with the transition provisions described in the Relationship Summary
Adopting Release.\835\ In light of the importance of the protections
provided by Regulation Best Interest, we believe that this compliance
date will provide adequate notice and opportunity for broker-dealers to
comply with Regulation Best Interest, including by creating or updating
the necessary disclosures and to developing, updating or establishing
their policies and procedures and systems, as appropriate, to achieve
compliance with Regulation Best Interest. On and after the Compliance
Date, broker-dealers that provide recommendations of securities
transactions or investment strategies that register with the Commission
would be required to comply with Regulation Best Interest as of the
date of registration.
---------------------------------------------------------------------------

    \835\ See Relationship Summary Adopting Release.
---------------------------------------------------------------------------

    While most commenters requested an implementation period of 18-24
months,\836\ one commenter requested an implementation period of 12-18
months.\837\ We believe the operational capability needed to develop
processes to comply with Regulation Best Interest is sufficiently
established by firms of all sizes and resources. While we understand
commenters' requests for periods longer than 12 months after
effectiveness, the Commission has determined, in light of the
importance of the protections afforded by Regulation Best Interest to
retail customers, that a Compliance Date of one year after
effectiveness is an appropriate timeframe for firms to conduct the
requisite operational changes to their systems to establish internal
processes to comply with Regulation Best Interest.\838\
---------------------------------------------------------------------------

    \836\ See Cetera August 2018 Letter; SIFMA August 2018 Letter;
HD Vest Letter (recommending that the Commission adopt a 24-month
implementation period); Northwestern Mutual Letter; IRI Letter
(recommending that the Commission adopt an 18-to-24-month
implementation period); CCMC Letters; AXA Letter (recommending that
the Commission adopt at least an 18-month implementation period);
ACLI Letter; TIAA Letter (recommending that the Commission adopt an
18-month implementation period).
    \837\ See Raymond James Letter (recommending that the Commission
adopt a 12-18-month implementation period).
    \838\ See footnote 809 and accompanying text.
---------------------------------------------------------------------------

    The Commission also believes that it is important to coordinate the
transition dates of the Relationship Summary requirements with those of
Regulation Best Interest to ensure that all retail investors receive
the full suite of protections and benefits afforded by the amended and
new rules. Finally, the Commission staff intends to offer firms
significant assistance and support during the transition period and
thereafter with the aim of helping to ensure that the investor
protections and other benefits of the final rule are implemented in an
efficient and effective manner.

III. Economic Analysis

A. Introduction and Primary Goals of the Regulation, Comments on Market
Failure and Quantification, and Broad Economic Considerations

1. Introduction and Primary Goals of the Regulation
    Regulation Best Interest enhances the broker-dealer standard of
conduct beyond existing suitability obligations and aligns the standard
of conduct with retail customers' reasonable expectations.
    Under Regulation Best Interest, broker-dealers and their associated
persons will be required 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 an associated
person making the recommendation ahead of the interests of the retail
customer. They also will be required to address conflicts of interest
by establishing, maintaining, and enforcing policies and procedures
reasonably designed to identify and fully and fairly disclose material
facts about conflicts of interest, and in instances where the
Commission has determined that disclosure is insufficient to reasonably
address the conflict, to mitigate or, in certain instances, eliminate
the conflict. As a result, Regulation Best Interest should enhance the
efficiency \839\ of recommendations that broker-dealers provide to
retail customers, allow retail customers to better evaluate the
recommendations received, improve retail customer protection when

receiving recommendations from broker-dealers, and, ultimately, reduce
agency costs \840\ and other costs. Importantly, Regulation Best
Interest is designed to preserve, to the extent possible, (1) access
and choice for investors who may prefer the transaction-based model
that broker-dealers generally provide, or the fee-based model that
investment advisers generally provide, or a combination of both types
of arrangements, and (2) retail customer choice of the level and types
of services provided and the securities available. For example, retail
customers who intend to buy and hold a long-term investment on a non-
discretionary basis may find that paying a one-time commission to a
broker-dealer who recommends such an investment is more cost effective
than paying an ongoing advisory fee to an investment adviser merely to
hold the same investment.\841\ Retail customers who would prefer
advisory accounts but have not yet accumulated sufficient assets to
qualify for investment advisory accounts, which may require customers
to have a minimum amount of assets, may similarly benefit from
recommendations from broker-dealers. Other retail customers who hold a
variety of investments, or prefer different levels of services from
financial professionals, may benefit from having access to both
brokerage and advisory accounts.
---------------------------------------------------------------------------

    \839\ See infra footnote 846 and accompanying text.
    \840\ See infra footnote 855 and accompanying text.
    \841\ See infra footnote 1353 and accompanying text.
---------------------------------------------------------------------------

    The Commission is mindful of the costs imposed by, and the benefits
obtained from our rules. Whenever the Commission engages in rulemaking
under the Exchange Act and is required to consider or determine whether
an action is necessary or appropriate in the public interest. Section
3(f) of the Exchange Act also requires the Commission to consider, in
addition to the protection of investors, whether the action would
promote efficiency, competition, and capital formation.\842\ Also, when
making rules pursuant to the Exchange Act, S the Commission is required
under Section 23(a)(2) to consider, among other matters, the impact any
rule would have on competition and is prohibited from adopting any rule
that would impose a burden on competition not necessary or appropriate
in furtherance of the purposes of the Exchange Act.\843\ The following
analysis considers, in detail, the economic effects that the Commission
believes are likely to or may result from Regulation Best Interest. The
analysis includes consideration of the benefits and costs to retail
investors and broker-dealers, and also takes into account the broader
implications of Regulation Best Interest for efficiency, competition,
and capital formation.
---------------------------------------------------------------------------

    \842\ See 15 U.S.C. 77b(b) and 15 U.S.C. 78c(f).
    \843\ See 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    Where possible, the Commission has sought to quantify the likely
economic effects of Regulation Best Interest. The Commission is
providing both a qualitative assessment and quantified estimates of the
potential effects of Regulation Best Interest, where feasible. The
Commission has incorporated data and other information provided by
commenters to assist it in the analysis of the economic effects of
Regulation Best Interest.\844\ However, as explained below in more
detail, because the Commission does not have, has not received, and, in
certain cases, does not believe it can reasonably obtain data that may
inform on certain economic effects, the Commission is unable to
quantify certain economic effects. The Commission further notes that
even in cases where it has some data or it has received some data
regarding certain economic effects, the quantification of these effects
is particularly challenging due to the number of assumptions that it
would need to make to forecast how broker-dealers will respond to
Regulation Best Interest, and how those responses will, in turn, affect
the broader market for investment advice and the retail customers'
participation in financial markets.
---------------------------------------------------------------------------

    \844\ See infra Section III.A.3.
---------------------------------------------------------------------------

2. Broad Economic Considerations
    Investors generally derive utility from consuming goods and
services over their lifetime and from bequeathing wealth to
others.\845\ The amount of goods and services that an investor can
consume or the amount of wealth the investor can bequeath is limited by
the value of the resources available to the investor over his or her
lifetime. These resources generally vary across market and economic
conditions and over time. An investor generally seeks to allocate his
or her resources across market and economic conditions and over time to
achieve the highest expected utility possible over his or her lifetime.
For example, an investor may decide to save, and therefore allocate, a
proportion of his or her wages to maximize his or her expected utility
from bequeathing wealth toward his or her children's future education.
---------------------------------------------------------------------------

    \845\ See, e.g., Irving Fisher, Theory of Interest, as
Determined by Impatience to Spend Income and Opportunity to Invest
it (1930).
---------------------------------------------------------------------------

    Capital markets facilitate this allocation and reallocation of
resources. An investor can allocate available resources across
financial assets available to them in the capital markets, such that
these resources become available to the investor at the times, and in
the market and economic conditions, when he or she needs them. There
may be many combinations of financial assets or investment strategies
that achieve an investor's allocation goals, but each of these
strategies may not necessarily provide the investor with the same
benefits or cause the investor to bear the same costs. The expected
benefit of allocating resources to an investment strategy depends on
the expected utility to the investor from the expected payoff of the
strategy and from whether this strategy pays off in the market and
economic conditions and at the times that the investor cares about.
Importantly, the various costs of allocating resources to any strategy
reduce the resources available for consumption and saving.
    A rational investor seeks out investment strategies that are
efficient in the sense that they provide the investor with the highest
possible expected net benefit, in light of the investor's investment
objective that maximizes expected utility.\846\ From the discussion
above, an efficient investment strategy may depend on the investor's
utility from consumption, including: (1) His or her risk tolerance; (2)
time available for the funds to be invested, and not consumed; (3) the
resources that the investor has currently available (e.g., current
wealth) or anticipates to become available at some point in the future
(e.g., future income); and (4) the cost to the investor of implementing
the strategy. An investor's efficient investment strategy may change
over time because the investor's preferences, as well as market
conditions and investment performance, may change over time.
---------------------------------------------------------------------------

    \846\ See, e.g., Andreu Mas-Colell, Michael D. Whinston, & Jerry
R. Green, Microeconomic Theory (1995), specifically Chapter 10:
Competitive Markets for a discussion of efficient allocations of
resources.
---------------------------------------------------------------------------

    In general, a typical investor may not have the knowledge or the
time to identify efficient strategies on his or her own. In addition,
investors may be limited in their access to information and their human
computational capacity when evaluating choices.\847\ As

an alternative to attempting to identify efficient strategies on his or
her own, an investor may solicit advice from financial professionals.
---------------------------------------------------------------------------

    \847\ See, e.g., Herbert A. Simon, A Behavioral Model of
Rational Choice, 69 Q. J. Econ. 99 (1955) for one of the first works
on bounded rationality. See also Richard H. Thaler, Behavioral
Economics: Past, Present, and Future, 106 Am. Econ. Rev. 1577 (2016)
for a discussion of the evolution of bounded rationality in
economics.
---------------------------------------------------------------------------

    While there are many types of financial professionals \848\ that
can provide advice related to a retail customer's finances, we focus
here (and in Regulation Best Interest) on a type of professional that
retail customers commonly access, namely broker-dealers and their
associated persons.
---------------------------------------------------------------------------

    \848\ The list of financial professionals that can provide
advice related to a retail customer's finances includes broker-
dealers and their associated persons, investment advisers, banks,
and insurance agents.
---------------------------------------------------------------------------

    A broker is any person engaged in the business of effecting
transactions in securities for the account of others.\849\ A dealer is
any person engaged in the business of buying and selling securities for
its own account, through a broker or otherwise.\850\ Within the scope
of these definitions, a ``broker-dealer'' (or, a firm that fits both
definitions) may offer a wide variety of services to retail customers.
These services include buying and selling securities for the retail
customer as well as providing limited personalized investment advice in
the form of recommendations of whether or not to engage in securities
transactions or investment strategies involving securities.\851\
---------------------------------------------------------------------------

    \849\ See Section 3(a)(4)(A) of the Securities Exchange Act.
    \850\ See Section 3(a)(5)(A) of the Securities Exchange Act.
    \851\ We focus our discussion on recommendations that are the
focus of Regulation Best Interest but note that broker-dealers and
their representatives provide a wide variety of ``agency services''
as described in footnote 1 of the Proposing Release. See, e.g., 913
Study. See also infra Section III.B.1.a.
---------------------------------------------------------------------------

    Federal securities laws and SRO rules govern broker-dealers'
conduct of business. Among other things, they require that a broker-
dealer or associated person ``have a reasonable basis to believe that a
recommended transaction or investment strategy involving a security or
securities is suitable for the customer, based on the information
obtained through the reasonable diligence of the [firm] or associated
person to ascertain the customer's investment profile.'' \852\ While a
suitable recommendation must take into account the elements of a retail
customer's investment profile that make securities transactions or an
investment strategy efficient for that particular retail customer, this
requirement for suitability may not lead to an efficient result for the
retail customer.
---------------------------------------------------------------------------

    \852\ See FINRA Rule 2111 (Suitability); see also infra Section
III.B.2.b.
---------------------------------------------------------------------------

    The efficiency of a recommendation to a retail customer may depend
on: (1) The menu of securities transactions and investment strategies
the broker-dealer or its associated persons considers and makes
available to the retail customer; (2) the return distribution and the
costs of these securities transactions and strategies; (3) the
associated person's understanding of these investment options and the
retail customer's objectives, such as the retail customer's risk
tolerance and time preference; and (4) the retail customer's resource
constraints.
    A recommendation provided by an associated person of the broker-
dealer may be influenced by the conflicts of interest that the
associated person may have or the conflicts of interest that the
broker-dealer may have at the time of the recommendation. These
conflicts can arise as a result of how broker-dealers generate revenue
from various securities or investment strategies that they make
available to retail customers and how broker-dealers compensate their
associated persons for providing recommendations to retail customers.
In the United States, broker-dealers may earn transaction-based
compensation that is commonly paid either directly by the retail
customer (e.g., commissions and markups or markdowns) or indirectly
through the investment sponsor (e.g., 12b-1 fees or revenue sharing).
Broker-dealers may compensate their associated persons that provide
recommendations to retail customers with a portion of the commissions
and markups or markdowns these persons generate through their
recommendations. Such financial incentives can vary depending on the
investment product line, account type, or other factors (e.g., amount
of customer assets brought into the broker-dealer or revenue generated
from customer accounts).
    A retail customer generally chooses to accept or reject a
recommendation supplied by the associated person of the broker-
dealer.\853\ Some retail customers may base their decisions on an
assessment of whether the recommendations they receive would result in
securities transactions or investment strategies that are efficient for
them. These customers' assessment may depend on factors such as their
perception of the associated person's ability to properly understand
and account for the customer's objectives, any information they have
about the associated person's or firm's conflicts of interest with
respect to that recommendation, and the extent to which these conflicts
are expected to result in less than efficient recommendations for the
retail customer. However, other retail customers may rely in full or in
part on factors less directly related to the recommendation at hand.
Instead, they might rely on factors such as their level of trust with
the associated person or firm, and in certain circumstances might be
inclined to simply accept all of the associated person's
recommendations without evaluating for themselves whether the
recommendations are efficient.\854\
---------------------------------------------------------------------------

    \853\ Note, however, that a retail customer may receive
automated advice without involvement of an associated person of the
broker-dealer. For example, a broker-dealer may generate
recommendations through an asset allocation model. FINRA Regulatory
Notice 12-25; See also FINRA Report on Digital Investment Advice
(Mar. 2016).
    \854\ See, e.g., the discussion on investor trust in the markets
for financial advice in Section III.B.4.a, infra. See also Gross
Letter. See also Roman Inderst & Marco Ottaviani, How (not) to pay
for advice: A framework for consumer financial protection, 105 the
J. Fin. Econ 393 (2012) for a discussion of the economic surplus
extracted by broker-dealers that provide recommendations to retail
customers, and how this surplus relates to the factors that
determine a retail customer's decision to accept or reject a
recommendation.
---------------------------------------------------------------------------

    As noted above, broker-dealers or their associated persons may have
conflicts of interest that could influence their recommendations to
retail customers at the time when they are provided.
    A retail customer's choice to accept a particular recommendation
often directly affects the compensation that an associated person or
broker-dealer itself receives. For example, an associated person may
receive greater compensation from selling certain securities or
strategies relative to other securities or strategies. Differences in
compensation across the securities or strategies offered by a broker-
dealer may add complexity to an associated person's incentives and may
create conflict between the interests of the associated person, who
desires to maximize his or her compensation, and the interests of the
retail customer, who expects the recommended transaction to be
efficient for him or her.
    In general, this conflict of interest may result in a broker-dealer
recommending securities or investment strategies that are less
efficient for the retail customer. For instance, the recommended
securities or strategies may be enhancing the associated person's
compensation at the expense of the retail customer. Put another way,
because of the financial incentives, broker-dealers and their
associated

persons may be motivated to recommend certain types or quantities of
securities or strategies, and those recommendations may place the
interests of the broker-dealer or its associated persons ahead of the
interests of the retail customer, which may not result in the retail
customer maximizing his or her expected net benefit. An inefficient
recommendation may lead to various results for the retail customer,
including inferior investment outcomes, such as risk-adjusted expected
returns that are lower relative to other similar investments or
investment strategies.
    A retail customer may accept a recommendation that is less
efficient if he or she is unable to assess correctly the efficiency of
the recommendation.
    The difference between the net benefit to the retail customer from
accepting a less than efficient recommendation about a securities
transaction or investment strategy, where the associated person or
broker-dealer puts its interests ahead of the interests of the retail
customer, and the net benefit the retail customer might expect from a
similar securities transaction or investment strategy that is efficient
for him or her, as defined above, is an agency cost.\855\ As discussed
in the Proposing Release and above, this agency cost arises because of
the conflicts of interest of the broker-dealer and its associated
persons, and the differences between the information sets available to
the broker-dealer and the retail customer at the time of the
recommendation.
---------------------------------------------------------------------------

    \855\ See, e.g., Michael C. Jensen, and William. H. Meckling,
Theory of the Firm: Managerial Behavior, Agency Costs and Ownership
Structure, 3 J. Fin. Econ. 305 (1976) for a more general discussion
of agency costs.
---------------------------------------------------------------------------

    In certain principal-agent relationships, the principal may be able
to reduce the agency costs that he or she is facing in various ways,
including by structuring the agent's compensation in a way that better
aligns the interest of the agent with that of the principal.\856\ A
feature of the agency relationship between a retail customer (the
principal) and a broker-dealer (the agent) that is common in many
principal-agent relationships (including the investment adviser-client
relationship) is that the retail customer generally does not have full
transparency about the agent's compensation for providing advice and
the sources of the agent's compensation. Thus, the retail customer,
through the decision to accept or reject a recommendation received, has
generally limited understanding of and control over the compensation
that the broker-dealer and its associated person obtains from providing
the recommendation. These limitations restrict the retail customer's
ability to reduce the agency costs that he or she is facing.
---------------------------------------------------------------------------

    \856\ See, e.g., Stephen A. Ross, The Economic Theory of Agency:
The Principal's Problem, 63 Am. Econ. Rev. ( Papers & Proc.) 134
(1973).
---------------------------------------------------------------------------

    We also recognize that even if the retail customer were to have
full transparency about the broker-dealer's and its associated person's
compensation from providing advice, the retail customer's ability to
reduce the agency costs may be constrained in other ways. For example,
if the menu of securities from which the associated person of the
broker-dealer offers recommendations is limited, the retail customer's
and the associated person's ability to identify and select a more
efficient investment may be constrained.
    Different retail customers may face different agency costs
depending on whether they base their decision to act on a
recommendation on an assessment of the efficiency of the
recommendation. Specifically, as noted above, a retail customer that
evaluates and uses a recommendation received based on an assessment
about the efficiency of that recommendation may be more successful in
identifying and controlling, albeit in a limited fashion, the
compensation that the broker-dealer and its associated person receive
from the recommendation--such as by being more likely to reject a less
than efficient recommendation--compared to a retail customer that makes
this decision without forming an assessment of the efficiency of the
recommendation. Thus, the agency costs may be higher for those retail
customers that make their decision of whether to act on a
recommendation received without an assessment of the efficiency of the
recommendation.
    While the discussion above focuses on the actions that the
principal (i.e., the retail customer) can take to reduce the agency
costs that he or she is facing, the agent can also take actions to
reduce the agency costs to the principal. For example, in the agency
paradigm, when the principal may forgo sharing a potentially large
surplus with the agent because of the high agency costs, the agent may
have an incentive to structure the terms of the relationship in a way
that reduces the agency costs to the principal.\857\ In the agency
relationship between a retail customer and a broker-dealer, given the
features of the compensation that the broker-dealer and its associated
persons receive for providing recommendations (e.g., this compensation
does not depend on the value of the assets in a principal's account),
the broker-dealer and its associated persons may not have sufficient
incentive to take actions voluntarily that would reduce agency costs to
the retail customer, such as voluntarily increasing transparency with
respect to compensation.\858\
---------------------------------------------------------------------------

    \857\ See, e.g., Sanford J. Grossman & Oliver D. Hart, The Costs
and Benefits of Ownership: A Theory of Vertical and Lateral
Integration, 94 J. Pol. Econ. 691 (1986) for a discussion of the
actions that agents can take to reduce the agency costs to the
principal in the context of the relationship between an owner (the
principal) and a manager (the agent) when the agent that has a
valuable investment opportunity that can only be financed by the
principal.
    \858\ Limited transparency with respect to how broker-dealers
and their associated persons are compensated from recommending a
security and what constrains their menus of securities may make it
difficult for retail customers to grasp the size of the agency costs
that they are facing at the time when they receive the
recommendation. As a result, this limited transparency may allow
broker-dealers and their associated persons to extract informational
rents (i.e., in the context of a transaction, compensation in excess
of what is competitively feasible that stems solely from the
informational advantage of one party over another) from the retail
customers when providing recommendations. The adviser business model
also has its own set of conflicted incentives to gather assets
(based on AUM fees) or maximize the time that it takes to complete a
job (if paid an hourly fee). Dual-registrants also have an incentive
to recommend the type of account that is most profitable to the
firm. See AFL-CIO April 2019 Letter. See also Morgan Lewis Letter
(describing investment adviser compensation and conflicts disclosure
in Form ADV); Bruce Ian Carlin & Gustavo Manso, Obfuscation,
Learning, and the Evolution of Investor Sophistication, 24 Rev. Fin.
Stud. 754 (2011) for a discussion about the relationship between
informational rents and the opacity of recommended investments
(e.g., securities with complex payoff structures).
---------------------------------------------------------------------------

    Although the dynamics of the agency relationship between a retail
customer and a broker-dealer may not cause the broker-dealer to take
steps to increase transparency, competitive factors in the broker-
dealer industry such as steps toward transparency taken by other
broker-dealers may cause increased transparency in that relationship.
Competitive dynamics are more effective in areas where comparisons can
be more easily made. For example, in the market for mutual funds --
particularly index funds--comparability and competition, among other
factors, have driven down fees significantly.\859\
---------------------------------------------------------------------------

    \859\ Comparability among index funds that follow the same
market index is facilitated in part by their passive style of
investing. Actively managed funds that follow the same investment
strategy can show different performance due to, among other things,
the ``skill'' of the manager of outperforming the market (or any
other benchmark). This skill is unobservable and generally hard to
measure, which makes comparisons across actively managed funds
difficult. In contrast, comparisons across index funds that follow
the same market index and that have passive investment styles are
based more on observable variables, such as fees, rather than
unobservable variables, such as managerial skill. In this context,
disclosure that is more salient with respect to these observable
variables may facilitate comparisons across index funds.

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

    While we do not have evidence to establish the degree to which
broker-dealers can extract large informational rents from retail
customers under the current legal and regulatory regime that governs
the broker-dealers' standard of conduct, the existing agency costs of
the relationship between the retail customer and the broker-dealer
would likely be larger, absent the current legal and regulatory
regime.\860\ In general, standards and regulation are effective means
of reducing agency costs when principals (e.g., retail customers) and
agents (e.g., broker-dealers) cannot reduce the agency costs on their
own by negotiating to address the market frictions in their
relationship through mechanisms available to them, such as bilateral
contracting \861\ or ``side payments.'' \862\
---------------------------------------------------------------------------

    \860\ See, e.g., Matthew L. Kozora, Security Recommendations and
the Liabilities of Broker-Dealers (U.S. Sec. & Exch. Comm'n, Working
Paper, May 1, 2016), available at https://www.sec.gov/files/Kozora_BD-Liability_05-2016.pdf, which provides evidence from
investor awards in FINRA arbitrations that the author interprets as
indicative of informational rents being nonzero. See also our more
comprehensive discussion in Section III.B.3.c, infra, about
potential investor harm associated with investment advice, including
from potential informational rents.
    \861\ See Proposing Release at 21643.
    \862\ Another way principals and agents negotiate around market
frictions is through ``side payments.'' In a transaction between two
parties, a side payment is a monetary exchange from one party to
another that is not part of the transaction. This mechanism is
discussed in the literature on bilateral externalities, which
focuses on how the actions of one party can affect the well-being of
the other party. This mechanism also applies to the relationship
between a broker-dealer and a retail customer because the action
taken by a broker-dealer, namely providing a recommendation, may
affect the well-being of the retail customer receiving that
recommendation. In the literature on bilateral externalities, if the
party taking these externality actions is unconstrained, the
allocation of resources across the two parties may be inefficient.
However, in certain circumstances, the parties can avoid this
inefficient outcome through side payments that neutralize the effect
of the externality on the allocations. See, e.g., Mas-Colell et al.
(1995), supra footnote 846, specifically Part 3: Market Equilibrium
and Market Failure for a discussion of bilateral externalities.
---------------------------------------------------------------------------

    Regulation Best Interest enhances the current standard of conduct
for broker-dealers and codifies it in an Exchange Act rule. Regulation
Best Interest is designed to: (1) Enhance the current standard of
conduct applicable to broker-dealers and associated persons when they
make a recommendation to a retail customer of any securities
transaction or investment strategy involving securities; (2) reduce
conflicts of interest that currently exist between retail customers and
broker-dealers and their associated persons; and (3) reduce information
asymmetries that currently limit the ability of retail customers to
evaluate the efficiency of recommendations they receive from broker-
dealers and their associated persons. In each of these three ways,
Regulation Best Interest is designed to reduce the agency costs in the
relationship between broker-dealers and their retail customers,
including in situations where the existing legal and regulatory regime
that governs broker-dealers' standard of conduct has had limited
effectiveness.
3. Comments on Market Failure of the Principal-Agent Relationship and
Quantification; Comments That the Broker-Dealer, Commission-Based Model
Should Be Severely Restricted or Eliminated
    The economic analysis in the Proposing Release characterized the
relationship between a retail customer and a broker-dealer as one
between a principal (the retail customer) and an agent (the broker-
dealer).\863\ The analysis noted that the potential conflict between
interests and the differences between the information sets available to
the agent and the principal may result in agency costs. It further
noted that the inability of the broker-dealers and retail customers to
overcome the market frictions underlying these agency costs may result
in inefficient allocations of resources. An inability of the principal
and the agent to efficiently negotiate around the frictions that
produce agency costs and take actions that would increase the
efficiency of their allocations is what economists refer to as a
``market failure'' of the principal-agent relationship,\864\ generally,
and of the agency relationship between the retail customer and the
broker-dealer, specifically.\865\
---------------------------------------------------------------------------

    \863\ See Proposing Release at 21629-21631.
    \864\ See, e.g., Mas-Colell et al. (1995), supra footnote 846.
    \865\ In general, because frictions such as asymmetric
information are ever present, all markets and agency relationships
have some degree of market failure.
---------------------------------------------------------------------------

    The analysis in the Proposing Release recognized that while the
Commission cannot provide a quantified estimate of the magnitude of
this agency cost, the existence of these costs and their persistence
justifies regulatory intervention.\866\
---------------------------------------------------------------------------

    \866\ See Proposing Release at 21631.
---------------------------------------------------------------------------

    A number of commenters questioned this approach. Certain of these
commenters stated that the Commission needs to more fully identify the
market failure that needs to be addressed, and certain commenters
stated that the Commission did not provide a quantitative assessment of
the severity of the market failure that would prompt the need for
regulatory intervention.\867\ We address these concerns below.
---------------------------------------------------------------------------

    \867\ See, e.g., CFA August 2018 Letter at 105, noting that
``[c]orrectly diagnosing the problem requires identifying and
analyzing the market failure that has occurred in investment advice
securities markets, as well as assessing the significance of that
problem''; See also, e.g., Letter from Charles Cox, Former SEC Chief
Economist, et al. (Feb. 6, 2019) (``Former SEC Senior Economists
Letter'') at 2, noting that ``the Commission confronts important
questions about advisers balancing their own compensation against
the effect of that compensation on the customer's expected returns.
We wonder if the extreme asymmetry of information and financial
sophistication between advisers and many of their clients
constitutes a market failure that the April proposals are intended
to ameliorate.'' In addition, the Former SEC Senior Economists
Letter raised three main concerns with the economic analysis in the
Proposing Release: (1) The discussion of the potential problems in
the customer-adviser relationship was incomplete and identified
other features of the market for ongoing retail investment advice
that might be problematic; (2) there was inadequate discussion and
analysis of the existing economic literature on financial advice;
and (3) there were questions of whether the disclosure requirements
in the Proposing Release would provide meaningful information for
customers. The economic analysis addresses these concerns. For
instance, with respect to (1), Section III.A.2 provides a more in
depth discussion of the potential problems that may arise when a
broker-dealer provides recommendations to a retail customer. With
respect to (2), Section III.B.3 engages more fully with the economic
literature on financial advice. Finally, with respect to (3),
Sections III.B.4, III.C.2, and III.C.4 provide discussions on the
effectiveness of the disclosure requirements of Regulation Best
Interest.
---------------------------------------------------------------------------

    With respect to the issue of appropriately identifying the market
failure, one commenter questioned whether the relationship between the
retail customer and the broker-dealer is a principal-agent
relationship.\868\ This commenter stated that in many instances, a
broker-dealer's provision of recommendations to a retail customer
resembles an arm's length transaction (e.g., purchasing a car) that
benefits the more informed broker-dealer at the expense of the less
informed retail customer. This commenter disagreed with the
Commission's broader view that the market failure stems from the agency
costs of the relationship between

a broker-dealer and a retail customer,\869\ and instead stated that the
market failure is due to conflicts of interest caused by the way
broker-dealers and their associated persons are generally compensated
for providing recommendations to retail customers.\870\ Similarly,
another commenter stated that the Commission failed to discuss how the
current compensation practices associated with providing
recommendations to retail customers creates incentives for the broker-
dealer and its associated persons to favor one securities transaction
or investment strategy over another when making recommendations to
retail customers.\871\ This commenter further questioned whether the
information asymmetry and the discrepancy in the level of financial
sophistication between broker-dealers and their retail customers
constitute a market failure.\872\ One commenter noted that the poor
performance of actively managed funds that are being recommended by
broker-dealers to small retail customers reflects a principal-agent
problem that causes an ``enormous'' wealth transfer from retail
customers to the financial industry, including broker-dealers.\873\
This commenter stated that this problem arises because of the broker-
dealer's commission-based compensation for providing recommendations
and because of the information asymmetries between the broker-dealer
and the retail customer at the time of the recommendation.\874\ This
commenter also stated that recommendations subject to conflicts of
interest may have no value for retail customers.\875\
---------------------------------------------------------------------------

    \868\ See CFA August 2018 Letter at 107, noting that ``[t]he
Commission's economic analysis gets off to a faulty start by
mischaracterizing, or at least over-simplifying, the broker-customer
`advice' relationship, as a principal-agent relationship. While
there are certainly instances where a broker and its customer can
exhibit features of a bona fide principal-agent relationship--for
example when executing a customer's order--it's not clear that, in
the context of receiving investment recommendations, those same
characteristics are present. Certainly, the brokerage industry
expressly refutes this characterization, having argued successfully
in the Fifth Circuit that brokers engage in nothing more than an
arm's length commercial sales transaction, no different from a car
dealer soliciting interest in inventory.''
    \869\ See CFA August 2018 Letter at 108, noting that
``[t]ypically, principal-agent relationships don't involve third
party payments to the agent, which can adversely affect the level of
loyalty the agent provides to the principal.''
    \870\ See CFA August 2018 Letter at 107, noting that the
Commission ``fails to acknowledge that conflicts of interest are a
real problem that result in real harm to investors [. . .]'' and
``[. . .] the Release fails to make clear whether the Commission is
truly seeking to address the underlying problem of conflicts'
harmful impact on investors.''
    \871\ See Former SEC Senior Economists Letter at 3, noting that
``[n]owhere does the EA emphasize that an adviser's compensation
provides numerous opportunities for her to favor one investment over
another on the basis of the compensation it pays to her or to her
firm.''
    \872\ See Former SEC Senior Economists Letter at 2. See also
supra footnote 867 that describes in more detail the concerns raised
by this commenter.
    \873\ See Letter from Monique Morrissey, Economist and Heidi
Shierholz, Senior Economist and Director of Policy, EPI (Aug. 7,
2018) (``EPI Letter'') at 6, noting that ``[i]n an equilibrium with
knowledgeable investors, we would expect returns from active and
passive strategies to be equal. The fact that actively-managed funds
marketed to small investors tend to perform poorly reflects a market
distortion--naivet[eacute]--or a `principal-agent problem' in
economics parlance, which results in enormous transfers from
investors to the financial industry.''
    \874\ See EPI Letter at 2, noting that ``[c]onflicts of interest
between buyers and sellers are commonplace. Many salesmen, including
brokers and car dealers, are paid on commission. However, it has
long been recognized that markets for professional advice are
different from markets for automobiles because information
asymmetries are inherent in these transactions.''
    \875\ See EPI Letter at 8, noting that ``the SEC never considers
that `advice' offered may not just be of lower quality than
expected, but worse than no advice at all'' and that ``much of the
`advice' provided by broker-dealers not only lacks value, but is
actually harmful, steering savers to higher-cost products and costly
services that will reduce their future standard of living compared
to how they would fare in the absence of this `advice.' This may be
true whether or not, in the absence of conflicted `advice,'
investors would have availed themselves of more paid or free advice
from more impartial sources.''
---------------------------------------------------------------------------

    As an initial matter, in response to comments regarding the need to
discuss fully the existing market failure, it is important to recognize
that the Commission has been studying and carefully considering the
issues related to the broker-dealer-client relationship and the related
standard of conduct for broker-dealers for many years, which led to the
development of the Proposing Release and the economic analysis
therein.\876\ In light of the comments on the Proposing Release, the
extensive outreach by the Commission and staff, as well as investor
testing, the Commission has more specifically and fully described the
relationship between the broker-dealer and the client, the related
market failure, and the resulting potential economic effects of
Regulation Best Interest in addressing the market failure.\877\
---------------------------------------------------------------------------

    \876\ See Proposing Release at 21579-21583.
    \877\ See supra Section III.A.2.
---------------------------------------------------------------------------

    The Commission continues to believe that agency costs are at the
root of existing allocative inefficiencies in the market for broker-
dealer advice. Moreover, this economic analysis recognizes that a
proper understanding of the economic fundamentals of an investor's
decision to allocate resources across market and economic conditions
and over time is central to identifying the frictions that cause
inefficiencies in the agency relationship between a broker-dealer and a
retail customer.
    In response to the commenter that stated that in a principal-agent
relationship agents do not receive compensation from third parties
(e.g., investment sponsors), the Commission notes that the compensation
that the investment sponsor provides to the agent is ultimately funded
by the principal (i.e., the retail customer).\878\ In addition, in
response to the commenter's concern that a broker-dealer's provision of
recommendations to retail customers resembles an arm's length
transaction that is ``no different from a car dealer soliciting
interest in inventory,'' \879\ the Commission notes that under the
current regulatory regime broker-dealers and their associated persons
are subject to a suitability standard of conduct that has been
interpreted to ``be consistent with [the] customer's best interests.''
\880\ In contrast, in an arm's length transaction, the parties involved
are generally not subject to a standard of conduct that would constrain
the more informed party from acting solely in its own interest.\881\
Finally, in response to the commenter's concern with respect to the
identification of the market failure,\882\ the Commission notes that
while conflicts of interest arise in many types of transactions, in
certain instances the parties involved can negotiate an arrangement
between themselves that would reduce the effect of conflicts of
interest on the allocation of resources across the parties and improve
the efficiency of this allocation. The Commission further notes that
agency costs may deter the parties from engaging in privately
negotiated arrangements that would improve the efficiency of the
allocation of resources between the parties. From this perspective, the
Commission believes that it is the agency costs rather than the
conflicts of interest themselves that should be viewed as the source of
the market failure.
---------------------------------------------------------------------------

    \878\ See supra footnote 869.
    \879\ See supra footnote 868.
    \880\ See infra footnote 979 and accompanying text.
    \881\ However, in certain markets, there may be market
mechanisms in place that would prevent the more informed party to a
transaction from acting solely in its own interest.
    \882\ See supra footnote 870.
---------------------------------------------------------------------------

    In response to the commenter that noted that the Commission did not
discuss how the compensation received by the broker-dealer and its
associated persons creates incentives to favor one security or
investment strategy over another when making recommendations to retail
customers,\883\ the Commission has incorporated into this economic
analysis a detailed discussion of the incentives created by the current
compensation practices associated with providing recommendations to
retail customers.\884\ In addition, in response to the commenter's
concerns about whether the information asymmetry and the discrepancy in
the level of financial sophistication between retail customers and a
broker-dealer and its associated persons are the source of market
failure, the Commission notes that this economic analysis establishes a
more

clear link between bounded rationality, including access to information
and financial literacy of retail customers, and agency costs, and
reflects our conclusion that the agency costs are at the root of the
market failure.
---------------------------------------------------------------------------

    \883\ See supra footnote 871.
    \884\ See infra Section III.C.4.
---------------------------------------------------------------------------

    The Commission further notes that the so-called ``informational
rent'' that a broker-dealer may be incentivized to extract from a
retail customer to take advantage of the information asymmetry or the
discrepancy in the level of financial sophistication is one component
of the agency costs associated with the relationship between a retail
customer and a broker-dealer. In addition, the Commission notes that
the evidence on the size of the agency costs associated with such
informational rents is limited.\885\ This evidence is not generally
supportive of a commenter's assessment that the wealth transfer from
retail customers to broker-dealers is ``enormous.'' \886\ The
Commission agrees with this commenter, who stated that the way broker-
dealers are compensated for providing recommendations and the
information asymmetry between retail customers and broker-dealers are
important determinants of the agency costs. However, based on the
evidence discussed below, the Commission disagrees with this
commenter's assessment that the advice provided by the associated
persons of the broker-dealer has no value.\887\
---------------------------------------------------------------------------

    \885\ See supra Section III.A.2 and infra Section III.B.3.
    \886\ See supra footnote 873.
    \887\ See infra Section III.B.3.b.
---------------------------------------------------------------------------

    With respect to the issue of measuring the severity of the market
failure, some commenters stated that the Commission failed to take into
account existing academic literature that provides evidence of investor
harm caused by accepting advice from the associated persons of the
broker-dealer. A subset of these commenters believed that the evidence
provided in some of these academic studies is compelling and that the
Commission should use it to quantify the severity of the market
failure.\888\ One commenter also urged the Commission to supplement the
academic evidence on investor harm with evidence from data available to
the Commission from regulatory oversight.\889\
---------------------------------------------------------------------------

    \888\ See, e.g., CFA August 2018 Letter; EPI Letter; AARP August
2018 Letter; Better Markets August 2018 Letter; Former SEC Senior
Economists Letter.
    \889\ See CFA August 2018 Letter at 112. This commenter
suggested that we present additional information about the existence
and frequency of the potential harm to investors ``that results from
conflicted brokerage `advice','' which may collectively be seen as
misconduct by financial professionals.
---------------------------------------------------------------------------

    In response to these comments, the Commission maintains that the
existence of misconduct that commenters requested the Commission to
document does not render the approach taken in Regulation Best Interest
irrational, inappropriate, or unreasonable, nor does it suggest that an
alternative approach would be more effective in fulfilling the
Commission's mission. The Commission is aware and understands the
concerns raised by the commenters with regards to the evidence on
investor harm and the extent to which such evidence can inform on our
understanding of the severity of the market failure in the market for
broker-dealer advice. As discussed in the Proposing Release and
reiterated in this economic analysis, the Commission believes that
retail investors can be harmed when they accept recommendations from a
broker-dealer that places the financial or other interest of the
broker-dealer or its associated persons ahead of the interests of the
retail customers. In addition, this economic analysis engages more
fully with the economic literature on financial advice and considers
these studies in analyzing the costs and benefits associated with
Regulation Best Interest.\890\
---------------------------------------------------------------------------

    \890\ See infra Section III.B.3.c.
---------------------------------------------------------------------------

B. Economic Baseline

    This section discusses, as it relates to this rulemaking, the
current state of the broker-dealer and investment adviser markets; the
current regulatory environment and market practices surrounding the
provision of recommendations by broker-dealers; evidence on the
potential value and harm of investment advice; and how issues related
to trust, financial literacy, and disclosure effectiveness affect
conflicts between investors and financial professionals. The economic
baseline has been revised and expanded relative to the Proposing
Release to address comments, discussed more fully below.
1. Providers of Financial Services \891\
---------------------------------------------------------------------------

    \891\ 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 bank holding companies, and insurance
companies, which also provide financial advice services to retail
customers; however, because of unavailability of data, the
Commission is unable to estimate the number of some of those other
entities that are likely to provide financial advice to retail
customers as well as their size and the scope of services they
provide. A number of broker-dealers (see infra footnote 899) have
non-securities businesses, such as insurance or tax services. As of
December 2018, there were approximately 17,300 state-registered
investment advisers. The Department of Labor in its Regulatory
Impact Analysis identifies approximately 398 life insurance
companies that could provide advice to retirement investors. See
infra footnote 1002.
---------------------------------------------------------------------------

a. Broker-Dealers
    Regulation Best Interest will affect the market for broker-dealer
services, including firms that are dually registered as broker-dealers
and investment advisers \892\ and broker-dealers affiliated with an
investment adviser.\893\ The market for broker-dealer services
encompasses a small set of large and medium sized broker-dealers and
thousands of smaller broker-dealers competing for niche or regional
segments of the market.\894\ The market for broker-dealer services
includes many different markets for a variety of services, including
(1) managing orders for customers and routing them to various trading
venues; (2) providing advice to customers that is in connection with
and reasonably related to their primary business of effecting
securities transactions; \895\ (3) holding retail customers' funds and
securities; (4) handling clearance and settlement of trades; (5)
intermediating between retail customers and carrying/clearing brokers;
(6) dealing in corporate debt and equities, government bonds, and
municipal bonds, among other securities; (7) privately placing
securities; and (8) 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.
---------------------------------------------------------------------------

    \892\ 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 dually registered
firms offer advisory accounts to retail investors but offer only
brokerage services, such as underwriting services, to institutional
clients. For purposes of the discussion of the baseline in this
economic analysis, a dually registered firm is any firm that is
dually registered with the Commission as an investment adviser and a
broker-dealer.
    \893\ Some broker-dealers may be affiliated with investment
advisers and not dually registered. From Question 10 on Form BD,
2,098 (55.7%) broker-dealers report that, directly or indirectly,
they control, are controlled by, or are under common control with an
entity that is engaged in the securities or investment advisory
business. Comparatively, 2,421 (18.2%) SEC-registered investment
advisers report an affiliate that is a broker-dealer in Section 7A
of Schedule D of Form ADV, including 1,878 SEC-registered investment
advisers that report an affiliate that is a registered broker-
dealer. Approximately 77% of total regulatory AUM are managed by the
2,421 SEC-registered investment advisers.
    \894\ See Risk Management Controls for Brokers or Dealers with
Market Access, Securities Exchange Act Release No. 63241 (Nov. 3,
2010) [75 FR 69791, 69822 (Nov. 15, 2010)]. For simplification, we
present our analysis as if the market for broker-dealer services
encompasses one broad market with multiple segments, even though, in
terms of competition, it could also be discussed in terms of
numerous interrelated markets.
    \895\ See Solely Incidental Interpretation.
---------------------------------------------------------------------------

    As of December 2018, there were approximately 3,764 registered
broker-dealers with over 140 million customer accounts. In total, these
broker-dealers have over $4.3 trillion in total assets, which are total
broker-dealer assets as reported on Form X-17a-5.\896\ More than two-
thirds of all brokerage assets and close to one-third of all customer
accounts are held by the 17 largest broker-dealers, as shown in Table
1, Panel A.\897\ Of the broker-dealers registered with the Commission
as of December 2018, 563 broker-dealers were dually registered as
investment advisers.\898\ These firms hold over 90 million (63%)
customer accounts. Approximately 539 broker-dealers (14%) report at
least one type of non-securities business, including insurance,
retirement planning, mergers and acquisitions, and real estate, among
others.\899\ Approximately 73.5% of registered broker-dealers report
retail customer activity.\900\
---------------------------------------------------------------------------

    \896\ 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.
    \897\ Approximately $4.24 trillion of total assets of broker-
dealers (98%) are at broker-dealers with total assets in excess of
$1 billion. Of the 33 dual-registrants in the group of broker-
dealers with total assets in excess of $1 billion, total assets for
these dual-registrants are $2.32 trillion (54%) of aggregate broker-
dealer assets. Of the remaining 99 broker-dealers with total assets
in excess of $1 billion that are not dual-registrants, 91 have
affiliated investment advisers.
    \898\ This number includes the number of broker-dealers who are
also registered as state investment advisers. For purposes of the
discussion of the baseline in this economic analysis, a dual-
registrant is any firm that is dually registered with either the
Commission or a state as an investment adviser and a broker-dealer.
Excluding state registered advisers, there are 359 entities that are
dually registered with the Commission as an investment adviser and a
broker-dealer.
    \899\ We examined Form BD filings to identify broker-dealers
reporting non-securities business. For the 393 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 (202), management/financial/other
consulting (99), advisory/retirement planning (71), mergers and
acquisitions (70), foreign exchange/swaps/other derivatives (28),
real estate/property management (30), tax services (15), and other
(146). Note that a broker-dealer may have more than one line of non-
securities business.
    \900\ 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.
---------------------------------------------------------------------------

    Panel B of Table 1 is limited to the broker-dealers that report
some retail investor activity. As of December 2018, there were
approximately 2,766 broker-dealers that served retail investors, with
over $3.8 trillion in total assets (89% of total broker-dealer assets)
and almost 139 million (97%) customer accounts.\901\ Of those broker-
dealers serving retail investors, 452 were dually registered as
investment advisers.\902\ The number of broker-dealers that serve
retail customers (i.e., 2,766) likely overstates the number of broker-
dealers that will be subject to Regulation Best Interest, because not
all broker-dealers that serve retail investors provide recommendations
to retail investors. We do not have reliable data to determine the
precise number of broker-dealers that provide recommendations (and the
extent to which broker-dealers that provide recommendations do so, as
opposed to executing unsolicited trades), and as a result, we have
assumed, for purposes of this Section III and Sections IV (Paperwork
Reduction Act Analysis) and V (Final Regulatory Flexibility Act
Analysis) that 2,766 broker-dealers will be subject to Regulation Best
Interest.
---------------------------------------------------------------------------

    \901\ 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.
    \902\ Excluding state registered advisers, there are 359
entities that are dually registered with the Commission as an
investment adviser and a broker-dealer. Of the 31 dual-registrants
in the group of retail broker-dealers with total assets in excess of
$500 million, total assets for these dual-registrants are nearly
$2.01 trillion (53%) of aggregate retail broker-dealer assets (Table
1, Panel B). Of the remaining 81 retail broker-dealers with total
assets in excess of $500 million that are not dual-registrants, 76
have affiliated investment advisers.
    \903\ The data is obtained from FOCUS filings as of December
2018. 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.
    \904\ In addition to the approximately 143 million individual
accounts at broker-dealers, there are approximately 302,000 omnibus
accounts (0.2% of total accounts at broker-dealers), with total
assets of $32.1 billion, across all 3,764 broker-dealers, of which
approximately 99% are held at broker-dealers with greater than $1
billion in total assets. See also supra footnote 897. 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 under inclusive of all customer accounts held at
broker-dealers.
    \905\ Customer Accounts includes both broker-dealer and
investment adviser accounts for dual-registrants.

                      Table 1--Panel A: Registered Broker-Dealers as of December 2018 \903\
                       [Cumulative broker-dealer total assets and customer accounts] \904\
----------------------------------------------------------------------------------------------------------------
                                                                                Cumulative
                                              Total number of     Number of        Cumulative       number of
    Size of broker-dealer (total assets)            BDs             dually        total assets       customer
                                                                registered BDs     (billion)      accounts \905\
----------------------------------------------------------------------------------------------------------------
>$50 billion................................               17               10           $2,879       40,550,200
$1 billion to $50 billion...................              114               23            1,363       96,037,591
$500 million to $1 billion..................               35                7               23          397,814
$100 million to $500 million................              105               20               23        1,603,818
$10 million to $100 million.................              490              115               17        4,277,432
$1 million to $10 million...................            1,021              182              3.6          460,748
<$1 million.................................            1,982              206              0.5            5,675
                                             -------------------------------------------------------------------
    Total...................................            3,764              563            4,309      143,333,278
----------------------------------------------------------------------------------------------------------------

                     Table 1--Panel B: Registered Retail Broker-Dealers as of December 2018
                          [Cumulative broker-dealer total assets and customer accounts]
----------------------------------------------------------------------------------------------------------------
                                                                                Cumulative
                                              Total number of     Number of        Cumulative       number of
    Size of broker-dealer (total assets)            BDs             dually        total assets       customer
                                                                registered BDs     (billion)         accounts
----------------------------------------------------------------------------------------------------------------
>$50 billion................................               16                8           $2,806       40,545,792
$1 billion to $50 billion...................               75               18              990       91,991,118
$500 million to $1 billion..................               21                5               13          365,632
$100 million to $500 million................               84               17               18        1,603,818
$10 million to $100 million.................              378               96               14        3,762,620
$1 million to $10 million...................              783              153              2.8          450,132
<$1 million.................................            1,409              155              0.4            5,672
                                             -------------------------------------------------------------------
    Total BDs \906\.........................            2,766              452            3,844      138,724,784
----------------------------------------------------------------------------------------------------------------

    Table 2 reports information on brokerage commissions,\907\ fees,
and selling concessions from the fourth quarter of 2018 for all broker-
dealers, including dual-registrants.\908\ We observe significant
variation in the sources of revenues for broker-dealers, with large
broker-dealers, on average, generating substantially higher levels of
aggregate commission and fee revenues (on a nominal basis) than smaller
broker-dealers. On average, broker-dealers, including those that are
dually registered as investment advisers, earn about $5.1 million per
quarter in revenue from commissions and nearly four times that amount
in fees,\909\ although the Commission notes that fees encompass various
types of fees, not just fees for advisory services.\910\ The level of
revenues earned by broker-dealers (including dually registered firms)
for commissions and fees increases with broker-dealer size, but also
tends to be more heavily weighted toward commissions for broker-dealers
with less than $10 million in assets and is weighted more heavily
toward fees for broker-dealers with assets in excess of $10 million.
For example, for the 114 broker-dealers with assets between $1 billion
and $50 billion, average revenues from commissions are approximately
$45 million, while average revenues from fees are approximately $225
million.\911\
---------------------------------------------------------------------------

    \906\ Total BDs includes all retail-facing broker-dealers,
including those dual-registrants that have retail-facing broker-
dealers.
    \907\ Mark-ups or mark-downs are not included as part of the
brokerage commission revenue in FOCUS data; instead, they are
included in Net Gains or Losses on Principal Trades, but are not
uniquely identified as a separate revenue category.
    \908\ Source: FOCUS data.
    \909\ Fees, as detailed in the FOCUS data, include fees for
account supervision, investment advisory services, and
administrative services. Beyond the broad classifications of fee
types included in fee revenue, we are unable to determine whether
fees such as Rule 12b-1 fees, sub-accounting, or other such service
fees (e.g., payments by an investment company for personal service
and/or maintenance of shareholder accounts) are included. The data
covers both broker-dealers and dually registered firms. FINRA's
Supplemental Statement of Income, Line 13975 (Account Supervision
and Investment Advisory Services) denotes that fees earned for
account supervision are those fees charged by the firm for providing
investment advisory services where there is no fee charged for trade
execution. Investment Advisory Services generally encompass
investment advisory work and execution of client transactions, such
as wrap arrangements. These fees also include fees charged by
broker-dealers that are also registered with the Commodity Futures
Trading Commission (``CFTC''), but do not include fees earned from
affiliated entities (Item A of question 9 under Revenue in the
Supplemental Statement of Income).
    \910\ With respect to the FOCUS data, additional granularity of
what services comprise ``advisory services'' is not available. See
also Solely Incidental Interpretation.
    \911\ An estimate of total fees in this size category would be
114 broker-dealers with assets between $1 billion and $50 billion
multiplied by the average fee revenue of $225 million, or $25.65
billion in total fees.
---------------------------------------------------------------------------

    In addition to revenue generated from commissions and fees, broker-
dealers may also receive revenues from other sources, including margin
interest, underwriting, research services, and third-party selling
concessions, such as from sales of investment company (``IC'') shares.
As shown in Table 2, Panel A, these selling concessions are generally a
smaller fraction of broker-dealer revenues than either commissions or
fees, except for broker-dealers with total assets between $10 million
and $100 million. For these broker-dealers, revenue from third-party
selling concessions is the largest category of revenues and constitutes
approximately 42% of total revenues earned by these firms.
    Table 2, Panel B below provides aggregate revenues by revenue type
(commissions, fees, or selling concessions from sales of IC shares) for
broker-dealers delineated by whether the broker-dealer is also a dual-
registrant. Broker-dealers dually registered as investment advisers
have a significantly larger fraction of their revenues from fees
compared to commissions or selling concessions, whereas broker-dealers
that are not dually registered generate approximately 42% of their
advice-related revenues as commissions and only 33% of their advice-
related revenues from fees, although we lack granularity to determine
whether advisory services, in addition to supervision and
administrative services, contribute to fees at standalone broker-
dealers.
---------------------------------------------------------------------------

    \912\ The data is obtained from December 2018 FOCUS reports and
averaged across size groups.
    \913\ Fees, as detailed in the FOCUS data, include fees for
account supervision, investment advisory services, and
administrative services. The data covers both broker-dealers and
dually registered firms.

            Table 2--Panel A: Average Broker-Dealer Revenues From Revenue Generating Activities \912\
----------------------------------------------------------------------------------------------------------------
                                                                                Sales of IC
    Size of broker-dealer in total assets            N           Commissions       Fees \913\         shares
----------------------------------------------------------------------------------------------------------------
>$50 billion................................               17     $170,336,258     $414,300,268      $23,386,192
$1 billion-$50 billion......................              114       45,203,225      225,063,257       53,671,602
500 million-1 billion.......................               35        8,768,547       30,141,270        5,481,248
100 million-500 million.....................              105       12,801,889       33,726,336       16,610,013
10 million-100 million......................              490        3,428,843        8,950,892        9,092,971

1 million-10 million........................            1,021          996,130        1,037,825          652,905
<1 million..................................            1,982          197,907          269,459           85,219
                                             -------------------------------------------------------------------
    Average of All Broker-Dealers...........            3,764        5,092,808       21,948,551        4,368,823
----------------------------------------------------------------------------------------------------------------

 Table 2--Panel B: Aggregate Total Revenues From Revenue Generating Activities for Broker-Dealers Based on Dual-
                                                Registrant Status
----------------------------------------------------------------------------------------------------------------
                                                                                Sales of IC
             Broker-dealer type                      N           Commissions       Fees \914\         shares
                                                                  (billion)        (billion)        (billion)
----------------------------------------------------------------------------------------------------------------
Dually Registered as IAs....................              563            $4.62           $17.56            $2.65
Standalone Registered BDs...................            3,201             4.07             3.22             2.55
                                             -------------------------------------------------------------------
    All.....................................            3,764             8.69            20.78             5.20
----------------------------------------------------------------------------------------------------------------

    As shown in Table 3, based on responses to Form BD, broker-dealers'
most commonly provided business lines include private placements of
securities (62.7% of broker-dealers); retail sales of mutual funds
(55.4%); acting as a broker or dealer retailing corporate equity
securities over the counter (52.0%); acting as a broker or dealer
retailing corporate debt securities (47.2%); acting as a broker or
dealer selling variable contracts, such as life insurance or annuities
(41.0%); acting as a broker of municipal debt/bonds or U.S. government
securities (39.8% and 37.4%, respectively); acting as an underwriter or
selling group participant of corporate securities (31.2%); and
investment advisory services (26.4%), among others.\915\
---------------------------------------------------------------------------

    \914\ See id.
    \915\ 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 3 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 2018.

                     Table 3--Lines of Business at Retail Broker-Dealers as of December 2018
----------------------------------------------------------------------------------------------------------------
                                                                                Total
                                                                               ---------------------------------
                               Line of business                                    Number of        Percent of
                                                                                broker-dealers   broker-dealers
----------------------------------------------------------------------------------------------------------------
Private Placements of Securities..............................................            1,735            62.70
Mutual Fund Retailer..........................................................            1,533            55.40
Broker or Dealer Retailing:
    Corporate Equity Securities OTC...........................................            1,438            51.97
    Corporate Debt Securities.................................................            1,306            47.20
    Variable Contracts........................................................            1,132            40.91
Municipal Debt/Bonds Broker...................................................            1,101            39.79
U.S. Government Securities Broker.............................................            1,035            37.41
Put and Call Broker or Dealer or Options Writer...............................              993            35.89
Underwriter or Selling Group Participant--Corporate Securities................              862            31.15
Non-Exchange Member Arranging For Transactions in Listed Securities by                      785            28.37
 Exchange Member..............................................................
Investment Advisory Services..................................................              730            26.38
Broker or Dealer Selling Tax Shelters or Limited Partnerships--Primary Market.              619            22.37
Trading Securities for Own Account............................................              614            22.19
Municipal Debt/Bonds Dealer...................................................              475            17.17
U.S. Government Securities Dealer.............................................              339            12.25
Solicitor of Time Deposits in a Financial Institution.........................              308            11.13
Underwriter--Mutual Funds.....................................................              237             8.57
Broker or Dealer Selling Interests in Mortgages or Other Receivables..........              216             7.81
Broker or Dealer Selling Oil and Gas Interests................................              207             7.48
Broker or Dealer Making Inter-Dealer Markets in Corporate Securities OTC......              207             7.48
Broker or Dealer Involved in Networking, Kiosk, or Similar Arrangements                     197             7.12
 (Banks, Savings Banks, Credit Unions)........................................
Internet and Online Trading Accounts..........................................              192             6.94
Exchange Member Engaged in Exchange Commission Business Other than Floor                    171             6.18
 Activities...................................................................
Broker or Dealer Selling Tax Shelters or Limited Partnerships--Secondary                    164             5.93
 Market.......................................................................
Commodities...................................................................              162             5.85
Executing Broker..............................................................              107             3.87
Day Trading Accounts..........................................................               89             3.22
Broker or Dealer Involved in Networking, Kiosk, or Similar Arrangements                      88             3.18
 (Insurance Company or Agency)................................................
Real Estate Syndicator........................................................               94             3.40
Broker or Dealer Selling Securities of Non-Profit Organizations...............               71             2.57

Exchange Member Engaged in Floor Activities...................................               61             2.20
Broker or Dealer Selling Securities of Only One Issuer or Associate Issuers...               43             1.55
Prime Broker..................................................................               21             0.76
Crowdfunding FINRA Rule 4518(a)...............................................               21             0.76
Clearing Broker in a Prime Broker.............................................               14             0.51
Funding Portal................................................................                8             0.29
Crowdfunding FINRA Rule 4518(b)...............................................                5             0.18
Number of Retail-Facing Broker-Dealers........................................            2,766  ...............
----------------------------------------------------------------------------------------------------------------

b. Investment Advisers
    Other parties that could be affected by Regulation Best Interest
are SEC- or state-registered investment advisers, because Regulation
Best Interest could affect the competitive landscape in the market for
the provision of financial advice.\916\ This section first discusses
SEC-registered investment advisers, followed by a discussion of state-
registered investment advisers.
---------------------------------------------------------------------------

    \916\ In addition to SEC-registered investment advisers, which
are the focus of this section, Regulation Best Interest could also
affect banks, trust companies, insurance companies, and other
providers of financial advice.
---------------------------------------------------------------------------

    As of December 2018, there were approximately 13,300 investment
advisers registered with the Commission. The majority of SEC-registered
investment advisers report that they provide portfolio management
services for individuals and small businesses.\917\
---------------------------------------------------------------------------

    \917\ Of the approximately 13,300 SEC-registered investment
advisers, 8,410 (63.24%) 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 17,300 state-
registered investment advisers, of which 125 are also registered
with the Commission. Approximately 13,900 state-registered
investment advisers are retail facing (see Item 5.D of Form ADV).
---------------------------------------------------------------------------

    Of all SEC-registered investment advisers, 359 identify themselves
as dually registered broker-dealers.\918\ Further, 2,421 investment
advisers (18%) report an affiliate that is a broker-dealer, including
1,878 investment advisers (14%) that report an SEC-registered broker-
dealer affiliate.\919\ As shown in Panel A of Table 4 below, in
aggregate, investment advisers have over $84 trillion in 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, the total
number of accounts for investment advisers is only 29% of the number of
customer accounts for broker-dealers.
---------------------------------------------------------------------------

    \918\ See supra footnote 892.
    \919\ Item 7.A.1 of Form ADV.
---------------------------------------------------------------------------

    Based on staff analysis of Form ADV data, approximately 62% of
registered investment advisers (8,235) have some portion of their
business dedicated to retail investors, including both high net worth
and non-high net worth individual clients,\920\ as shown in Panel B of
Table 4.\921\ In total, these firms have approximately $41.4 trillion
of AUM.\922\ Approximately 8,200 registered investment advisers (61%)
serve almost 32 million non-high net worth individual clients and have
approximately $4.8 trillion in AUM, while approximately 8,000
registered investment advisers (60%) serve approximately 4.8 million
high net worth individual clients with $6.15 trillion in AUM.\923\
---------------------------------------------------------------------------

    \920\ 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 Regulation Best Interest because the data
obtained from Form ADV regarding clients who are individuals does
not involve any test of use for personal, family, or household
purposes.
    \921\ 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. Part 1A of
Form ADV.
    \922\ 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.
    \923\ Estimates are based on IARD system data as of December 31,
2018. The AUM reported here is specifically that of those non-high
net worth clients. Of the 8,235 investment advisers serving retail
investors, 318 are also dually registered as broker-dealers.

                   Table 4--Panel A: Registered Investment Advisers (RIAs) as of December 2018
                                        [Cumulative RIA AUM and accounts]
----------------------------------------------------------------------------------------------------------------
                                                                  Number of                         Cumulative
      Size of investment adviser (AUM)         Number of RIAs       dually       Cumulative AUM     number of
                                                               registered RIAs     (billion)         accounts
----------------------------------------------------------------------------------------------------------------
>$50 billion................................              270               15          $59,264       20,655,756
$1 billion to $50 billion...................            3,453              121           22,749       13,304,154
$500 million to $1 billion..................            1,635               47            1,151        1,413,099
$100 million to $500 million................            5,927              119            1,397        5,135,070
$10 million to $100 million.................            1,070               24               59          310,031
$1 million to $10 million...................              162                3              0.8           69,664
<$1 million.................................              782               30             0.02           13,976
                                             -------------------------------------------------------------------
    1Total..................................           13,299              359           84,621       41,081,750
----------------------------------------------------------------------------------------------------------------

               Table 4--Panel B: Retail Registered Investment Advisers (RIAs) as of December 2018
                                        [Cumulative RIA AUM and accounts]
----------------------------------------------------------------------------------------------------------------
                                                                  Number of                         Cumulative
      Size of investment adviser (AUM)         Number of RIAs       dually       Cumulative AUM     number of
                                                               registered RIAs     (billion)         accounts
----------------------------------------------------------------------------------------------------------------
>$50 billion................................              119               14          $30,291       20,592,326
$1 billion to $50 billion...................            1,614              111            9,570       13,224,188
$500 million to $1 billion..................            1,007               44              700        1,392,842
$100 million to $500 million................            4,548              113            1,026        5,287,584
$10 million to $100 million.................              706               23               40          308,285
$1 million to $10 million...................              102                3              0.5           69,534
<$1 million.................................              169               10             0.02           13,946
                                             -------------------------------------------------------------------
    Total IAs \924\.........................            8,235              318           41,434       40,887,325
----------------------------------------------------------------------------------------------------------------

    In addition to SEC-registered investment advisers, other investment
advisers are registered with state regulators.\925\ As of December
2018, there are 17,268 state-registered investment advisers,\926\ of
which 125 are also registered with the Commission. Of the state-
registered investment advisers, 204 are dually registered as broker-
dealers, while approximately 4.6% (786) report a broker-dealer
affiliate. In aggregate, state-registered investment advisers have
approximately $334 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
63% for Commission-registered investment advisers.
---------------------------------------------------------------------------

    \924\ Total IAs includes all retail-facing investment advisers,
including those dual-registrants that have retail-facing SEC-
registered broker-dealers and SEC-registered investment advisers.
    \925\ Item 2.A. of Part 1A of Form ADV and Advisers Act rules
203A-1 and 203A-2 require an investment adviser to register with the
SEC if it (1) is a large adviser that has $100 million or more of
regulatory AUM (or $90 million or more if an adviser is filing its
most recent annual updating amendment and is already registered with
the SEC); (2) is a mid-sized adviser that does not meet the criteria
for state registration or is not subject to examination; (3) meets
the requirements for one or more of the revised exemptive rules
under section 203A; (4) is an adviser (or subadviser) to a
registered investment company; (5) is an adviser to a business
development company and has at least $25 million of regulatory AUM;
or (6) receives 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 to provide a buffer for
mid-sized advisers with AUM close to $100 million to determine
whether and when to switch between state and Commission
registration. Advisers Act rule 203A-1(a).
    \926\ There are 70 investment advisers with latest reported
regulatory AUM in excess of $110 million but that are not listed as
registered with the SEC. None of these 70 investment advisers has
exempted status with the Commission. For the purposes of this
rulemaking, these are considered potentially erroneous submissions.
---------------------------------------------------------------------------

    Approximately 81% of state-registered investment advisers (13,927)
have some portion of their business dedicated to retail investors,\927\
and in aggregate, these firms have approximately $324 billion in
AUM.\928\ Approximately 13,910 (81%) state-registered advisers serve 14
million non-high net worth retail clients and have approximately $137
billion in AUM, while over 11,497 (67%) state-registered advisers serve
approximately 170,000 high net worth retail clients with $169 billion
in AUM.\929\
---------------------------------------------------------------------------

    \927\ 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. 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.
    \928\ 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.
    \929\ Estimates are based on IARD system data as of February 10,
2018. The AUM reported here is specifically that of those non-high
net worth investors. Of the 13,927 state-registered investment
advisers serving retail investors, 134 may also be dually registered
as broker-dealers.
---------------------------------------------------------------------------

c. Trends in the Relative Numbers of Providers of Financial Services
    Over time, the relative number of broker-dealers and investment
advisers has changed. Figure 1 presented below shows the time series
trend of growth in broker-dealers and SEC-registered investment
advisers between 2005 and 2018. Over the last 14 years, the number of
broker-dealers has declined from over 6,000 in 2005 to less than 4,000
in 2018, while the number of investment advisers has increased from
approximately 9,000 in 2005 to over 13,000 in 2018. This change in the
relative numbers of broker-dealers and investment advisers over time
likely is a reflection of the market for investment advice, and
potentially of the choices available to retail investors regarding how
to receive or pay for such advice, the nature of the advice, and the
attendant conflicts of interest.

[GRAPHIC] [TIFF OMITTED] TR12JY19.000

    Increases in the number of investment advisers and decreases in the
number of broker-dealers could have occurred for a number of reasons,
including changes in regulation and the enforcement of regulation,
anticipation of possible regulatory changes, technological innovation
(e.g., the increase in automated advisers, which are often colloquially
referred to as ``robo-advisors'' and online trading platforms), product
proliferation (e.g., index mutual funds and exchange-traded products),
and industry consolidation driven by economic and market conditions,
particularly among broker-dealers.\930\ Commission staff has observed
the transition by broker-dealers from traditional brokerage services to
also providing 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 because they provide a
more steady source of revenue than accounts that charge commissions and
are dependent on transactions.\931\ Broker-dealers have indicated that
the following factors have contributed to this migration: Provision of
revenue stability or increase in profitability,\932\ perceived lower
regulatory burden, and provisions of more services to retail
customers.\933\ Some firms have reported record profits as a result of
moving clients into fee-based accounts, and cite that it provides
``stability and high returns.'' \934\

    \930\ See Hester Peirce, Dwindling Numbers in the Financial
Industry, Brookings Center on Markets and Regulation Report (May 15,
2017), available at https://www.brookings.edu/research/dwindling-numbers-in-the-financial-industry/ (``Brookings Report''), which
notes 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, other SROs, National Futures Association
(``NFA''), or the Municipal Securities Rulemaking Board (``MSRB'').
    \931\ Beyond Commission observations, the Brookings Report,
supra footnote 930, also discusses the shift from broker-dealer to
investment advisory business models for retail investors, in part
due to the DOL Fiduciary Rule. Declining transaction-based revenue
due to declining commission rates and competition from discount
brokerage firms has made fee-based securities and services more
attractive to providers of such securities and services. 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. See also Angela A. Hung, et al.,
Investor and Industry Perspectives on Investment Advisers and
Broker-Dealers, RAND Institute for Civil Justice Technical Report
(2008), available at https://www.rand.org/content/dam/rand/pubs/technical_reports/2008/RAND_TR556.pdf (``2008 RAND Study''), which
discusses a shift from transaction-based to fee-based brokerage
accounts prior to recent regulatory changes.
    \932\ 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 3/14/2019 Form 10-K available at https://www.sec.gov/Archives/edgar/data/815917/000156459019007788/ck0000815917-10k_20181231.htm; Raymond James 11/21/2018 Form 10-K
available at https://www.sec.gov/Archives/edgar/data/720005/000072000518000083/rjf-20180930x10k.htm; Stifel 2/20/2019 Form 10-K
available at https://www.sec.gov/Archives/edgar/data/720672/000156459019003474/sf-10k_20181231.htm; Wells Fargo 2/27/2019 10-K
available at https://www.sec.gov/Archives/edgar/data/72971/000007297119000227/wfc-12312018x10k.htm; and Ameriprise 2/23/2018
Form 10-K available at https://www.sec.gov/Archives/edgar/data/820027/000082002718000008/amp12312017.htm. We note that discussions
in Form 10-K and 10-Q filings of this sample of broker-dealers here
may not be representative of other large broker-dealers or of small
to mid-size broker-dealers.
    \933\ See infra Section III.B.2.e.ii, which discusses industry
trends, particularly in response to the DOL Fiduciary Rule.
    \934\ See Hugh Son, Morgan Stanley Wealth-Management Fees Climb
to All-Time High, Bloomberg, Jan. 18, 2018, 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. See Morgan
Stanley Strategic Update (Jan. 18, 2018), available at https://www.morganstanley.com/about-us-ir/shareholder/4q2017-strategic-update.pdf. See also Lisa Beilfuss & Brian Hershberg, WSJ Wealth
Adviser Briefing: The Reinvention of Morgan and Merrill, Adviser
Profile, Wall St. J., Jan. 25, 2018, 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, it increased by more than 12 million new non-
high net worth retail clients between 2012 and 2017, and has declined
since 2017. With respect to AUM, 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 and there also has been leveling and subsequent reduction in
AUM for non-high net worth retail clients over a similar time period.
[GRAPHIC] [TIFF OMITTED] TR12JY19.001

[GRAPHIC] [TIFF OMITTED] TR12JY19.002

BILLING CODE 8011-01-Cd. 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'').\935\ 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.\936\
---------------------------------------------------------------------------

    \935\ 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 with
FINRA. Therefore, 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.
    \936\ See Advisers Act, [17 CFR 275.203A-3 (2019)]. 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 to retail investors 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 that meet the definition of
``qualified client.'' In addition, state securities authorities may
impose different criteria for requiring registration as an
investment adviser representative.
---------------------------------------------------------------------------

    We estimate the number of registered representatives and registered
IARs, including dually-registered representatives, (together
``registered financial professionals'') 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 registered representative or investment adviser
representative.\937\ We only consider employees at firms who have
retail-facing business, as defined previously.\938\ We observe in Table
5 that approximately 60% 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, 67% of all registered financial professionals
in that size category are employed by dually registered firms. Focusing
on dually registered firms only, approximately 60.5% of total
registered financial professionals at these firms are dually registered
representatives; approximately 39.1% are only registered
representatives; and less than one percent are only registered
investment adviser representatives.
---------------------------------------------------------------------------

    \937\ We calculate these numbers based on Form U4 filings.
Representatives of broker-dealers, investment advisers, and issuers
of securities must file this form when applying to become registered
in appropriate jurisdictions and with SROs. Firms and
representatives have an obligation to amend and update information
as changes occur. Using the examination information contained in the
form, we consider an employee a registered financial professional if
he or she has an approved, pending, or temporary registration status
for either Series 6 or 7 (registered representative) or is
registered as an investment adviser representative in any state or
U.S. territory (IAR). We limit the firms to only those that do
business with retail investors, and only to licenses specifically
required as a registered representative or IAR.
    \938\ See supra footnotes 900 and 927.

        Table 5--Total Registered Representatives at Broker-Dealers, Investment Advisers, and Dually Registered Firms With Retail Investors \939\
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                           % of reps. in   % of reps. in   % of reps. in   % of reps. in    % reps. in
Size of firm (total assets for standalone BDs and dually   Total number       dually       standalone BD   standalone BD   standalone IA   standalone IA
        registered firms; AUM for standalone IAs)            of reps.       registered        w/an IA        w/o an IA        w/a BD         w/o a BD
                                                                               firms         affiliate       affiliate       affiliate       affiliate
--------------------------------------------------------------------------------------------------------------------------------------------------------
>$50 billion............................................          84,461              73               7               0              19               1
$1 billion to $50 billion...............................         170,256              67              11               0              15               7
$500 million to $1 billion..............................          29,874              71               5               1               7              16
$100 million to $500 million............................          66,924              51              27               0               4              18
$10 million to $100 million.............................         106,178              55              42               2               1               1
$1 million to $10 million...............................          33,790              35              54              11               0               0
<$1 million.............................................          12,522               8              52              36               3               1
                                                         -----------------------------------------------------------------------------------------------
    Total Licensed Representatives......................         504,005              60              23               2               9               6
--------------------------------------------------------------------------------------------------------------------------------------------------------

    In Table 6 below, we estimate the number of employees who are
registered representatives, registered investment adviser
representatives, or dually registered representatives.\940\ 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.\941\
---------------------------------------------------------------------------

    \939\ 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.
    \940\ We calculate these numbers based on Form U4 filings.
    \941\ See supra footnotes 900 and 927.
---------------------------------------------------------------------------

    In Table 6, approximately 25% of registered employees at registered
broker-dealers or investment advisers are dually registered
representatives. However, this proportion varies significantly across
size categories. For example, for firms with total assets between $1
billion and $50 billion,\942\ approximately 35% of all registered
employees are dually registered representatives. In contrast, for firms
with total assets below $1 million, 13% of all employees are dually
registered representatives.
---------------------------------------------------------------------------

    \942\ Firm size is defined as total assets from the balance
sheet for broker-dealers and dual-registrants (source: FOCUS
reports) and as AUM 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 AUM, 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 \943\
----------------------------------------------------------------------------------------------------------------
                                                                Percentage of    Percentage of
  Size of firm (total assets for standalone   Total number of       dually         registered     Percentages of
  BDs and dually registered firms; AUM for       employees        registered    representatives     IARs only
               standalone IAs)                                 representatives        only
----------------------------------------------------------------------------------------------------------------
>$50 billion................................          218,539               19               16                1
$1 billion to $50 billion...................          328,842               35               12                4
$500 million to $1 billion..................           43,211               18               40               10
$100 million to $500 million................          119,214               23               24                9
$10 million to $100 million.................          176,559               20               39                1
$1 million to $10 million...................           56,230               17               39                1
<$1 million.................................           18,334               13               46                3
                                             -------------------------------------------------------------------
    Total Employees at Retail-Facing Firms..          960,929               25               23                4
----------------------------------------------------------------------------------------------------------------

    Approximately 87% of investment adviser representatives are dually
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.\944\ In contrast, approximately
52% of registered representatives were dually registered as investment
adviser representatives at the end of 2018.\945\
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    \943\ See supra footnotes 899, 920, 940, and 942. Note that all
percentages in the table have been rounded to the nearest whole
percentage point.
    \944\ See Letter from Angela C. Goelzer, FINRA, to Jennifer B.
McHugh, Senior Advisor to the Chairman, U.S. Securities and Exchange
Commission, re: File Number 4-606; Obligations of Brokers, Dealers
and Investment Advisers (Nov. 3, 2010), at 1, available at https://www.sec.gov/comments/4-606/4606-2836.pdf.
    \945\ 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.
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e. Investor Account Statistics
    Investors seek financial advice and services to achieve a number of
different goals, such as saving for retirement or children's college
education. Approximately 73% of adults live in a

household that invests.\946\ The OIAD/RAND survey indicates that non-
investors are more likely to be female, to have lower family income and
educational attainment, and to be younger than investors.\947\
Approximately 35% of households that do invest do so through accounts
such as broker-dealer or advisory accounts.\948\
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    \946\ See OIAD/RAND, defining ``investors'' as persons ``owning
at least one type of investment account, (e.g., an employer-
sponsored retirement account, a non-employer sponsored retirement
account such as an IRA, a college savings investment account, or
some other type of investment account such as a brokerage or
advisory account), or owning at least one type of investment asset
(e.g., mutual funds, exchange-traded funds or other funds;
individual stocks; individual bonds; derivatives; and annuities).''
    \947\ Id. at 36.
    \948\ Id. at 39.
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    As shown above in Figures 2 and 3, the number of retail investors
and their AUM associated with investment advisers has increased
significantly, particularly since 2012. As of December 2016, nearly
$24.2 trillion is invested in retirement accounts, of which $7.5
trillion is in IRAs.\949\ A total of 43.3 million U.S. households have
either an IRA or a brokerage account; an estimated 20.2 million U.S.
households have a brokerage account, and 37.7 million households have
an IRA (including 72% of households that also hold a brokerage
account).\950\ With respect to IRA accounts, one commenter documents
that 43 million U.S. households own either traditional or Roth IRAs and
that approximately 70% are held with financial professionals, with the
remainder being direct market.\951\ Further, this commenter finds that
approximately 64% of households have aggregate IRA (traditional and
Roth) balances of less than $100,000, and approximately 36% of
investors have balances below $25,000. As noted in one study, the
growth of assets in traditional IRAs comes from rollovers from
workplace retirement plans; for example, 58% of traditional IRAs
consist of rollover assets, and contributions due to rollovers exceeded
$460 billion in 2015 (the most recently available data).\952\
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    \949\ See Sarah Holden & Daniel Schrass, The Role of IRAs in
U.S. Households' Saving for Retirement, 2016, ICI Res. Persp., Jan.
2017, available at https://www.ici.org/pdf/per17-08.pdf. See also
ICI Letter.
    \950\ The data is obtained from the Federal Reserve System's
2016 Survey of Consumer Finances (``SCF Survey''), a triennial
survey of approximately 6,200 U.S. households, and imputes weights
to extrapolate the results to the entire U.S. population. As noted,
some survey respondent households have both a brokerage and an IRA.
See Board of Governors of the Federal Reserve System, Survey of
Consumer Finances (2016), available at https://www.federalreserve.gov/econres/scfindex.htm. The SCF Survey data
does not directly examine the incidence of households that could use
advisory accounts instead of brokerage accounts; however, some
fraction of IRA accounts reported in the survey could be those held
at investment advisers.
    \951\ See Sarah Holden & Daniel Schrass, The Role of IRAs in US
Households' Saving for Retirement, 2018, ICI Res. Persp., Dec. 2018,
available at https://www.ici.org/pdf/per24-10.pdf. See also ICI
Letter.
    \952\ See Holden & Schrass (2018), supra footnote 951.
---------------------------------------------------------------------------

    While the number of retail investors obtaining services from
investment advisers and the aggregate value of associated AUM has
increased, the OIAD/RAND study also suggests that the general
willingness of investors to use planning or to take financial advice
regarding strategies, securities, or accounts is relatively fixed over
time.\953\ With respect to the account assets associated with retail
investors, the OIAD/RAND survey also estimates that approximately 10%
of investors who have brokerage or advisory accounts hold more than
$500,000 in assets, while approximately 47% hold $50,000 in assets or
less. Altogether, investors who have brokerage or advisory accounts
typically trade infrequently, with approximately 31% reporting no
annual transactions and an additional approximately 30% reporting three
or fewer transactions per year.\954\
---------------------------------------------------------------------------

    \953\ See OIAD/RAND at 50 (noting that this conclusion was
limited by the methodology of comparing participants in a 2007
survey with those surveyed in 2018).
    \954\ See OIAD/RAND.
---------------------------------------------------------------------------

    With respect to particular securities, commenters have provided us
with additional information about ownership of mutual funds and IRA
account statistics. For example, one commenter stated that 56 million
U.S. households and nearly 100 million individual investors own mutual
funds, of which 80% are held through 401(k) and other work-based
retirement plans, while 63% of investors hold mutual funds outside of
those plans.\955\ Of those investors who own mutual funds outside of
workplace retirement plans, approximately 50% use financial
professionals, while nearly one-third purchase direct-sold funds either
directly from the fund company or through a discount broker.\956\
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    \955\ See ICI Letter; see also Sarah Holden, Daniel Schrass, &
Michael Bogdan, Ownership of Mutual Funds, Shareholder Sentiment,
and Use of the internet, 2018, ICI Res. Persp., Nov. 2018, available
at https://www.ici.org/pdf/per22-06.pdf.
    \956\ See Holden et al. (2018), supra footnote 955. See also ICI
Letter.
---------------------------------------------------------------------------

    Table 7 below provides an overview of account ownership segmented
by account type (e.g., IRA, brokerage, or both) and investor income
category based on the SCF Survey.\957\
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    \957\ See SCF Survey, supra footnote 950. To the extent that
investors have IRA accounts at banks that are not also registered as
broker-dealers, our data may overestimate the numbers of IRA
accounts held by retail investors that could be subject to
Regulation Best Interest.

                         Table 7--Ownership by Account Type in the U.S. by Income Group
                                      [As reported by the 2016 SCF Survey]
----------------------------------------------------------------------------------------------------------------
                                                                                % Both
                         Income category                            % Brokerage     % IRA only     brokerage and
                                                                       only                             IRA
----------------------------------------------------------------------------------------------------------------
Bottom 25%......................................................             1.2             7.6             2.4
25%-50%.........................................................             3.2            14.5             5.4
50%-75%.........................................................             4.1            21.4            11.4
75%-90%.........................................................             7.5            33.4            16.5