/news/articles/2018-01-18/morgan-stanley-wealth-management-fees-hit-record-on-stock-rally. Morgan Stanley increased
the percentage of client assets in fee-based accounts from 37% in
2013 to 44% in 2017, while decreasing the dependence on transaction-
based revenues from 30% to 19% over the same time period (Morgan
Stanley Strategic Update, Jan. 18, 2018, available at https://www.morganstanley.com/about-us-ir/shareholder/4q2017-strategic-update.pdf). See also Beilfuss, Lisa and Brian Hershberg, ``WSJ
Wealth Adviser Briefing: The Reinvention of Morgan and Merrill,
Adviser Profile,'' The Wall Street Journal, Jan. 25, 2018, available
at https://blogs.wsj.com/moneybeat/2018/01/25/wsj-wealth-adviser-briefing-the-reinvention-of-morgan-and-merrill-adviser-profile/.
---------------------------------------------------------------------------

    Further, there has been a substantial increase in the number of
retail clients at investment advisers, both high net worth clients and
non-high net worth clients, as shown in Figure 2. Although the number
of non-high net worth retail customers of investment advisers dipped
between 2010 and 2012, since 2012, more than 12 million new non-high
net worth retail clients have been added. With respect to assets under
management, we observe a similar, albeit more pronounced pattern for
non-high net worth retail clients as shown in Figure 3. For high net
worth retail clients, there has been a pronounced increase in AUM since
2012, although AUM has leveled off since 2015.
[GRAPHIC] [TIFF OMITTED] TP09MY18.001

d. Registered Representatives of Broker-Dealers, Investment Advisers,
and Dually-Registered Firms
    We estimate the number of associated natural persons of broker-
dealers through data obtained from Form U4, which generally is filed
for individuals who are engaged in the securities or investment banking
business of a broker-dealer that is a member of an SRO (``registered
representatives'' or ``RR''s).\415\ Similarly, we approximate the
number of supervised persons of registered investment advisers through
the number of registered investment adviser representatives (or
``registered IARs''), who are supervised persons of investment advisers
who meet the definition of investment adviser representatives in
Advisers Act Rule 203A-3 and are registered with one or more state
securities authorities to solicit or communicate with clients.\416\
---------------------------------------------------------------------------

    \415\ The number of associated natural persons of broker-dealers
may be different from the number of registered representatives of
broker-dealers, because clerical/ministerial employees of broker-
dealers are associated persons, but are not required to register.
Therefore, using the registered representative number does not
include such persons. However, we do not have data on the number of
associated natural persons and therefore are not able to provide an
estimate of the number of associated natural persons. We believe
that the number of registered representatives is an appropriate
approximation because they are the individuals at broker-dealers
that provide advice and services to customers.
    \416\ See Advisers Act Rule 203A-3. However, we note that the
data on numbers of registered IARs may undercount the number of
supervised persons of investment advisers who provide investment
advice to retail investors because not all supervised persons who
provide investment advice on behalf on an investment adviser are
required to register as IARs. For example, Commission rules exempt
from IAR registration supervised persons who provide advice only to
non-individual clients or to individuals who meet the definition of
``qualified client,'' all of which individuals would fall under the
definition of retail investor if they use the assets in advisory
accounts for personal, family, or household purposes. See id. In
addition, state securities authorities may impose additional
criteria for requiring registration as an IAR.
---------------------------------------------------------------------------

    We estimate the number of registered representatives and registered
IARs (together ``dually-registered representatives'') at broker-
dealers, investment advisers, and dual-registrants by considering only
the employees of those firms that have Series 6 or Series 7 licenses or
are registered with a state as a broker-dealer agent or investment
adviser representative.\417\ We consider only employees at firms who
have retail-facing business, as defined previously.\418\ We observe in
Table 5 that approximately 61% of registered financial professionals
are employed by dually-registered entities. The percentage varies by
the size of the firm. For example, for firms with total assets between
$1 billion and $50 billion, 72% of all registered financial
professionals in that size category are employed by dually-registered
firms. Focusing on dually-registered firms only, approximately 59.7% of
total licensed representatives at these firms are dually-registered,
approximately 39.9% are only registered representatives; and less than
1% are only registered investment adviser representatives.
---------------------------------------------------------------------------

    \417\ We calculate these numbers based on Form U4 filings.
Broker-dealers, investment advisers, and issuers of securities must
file this form when applying to register persons in certain
jurisdictions and with certain SROs. Such firms and representatives
generally have an obligation to amend and update information as
changes occur. Using the examination information contained in the
form, we consider an employee a financial professional if he has an
approved, pending, or temporary registration status for either
Series 6 or 7 (RR) or is registered as an investment adviser
representative in any state or U.S. territory (IAR), although there
are representatives that have passed exams other than the Series 7.
We limit the firms to only those that do business with retail
investors.
    \418\ See supra notes 392 and 404.

Table 5--Total Licensed Representatives at Broker-Dealers, Investment Advisers, and Dually-Registered Firms With
                                             Retail Customers \419\
----------------------------------------------------------------------------------------------------------------
                                                           Percentage of
   Size of firm (total assets for      Total number of    representatives     Percentage of        Percentage
standalone BDs and dually-registered   representatives       in dually-      representatives    representatives
   firms; AUM for standalone IAs)                         registered firms   in standalone BD   in standalone IA
----------------------------------------------------------------------------------------------------------------
>$50 billion........................             82,668                 75                  8                 18
$1 billion to $50 billion...........            150,662                 72                 10                 18
$500 million to $1 billion..........             31,673                 67                 16                 16
$100 million to $500 million........             62,539                 58                 24                 18
$10 million to $100 million.........            116,047                 52                 47                  1
$1 million to $10 million...........             37,247                 34                 63                  2
<$1 million.........................             13,563                  7                 87                  6
                                     ---------------------------------------------------------------------------
    Total Licensed Representatives..            494,399                 61                 27                 12
----------------------------------------------------------------------------------------------------------------

    In Table 6 below, we estimate the number of employees who are
registered representatives, investment adviser representatives, or
dually-registered representatives.\420\ Similar to Table 5, we
calculate these numbers using Form U4 filings. Here, we also limit the
sample to employees at firms that have retail-facing businesses as
discussed previously.\421\
---------------------------------------------------------------------------

    \419\ The classification of firms as dually-registered,
standalone broker-dealers, and standalone investment advisers comes
from Forms BD, FOCUS, and ADV as described earlier. The number of
representatives at each firm is obtained from Form U4 filings. Note
that all percentages in the table have been rounded to the nearest
whole percentage point.
    \420\ We calculated these numbers based on Form U4 filings.
    \421\ See supra notes 392 and 404.
---------------------------------------------------------------------------

    In Table 6, approximately 24% of registered employees at registered
broker-dealers or investment advisers are dually-registered
representatives. However, this proportion varies significantly across
size buckets. For example, for firms with total assets between $1
billion and $50 billion,\422\ approximately 36% of all registered
employees are dually-registered representatives. In contrast, for firms
with total assets below $1 million, 15% of all employees are dual-
hatted representatives.
---------------------------------------------------------------------------

    \422\ Firm size is measured by total firm assets from the
balance sheet (source: FOCUS reports) for broker-dealers and dual
registrants, and by assets under management for investment advisers
(source: Form ADV). We are unable to obtain customer assets for
broker-dealers, and for investment advisers, we can only obtain
information from Form ADV as to whether the firm assets exceed $1
billion. We recognize that our approach of using firm assets for
broker-dealers and customer assets for investment advisers does not
allow for direct comparison; however, our objective is to provide
measures of firm size and not to make comparisons between broker-
dealers and investment advisers based on firm size. Across both
broker-dealers and investment advisers, larger firms, regardless of
whether we stratify on firm total assets or assets under management,
have more customer accounts, are more likely to be dually-
registered, and have more representatives or employees per firm,
than smaller broker-dealers or investment advisers.

   Table 6--Number of Employees at Retail-Facing Firms who Are Registered Representatives, Investment Adviser
                                         Representatives, or Both \423\
----------------------------------------------------------------------------------------------------------------
   Size of firm (total assets for                          Percentage of
standalone BDs and dually-registered   Total number of      dual-hatted     Percentage of RRs    Percentages of
   firms; AUM for standalone IAs)         employees       representatives          only            IARs only
----------------------------------------------------------------------------------------------------------------
>$50 billion........................            216,655                 18                 17                  1
$1 billion to $50 billion...........            292,663                 36                 11                  3
$500 million to $1 billion..........             50,531                 15                 40                  6
$100 million to $500 million........            112,119                 23                 24                  8
$10 million to $100 million.........            189,318                 19                 41                  1
$1 million to $10 million...........             61,310                 19                 39                  1
< $1 million........................             19,619                 15                 46                  3
----------------------------------------------------------------------------------------------------------------
    Total Employees at Retail-Facing            942,215                 24                 24                  3
     Firms..........................
----------------------------------------------------------------------------------------------------------------

    Approximately 88% of investment adviser representatives in Table 5
are dually-registered as registered representatives. This percentage is
relatively unchanged from 2010. According to information provided in a
FINRA comment letter in connection with the 913 Study, 87.6% of
registered investment adviser representatives were dually-registered as
registered representatives as of mid-October 2010.\424\ In contrast,
approximately 50% of registered representatives were dually-registered
as investment adviser representatives at the end of 2017.\425\
---------------------------------------------------------------------------

    \423\ See supra notes 391, 403, 420, and 422. Note that all
percentages in the table have been rounded to the nearest whole
percentage point.
    \424\ FINRA comment letter to File Number 4-606; Obligations of
Brokers, Dealers and Investment Advisers (Nov. 3, 2010), available
at https://www.sec.gov/comments/4-606/4606-2836.pdf.
    \425\ In order to obtain the percentage of IARs that are dually-
registered as registered representatives of broker-dealers, we sum
the representatives at dually-registered entities and those at
investment advisers, across size categories to obtain the aggregate
number of representatives in each of the two categories. We then
divide the aggregate dually-registered representatives by the sum of
the dually-registered representatives and the IARs at investment
adviser-only firms. We perform a similar calculation to obtain the
percentage of registered representatives of broker-dealers that are
dually-registered as IARs.
---------------------------------------------------------------------------

e. Financial Incentives of Firms and Financial Professionals
    Commission experience indicates that there is a broad range of
financial incentives provided by standalone broker-dealers and dually-
registered firms to their representatives.\426\ While some firms
provided a base pay for their financial professionals ranging from
approximately $45,000 to $85,000 per year, many firms provided
compensation only through a percentage of commissions, plus
performance-based awards, such as individual or team bonus based on
production. Commission-based payouts to financial professionals ranged
from 30% to 95%, although these payouts were generally reduced by
various costs and expenses attributable to the financial professional
(e.g., clearing costs associated with some securities, SRO or SIPC-
related charges, and insurance, among others).
---------------------------------------------------------------------------

    \426\ Information on compensation and financial incentives
generally relates to 2016 compensation arrangements for a sample of
approximately 20 firms, comprised of both standalone broker-dealers
and dually-registered firms. We acknowledge that the information
provided in this baseline may not be representative of the
compensation structures more generally because of the diversity and
complexity of services and products offered by standalone broker-
dealers and dually-registered firms.
---------------------------------------------------------------------------

    Several firms had varying commission payout rates depending on the
product type being sold. For example, payouts ranged from 76.5% for
stocks, bonds, options, and commodities to 90% for open-ended mutual
funds, private placements, and unit investment trusts. Several firms
charged varying commissions on products depending on the amount of
product sold (e.g., rates on certain proprietary mutual funds ranged
from 0.75% to 5.75% depending on the share class), but did not provide
those payout rates to financial professionals based on product type.
Some firms also provided incentives for their financial professionals
to recommend proprietary products and services over third-party or non-
proprietary products. Commission rates for some firms, however,
declined as the dollar amount sold increased and such rates varied
across asset classes as well (e.g., within a given share class, rates
ranged from 1.50% to 5.75% depending on the dollar amount of the fund
sold). With respect to compensation to individual financial
professionals, if payout rates for mutual funds were approximately 90%
(as discussed above, for example), financial professionals could earn
between 0.68% and 5.18%, depending on the type and amount of product
sold.
    For financial professionals who did not earn commission-based
compensation, some firms charged retail customers flat fees ranging
from $500 to $2,500, depending on the level of service required, such
as financial planning, while others charged hourly rates ranging from
$150 to $350 per hour. For dually-registered firms that charged clients
based on a percentage of assets under management, the average
percentage charged varied based on the size of the account: The larger
the assets under management, the lower the percentage fee charged.
Percentage-based fees for the sample firms ranged from approximately
1.5% for accounts below $250,000 to 0.5% for accounts in excess of $1
million.\427\ If payout rates range between 30% and 95%, a firm
charging a customer $500 could provide compensation to the financial
professional between $150 and $475 for each financial plan provided.
For fee-based accounts, assuming that a retail customer had an account
worth $250,000, the firm would charge fees of $3,750 ($250,000 x 1.5%),
and the financial professional could earn between $1,170 and $3,560
annually for each account.
---------------------------------------------------------------------------

    \427\ We note that some firms could have higher or lower
commission payout rates or asset-based fee percentages than those
provided here. For example, based on a review of Form ADV Part 2A
(the brochure) of several large dual registrants (not included in
the sample above), asset-based fees for low AUM accounts could range
as high as 2.0% to 3.0%, with the average fee for high AUM accounts
ranging between 0.5% to 1.5%. See also ``Average Financial Advisor
Fees & Costs, 2017 Report, Understanding Advisory & Investment
Management Fees,'' AdvisoryHQ, available at http://www.advisoryhq.com/articles/financial-advisor-fees-wealth-managers-planners-and-fee-only-advisors/. The AdvisoryHQ report shows that
average asset-based fees range from 1.18% for accounts less than
$50,000 to less than 0.60% for accounts in excess of $30 million,
while fixed-fees range from $7,500 for accounts less than $500,000
to $55,000 for accounts in excess of $7.5 million. Again, we note
that these are charges to clients and are not indicative of the
total compensation earned by the financial professional per account.
---------------------------------------------------------------------------

    In addition to ``base'' compensation, most firms also provided
bonuses (based on either individual or team performance) or variable
compensation, ranging from approximately 10% to

83% of base compensation. While the majority of firms based at least
some portion of their bonuses on production, usually in the form of
total gross revenue, other forms of bonus compensation were derived
from customer retention, customer experience, and manager assessment of
performance. Moreover, some firms used a tiered system within their
compensation grids depending on firm experience and production levels.
Financial professionals' variable compensation could also increase when
they enrolled retail customers in advisory accounts versus other types
of accounts, such as brokerage accounts. Some firms also provided
transition bonuses for financial professionals with prior work
experience based on historical trailing production levels and AUM.
Although many firms did not provide any incentive-based contests or
programs, some firms awarded non-cash incentives for meeting certain
performance, best practices, or customer service goals, including
trophies, dinners with senior officers, and travel to annual meetings
with other award winners.
2. Regulatory Baseline
    Regulation Best Interest would require broker-dealers and natural
persons associated with broker-dealers, when making a recommendation of
any securities transaction or investment strategy involving securities
to a retail customer, to act in the best interest of the retail
customer at the time the recommendation is made without placing the
financial or other interest of the broker, dealer, or natural person
who is an associated person of the broker or dealer making the
recommendation, ahead of the interest of the retail customer.
Regulation Best Interest incorporates and goes beyond the existing
broker-dealer regulatory regime for advice. In this section, we
describe the existing regulatory baseline for broker-dealers, including
existing obligations under the federal securities laws and FINRA rules,
in particular those related to the suitability of recommendations and
disclosure of conflicts of interest, state regulation, existing
antifraud provisions, and state laws that impose fiduciary obligations,
and other obligations that would be imposed by the DOL Fiduciary Rule
and related PTEs, most notably the BIC Exemption.
a. Suitability Obligations
    Under the antifraud provisions of the federal securities laws and
SRO rules, broker-dealers are required to deal fairly with their
customers. By virtue of engaging in the brokerage profession, a broker-
dealer makes an implicit representation to those persons with whom it
transacts business that it will deal fairly with them, consistent with
the standards of the profession.\428\ A central aspect of a broker-
dealer's duty of fair dealing is the suitability obligation, which has
been interpreted as requiring a broker-dealer to make recommendations
that are consistent with the best interest of his customer under SRO
rules.\429\ The concept of suitability has been interpreted as an
obligation under the antifraud provisions of the federal securities
laws and also under specific SRO rules.\430\ FINRA Rule 2111
(``Suitability'') requires that a broker-dealer or associated person
have a reasonable basis to believe that a recommendation or investment
strategy is ``suitable'' for the retail customer.\431\ The suitability
obligation is fundamental to fair dealing and is intended to promote
ethical sales practices and high standards of commercial conduct.\432\
---------------------------------------------------------------------------

    \428\ See 913 Study at 51; see also Charles Hughes & Co. v. SEC,
139 F.2d 434 (2d Cir. 1943), cert. denied, 321 U.S. 786 (1944).
    \429\ See, e.g., In re Application of Raghavan Sathianathan,
Exchange Act Release No. 54722 at 21 (Nov. 8, 2006). See also supra
note 15.
    \430\ See Hanly v. SEC, 415 F.2d 589, 596 (2d Cir. 1969).
    \431\ See FINRA Rule 2111.
    \432\ See FINRA Rule 2111.01.
---------------------------------------------------------------------------

    Under FINRA Rule 2111, there are three primary suitability
requirements for broker-dealers and associated persons. First,
reasonable-basis suitability requires that, based on reasonable
diligence, a broker-dealer must have a reasonable basis that a
recommendation is suitable for at least some retail customers.\433\
Second, customer-specific suitability requires that, based on a given
customer's investment profile as detailed above, the broker-dealer has
a reasonable basis to believe that the recommendation or investment
strategy is suitable for that customer.\434\ Finally, quantitative
suitability requires that a broker-dealer must have a reasonable basis
to believe that a series of recommended transactions is not excessive
or unsuitable for a customer when taken together in light of the
customer's investment profile, even if each individual recommendation
is suitable in isolation.\435\ Broker-dealers also have additional
specific suitability obligations with respect to certain types of
products or transactions, such as variable insurance products and non-
traditional products, including structured products and leveraged and
exchange-traded funds.\436\
---------------------------------------------------------------------------

    \433\ According to FINRA Rule 2111, reasonable diligence
requires that the broker-dealer or the associated person understands
the potential risks and rewards of the recommendation or the
investment strategy.
    \434\ Id.
    \435\ Id.
    \436\ See, e.g., FINRA Rule 2330, ``Members' Responsibilities
Regarding Deferred Variable Annuities;'' FINRA Rule 2370,
``Securities Futures;'' see also 913 Study at 65-66.
---------------------------------------------------------------------------

b. Existing Broker-Dealer Disclosure Obligations
    As described above, broker-dealers are subject to a number of
specific disclosure obligations when they effect certain customer
transactions, and are subject to additional disclosure obligations
under the antifraud provisions of the federal securities laws.\437\
Generally, under the antifraud provisions of the federal securities
laws, a broker-dealer's duty to disclose material information to its
customers depends on the scope of the relationship with the customer,
which is fact intensive.\438\ When making recommendations, broker-
dealers may be held liable if they do not provide honest and complete
information or do not disclose material conflicts of interest of which
they are aware.\439\ For example, in making recommendations, courts
have found broker-dealers should have disclosed that they were: acting
as a market maker for the recommended security; trading as a principal
with respect to the recommended security; engaging in revenue sharing
with a recommended mutual fund; or ``scalping'' a recommended
security.\440\
---------------------------------------------------------------------------

    \437\ See supra notes 175-177 and 205 and accompanying text.
    \438\ See supra note 176.
    \439\ Id.
    \440\ See 913 Study at notes 251-54.
---------------------------------------------------------------------------

    In addition to the antifraud provisions of the federal securities
laws, courts interpreting state common law have imposed fiduciary
obligations on broker-dealers in certain circumstances. Generally,
courts have found that broker-dealers that exercise discretion or
control over customer assets, or have a relationship of trust and
confidence with their customers, owe customers a fiduciary duty.\441\
As discussed above, in developing proposed Regulation Best Interest,
the Commission has drawn from state common law fiduciary principles,
among other things, in order to establish greater consistency in the
level of retail customer protections and to ease compliance with
Regulation Best Interest where other legal regimes--such as state
common law--might also apply. For instance, under proposed Regulation
Best Interest, a broker-

dealer's duty to exercise reasonable diligence, care, skill, and
prudence would resemble the standard of conduct that has been imposed
on broker-dealers found to be acting in a fiduciary capacity under
state common law.\442\ Similarly, a broker-dealer's Disclosure
Obligation (along with the Conflict of Interest Obligations) under
proposed Regulation Best Interest would resemble the duty to disclose
material conflicts imposed on broker-dealers found to be acting as
fiduciaries under state common law.\443\
---------------------------------------------------------------------------

    \441\ See supra note 15.
    \442\ See, e.g., Davis v. Merrill Lynch, Pierce, Fenner & Smith,
Inc., 906 F.2d 1206, 1215 (8th Cir. 1990) (finding that the district
court did not abuse its discretion in instructing the jury that
licensed securities brokers were fiduciaries that owed their
customers a duty of utmost good faith, integrity, and loyalty).
    \443\ See, e.g., United States v. Szur, 289 F.3d 200, 212 (2d
Cir. 2002) (broker's fiduciary relationship with customer gave rise
to a duty to disclose commissions to customer, which would have been
relevant to customer's decision to purchase stock); Arleen W.
Hughes, Exchange Act Release No. 4048 (Feb. 18, 1948) (Commission
Opinion), aff'd sub nom. Hughes v. SEC, 174 F.2d 969, 976 (D.C. Cir.
1949) (broker-dealer acted in the capacity of a fiduciary and, as
such, broker-dealer was under a duty to make full disclosure of the
nature and extent of her adverse interest, ``including her cost of
the securities and the best price at which the security might be
purchased in the open market'').
---------------------------------------------------------------------------

c. Department of Labor's Fiduciary Rule and Related Federal Securities
Laws
    DOL amendments to its regulation defining investment advice in the
DOL Fiduciary Rule would broadly expand the types of broker-dealer
services that may trigger fiduciary status for the purposes of the
prohibited transaction provisions of ERISA and the Code as a result of
rendering investment advice to retirement accounts.\444\ As noted, in
connection with the DOL Fiduciary Rule, DOL amended certain existing
PTEs and adopted new PTEs, including in particular the BIC Exemption,
which generally permits certain financial institutions including
broker-dealers to recommend investment transactions and receive
commissions and other compensation resulting from the recommended
transactions under certain conditions.\445\ As discussed above, a
broker-dealer that wishes to rely on the BIC Exemption to engage in
transactions that would otherwise be prohibited (e.g., providing
investment recommendations and receiving ``conflicted compensation'')--
would have to adhere to the Impartial Conduct Standards (including
obligations to provide ``best interest'' recommendations, receive no
more than reasonable compensation, and avoid making statements that are
materially misleading at the time they are made). Broker-dealers that
seek to rely on the BIC Exemption would have to satisfy additional
conditions including (among other things) that, as described above,
require broker-dealers to (1) enter into a written contract with each
IRA owner enforceable against the broker-dealer that acknowledges
fiduciary status, commits to adhere to the Impartial Conduct Standards,
and warrants to the adoption of certain policies and procedures, (2)
implement policies and procedures reasonably designed to ensure that
the firm and its advisers provide best interest advice and minimize the
harmful impact of conflicts of interest in conflicts, including a
prohibition against differential compensation or other incentives that
were intended or expected to cause advisers to provide recommendations
that are not in the customer's best interest, and (3) disclose
information about fees, compensation and material conflicts of interest
associated with recommendations in initial and ongoing disclosures,
including website disclosures.\446\
---------------------------------------------------------------------------

    \444\ See BIC Exemption Release, 81 FR at 21007 (DOL states that
it ``anticipates that the [DOL Fiduciary Rule] will cover many
investment professionals who did not previously consider themselves
to be fiduciaries under ERISA or the Code.'').
    \445\ See BIC Exemption Release. Broker-dealers and their
registered representatives are not, however, required to comply with
conditions under the BIC Exemption if they adopt a different
approach to avoid non-exempt prohibited transactions, including by
meeting the conditions of the statutory exemption for the provision
of investment advice to participants of individual account plans
under ERISA sections 408(b)(14) and 408(g), or by offsetting third-
party payments against level fees, see BIC Exemption Release, 81 FR
at 21013, at n. 23 and accompanying text.
    \446\ See BIC Exemption Release, 81 FR at 21007. These
conditions are discussed in more detail below.
---------------------------------------------------------------------------

    Existing broker-dealer obligations under the federal securities
laws and FINRA rules prohibit misleading statements and require fair
and reasonable compensation. The antifraud provisions of the federal
securities laws prohibit broker-dealers from making misleading
statements,\447\ while FINRA Rule 2210 specifically addresses
communications between broker-dealers and the public and requires that
these communications be based on principles of fair dealing and good
faith and be fair and balanced.\448\ Under FINRA rules, prices for
securities and broker-dealer compensation are required to be fair and
reasonable, taking into consideration all relevant circumstances.\449\
Although the existing standards and rules identified above prohibit
broker-dealers from making misleading statements, address their
communications with the public, and require fair and reasonable
compensation, the DOL also adopted the Impartial Conduct Standards to
address these issues in the BIC Exemption.\450\
---------------------------------------------------------------------------

    \447\ See Exchange Act Sections 10(b) and 15(c).
    \448\ See FINRA Rule 2210 (``Communications with the Public'').
    \449\ See e.g., Exchange Act Sections 10(b) and 15(c); FINRA
Rules 2121 (``Fair Prices and Commissions''), 2122 (``Charges for
Services Performed''), and 2341 (``Investment Company Securities'').
    \450\ See BIC Exemption Release, 81 FR 21007, 21030-32.
---------------------------------------------------------------------------

    As discussed above, as a practical matter, broker-dealers offering
IRA brokerage accounts would generally need to meet the conditions of
the BIC Exemption or one of the related PTEs to make recommendations to
brokerage customers with such accounts and receive commissions or other
compensation relating to recommended transactions. To determine the
universe of broker-dealers that offer IRA brokerage accounts and
generally would need to meet the conditions of the BIC Exemption for
purposes of this baseline, we assume that all broker-dealers that have
retail accounts are required to comply with the PTEs, including the BIC
Exemption, in providing services to at least some of their retail
accounts. The Commission does not currently have data on the number of
firms that would rely on these PTEs and that would be required to
provide these disclosures.\451\ However, the Commission can broadly
estimate the maximum number of broker-dealers that would be subject to
the requirements of the PTEs from the number of broker-dealers that
have retail customer accounts. Approximately 74.4% (2,857) of
registered broker-dealers report sales to retail customers.\452\
Similarly, approximately 7,600 (60% of) investment advisers serve high
net worth and non-high net worth individual clients. The Commission
understands that these numbers are an upper bound and likely
overestimates the broker-dealers and investment advisers that provide
retirement account services.\453\
---------------------------------------------------------------------------

    \451\ In order to perform this analysis, the Commission would
need to know which financial firms have retirement-based assets as
part of their business model. Under the current reporting regimes
for both broker-dealers and investment advisers, they are not
required to disclose whether (or what fraction of) their accounts
are held by retail investors in retirement-based accounts.
    \452\ As of December 2017, 3,841 broker-dealers filed Form BD.
Retail sales by broker-dealers were obtained from Form BR. See supra
note 392.
    \453\ The Department of Labor Regulatory Impact Analysis (``DOL
RIA'') identified approximately 4,000 broker-dealers (FINRA, 2016),
of which approximately 2,500 are estimated to have either ERISA
accounts or IRA associated with the broker-dealers, similar to the
estimates that we provide above. In addition to broker-dealers, the
DOL RIA estimates that other providers of ERISA or IRA accounts
include: Approximately 10,600 federally registered investment
advisers and 17,000 state-registered investment advisers (NASAA
2012/2013 Report), of which approximately 17,000 of federal and
state investment advisers that are not dual registered,
approximately 6,000 ERISA plan sponsors (2013 Form 5500 Schedule C),
and approximately 400 life insurance companies (2014 SNL Financial
Data). See The Department of Labor, Regulating Advice Markets:
Regulatory Impact Analysis for Final Rule and Exemptions (Apr.
2016), available at https://www.dol.gov/sites/default/files/ebsa/laws-and-regulations/rules-and-regulations/completed-rulemaking/1210-AB32-2/conflict-of-interest-ria.pdf.

---------------------------------------------------------------------------

    A recent survey and study were conducted to provide information
about how the broker-dealer industry has begun to transition as a
result of the DOL Fiduciary Rule. In 2017, the Securities Industry and
Financial Markets Association (``SIFMA'') teamed with Deloitte and
conducted a study focusing on the impact of the DOL Fiduciary Rule on
retirement investors and financial institutions.\454\ The SIFMA Study
surveyed 21 SIFMA members and captured 43% of U.S. ``financial
advisors'' (132,000 out of 310,000), 35 million retail retirement
accounts,\455\ and 27% of qualified retirement savings assets ($4.6
trillion out of $16.9 trillion).
---------------------------------------------------------------------------

    \454\ See The DOL Fiduciary Rule: A study on how financial
institutions have responded and the resulting impacts on retirement
investors, SIFMA and Deloitte (Aug. 9, 2017), available at https://www.sifma.org/wp-content/uploads/2017/08/Deloitte-White-Paper-on-the-DOL-Fiduciary-Rule-August-2017.pdf (``SIMFA Study'').
    \455\ The types of retirement accounts serviced by the
participants in the SIFMA Study were not defined.
---------------------------------------------------------------------------

    Of the 21 SIFMA members that participated in the survey, 53%
eliminated or reduced access to brokerage advice services and 67% have
migrated away from open choice to fee-based or limited brokerage
services. For those retail customers faced with eliminated or reduced
brokerage advice services, 63% chose to move to self-directed accounts
rather than fee-based accounts and cited the reasons as ``not wanting
to move to a fee-based model, not in the best interest to move to a
fee-based model, did not meet account minimums, or wanted to maintain
positions in certain asset classes prohibited by the fee-based
models.'' For those retail customers that migrated from brokerage to
fee-based models, the average change in all-in fees increased by 141%
from 46 basis points (bps) to 110 bps.
    Further, 95% of survey participants altered their product
offerings, by reducing or eliminating certain asset or share classes.
For example, 86% of the respondents reduced the number or type of
mutual funds (e.g., 29% eliminated no-load funds, while 67% reduced the
number of mutual funds), and 48% reduced annuity product offerings.
Moreover, although the DOL Fiduciary Rule applies only in connection
with services for retirement accounts, many of the survey participants
have implemented the changes to both retirement and non-retirement
accounts.\456\
---------------------------------------------------------------------------

    \456\ In July 2017, the American Bankers Association (``ABA'')
conducted a survey of 57 banks about their understanding of the
Fiduciary Rule on products and the impact of the rule on products
and services available to retirement investors. None of the survey
respondents added to the retirement products or services available,
while 30% eliminated or reduced products or services available to
retirement investors in response to the Fiduciary Rule. Nearly 40%
of banks further believed that the relationship with their customers
has been altered as a result of the Fiduciary Rule applying only to
retirement assets ``since the bank is unable to provide holistic
financial advice to its customers.'' available at https://www.aba.com/Advocacy/Issues/Documents/dol-fiduciary-rule-survey-summary-report.pdf. See ``Department of Labor Fiduciary Rule:
National Survey of Financial Professionals'' Financial Services
Roundtable/Harper Polling (July 2017), available at http://www.fsroundtable.org/wp-content/uploads/2017/08/17.07-FSR-Presentation-1.pdf. We note that the developments of business models
and practices discussed herein reflect changes made voluntarily by
firms in response to the DOL Fiduciary Rule, but were not
necessarily required by the DOL Fiduciary Rule.
---------------------------------------------------------------------------

    To date, the survey participants have incurred compliance costs of
$600 million, although the costs vary by the size of the respondent.
For instance, large firms with net capital in excess of $1 billion are
expected to have start-up and ongoing compliance costs of $55 million
and $6 million, respectively, while firms between $50 million and $1
billion in net capital are expected to have start-up and ongoing
compliance costs of $16 million and $3 million, respectively. The SIFMA
Study estimates that total start-up compliance costs for large and
medium-size firms combined will be approximately $4.7 billion, compared
to the DOL's estimate of between $2 billion and $3 billion, while
ongoing costs will be approximately $700 million per year (DOL's
estimates between $463 million and $679 million annually).

C. Benefits, Costs, and Effects on Efficiency, Competition, and Capital
Formation

    In formulating Regulation Best Interest, the Commission has
considered the potential benefits of establishing a best interest
standard of conduct for broker-dealers and the potential costs to the
firms and retail customers of complying with the best interest
obligation.
    The best interest standard of conduct for broker-dealers would
enhance the quality of investment advice that broker-dealers provide to
retail customers, help retail customers evaluate the advice received,
and improve retail customer protection when soliciting advice from
broker-dealers. By imposing a best interest obligation on broker-
dealers, Regulation Best Interest would achieve these benefits by
ameliorating the agency conflict between broker-dealers and retail
customers. The three components of the best interest obligation, namely
the Disclosure Obligation, the Care Obligation, and the Conflict of
Interest Obligations work together towards ameliorating this agency
conflict by addressing specific aspects of the conflict. In particular,
these obligations, taken together, are meant to provide assurances to
the retail customer that a broker-dealer provides a certain quality of
recommendation that is consistent with the customer's best interest.
    The Disclosure Obligation, as discussed above, would reduce the
informational gap with respect to certain elements of the relationship
that are not currently fully disclosed. In particular, this obligation
would foster retail customer awareness and understanding of key broker-
dealer practices as well as material conflicts of interest associated
with broker-dealer recommendations that would ultimately improve a
retail customer's assessment of the recommendations received.
    The Care Obligation, as discussed above, is designed to result in
the broker-dealer providing advice at a level of quality that better
matches the expectations of retail customers, and, as a result, should
enhance the quality of recommendations received.\457\
---------------------------------------------------------------------------

    \457\ See supra Section IV.D.2.
---------------------------------------------------------------------------

    Proposed Regulation Best Interest would impose two concurrent
Conflict of Interest requirements, as described above. These Conflict
of Interest Obligations would enable broker-dealers to meet the
Disclosure Obligation with regard to material conflicts of interest
which would enhance customer understanding of broker-dealer conflicts
associated with a recommendation and the extent to which those
conflicts may influence a recommendation. This enhanced understanding
of broker-dealer conflicts would aid retail customers in assessing, and
deciding whether to act on, broker-dealer recommendations. Taken
together, the Disclosure Obligation, the Care Obligation and the
Conflict of Interest Obligations are designed to reduce the effects of
conflicted broker-dealer advice and thereby improve retail customer
protection.

    The Commission acknowledges, however, that Regulation Best
Interest, through its component obligations, would potentially give
rise to direct costs to broker-dealers and indirect costs to retail
customers. For example, the requirement to act in the retail customer's
best interest of the Care Obligation may lead some broker-dealers to
determine that they no longer wish to make certain recommendations,
and, as a result, may forgo some of the revenue stream associated with
such recommendations. The disclosure requirements of the Disclosure
Obligation and the Conflict of Interest Obligations would go beyond
existing disclosure obligations, and, as a result, may impose direct
costs on broker-dealers. Certain aspects of the Conflict of Interest
Obligations may decrease the incentives of registered representatives
to expend effort in providing quality advice, and, therefore, may
impose a cost on retail customers if there is a decline in the quality
of recommendations. Finally, other aspects of the Conflict of Interest
Obligations may limit retail customer choice and, therefore, impose
costs on retail customers, because broker-dealers, for compliance or
business reasons, may determine to avoid certain products, despite the
fact that those products may be beneficial to certain retail customers
in certain circumstances.
    Although, in establishing a best interest obligation for broker-
dealers, the Commission considers these and other potential benefits
and costs, the Commission notes that generally it is difficult to
quantify such benefits and costs. Several factors make the
quantification of the effects of the best interest obligation
difficult. There is a lack of data on the extent to which broker-
dealers with different business practices engage in disclosure and
conflict mitigation activities to comply with existing requirements,
and therefore how costly it would be to comply with the proposed
requirements. The proposed rule would also give broker-dealers
flexibility in complying with the best interest obligation, and, as a
result, there could be multiple ways in which broker-dealers could
satisfy this obligation, so long as it complies with its baseline
obligations. Finally, any estimate of the magnitude of such benefits
and costs would depend on assumptions about the extent to which broker-
dealers are currently engaging in disclosure and conflict mitigation
activities, how broker-dealers would choose to satisfy the best
interest obligation, and, potentially, how retail customers perceive
the risk and return of their portfolio, the likelihood of acting on a
recommendation that complies with the best interest obligation, and how
the risk and return of their portfolio change as a result of how they
act on the recommendation. Since the Commission lacks the data that
would help narrow the scope of these assumptions, the resulting range
of potential quantitative estimates would be wide and, therefore, not
informative about the magnitude of the benefits or costs associated
with the best interest obligation.
1. Benefits
    In this section, we discuss the benefits of a best interest
standard of conduct, generally, and the benefits associated with the
components of Regulation Best Interest, specifically.
    Proposed Regulation Best Interest would create an express best
interest obligation under the Exchange Act that consists of three
components: The Disclosure Obligation, the Care Obligation, and the
Conflict of Interest Obligations. These obligations, taken together,
are meant to provide assurances to retail customers that broker-dealers
provide a certain quality of recommendations that are consistent with
the customers' best interest and to enhance retail customer protection.
The best interest obligation, including the specific component
obligations, may not be reduced or narrowed through contract with a
retail customer.
    As discussed in Section IV.2, explicit contracts may, in some
cases, be inefficient means of ameliorating agency costs. In such
cases, legal and regulatory obligations can provide alternative and
more efficient tools to ameliorate these costs. For example, FINRA
rules require broker-dealers making recommendations to: (i) Have a
reasonable basis to believe, based on reasonable diligence, that the
recommendation is suitable for at least some investors, and (ii) based
on a particular customer's investment profile, have a reasonable basis
to believe that the recommendation is suitable for that customer.
Moreover, under FINRA rules, a broker-dealer or associated person who
has actual or de facto control over a customer's account must have a
reasonable basis for believing that a series of recommended
transactions, even if suitable when viewed in isolation, is not
excessive and unsuitable for the customer when taken together in light
of the customer's investment profile.
    In the absence of these rules, these requirements are all
provisions that could, at least theoretically, be included in broker-
dealer account agreements with retail customers. Including these
provisions would be meant to provide assurance to the retail customer
that a broker-dealer provides a certain quality of recommendations. But
inclusion of such provisions would likely have limited effectiveness
because the retail customer would have little, if any, ability to
confirm the broker-dealer's compliance with the provisions. If these
provisions regarding the quality of advice were left open to contract,
it is equally likely that the broker-dealer (as the more informed
party) would be able to offer less optimal terms regarding the quality
of advice to be provided to the retail customer.
    Proposed Regulation Best Interest, through the Disclosure, the
Care, and the Conflict of Interest Obligations, would incorporate and
go beyond current broker-dealer obligations under federal securities
laws and SRO rules in ways that would ameliorate the agency conflict
between broker-dealers and retail customers and would create a number
of potentially significant benefits for retail customers.
    As discussed in more detail below, the Disclosure Obligation would
foster retail customer awareness and understanding of certain specified
information regarding the retail customer's relationship with the
broker-dealer as well as material conflicts of interest associated with
broker-dealer recommendations. As a result, this obligation would
reduce the informational gap between a broker-dealer making a
recommendation and a retail customer receiving that recommendation,
which, in turn, may cause the retail customer to act differently with
regard to the recommendation. For example, the retail customer may
reject a broker-dealer recommendation that she would otherwise not
reject absent the new information made available by the Disclosure
Obligation. Anticipating a potential change in the behavior of the
retail customer with respect to acting on recommendations as a result
of the Disclosure Obligation, a broker-dealer may adjust its own
behavior by providing recommendations that are less likely to be
rejected by the retail customer. By virtue of being tailored to the
retail customer's anticipated behavior, these recommendations are more
likely to be in the retail customer's best interest, and therefore of
higher quality relative to the recommendations that the broker-dealer
would supply absent this obligation. Thus, the Disclosure Obligation
would enhance the quality of recommendations that broker-dealers
provide to retail customers. Furthermore, to the extent

that uncertainty about a broker-dealer's conflicts of interest
associated with a recommendation complicates a retail customer's
evaluation of the recommendation, the Disclosure Obligation would
reduce that uncertainty and, therefore, would help retail customers
better evaluate broker-dealer recommendations.
    Similarly, the Care Obligation would allow broker-dealers to
provide recommendations at a level of quality that better matches the
expectations of its retail customers, and, therefore, would enhance the
quality of recommendations that broker-dealers provide to retail
customers.
    Finally, the Conflict of Interest Obligations would require broker-
dealers to establish, maintain, and enforce policies and procedures
that are reasonably designed to identify and disclose or eliminate
material conflicts of interest and establish, maintain, and enforce
policies and procedures that are reasonably designed to identify and
eliminate, or disclose and mitigate, material conflicts of interest
arising from financial incentives associated with their
recommendations. Such policies and procedures would benefit retail
customers because they would be designed to reduce conflicts of
interest that may motivate the behavior of associated persons of
broker-dealers and thereby enhance the quality of the recommendations
that they provide to their retail customers. Furthermore, these
obligations work in conjunction with the Disclosure Obligation by
including requirements designed to reduce the uncertainty with respect
to whether a broker-dealer recommendation is subject to conflicts of
interest. In particular, the Conflict of Interest Obligations would
benefit retail customers by helping them better evaluate the
recommendations received from broker-dealers.
a. Disclosure Obligation
    Proposed Regulation Best Interest would establish the Disclosure
Obligation, which would foster a retail customer's awareness and
understanding of specified information regarding the relationship with
the broker-dealer as well as material conflicts of interest associated
with broker-dealer recommendations. To meet the Disclosure Obligation,
the Commission would consider the following to be examples of material
facts relating to the scope and terms of the relationship with the
retail customer that a broker-dealer would be required to disclose in
writing: (1) That it is acting in a broker-dealer capacity with respect
to the recommendation; (2) fees and charges that apply to the retail
customer's transactions, holdings, and accounts; and (3) type and scope
of services provided by the broker-dealer. Additionally, a broker-
dealer would be required to disclose in writing all material conflicts
of interest that are associated with the recommendation.
    Currently, broker-dealers are not subject to an explicit and broad
disclosure obligation under the Exchange Act. However, broker-dealers
may provide information about their services and accounts, which may
include disclosure about a broker-dealer's capacity, fees, and
conflicts on their firm websites and in their account opening
agreements. In addition, as noted above, broker-dealers are currently
subject to specific disclosure obligations when making recommendations.
Broker-dealers generally may be liable under federal securities laws'
antifraud provisions if they do not give ``honest and complete
information'' or disclose any material adverse facts or material
conflict of interest, including economic self-interest. Many of these
existing disclosure obligations depend on the facts and circumstances
around recommendations, and different broker-dealers may comply with
them differently. In addition, these disclosure obligations may not
always produce information that is sufficiently relevant to a
recommendation to assist a retail customer in meaningfully evaluating
the recommendation. For instance, retail customers may not be aware of
or understand the broker-dealer's conflicts of interest.\458\
---------------------------------------------------------------------------

    \458\ See supra discussion in Section II.D.
---------------------------------------------------------------------------

    The disclosure obligations for broker-dealers under Regulation Best
Interest are more express and more comprehensive compared to existing
disclosure requirements and liabilities. Namely, a broker-dealer that
makes recommendations to a retail customer would be required to provide
the retail customer with sufficiently specific facts about any material
conflicts of interest such that the retail customer would be able to
understand the conflict and make an informed decision about the broker-
dealer recommendations. The Commission has provided preliminary
guidance above on aspects of disclosure by a broker-dealer to a retail
customer; this disclosure would help the retail customer understand
specified information regarding the relationship with the broker-
dealer, including the broker-dealer's material conflicts of interest.
    In the case of retail customers who have both brokerage and
advisory accounts with the same financial professional, such as dual-
registrants, it may not always be clear whether the financial
professional is acting in a capacity of broker-dealer or investment
adviser when providing advice.\459\ This information may be useful to
the retail customer when evaluating the advice received. For instance,
the cost to the retail customer of acting on such advice may depend on
whether the advice is tied to the retail customer's brokerage or
advisory account.
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    \459\ See supra discussion in Section II.C.4.
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    By articulating an explicit disclosure requirement under the
Exchange Act as part of the best interest obligation, the Disclosure
Obligation would facilitate improved disclosure practices among broker-
dealers. In addition, the Disclosure Obligation would facilitate retail
customer awareness and understanding of certain key facts concerning
their relationship with a broker-dealer, as well as conflicts of
interest, and would provide retail customers with sufficiently specific
facts to help them evaluate a broker-dealer recommendation. As a
result, the Disclosure Obligation ameliorates the agency conflict
between retail customers and broker-dealers, and therefore provides a
potentially important benefit to investors in the form of reduced
agency conflict between retail customers and broker-dealers.
    The magnitude of the benefit from the reduced agency conflict would
depend on a number of determinants, such as how retail customers
perceive the risk and return of their portfolio, how they would act on
a recommendation given the new information made available by the
Disclosure Obligation, and, finally, how the risk and return of their
portfolio would change as a result of acting on a recommendation. Given
the number and complexity of assumptions, the Commission lacks the data
that would allow it to narrow the scope of the assumptions regarding
these determinants and estimate the magnitude of the benefit.
b. Exercise Reasonable Diligence, Care, Skill, and Prudence
    As noted above, the Care Obligation of the proposed rule would go
beyond the existing broker-dealer obligations under FINRA's suitability
rule by requiring that broker-dealers act in the best interest of their
retail customers, without placing the financial or other interest of
the broker-dealer or associated person making the recommendation ahead
of the interest of the retail customer. Furthermore, the Care
Obligation does not include an

element of control, unlike the quantitative suitability prong of
FINRA's suitability rule.
    The new requirements of the Care Obligation of proposed Regulation
Best Interest may restrict broker-dealers from making certain
recommendations. For instance, broker-dealers would not be able to make
recommendations to retail customers that comply with FINRA's
suitability rule if they do not also comply with all the requirements
of the Care Obligation. While the impact of the Care Obligation
restrictions on broker-dealer recommendations to retail customers would
depend largely, as noted earlier, on the facts and circumstances
related to each recommendation and the investment profile of the retail
customer receiving that recommendation, the fact that the Care
Obligation incorporates and goes beyond existing broker-dealer
suitability obligations may yield certain benefits for retail
customers. For instance, to the extent that currently broker-dealers
comply at all times with FINRA's suitability requirements but do not
always account for the retail customer's best interest, as proposed
here, when choosing between securities with similar payoffs but
different cost structures, the Care Obligation would encourage broker-
dealers to recommend a security that would be more appropriately suited
to achieve the retail customer's objectives. Thus, by promoting
recommendations that are better aligned with the objectives of the
retail customer, the Care Obligation of proposed Regulation Best
Interest would provide an important benefit to retail customers,
ameliorating the agency conflict between broker-dealers and retail
customers and, in turn, improving the quality of recommendations that
broker-dealers provide to retail customers.
    The Commission is unable to quantify the magnitude of these
benefits to retail customers for a number of reasons. First, broker-
dealer recommendations would depend largely on the facts and
circumstances related to each recommendation and the investment profile
of the retail customer receiving that recommendation. Second, broker-
dealers currently do not have an explicit obligation to act in their
customers' best interest when making recommendations. Finally, the
magnitude of these benefits to retail customers would depend on how
retail customers generally perceive the risk and return of their
portfolio, the likelihood of acting on a recommendation that complies
with the best interest obligation, and, ultimately, how the risk and
return of their portfolio change as a result of how they act on the
recommendation. Any estimate of the magnitude of such benefits would
depend on assumptions about the facts and circumstances surrounding a
recommendation, the investment profile of the retail customer, how
retail customers perceive the risk and return of their portfolio, the
determinants of the likelihood of acting on a recommendation that
complies with the best interest obligation, and, finally, how the risk
and return of their portfolio change as a result of how they act on the
recommendation. Because the Commission lacks the data that would help
narrow the scope of these assumptions, the resulting range of potential
estimates would be wide, and, therefore, would not be informative about
the magnitude of these benefits to retail customers.
    Another way in which the proposed rules would incorporate and go
beyond existing standards is by requiring a broker-dealer to have a
reasonable basis to believe that a series of recommended transactions,
even if in the retail customer's best interest when viewed in
isolation, is not excessive and is in the retail customer's best
interest when taken together in light of the retail customer's
investment profile, regardless of whether the broker-dealer has actual
or de facto control over a retail customer account. This represents a
heightened standard relative to obligations under federal securities
laws and under FINRA's concept of quantitative suitability in two ways.
First, this proposed requirement applies a best interest standard to a
series of recommendations, rather than requiring broker-dealers to
merely have a reasonable basis for believing that a series of
recommendations are not excessive or unsuitable. Second, by removing
the control element, the proposed requirement would expand the scope of
retail customers that could benefit from existing suitability
requirements to those retail customers who, while retaining control
over their own accounts, nevertheless accept a series of broker-dealer
recommendations.
    The Commission is unable to quantify the magnitude of the benefits
that retail customers could receive as a result of the new obligations
for broker-dealers that provide a series of recommendations to retail
customers for largely the same reasons that make the quantification of
the other Care Obligation benefits, as discussed above, difficult.\460\
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    \460\ The DOL RIA estimates that due to one source of adviser
conflicts, namely that conflict related to underperformance
associated with front-end load mutual funds, retirement investors
will underperform no-load mutual funds by approximately 0.50% to
1.00%, on average, which translates to aggregate losses of between
$95 billion to $189 billion over 10 years. See The Department of
Labor, Regulating Advice Markets: Regulatory Impact Analysis for
Final Rule and Exemptions (Apr. 2016), available at https://www.dol.gov/sites/default/files/ebsa/laws-and-regulations/rules-and-regulations/completed-rulemaking/1210-AB32-2/conflict-of-interest-ria.pdf. The Department of Labor further estimates that its
Fiduciary Rule and the BIC Exemption will reduce those losses
attributed to underperformance of front-end load mutual funds by $33
billion to $36 billion over 10 years. But see Letter from Craig
Lewis (Aug. 31, 2017) (offering a critique of the DOL RIA).
Generally, although the DOL RIA provides potential estimates of
investor harm and gains to investors as a result of that agency's
rule, the Commission has not incorporated those estimates into its
own economic analysis because of the differences in scope of the
intended effects of Regulation Best Interest. Moreover, because of
the range of investor risk profiles and the diversity of products
offered by broker-dealers outside of the retirement account context,
the Commission is unable to apply the DOL's analytical framework--
which focuses primarily on the differences between load and no-load
mutual funds as well as analyses that compare broker-dealer advised
investments to unadvised direct investments--to its own analysis.
With respect to the analysis of costs and benefits associated with
proposed Regulation Best Interest, the relevant metric is the
differences between broker-dealer advised accounts subject to the
current legal framework and broker-dealer advised accounts subject
to the proposed rule overlaid on the existing legal framework. See
also Council of Economic Advisers, The Effects of Conflicted
Investment Advice on Retirement Savings, 2015, available at https://obamawhitehouse.archives.gov/sites/default/files/docs/cea_coi_report_final.pdf, (using the same approach as the DOL RIA,
estimates annual losses to retirement investors from conflicted
advice at $17 billion per year). See also Economic Policy Letter,
supra note 27. The Consumer Federation of American estimated annual
losses from conflicted investment advice between $20 billion and $40
billion per year, while PIABA estimated annual losses at
approximately $21 billion per year. See CFA 2017 Letter; PIABA
Letter.
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c. Obligation To Establish, Maintain, and Enforce Written Policies and
Procedures Reasonably Designed To Identify and at a Minimum Disclose,
or Eliminate, All Material Conflicts of Interest Associated With a
Recommendation
    Regulation Best Interest would include two requirements relating to
the treatment of conflicts. The first requirement under the Conflict of
Interest Obligations would require a broker-dealer \461\ to establish,
maintain, and enforce written policies and procedures reasonably
designed to identify and at a minimum disclose, or

eliminate, all material conflicts of interest that are associated with
a recommendation. Conflicts of interest may arise for a number of
reasons. For example, a broker-dealer may be in a position to
recommend: Proprietary products, products of affiliates, or a limited
range of products; one share class versus another share class of a
mutual fund; securities underwritten by the firm or a broker-dealer
affiliate; the roll over or transfer of assets from one type of account
to another (such as recommendations to rollover or transfer assets in
an ERISA account to an IRA, when the recommendation involves a
securities transaction); and allocation of investment opportunities
among retail customers. This Conflict of Interest Obligation may
benefit retail customers to the extent that a broker-dealer
establishes, maintains and enforces policies and procedures to
disclose, or eliminate, a material conflict of interest that may have a
negative impact on its recommendations to retail customers.
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    \461\ The proposed Conflict of Interest Obligations apply solely
to the broker or dealer entity, and not to the natural persons who
are associated persons of a broker or dealer. For purposes of
discussing the Conflict of Interest Obligations, the term ``broker-
dealer'' refers only to the broker-dealer entity, and not to such
individuals. However, the policies and procedures a broker-dealer
establishes, maintains, and enforces, pursuant to the proposed
Conflict of Interest Obligation, would apply to a broker-dealer's
registered representative's conflicts of interest.
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    As noted in our earlier discussion of the Disclosure Obligation, a
broker-dealer that determines to address a conflict of interest
identified through policies and procedures by disclosing it should
provide the retail customer, in writing, with sufficiently specific
facts so that the customer is able to understand the material conflicts
of interest and is able to make an informed decision about the broker-
dealer recommendations.
    The benefits to retail customers of this disclosed information have
been discussed earlier under the Disclosure Obligation. These benefits
are difficult to quantify for the same reasons that the benefits of the
overall Disclosure Obligation in Section IV.D.1.a. are difficult to
quantify.
    As noted earlier, as an alternative to addressing a conflict of
interest identified through policies and procedures by disclosing it, a
broker-dealer may choose, instead, to satisfy this Conflict of Interest
Obligation by eliminating it altogether. If a broker-dealer addresses
the material conflict of interest by eliminating it, a retail customer
benefits from receiving a recommendation that is free of that
particular conflict of interest.
    Generally, we preliminarily believe that having express Conflict of
Interest Obligations would result in broker-dealers establishing
policies and procedures focusing specifically on identifying and
evaluating conflicts and determining whether each of the identified
conflicts is material and should be disclosed or eliminated. We also
preliminarily believe that broker-dealers may be more inclined to
evaluate and address material conflicts of interest and eliminate more
egregious conflicts of interest to the extent that disclosure of the
conflict would result in reputation risk. Further, having a clearly
defined obligation that would require, among other things, that a
broker-dealer establish written policies and procedures reasonably
designed to identify and disclose, or eliminate, all material conflicts
of interest associated with a recommendation may result in increased
retail customer confidence in the recommendation received. Finally, the
Conflict of Interest Obligation may improve retail customer welfare, to
the extent that the obligation permits retail customers to understand
better which recommendations, within a broader set of suitable