[Federal Register Volume 83, Number 90 (Wednesday, May 9, 2018)]
[Proposed Rules]
[Pages 21574-21682]
[FR Doc No: 2018-08582]

Vol. 83

Wednesday,

No. 90

May 9, 2018

Part IV

Securities and Exchange Commission

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17 CFR Part 240

Regulation Best Interest; Proposed Rule

Federal Register / Vol. 83 , No. 90 / Wednesday, May 9, 2018 /
Proposed Rules

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-83062; File No. S7-07-18]
RIN 3235-AM35

Regulation Best Interest

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: We are proposing a new rule under the Securities Exchange Act
of 1934 (``Exchange Act'') establishing a standard of conduct for
broker-dealers and natural persons who are associated persons of a
broker-dealer when making a recommendation of any securities
transaction or investment strategy involving securities to a retail
customer.

DATES: Comments should be received on or before August 7, 2018.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's internet comment form (http://www.sec.gov/rules/proposed.shtml); or
     Send an email to [email protected]. Please include
File Number S7-07-18 on the subject line.

Paper Comments

     Send paper comments to Brent J. Fields, Secretary,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549-1090.

All submissions should refer to File Number S7-07-18. This file number
should be included on the subject line if email is used. To help the
Commission process and review your comments more efficiently, please
use only one method. The Commission will post all comments on the
Commission's internet website (http://www.sec.gov/rules/proposed.shtml). Comments also are available for website viewing and
printing in the Commission's Public Reference Room, 100 F Street NE,
Washington, DC 20549, on official business days between the hours of
10:00 a.m. and 3:00 p.m. All comments received will be posted without
change. Persons submitting comments are cautioned that we do not redact
or edit personal identifying information from comment submissions. You
should submit only information that you wish to make publicly
available.
    Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any such materials
will be made available on the Commission's website. To ensure direct
electronic receipt of such notifications, sign up through the ``Stay
Connected'' option at www.sec.gov to receive notifications by email.

FOR FURTHER INFORMATION CONTACT: Lourdes Gonzalez, Assistant Chief
Counsel--Office of Sales Practices; Emily Westerberg Russell, Senior
Special Counsel; Alicia Goldin, Senior Special Counsel; Bradford
Bartels, Special Counsel; Geeta Dhingra, Special Counsel; and Stacy
Puente, Special Counsel, Office of Chief Counsel, Division of Trading
and Markets, at<PHONE_NUMBER>, Securities and Exchange Commission, 100
F Street NE, Washington, DC 20549-8549.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Introduction
    A. Background
    1. Evaluation of Standards of Conduct Applicable to Investment
Advice
    2. DOL Rulemaking
    3. Statement by Chairman Clayton
    B. General Objectives of Proposed Approach
II. Discussion of Regulation Best Interest
    A. Overview of Regulation Best Interest
    B. Best Interest, Generally
    1. Consistency With Other Approaches
    2. Request for Comment on the Best Interest Obligation
    C. Key Terms and Scope of Best Interest Obligation
    1. Natural Person Who Is an Associated Person
    2. When Making a Recommendation, at Time Recommendation is Made
    3. Any Securities Transaction or Investment Strategy
    4. Retail Customer
    5. Request for Comment on Key Terms and Scope of Best Interest
Obligation
    D. Components of Regulation Best Interest
    1. Disclosure Obligation
    2. Care Obligation
    3. Conflict of Interest Obligations
    E. Recordkeeping and Retention
    F. Whether the Exercise of Investment Discretion Should Be
Viewed as Solely Incidental to the Business of a Broker or Dealer
III. Request for Comment
    A. Generally
    B. Interactions With Other Standards of Conduct
IV. Economic Analysis
    A. Introduction, Primary Goals of Proposed Regulations and Broad
Economic Considerations
    1. Introduction and Primary Goals of Proposed Regulation
    2. Broad Economic Considerations
    B. Economic Baseline
    1. Market for Advice Services
    2. Regulatory Baseline
    C. Benefits, Costs, and Effects on Efficiency, Competition, and
Capital Formation
    1. Benefits
    2. Costs
    D. Effects on Efficiency, Competition, and Capital Formation
    E. Reasonable Alternatives
    1. Disclosure-Only Alternative
    2. Principles-Based Standard of Conduct Obligation
    3. A Fiduciary Standard for Broker-Dealers
    4. Enhanced Standards Akin to Conditions of the BIC Exemption
    F. Request for Comment
V. Paperwork Reduction Act Analysis
    A. Respondents Subject to Proposed Regulation Best Interest and
Proposed Amendments to Rule 17a-3(a)(25), Rule 17a-4(e)(5)
    1. Broker-Dealers
    2. Natural Persons Who Are Associated Persons of Broker-Dealers
    B. Summary of Collections of Information
    1. Conflict of Interest Obligations
    2. Disclosure Obligation
    3. Care Obligation
    4. Record-Making and Recordkeeping Obligations
    C. Collection of Information Is Mandatory
    D. Confidentiality
    E. Request for Comment
VI. Small Business Regulatory Enforcement Fairness Act
VII. Initial Regulatory Flexibility Act Analysis
    A. Reasons for and Objectives of the Proposed Action
    B. Legal Basis
    C. Small Entities Subject to the Proposed Rule
    D. Projected Compliance Requirements of the Proposed Rule for
Small Entities
    1. Conflict of Interest Obligations
    2. Disclosure Obligations
    3. Obligation To Exercise Reasonable Diligence, Care, Skill and
Prudence
    4. Record-Making and Recordkeeping Obligations
    E. Duplicative, Overlapping, or Conflicting Federal Rules
    F. Significant Alternatives
    1. Disclosure-Only Alternative
    2. Principles-Based Alternative
    3. Enhanced Standards Akin to BIC Exemption
    G. General Request for Comment
VIII. Statutory Authority and Text of Proposed Rule

I. Introduction

    Broker-dealers play an important role in helping Americans organize
their financial lives, accumulate and manage retirement savings, and
invest toward other important long-term goals, such as buying a house
or funding a child's college education. Broker-dealers may offer a wide
variety of brokerage (i.e., agency) services to retail customers
ranging from providing customers with execution-only services (e.g.,
discount brokerage), which typically does not involve advice, to
providing a range of services, including advice, to customers

(i.e., full-service brokerage).\1\ Broker-dealers are typically
considered to provide advice when they make recommendations of
securities transactions or investment strategies involving securities
to customers.\2\ Broker-dealers also may offer a variety of dealer
(i.e., principal) services and investment products to retail
customers,\3\ and may make recommendations to retail customers about
such principal services, such as recommending transactions where the
broker-dealer is buying securities from or selling securities to retail
customers on a principal basis or recommending proprietary products.\4\
Like many principal-agent relationships, the relationship between a
broker-dealer and an investor has inherent conflicts of interest, which
may provide an incentive to a broker-dealer to seek to maximize its
compensation at the expense of the investor it is advising. As we
discuss below, concerns regarding the potential harm to retail
customers resulting from broker-dealer conflicts of interest, and in
particular the conflicts associated with financial incentives, have
existed for some time.
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    \1\ Such ``agency'' services may include, but are not limited
to: Providing transaction-specific recommendations to buy or sell
securities for commissions; providing asset allocation services with
recommendations about asset classes, specific sectors, or specific
securities; providing generalized research, advice, and education;
providing custody and trade execution to a customer who has selected
an independent investment manager or other money manager; executing
trades placed by investment advisers in wrap fee programs; offering
margin accounts; and operating a call center (e.g., responding to a
customer request for stock quotes, information about an issuer or
industry, and then placing a trade at the customer's request). See,
e.g., Staff of the U.S. Securities and Exchange Commission, Study on
Investment Advisers and Broker-Dealers As Required by Section 913 of
the Dodd-Frank Wall Street Reform and Consumer Protection Act (Jan.
2011) (``913 Study''), at 9-10, available at www.sec.gov/news/studies/2011/913studyfinal.pdf.
    \2\ See 913 Study at 124.
    \3\ As the Staff noted in the 913 Study, such ``dealer''
services may include, but are not limited to: Selling securities
(such as bonds) out of inventory; buying securities from customers;
selling proprietary products (e.g., products such as affiliated
mutual funds, structured products, private equity and other
alternative investments); selling initial and follow-on public
offerings; selling other underwritten offerings; acting as principal
in Individual Retirement Accounts (``IRAs''); acting as a market
maker; and otherwise acting as a dealer. Broker-dealers may offer
solely proprietary products, a limited range of products, or a
diverse range of products. Id. at 10.
    \4\ Id. at 13.
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    The rule we are proposing today addresses the question of whether
changes should be made to the standard of conduct that applies to
broker-dealers when making recommendations about securities to retail
customers. As discussed below, broker-dealers are subject to regulation
under the Exchange Act and the rules of each self-regulatory
organization (``SRO'') of which the broker-dealer is a member,\5\
including a number of obligations that attach when a broker-dealer
makes a recommendation to a customer, as well as general and specific
requirements aimed at addressing certain conflicts of interest. These
obligations have developed in response to and reflect the unique
structure and characteristics of the broker-dealer relationship with
retail customers--in particular, the compensation and other conflicts
presented, the variety in the frequency and level of advice services
provided (i.e., one-time, episodic or on a more frequent basis), and
the spectrum of services provided to retail customers that may or may
not include advice (such as executing unsolicited transactions). While
these obligations are extensive, there is no specific obligation under
the Exchange Act that broker-dealers make recommendations that are in
their customers' best interest.\6\
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    \5\ Generally, all registered broker-dealers that deal with the
public must become members of the Financial Industry Regulatory
Authority (``FINRA''), a registered national securities association,
and may choose to become exchange members. See Exchange Act Section
15(b)(8) and Exchange Act Rule 15b9-1. FINRA is the sole national
securities association registered with the SEC under Section 15A of
the Exchange Act. Accordingly, for purposes of discussing a broker-
dealer's regulatory requirements when providing advice, we focus on
FINRA's regulation, examination and enforcement with respect to
member broker-dealers.
    \6\ As discussed infra note 15, FINRA and a number of cases have
interpreted FINRA's suitability rule as requiring a broker-dealer to
make recommendations that are ``consistent with his customers' best
interests'' or are not ``clearly contrary to the best interest of
the customer,'' but this is not an explicit requirement of FINRA's
suitability rule.
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    After extensive consideration of these issues, we believe it is
appropriate to make enhancements to the obligations that apply when
broker-dealers make recommendations to retail customers. Accordingly,
we are proposing a new rule under the Exchange Act that would establish
an express best interest obligation: That all broker-dealers and
natural persons who are associated persons of a broker-dealer (unless
otherwise indicated, together referred to as ``broker-dealer''), when
making a recommendation of any securities transaction or investment
strategy involving securities to a retail customer, act in the best
interest of the retail customer at the time the recommendation is made
without placing the financial or other interest of the broker-dealer or
natural person who is an associated person making the recommendation
ahead of the interest of the retail customer (``Regulation Best
Interest''). The proposed rule would provide that the best interest
obligation shall be satisfied if:
     The broker-dealer or natural person who is an associated
person of a broker or dealer, prior to or at the time of the
recommendation, reasonably discloses to the retail customer, in
writing, the material facts relating to the scope and terms of the
relationship with the retail customer and all material conflicts of
interest that are associated with the recommendation;
     The broker-dealer or natural person who is an associated
person of a broker or dealer, in making the recommendation, exercises
reasonable diligence, care, skill, and prudence to: (1) Understand the
potential risks and rewards associated with the recommendation, and
have a reasonable basis to believe that the recommendation could be in
the best interest of at least some retail customers; (2) have a
reasonable basis to believe that the recommendation is in the best
interest of a particular retail customer based on that retail
customer's investment profile and the potential risks and rewards
associated with the recommendation; and (3) have a reasonable basis to
believe that a series of recommended transactions, even if in the
retail customer's best interest when viewed in isolation, is not
excessive and is in the retail customer's best interest when taken
together in light of the retail customer's investment profile;
     The broker or dealer establishes, maintains, and enforces
written policies and procedures reasonably designed to identify and at
a minimum disclose, or eliminate, all material conflicts of interest
that are associated with such recommendations; and
     The broker or dealer establishes, maintains, and enforces
written policies and procedures reasonably designed to identify and
disclose and mitigate, or eliminate, material conflicts of interest
arising from financial incentives associated with such recommendations.
    Regulation Best Interest is designed to make it clear that a
broker-dealer may not put her or her firm's financial interests ahead
of the interests of her retail customer in making investment
recommendations. Our goal in designing proposed Regulation Best
Interest is to enhance investor protection, while preserving, to the
extent possible, access and choice for investors who prefer the ``pay
as you go'' model for advice from broker-dealers, as well as preserve
retail customer choice of the level and types of advice provided and
the products available. We believe that the proposed best interest
obligation for broker-

dealers set forth in Regulation Best Interest achieves this goal.
    Specifically, we believe that proposed Regulation Best Interest
will improve investor protection by enhancing the professional
standards of conduct that currently apply to broker-dealers when they
make recommendations to retail customers, in four key respects.
     First, it would enhance the quality of recommendations
provided by requiring broker-dealers make recommendations in the retail
customer's ``best interest,'' which incorporates and goes beyond a
broker-dealer's existing suitability obligations under the federal
securities laws, and could not be satisfied through disclosure
alone.\7\
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    \7\ As discussed herein, some of the enhancements that
Regulation Best Interest would make to existing suitability
obligations under the federal securities laws, such as the
collection of information requirement related to a customer's
investment profile, the inability to disclose away a broker-dealer's
suitability obligation, and a requirement to make recommendations
that are ``consistent with his customers' best interests,'' reflect
obligations that already exist under the FINRA suitability rule or
have been articulated in related FINRA interpretations and case law.
See infra Sections II.D and IV.D, and note 15. Unless otherwise
indicated, our discussion of how Regulation Best Interest compares
with existing suitability obligations focuses on what is currently
required under the Exchange Act.
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     Second, it would establish obligations under the Exchange
Act that do not rely on disclosure alone as the solution to conflicts
arising from financial incentives--including conflicts associated with
broker-dealer compensation incentives, the sale of proprietary
products, and effecting transactions in a principal capacity.
     Third, it would improve disclosure about the scope and
terms of the broker-dealer's relationship with the retail customer,
which would foster retail customer awareness and understanding of their
relationship with the broker-dealer, which aligns with our broader
effort to address retail investor confusion through our separate
concurrent rulemaking.\8\
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    \8\ As discussed in more detail in Section II.D.1 in a separate,
concurrent rulemaking, we propose to: (1) Require broker-dealers and
investment advisers to deliver to retail investors a short (i.e.,
four page or equivalent limit if in electronic format) relationship
summary; (2) restrict broker-dealers and associated natural persons
of broker-dealers, when communicating with a retail investor, from
using as part of a name or title the term ``adviser'' or ``advisor''
in certain circumstances; and (3) require broker-dealers and
investment advisers, and their associated natural persons and
supervised persons, respectively, to disclose in retail investor
communications the firm's registration status with the Commission
and an associated natural person's and supervised person's
relationship with the firm. See Form CRS Relationship Summary;
Amendments to Form ADV; Required Disclosures in Retail
Communications and Restrictions on the use of Certain Names or
Titles, Release No. 34-83063, IA-4888, File No. S7-08-18
(``Relationship Summary Proposal'').
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     Finally, it would enhance the disclosure of material
conflicts of interest and thereby help retail customers evaluate
recommendations received from broker-dealers.
    Through these enhancements, we preliminarily believe that the best
interest obligation will reduce the potential harm to retail customers
from recommendations provided in circumstances where conflicts of
interest, including those arising from financial incentives, exist
while preserving investor access to advice and choice with regard to
advice relationships and compensation methods, and is workable for the
transaction-based relationship offered by broker-dealers. Specifically,
proposed Regulation Best Interest is designed to achieve these
enhancements by building upon, and being tailored to, the unique
structure and characteristics of the broker-dealer relationship with
retail customers and existing regulatory obligations, while taking into
consideration and drawing on (to the extent appropriate) the principles
of the obligations that apply to investment advice in other contexts.
In drawing from these underlying principles, as opposed to adopting
identical or uniform obligations, we seek to apply consistent
principles across the spectrum of investment advice, and thereby
enhance investor protection while preserving investor choice across
products and advice models.
    We further believe that, through the establishment of a standard of
conduct for broker-dealers under the Exchange Act, this proposed
approach would foster greater clarity, certainty, and efficiency with
respect to broker-dealer standards of conduct. In addition, by drawing
from principles that have developed under other regulatory regimes, we
seek to establish greater consistency in the level of protection
provided across the spectrum of registered investment advice and ease
compliance with Regulation Best Interest where these other overlapping
regulatory regimes are also applicable.
    Before describing proposed Regulation Best Interest, we provide a
brief background on this subject, including recent Commission and other
regulators' considerations of the issues involved, the evolution of our
perspective on this subject, and our general objectives in proposing
Regulation Best Interest.

A. Background

    As noted, broker-dealers are subject to comprehensive regulation
under the Exchange Act and SRO rules, and a number of obligations
attach when a broker-dealer makes a recommendation to a customer. Under
the federal securities laws and SRO rules, broker-dealers have a duty
of fair dealing,\9\ which, among other things, requires broker-dealers
to make only suitable recommendations to customers \10\ and to receive
only fair and reasonable compensation.\11\ Broker-dealers are also
subject to general and specific requirements aimed at addressing
certain conflicts of interest, including

requirements to eliminate,\12\ mitigate,\13\ or disclose certain
conflicts of interest.\14\
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    \9\ See Report of the Special Study of Securities Markets of the
Securities and Exchange Commission, H.R. Doc. No. 88-95, at 238 (1st
Sess. 1963); In re Richard N. Cea, et al., Exchange Act Release No.
8662 at 18 (Aug. 6, 1969) (Commission opinion involving excessive
trading and recommendations of speculative securities without a
reasonable basis); In re Mac Robbins & Co. Inc., Exchange Act
Release No. 6846, 41 SEC. 116 (July 11, 1962); see also FINRA Rule
2010 (Standards of Commercial Honor and Principles of Trade)
(requiring a member, in the conduct of its business, to observe high
standards of commercial honor and just and equitable principles of
trade).
    \10\ See Richard N. Cea, Exchange Act Release No. 8662; F.J.
Kaufman and Co., Securities Exchange Act Release No. 27535 (Dec. 13,
1989); FINRA Rule 2111.01 (Suitability) (``Implicit in all member
and associated person relationships with customers and others is the
fundamental responsibility for fair dealing. Sales efforts must
therefore be undertaken only on a basis that can be judged as being
within the ethical standards of [FINRA's] Rules, with particular
emphasis on the requirement to deal fairly with the public. The
suitability rule is fundamental to fair dealing and is intended to
promote ethical sales practices and high standards of professional
conduct.''). See also 913 Study at 51-53, 59; A Joint Report of the
SEC and the CFTC on Harmonization of Regulation (Oct. 2009),
available at http://www.sec.gov/news/press/2009/cftcjointreport101609.pdf, at 61-64.
    \11\ See, e.g., FINRA Rules 2121 (Fair Prices and Commissions),
2122 (Charges for Services Performed), and 2341 (Investment Company
Securities). See also Exchange Act Sections 10(b) and 15(c).
    \12\ For example, FINRA rules establish restrictions on the use
of non-cash compensation in connection with the sale and
distribution of mutual funds, variable annuities, direct
participation program securities, public offerings of debt and
equity securities, and real estate investment trust programs. These
rules generally limit the manner in which members can pay or accept
non-cash compensation and detail the types of non-cash compensation
that are permissible. See FINRA Rules 2310, 2320, 2331, and 5110.
    \13\ See, e.g., FINRA Rule 3110(c)(3) (firm must have procedures
to prevent the effectiveness of an internal inspection from being
compromised due to conflicts of interest); FINRA Rule 3110(b)(6)(C)
(supervisory personnel generally cannot supervise their own
activities); FINRA Rule 3110(b)(6)(D) (firm must have procedures
reasonably designed to prevent the required supervisory system from
being compromised due to conflicts of interest). Further, a broker-
dealer may recommend a security even when a conflict of interest is
present, but that recommendation must be suitable. See FINRA Rule
2111. The antifraud provisions of the federal securities laws and
the implied obligation of fair dealing prohibit a broker-dealer
from, among other things, making unsuitable recommendations and may
impose liability on broker-dealers that do not investigate an issuer
before recommending the issuer's securities to a customer. See,
e.g., Hanly v. SEC, 415 F.2d 589, 596 (2d Cir. 1969). See also
Municipal Securities Disclosure, Exchange Act Release No. 26100, at
n. 75 (Sept. 22, 1988). The fair dealing obligation also requires a
broker-dealer to reasonably believe that its securities
recommendations are suitable for its customer in light of the
customer's financial needs, objectives and circumstances (customer-
specific suitability). See Richard N. Cea, Exchange Act Release No.
8662, at 18 (involving excessive trading and recommendations of
speculative securities without a reasonable basis).
    \14\ A broker-dealer may be liable if it does not disclose
``material adverse facts of which it is aware.'' See, e.g., Chasins
v. Smith, Barney & Co., 438 F.2d 1167, 1172 (2d Cir. 1970); SEC v.
Hasho, 784 F. Supp. 1059, 1110 (S.D.N.Y. 1992). For example, when
engaging in transactions directly with customers on a principal
basis, a broker-dealer violates Exchange Act Rule 10b-5 when it
knowingly or recklessly sells a security to a customer at a price
not reasonably related to the prevailing market price and charges
excessive markups (as discussed above), without disclosing the fact
to the customer. See, e.g., Grandon v. Merrill Lynch & Co., 147 F.3d
184, 189-90 (2d Cir. 1998). See also Exchange Act Rule 10b-10
(requiring a broker-dealer effecting transactions in securities to
provide written notice to the customer of certain information
specific to the transaction at or before completion of the
transaction, including the capacity in which the broker-dealer is
acting (i.e., agent or principal) and any third-party remuneration
it has received or will receive).
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    Despite the breadth of a broker-dealer's existing conduct
obligations, broker-dealers are not explicitly required to make
recommendations that are in a customer's ``best interest.'' \15\ Like
many principal-agent relationships, the relationship between a broker-
dealer and a retail customer has certain inherent and unavoidable
conflicts of interest.\16\ For example, as a result of transaction-
based compensation structures, broker-dealers often make
recommendations to retail customers against a backdrop of potential
conflicts that may provide them with an incentive to seek to increase
their compensation at the expense of the investors they are advising.
In addition, other conflicts of interest arise out of business
activities that broker-dealers may choose to engage in (including,
among others, receipt of third-party compensation, principal trading,
and the sale of proprietary or affiliated products). The Commission
believes that material conflicts of interest associated with the
broker-dealer relationship need to be well understood by the retail
customer and, in some cases, mitigated or eliminated.\17\
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    \15\ While not an explicit requirement of FINRA's suitability
rule, FINRA and a number of cases have interpreted the suitability
rule as requiring a broker-dealer to make recommendations that are
``consistent with his customers' best interests'' or are not
``clearly contrary to the best interest of the customer.'' See,
e.g., In re Application of Raghavan Sathianathan, Exchange Act
Release No. 54722 at 21 (Nov. 8, 2006); In re Application of Dane S.
Faber, Exchange Act Release No. 49216 at 23-24 (Feb. 10, 2004); In
re Powell & McGowan, Inc., Exchange Act Release No. 7302 (Apr. 24,
1964). In interpretive guidance, FINRA has stated that ``[t]he
suitability requirement that a broker make only those
recommendations that are consistent with the customer's best
interests prohibits a broker from placing his or her interests ahead
of the customer's interests.'' See FINRA Regulatory Notice 12-25,
Additional Guidance on FINRA's New Suitability Rule (May 2012)
(``FINRA Regulatory Notice 12-25'').
    In addition, a broker-dealer may have a fiduciary duty under
certain circumstances. This duty may arise under state common law,
which varies by state. Generally, courts have found that broker-
dealers that exercise discretion or control over customer assets, or
have a relationship of trust and confidence with their customers,
are found to owe customers a fiduciary duty similar to that of
investment advisers. See, e.g., United States v. Skelly, 442 F.3d
94, 98 (2d Cir. 2006); United States v. Szur, 289 F.3d 200, 211 (2d
Cir. 2002); Associated Randall Bank v. Griffin, Kubik, Stephens &
Thompson, Inc., 3 F.3d 208, 212 (7th Cir. 1993); MidAmerica Fed.
Savings & Loan Ass'n v. Shearson/American Express Inc., 886 F.2d
1249, 1257 (10th Cir. 1989); Leib v. Merrill Lynch, Pierce, Fenner &
Smith, Inc., 461 F. Supp. 951, 953-954 (E.D. Mich. 1978), aff'd, 647
F.2d 165 (6th Cir. 1981). Cf. De Kwiatkowski v. Bear, Stearns & Co.,
Inc., 306 F.3d 1293 (2d Cir. 2002) (finding that absent ``special
circumstances'' (i.e., circumstances that render the client
dependent--a client with impaired faculties, or one who has a closer
than arms-length relationship with the broker, or one who is so
lacking in sophistication that de facto control of the account is
deemed to rest in the broker-dealer), a broker-dealer does not have
a duty to give on-going advice between transactions in a non-
discretionary account, even if he volunteered advice at times;
``[I]t is uncontested that a broker ordinarily has no duty to
monitor a nondiscretionary account, or to give advice to such a
customer on an ongoing basis. The broker's duties ordinarily end
after each transaction is done, and thus do not include a duty to
offer unsolicited information, advice, or warnings concerning the
customer's investments. A nondiscretionary customer by definition
keeps control over the account and has full responsibility for
trading decisions. On a transaction-by-transaction basis, the broker
owes duties of diligence and competence in executing the client's
trade orders, and is obliged to give honest and complete information
when recommending a purchase or sale. The client may enjoy the
broker's advice and recommendations with respect to a given trade,
but has no legal claim on the broker's ongoing attention.'')
(citations omitted).
    For the staff's discussion of relevant case law see 913 Study,
at 54-55. See also A Joint Report of the SEC and the CFTC on
Harmonization of Regulation (Oct. 2009), available at http://www.sec.gov/news/press/2009/cftcjointreport101609.pdf, at 8-9 and
67. See also Section II.F. for a discussion and request for comment
regarding broker-dealer exercise of discretion and the extent to
which such exercise is ``solely incidental'' to the conduct of its
business as a broker-dealer.
    \16\ See infra Section IV.B.1. For instance, in the past,
brokerage firms have been fined for placing customers in fee-based
brokerage accounts that generated higher fees for the firm, where
such accounts were not appropriate for the customer. See, e.g., NASD
News Release, NASD Fines Raymond James $750,000 for Fee-Based
Account Violations (Apr. 27, 2005), available at http://www.finra.org/newsroom/2005/nasd-fines-raymond-james-750000-fee-based-account-violations (finding that Raymond James violated NASD
rules by recommending and opening fee-based brokerage accounts for
customers without first determining whether the accounts were
appropriate and by allowing those accounts to remain open). See also
NYSE Hearing Board Decision 06-133 (July 10, 2006), available at
https://www.nyse.com/publicdocs/nyse/markets/nyse/disciplinary-actions/2006/06-133.pdf (finding that A.G. Edwards had wrongfully
placed customers into non-managed fee accounts in lieu of
commission-based accounts, where non-managed fee-based brokerage
accounts were not appropriate for buy-and-hold investors or for
investors with few transactions, which resulted in such investors
paying substantially more in fees than they would have paid under a
commission-based structure); FINRA Press Release, FINRA Fines Robert
W. Baird & Co. $500,000 for Fee-Based Account, Breakpoint Violations
(Feb. 18, 2009), available at http://www.finra.org/newsroom/2009/finra-fines-robert-w-baird-co-500000-fee-based-account-breakpoint-violations (finding that Robert W. Baird & Co. failed to adequately
review customer accounts that were transferred into a fee-based
brokerage program, allowing numerous customers to remain in the
program despite conducting no trades, where the firm continued to
receive substantial fees despite inactivity on customers' accounts).
    \17\ See infra Section II.D.3.
---------------------------------------------------------------------------

    In this regard, it has been asserted that (1) retail customers do
not sufficiently understand the broker-dealer relationship, and in
particular the conflicts presented by broker-dealer compensation
arrangements and practices when making a recommendation, and (2)
regardless of the sufficiency of the retail customer's understanding of
the broker-dealer structure, broker-dealer regulatory requirements do
not require a broker-dealer's recommendations to be in a customer's
best interest and require limited disclosure that may not appropriately
address the conflicts of interest presented.\18\
---------------------------------------------------------------------------

    \18\ See, e.g., Letter from Marnie C. Lambert, President, Public
Investors Arbitration Bar Association (Aug. 11, 2017) (``PIABA
Letter'') (``The Suitability Rule is not sufficient on its own to
remove and manage these conflicts and ensure that brokers have acted
in their clients' best interests. . . . Any standards adopted by the
SEC should acknowledge that conflicts of interest are pervasive
throughout the industry and firms will continue to face challenges
when trying to balance the interests of their clients with those
conflicts. Any standards adopted should require mitigation of
conflicts of interest to the extent possible.''); Letter from Kevin
R. Keller, Chief Executive Officer, CFP Board, et al., Financial
Planning Coalition (Nov. 7, 2017) (``Financial Planning Coalition
Letter'') (stating that FINRA's suitability rule ``fails to mandate
disclosure of actual or potential conflicts of interest, proscribe
appropriate mitigation mechanisms, or require that broker-dealers
put the client's interests above their own earned commissions'').

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

    These concerns are not new. The Commission has previously expressed
long-held concerns about the incentives that commission-based
compensation provides to churn accounts, recommend unsuitable
securities, and engage in aggressive marketing of brokerage
services.\19\ This apprehension about the potentially harmful effects
of conflicts has been reflected over the years in, among other things,
our National Examination Program's examination priorities, which have
continually included conflicts of interest as an exam focus--either
generally or specifically (e.g., the role of conflicts of interest in
and suitability of recommendations involving retirement accounts (such
as investment or rollover recommendations), complex or structured
products, variable annuities, higher yield securities, exchange traded
funds, and mutual fund share class selection (i.e., share classes with
higher loads or distribution fees))--for many years.\20\ As our exam
staff has noted, ``[c]onflicts of interest, when not eliminated or
properly mitigated and managed, are a leading indicator and cause of
significant regulatory issues for individuals, firms and sometimes the
entire market.'' \21\
---------------------------------------------------------------------------

    \19\ These concerns led former Chairman Arthur Levitt to form
the Committee on Compensation Practices to review industry
compensation practices, identify actual and perceived conflicts of
interest, and identify ``best practices'' to eliminate, reduce, or
mitigate these conflicts. See Report of the Committee on
Compensation Practices (Apr. 10, 1995) (``Tully Report''). The Tully
Report observed that although the commission-based compensation
system ``works remarkably well for the vast majority of investors,''
conflicts of interest persist that can damage the interest of retail
customers, and identified various ``best practices'' for addressing
broker-dealer and registered representative compensation-related
conflicts, including fee-based brokerage accounts. Id. In 2005, the
Commission adopted Rule 202(a)(11)-1 under the Advisers Act, the
principal purpose of which was to deem broker-dealers offering
``fee-based brokerage accounts'' as not being subject to the
Advisers Act. See Certain Broker-Dealers Deemed Not To Be Investment
Advisers, Exchange Act Release No. 51523 (Apr. 12, 2005) at 8
(``Release 51523'') (adopting rule 202(a)(11)-1 under the Advisers
Act). This rule was later vacated by the Court of Appeals for the
District of Columbia Circuit. See Fin. Planning Ass'n v. SEC., 482
F.3d 481 (D.C. Cir. 2007).
    \20\ See Office of Compliance Inspections and Examinations
(``OCIE''), Examination Priorities for 2013 (Feb. 21, 2013),
available at https://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2013.pdf (``2013 Exam Priorities'');
OCIE, Examination Priorities for 2014 (Jan. 9, 2014), available at
https://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2014.pdf; OCIE, Examination Priorities for 2015 (Jan. 13,
2015), available at https://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2015.pdf; OCIE, Examination
Priorities for 2016 (Jan. 11, 2016), available at https://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2016.pdf; OCIE, Examination Priorities for 2017 (Jan. 12,
2017), available at https://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2017.pdf. See also OCIE Risk Alert,
``Retirement-Targeted Industry Reviews and Examinations Initiative''
(June 22, 2015), http://www.sec.gov/about/offices/ocie/retirement-targeted-industry-reviews-and-examinations-initiative.pdf.
    \21\ 2013 Exam Priorities.
---------------------------------------------------------------------------

    FINRA has similarly focused on the potential risks to broker-
dealers and to retail customers presented by broker-dealer conflicts,
and impact on brokerage recommendations, as reflected in guidance
addressing and highlighting circumstances in which various broker-
dealer conflicts of interest may create incentives that are contrary to
the interest of retail customers.\22\ Most notably, in 2013, FINRA
published a report on conflicts of interest in the broker-dealer
industry to highlight effective conflicts management practices.\23\ At
the time of publication of the FINRA Conflicts Report, FINRA Chairman
and Chief Executive Officer (``CEO'') Richard Ketchum noted that
``[w]hile many firms have made progress in improving the way they
manage conflicts, our review reveals that firms should do more.'' \24\
He later observed that ``some firms continue to approach conflict
management on a haphazard basis, only implementing an effective
supervisory process after a failure event involving customer harm
occurs,'' and suggested the development of a best interest standard
that includes, among other things, ``a requirement that financial firms
establish carefully designed and articulated structures to manage
conflicts of interest that arise in their businesses.'' \25\ In 2015,
FINRA launched a targeted exam regarding incentive structures and
conflicts of interest in connection with firms' retail brokerage
business, which encompassed firms' conflict mitigation processes
regarding compensation plans for registered representatives, and firms'
approaches to mitigating conflicts of interest that arise through the
sale of proprietary or affiliated products, or products for which a
firm receives third-party payments (e.g., revenue sharing).\26\
---------------------------------------------------------------------------

    \22\ See, e.g., FINRA Regulatory Notice 13-45, Rollovers to
Individual Retirement Accounts: FINRA Reminds Firms of Their
Responsibilities Concerning IRA Rollovers (Dec. 2013) (``FINRA
Regulatory Notice 13-45''), available at http://www.finra.org/sites/default/files/NoticeDocument/p418695.pdf. (noting the economic
incentive a financial professional has to encourage an investor to
roll plan assets into an IRA that he will represent as either a
broker-dealer or an investment adviser representative).
    \23\ See FINRA Report on Conflicts of Interest (Oct. 2013),
available at https://www.finra.org/sites/default/files/Industry/p359971.pdf (``FINRA Conflicts Report'').
    \24\ See Statement from Chairman and CEO Richard G. Ketchum on
FINRA's Report on Conflicts of Interest (Oct. 14, 2013), available
at http://www.finra.org/newsroom/2013/statement-chairman-and-ceo-richard-g-ketchum-finras-report-conflicts-interest.
    \25\ See Richard G. Ketchum, Remarks From the 2015 FINRA Annual
Conference (May 27, 2015), available at https://www.finra.org/newsroom/speeches/052715-remarks-2015-finra-annual-conference.
    \26\ See FINRA 2016 Regulatory and Examination Priorities Letter
(Jan. 5, 2016), available at http://www.finra.org/sites/default/files/2016-regulatory-and-examination-priorities-letter.pdf. See
also Conflicts of Interest Review--Compensation and Oversight (Apr.
2015), available at http://www.finra.org/industry/conflicts-interest-review-compensation-and-oversight.
---------------------------------------------------------------------------

    These concerns about the potential harms that may result from
broker-dealer conflicts of interest have been echoed by commenters over
the years. Recent commenters' analyses suggest that retail customers
have been harmed by conflicted advice, such as the incentives created
by broker-dealer compensation arrangements, due to the lack of an
explicit ``best interest'' obligation applying to such advice.\27\
---------------------------------------------------------------------------

    \27\ See, e.g., Letter from Monique Morrissey, Ph.D., Economist,
and Heidi Shierholz, Economist and Director of Policy; Economic
Policy Institute (Oct. 5, 2017) (``Economic Policy Institute
Letter''); Letter from Americans for Financial Reform (Sept. 22,
2017) (``AFR Letter''); Letter from Barbara Roper, Director of
Investor Protection, Consumer Federation of America (``CFA'') (Sept.
14, 2017) (``CFA 2017 Letter''); PIABA Letter (``Conflicted advice
causes substantial harm to investors. Just looking at retirement
savers, SaveOurRetirement.com estimates that investors lose between
$57 million and $117 million every day due to conflicted investment
advice, amounting to at least $21 billion annually.'')
---------------------------------------------------------------------------

    At the same time, many retail customers generally and reasonably
expect that their investment firms and professionals, including broker-
dealers, will--and rely on them to--provide advice that is in their
best interest by placing investors' interest before their own. Studies
have documented that many retail customers who use the services of
broker-dealers and investment advisers are not aware of the differences
in regulatory approaches for these entities, and their associated
persons, and the differing duties that flow from them.\28\ Commenters
assert

that any confusion regarding the standards of conduct that apply may
only enhance the potential for harm from broker-dealer conflicts of
interest, as this confusion results in retail customers mistakenly
relying on those recommendations as being in their ``best interest.''
\29\ Commenters have further observed that having differing standards
apply to the advice broker-dealers provide, in particular with respect
to advice provided to retirement versus non-retirement assets, will
create different levels of advice depending on the type of account and
will only further this investor confusion.\30\
---------------------------------------------------------------------------

    \28\ In 2006, the SEC retained the RAND Corporation's Institute
for Civil Justice (``RAND'') to conduct a survey, which concluded
that the distinctions between investment advisers and broker-dealers
have become blurred, and that market participants had difficulty
determining whether a financial professional was an investment
adviser or a broker-dealer and instead believed that investment
advisers and broker-dealers offered the same services and were
subject to the same duties. RAND noted, however, that generally
investors they surveyed as part of the study were satisfied with
their financial professional, be it a representative of a broker-
dealer or an investment adviser. Angela A. Hung, et al., RAND
Institute for Civil Justice, Investor and Industry Perspectives on
Investment Advisers and Broker-Dealers (2008) (``RAND Study''). See
also Letter from Barbara Roper, Director of Investor Protection,
Consumer Federation of America, et al., (Sept. 15, 2010) (submitting
the results of a national opinion survey regarding U.S. investors
and the fiduciary standard conducted by ORC/Infogroup for the
Consumer Federation of America, AARP, the North American Securities
Administrators Association, the Certified Financial Planner Board of
Standards, Inc., the Investment Adviser Association, the Financial
Planning Association and the National Association of Personal
Financial Advisors (``CFA 2010 Survey'')).
    \29\ CFA 2017 Letter.
    \30\ See, e.g., Letter from Kirt A. Walker, President and Chief
Operating Officer, Nationwide Financial (Nov. 2, 2017)
((``Nationwide Letter''); Letter from Deneen L. Donnley, Executive
Vice President, Chief Legal Officer Corp, USAA (Aug. 31, 2017)
(``USAA Letter''); Letter from Dorothy M. Donohue, Acting General
Counsel, Investment Company Institute (Aug. 7, 2017) (``ICI August
2017 Letter'').
---------------------------------------------------------------------------

    There is broad acknowledgement of the benefits of, and support for,
the continuing existence of the broker-dealer model as an option for
retail customers seeking investment advice, notwithstanding the
concerns regarding broker-dealer conflicts (including the transaction-
based compensation model) and retail customer confusion regarding these
conflicts and the limits of the applicable regulations.\31\ Among other
things, the Commission and our staff, commenters and others have
recognized the benefits of the broker-dealer model for advice and the
access to advice and the choice of products, services and payment
options, that the brokerage model provides retail customers.\32\
Moreover, the Commission is aware that certain conflicts of interest
are inherent in other principal-agent relationships.\33\ The issue at
hand, therefore, is how we should address these concerns in a manner
that both improves investor protection and preserves these beneficial
characteristics--in particular choice regarding access to a variety of
products and advice relationships.
---------------------------------------------------------------------------

    \31\ See, e.g., Letter from Barbara Roper, Director of Investor
Protection, CFA to the Department of Labor (Oct. 3, 2017)
(acknowledging that some customers are better off in commission
accounts); see also Tully Report; 913 Study at 151-54 (discussing
potential costs to retail investors, including loss of choice, if
the broker-dealer exclusion from the Advisers Act were eliminated).
    \32\ See id. See also Nationwide Letter; Letter from James D.
Gallagher, Executive Vice President and General Counsel, John
Hancock Life Insurance Company (U.S.A.) (Aug. 25, 2017) (``John
Hancock Letter''); Letter from Craig S. Tyle, Executive Vice
President and General Counsel, Franklin Templeton Investments
(``Franklin Templeton Letter'') (Aug. 7, 2017); ICI August 2017
Letter; USAA Letter.
    \33\ Conflicts of interest are not unique to the broker-dealer
commission-based relationship. A firm may earn more revenue in a
fee-based account rather than a commission-based account, and may
therefore have an incentive to recommend such a fee-based account
even if a commission-based advice relationship would be appropriate
and less costly for the customer. Customers with low trading
activity or long-term buy-and-hold investors in particular may pay
less in a commission-based account. An asset-based fee for advice
also creates a conflict because the firm is paid regardless of
whether it services the account, creating a disincentive to act. In
addition, a firm may have an incentive to recommend that a customer
maintain assets in either a fee-based account or a commission-based
account, even though it would be more appropriate for the customer
to use assets in the account to, for example, pay off an outstanding
loan, because the firm could continue to earn either kind of fee
while the assets remain in the account.
---------------------------------------------------------------------------

1. Evaluation of Standards of Conduct Applicable to Investment Advice
    The Commission and its staff have been evaluating the standards
applicable to investment advice for some time. In the past, the
Commission observed that the lines between full-service broker-dealers
and investment advisers have blurred, and expressed concern when
specific regulatory obligations depend on the statute under which a
financial intermediary is registered instead of the services
provided.\34\ At the same time, we acknowledged that the Exchange Act,
the rules thereunder, and SRO rules provide substantial protections for
broker-dealer customers, and expressed that we did not believe that
requiring most or all full-service broker-dealers to treat most or all
of their customer accounts as advisory accounts would be an appropriate
response to this blurring.\35\
---------------------------------------------------------------------------

    \34\ See Release 51523; see also Request, infra note 40.
    \35\ Release 51523 at 3, 35.
---------------------------------------------------------------------------

    In 2011, the Commission staff issued the 913 Study, which was
mandated by Section 913 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 (the ``Dodd-Frank Act''), in which they
made recommendations to the Commission that the staff believed would
enhance retail customer protections and decrease retail customers'
confusion about the standard of conduct owed to them when their
financial intermediary provided them personalized investment
advice.\36\ One of the staff's primary recommendations was that the
Commission engage in rulemaking to adopt and implement a uniform
fiduciary standard of conduct for broker-dealers and investment
advisers when providing personalized investment advice about securities
to retail customers. The staff's recommended standard would require
firms ``to act in the best interest of the customer without regard to
the financial or other interest of the broker, dealer or investment
adviser providing the advice.'' \37\
---------------------------------------------------------------------------

    \36\ See 913 Study, supra note 1.
    \37\ Id.
---------------------------------------------------------------------------

    The staff made a number of specific recommendations for
implementing the uniform fiduciary standard of conduct, including that
the Commission should: (1) Require firms to eliminate or disclose
conflicts of interest; (2) consider whether rulemaking would be
appropriate to prohibit certain conflicts, to require firms to mitigate
conflicts through specific action, or to impose specific disclosure and
consent requirements; and (3) consider specifying uniform standards for
the duty of care owed to retail customers, such as specifying what
basis a broker-dealer or investment adviser should have in making a
recommendation to a retail customer by referring to and expanding upon
broker-dealers' existing suitability requirements.\38\
---------------------------------------------------------------------------

    \38\ Id.
---------------------------------------------------------------------------

    The staff explained that the recommendations were intended to,
among other things, heighten investor protection, address retail
customer confusion about the obligations broker-dealers and investment
advisers owe to those customers, and preserve retail customer choice
without decreasing retail customers' access to existing products,
services, service providers, or compensation structures.\39\
---------------------------------------------------------------------------

    \39\ See 913 Study at viii, x, 101, 109, 166.
---------------------------------------------------------------------------

    Following the 913 Study, in 2013 the Commission issued a request
for information (``Request'') seeking additional information from the
public to assist the Commission in evaluating whether and how to
address certain standards of conduct for, and regulatory obligations
of, broker-dealers and investment advisers.\40\ The Request

sought information on the benefits and costs of the current standards
of conduct for broker-dealers and investment advisers, as well as
alternative approaches to the standards of conduct, including a uniform
fiduciary standard.
---------------------------------------------------------------------------

    \40\ See Request for Data and Other Information: Duties of
Brokers, Dealers and Investment Advisers, Exchange Act Release No.
69013 (Mar. 1, 2013), available at http://www.sec.gov/rules/other/2013/34-69013.pdf; see also SEC Seeks Information to Assess
Standards of Conduct and Other Obligations of Broker-Dealers and
Investment Advisers (press release), available at http://www.sec.gov/news/press/2013/2013-32.htm.
---------------------------------------------------------------------------

    The Commission received more than 250 comment letters from industry
groups, individual market participants, and other interested persons in
response to the Request.\41\ The vast majority of commenters provided
qualitative responses to the specific assumptions contained in the
Request, while a few industry commenters submitted surveys and other
quantitative data. Most commenters expressed support for a uniform
fiduciary standard of conduct requiring firms to ``act in the best
interest'' of the investor although they had different views of what
the standard would require and expressed concerns about its
implementation.\42\
---------------------------------------------------------------------------

    \41\ Comments submitted in response to the Request are available
at https://www.sec.gov/comments/4-606/4-606.shtml.
    \42\ For example, some commenters supported a new uniform,
rules-based fiduciary standard of conduct that is tailored to
broker-dealers' business models, but also expressed concern about,
among other things, the costs of implementation, the need to
preserve investor choice and avoid regulatory duplication or
conflict. See, e.g., Letter from Ira D. Hammerman, Senior Managing
Director and General Counsel, Securities Industry and Financial
Markets Association (``SIFMA'') (July 5, 2013). Others tended to
support a uniform fiduciary standard of conduct that is ``no less
stringent'' than the current standard under the Advisers Act (i.e.,
extending the current standard of conduct to broker-dealers), but
were concerned about ``watering down'' the current Advisers Act
standard to accommodate broker-dealers' business models. See, e.g.,
Letter from Barbara Roper, Director of Investor Protection, Consumer
Federation of America (July 5, 2013); Letter from David G.
Tittsworth, Executive Director, Investment Adviser Association (July
3, 2013).
---------------------------------------------------------------------------

    In November 2013, the Commission's Investor Advisory Committee
(``IAC'') adopted a recommendation on implementing a uniform fiduciary
standard (as proposed by the Investor as Purchaser Subcommittee).\43\
In the IAC's view, the current regulatory regime for broker-dealers
does not offer adequate investor protection when broker-dealers are
providing advice, as under the suitability standard, broker-dealers
generally remain free to place their own interests ahead of the
interest of their customers.\44\ The IAC also expressed its view that
any economic analysis should acknowledge the existence and importance
of investor harm that can result from the current suitability
standard.\45\ In considering the optimal regulatory approach to take
with respect to imposing a fiduciary duty on broker-dealers, the
overarching recommendation from the IAC was that ``the Commission
should weigh its various options with an eye toward determining which
will best ensure an outcome that strengthens investor protections,
preserves investor choice with regard to business models and
compensation methods, and is workable for broker-dealers and investment
advisers alike.'' \46\ The IAC recommended to the Commission two
options for imposing a fiduciary duty on broker-dealers when they are
providing personalized advice to retail investors: (1) Narrow the
broker-dealer exclusion from the definition of ``investment adviser''
under the Investment Advisers Act of 1940 (``Advisers Act'') (the IAC's
preferred approach); or (2) engage in rulemaking under Section 913 to
adopt a principles-based fiduciary duty that is ``no weaker'' than the
standard under the Advisers Act; permit certain sales-related conflicts
as long as conflicts are fully disclosed and appropriately managed; and
consider whether certain sales practices, conflicts of interest, or
compensation schemes should be prohibited or restricted.\47\
---------------------------------------------------------------------------

    \43\ Recommendation of the Investor Advisory Committee: Broker-
Dealer Fiduciary Duty (Nov. 2013) (``IAC Recommendation''),
available at https://www.sec.gov/spotlight/investor-advisory-committee-2012/fiduciary-duty-recommendation-2013.pdf. The IAC also
recommended that the Commission engage in rulemaking to adopt a
uniform, plain English disclosure document that includes certain
basic information (e.g., fees and conflicts of interest). Id. We are
considering this recommendation separately as part of the
Relationship Summary Proposal.
    \44\ Id.
    \45\ Id.
    \46\ Id.
    \47\ Id.
---------------------------------------------------------------------------

2. DOL Rulemaking
    The Department of Labor (``DOL'') has also engaged in rulemaking to
broaden the definition of ``fiduciary'' in connection with providing
investment advice under the Employee Retirement Income Security Act of
1974 (``ERISA'') and the Internal Revenue Code of 1986 (``Code'').\48\
Commission staff provided DOL staff with technical assistance and
expertise on our regulatory regime as DOL developed its rulemaking.\49\
---------------------------------------------------------------------------

    \48\ See Definition of the Term ``Fiduciary'' Conflict of
Interest Rule--Retirement Investment Advice, 81 FR 20945, 20958-59
(Apr. 8, 2016) (to be codified at 29 CFR pts. 2509, 2510, 2550)
(``DOL Fiduciary Rule Release''). The DOL has authority to issue
regulations under ERISA and prohibited transaction provisions under
the Code, including authority to define the circumstances in which
persons, including broker-dealers and investment advisers, are
``fiduciaries'' for purposes of ERISA and the Code as a result of
providing ``investment advice'' to plans and IRAs.
    \49\ See id.
---------------------------------------------------------------------------

    On April 8, 2016, DOL adopted a new, expanded definition of
``fiduciary'' that treats persons who provide investment advice or
recommendations for a fee or other compensation with respect to assets
of an ERISA plan or IRA as fiduciaries in a wider array of advice
relationships than under the previous regulation (``DOL Fiduciary
Rule'').\50\ On March 15, 2018, the DOL Fiduciary Rule was vacated by
the United States Court of Appeals for the Fifth Circuit.\51\
---------------------------------------------------------------------------

    \50\ 29 CFR 2510.3-21 (effective June 9, 2017). This rule also
applies to the definition of fiduciary in the prohibited transaction
provisions under the Code. See 29 CFR 2510.3-21(F). See also DOL
Fiduciary Rule Release.
    \51\ Chamber of Commerce of the U.S.A., et al. v. U.S. Dep't of
Labor, et. al., No. 17-10238 (5th Cir.) (Mar. 15, 2018).
---------------------------------------------------------------------------

    We understand that the DOL Fiduciary Rule would broadly expand the
circumstances in which broker-dealers making recommendations to ERISA
plans and ERISA plan participants may be fiduciaries under ERISA, and
thus subject to ERISA's prohibited transaction provisions. Similarly,
it would expand the circumstances in which broker-dealers providing
recommendations to IRAs would be subject to the prohibited transaction
provisions of the Code.\52\ Among other things, these prohibited
transactions provisions generally would prohibit such a fiduciary from
engaging in self-dealing and receiving compensation from third parties
in connection with transactions involving a plan or IRA, and from
acting on conflicts of interest, including using their authority to
affect or increase their own compensation, in connection with
transactions involving a plan or IRA, or from purchasing or selling any
property to ERISA plans or IRAs.\53\ As a result, we understand that--
in the absence of an exemption from the DOL--broker-dealers that would
be considered to be a ``fiduciary'' under the DOL Fiduciary Rule would
not only be prohibited from engaging in purchases and sales of certain
investments for their own account (i.e., engaging in principal
transactions), but more significantly, would be prohibited from
receiving

common forms of broker-dealer compensation (notably, transaction-based
compensation), which would effectively eliminate a broker-dealer's
ability or willingness to provide investment advice with respect to
investors' retirement assets.\54\
---------------------------------------------------------------------------

    \52\ See Best Interest Contract Exemption, 81 FR 21002, 21089
(Apr. 8, 2016) (``BIC Exemption Release''), as corrected Best
Interest Contract Exemption; Correction (Prohibited Transaction
Exemption 2016-01), 81 FR 44773 (July 11, 2016) (``BIC Exemption'').
DOL stated in the BIC Exemption Release that it ``anticipates that
the [DOL Fiduciary Rule] will cover many investment professionals
who did not previously consider themselves to be fiduciaries under
ERISA or the Code.''
    \53\ See BIC Exemption Release at 21002.
    \54\ See generally BIC Exemption; Principal Transactions
Exemption, infra note 55.
---------------------------------------------------------------------------

    To avoid this result, in connection with the DOL Fiduciary Rule,
DOL published two new administrative class exemptions from the
prohibited transaction provisions of ERISA and the Code--the Best
Interest Contract Exemption (``BIC Exemption'') and the Class Exemption
for Principal Transactions in Certain Assets Between Investment Advice
Fiduciaries and Employee Benefit Plans and IRAs (``Principal
Transactions Exemption'')--as well as amendments to previously granted
prohibited transaction exemptions (collectively referred to as
``PTEs'').\55\ The BIC Exemption and the Principal Transactions
Exemption would allow persons who are deemed investment advice
fiduciaries under the DOL Fiduciary Rule, such as broker-dealers, to
receive various forms of compensation (e.g., brokerage commissions) and
to engage in certain principal transactions, respectively, that in the
absence of an exemption, would be prohibited under ERISA and the
Code.\56\
---------------------------------------------------------------------------

    \55\ See, e.g., BIC Exemption Release (permitting certain
``Financial Institutions'' and ``Advisers'' to receive compensation
resulting from a provision of investment advice in connection with
securities transactions, including riskless principal transactions);
Class Exemption for Principal Transactions in Certain Assets Between
Investment Advice Fiduciaries and Employee Benefit Plans and IRAs
(Prohibited Transaction Exemption 2016-02), 81 FR 21089, 21105-10
(Apr. 8, 2016) (``Principal Transactions Release''); corrected at
Class Exemption for Principal Transactions in Certain Assets Between
Investment Advice Fiduciaries and Employee Benefit Plans and IRAs,
81 FR 44784 (July 11, 2016) (``Principal Transactions Exemption'')
(permitting investment advice fiduciaries to sell or purchase
certain debt securities and other investments in principal
transactions and riskless principal transactions). See also
Amendment to and Partial Revocation of Prohibited Transaction
Exemption (PTE) 86-128 for Transactions Involving Employee Benefit
Plans and Broker-Dealers; Amendment to and Partial Revocation of PTE
75-1, Exemptions from Prohibitions Respecting Certain Classes of
Transactions Involving Employee Benefit Plans and Certain Broker-
Dealers, Reporting Dealers and Banks, 81 FR 21181 (Apr. 8, 2016)
(permitting broker-dealers exercising investment discretion to
receive commissions and other fees for effecting securities
transactions as agent for a plan or IRA, under certain conditions,
including Impartial Conduct Standards like those applicable under
the BIC Exemption); DOL Fiduciary Rule Release, supra note 48, 81 FR
at 20991 (describing the new BIC Exemption, Principal Transactions
Exemption, and amendments to existing PTEs).
    \56\ See generally BIC Exemption; Principal Transactions
Exemption.
---------------------------------------------------------------------------

    Specifically, the BIC Exemption would provide conditional relief
for an ``adviser,'' as that term is used in the context of the BIC
Exemption,\57\ and the adviser's firm, to receive common forms of
``conflicted'' compensation, such as commissions and third-party
payments (such as revenue sharing), provided that the adviser's firm
meets certain conditions.\58\ Generally, the BIC Exemption would
require that the advice must be provided pursuant to a written contract
executed between the adviser's firm and the investor (and enforceable
against the adviser's firm).\59\ The contract must include specific
language and disclosures, including (among others) provisions:
Acknowledging fiduciary status; committing the firm and the adviser to
adhere to standards of impartial conduct (i.e., providing advice in the
investor's best interest; charging only reasonable compensation; and
avoiding misleading statements about fees and conflicts of interest)
(``Impartial Conduct Standards''); and warranting the adoption of
policies and procedures reasonably designed to ensure that advisers
provide best interest advice and minimize the harmful impact of
conflicts of interest. The firm must also disclose information on the
firm's and advisers' conflicts of interest and the cost of their advice
and provide certain ongoing web disclosures.\60\ As noted above, we
understand that, as a practical matter, most broker-dealers offering
IRA brokerage accounts would need to meet the conditions of the BIC
Exemption to advise (i.e., make recommendations to) brokerage customers
with IRA accounts and to receive transaction-based and other
compensation (including amounts paid from third parties, such as 12b-1
fees) in connection with their securities recommendations.
---------------------------------------------------------------------------

    \57\ The DOL explains that by using the term ``adviser,'' it
``does not intend to limit the exemption to investment advisers
registered under the Investment Advisers Act of 1940 or under state
law,'' and that rather, for purposes of the BIC Exemption, an
adviser ``is an individual who can be a representative of a
registered investment adviser, a bank or similar financial
institution, an insurance company, or a broker-dealer.'' BIC
Exemption Release, supra note 52, 81 FR at 21003, n.2.
    \58\ See BIC Exemption Release. ERISA and the Code generally
prohibit fiduciaries from receiving payments from third parties and
from acting on conflicts of interest, including using their
authority to affect or increase their own compensation, in
connection with transactions involving a plan or IRA. Certain types
of fees and compensation common in the retail market, such as
brokerage or insurance commissions, rule 12b-1 fees and revenue
sharing payments, may fall within these prohibitions when received
by fiduciaries as a result of transactions involving advice to the
plan, plan participants and beneficiaries, and IRA owners. Id.
    \59\ See BIC Exemption Release.
    \60\ See BIC Exemption.
---------------------------------------------------------------------------

    Generally, the Principal Transactions Exemption would (1) permit
certain principal transactions involving the purchase of limited
securities (i.e., certificates of deposits, interests in unit
investment trusts, and certain debt securities) \61\ by a plan or an
IRA owner and (2) more broadly permit principal transactions involving
the sale of ``securities or other investment property'' by the plan or
IRA owner, conditioned on adherence to, among other things, Impartial
Conduct Standards,\62\ as well as a contract requirement and a policies
and procedures warranty that mirror the requirements in the BIC
Exemption.\63\ The Principal Transactions Exemption also includes some
conditions that are different from those in the BIC Exemption,
including credit and liquidity standards for debt securities sold to
plans and IRAs pursuant to the exemption and additional disclosure
requirements.\64\
---------------------------------------------------------------------------

    \61\ Debt securities are generally registered corporate debt
securities, treasury securities, agency securities, and asset-backed
securities that are guaranteed by an agency or government sponsored
enterprise. See Principal Transactions Exemption.
    \62\ In the Principal Transactions Exemption, the Impartial
Conduct Standards specifically refer to the fiduciary's obligation
to seek to obtain the best execution reasonably available under the
circumstances with respect to the transaction, rather than to
receive no more than ``reasonable compensation.'' See Principal
Transactions Exemption. The Principal Transactions Exemption
provides that the adviser may satisfy the obligation under the
exemption to obtain best execution reasonably available under the
circumstances with respect to the transaction by complying with
FINRA rules on fair pricing and best execution (Rules 2121--Fair
Prices and Commissions; 5310--Best Execution and Interpositioning).
See Principal Transactions Exemption, Section II(c)(2)(i).
    \63\ See Principal Transactions Exemption; 18-Month Extension of
Transition Period and Delay of Applicability Dates; Best Interest
Contract Exemption (PTE 2016-01); Class Exemption for Principal
Transactions in Certain Assets Between Investment Advice Fiduciaries
and Employee Benefit Plans and IRAs (PTE 2016-02); Prohibited
Transaction Exemption 84-24 for Certain Transactions Involving
Insurance Agents and Brokers, Pension Consultants, Insurance
Companies, and Investment Company Principal Underwriters (PTE 84-
24), 82 FR 56545 (Nov. 29, 2017) (``DOL November Extension''),
available at https://federalregister.gov/d/2017-25760.
    \64\ See Principal Transactions Exemption; DOL November
Extension.
---------------------------------------------------------------------------

    The revised definition of ``fiduciary,'' as well as the Impartial
Conduct Standards, became effective on June 9, 2017.\65\ Compliance
with the remaining

conditions of the BIC Exemption and the Principal Transaction
Exemption, such as the general contract requirement, and conditions
requiring specific written warranties and disclosures, has been delayed
until July 1, 2019.\66\ During this transition period, ``financial
institutions'' and ``advisers,'' as defined in the PTEs, are currently
only required to comply with the Impartial Conduct Standards to satisfy
the conditions of these PTEs.\67\
---------------------------------------------------------------------------

    \65\ See Definition of the Term ``Fiduciary''; Conflict of
Interest Rule--Retirement Investment Advice; Best Interest Contract
Exemption (Prohibited Transaction Exemption 2016-01); Class
Exemption for Principal Transactions in Certain Assets Between
Investment Advice Fiduciaries and Employee Benefit Plans and IRAs
(Prohibited Transaction Exemption 2016-02); Prohibited Transaction
Exemptions 75-1, 77-4, 80-83, 83-1, 84-24 and 86-128 Proposed Rule,
82 FR 16902, (Apr. 7, 2017) (``DOL April Extension''), available at
https://www.gpo.gov/fdsys/pkg/FR-2017-04-07/pdf/2017-06914.pdf. But
see Chamber of Commerce of the U.S.A., et. al. v. U.S. Dep't of
Labor, et. al., No. 17-10238 (5th Cir.) Mar. 15, 2018).
    \66\ See DOL November Extension.
    \67\ Id.
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3. Statement by Chairman Clayton
    In light of the DOL Fiduciary Rule and related PTEs, and in
recognition of the significant developments in the marketplace that
have occurred since the Commission last solicited information from the
public in 2013, Chairman Clayton issued a statement on June 1, 2017
containing a number of questions regarding standards of conduct for
investment advisers and broker-dealers.\68\ The public input was
intended to provide the Commission with an updated assessment of the
current regulatory framework, the current state of the market for
retail investment advice, and market trends.\69\ Chairman Clayton also
invited commenters to submit data and other information that may inform
the Commission's analysis, including data covering periods since the
2013 solicitation of comment.
---------------------------------------------------------------------------

    \68\ Chairman Jay Clayton, Public Comments from Retail Investors
and Other Interested Parties on Standards of Conduct for Investment
Advisers and Broker-Dealers (June 1, 2017) (``Chairman Clayton
Statement''), available at https://www.sec.gov/news/public-statement/statement-chairman-clayton-2017-05-31.
    \69\ See Chairman Clayton Statement.
---------------------------------------------------------------------------

    To date, over 250 comments have been received from the public in
response to the Chairman Clayton Statement. While some commenters
opposed any changes to the standard of conduct \70\ and offered other
options,\71\ for the most part, commenters support changes to the
standards of conduct for investment advice, and in particular the
establishment of a fiduciary or best interest standard specific to
broker-dealers \72\ or, alternatively, a standard of conduct that
uniformly applies to investment advisers and broker-dealers.\73\
---------------------------------------------------------------------------

    \70\ See, e.g., Letter from Dan Pisenti, Whitehall-Parker
Securities, Inc. (July 7, 2017) (``Whitehall Letter'') (arguing that
the suitability standard is highly effective and no further
government intervention is necessary); Letter from Kevin Dunnigan
(July 5, 2017) (stating that the DOL Fiduciary Rule is government
overreach and consumers should be able to decide what to purchase).
    \71\ See, e.g., Letter from Herb W. Morgan (June 2, 2017)
(stating that a more effective solution would be a simpler one,
including increasing penalties and enforcement and requiring full
fee disclosure); Letter from Mark D. Moss (June 2, 2017) (supporting
SEC involvement in standardizing nomenclature).
    \72\ See, e.g., CFA 2017 Letter (supporting the Commission
taking a ``more rigorous approach'' to interpreting the fiduciary
standard by developing a new standard for brokers under the
[Securities Exchange Act of 1934] and in enforcing the existing
standard under the Advisers Act and stating that the fiduciary duty
must include a principles-based, legally enforceable best interest
standard); Letter from Gail C. Bernstein, General Counsel,
Investment Advisers Association (Aug. 31, 2017) (``IAA Letter'')
(recommending the SEC develop a best interest standard for brokers
that is as robust as the fiduciary standard under the Advisers Act);
ICI August 2017 Letter (supporting the SEC taking the lead in
establishing and enforcing a best interest standard of conduct for
broker-dealers providing recommendations to retail investors);
Letter from Kevin Carroll, Managing Director and Associate General
Counsel, SIFMA (July 21, 2017) (``SIFMA Letter'') (suggesting the
SEC consider a best interest standard for broker-dealers that
encompasses the duty of loyalty, duty of care and enhanced up-front
disclosures); Letter from Timothy E. Keehan, Vice President, Senior
Counsel, American Bankers Association (Sept. 1, 2017) (``ABA
Letter''); Letter from David Kowach, Head of Wells Fargo Advisors,
Wells Fargo & Company (Sept. 20, 2017) (``Wells Fargo Letter'')
(``[We] recommend the SEC establish and enforce a best interest
standard of conduct for broker-dealers when they provide
personalized investment advice to retail investors that is aligned
with the standard of conduct applicable to registered investment
advisors.''); Letter from Marc R. Bryant, Senior Vice President and
Deputy General Counsel, Fidelity Investments (Aug. 11, 2017)
(``Fidelity Letter'') (``Fidelity believes that the SEC should
review and consider an enhanced best interest standard of conduct
for broker-dealers that is clearly defined, disclosure and
materiality-based, and that applies across all of an investor's
brokerage accounts and interactions''); Letter from F. William
McNabb, Chairman and Chief Executive Officer, The Vanguard Group,
Inc. (Sept. 29, 2017) (``Vanguard Letter''); Letter from Derek B.
Dorn, Managing Director, Regulatory Engagement and Policy, TIAA
(Sept. 26, 2017) (``TIAA Letter'') (supporting application of a best
interest standard of conduct to all personalized investment advice
provided to retail investors through raising the broker-dealer
standard and maintaining the investment adviser standard); Letter
from Robert Grohowski, Vice President, Senior Legal Counsel--
Legislative and Regulatory Affairs, T. Rowe Price (Oct. 12, 2017)
(``T. Rowe Letter'') (``Given the history, we believe that the SEC's
best path forward would be to focus specifically on updating the
standard applicable to non-discretionary broker-dealer
recommendations, irrespective of account type.''); Letter from
Americans for Financial Reform (Sept. 22, 2017) (``AFR Letter'')
(proposing extension of a strong fiduciary ``best interest''
standard to all those who hold themselves out as advisers or offer
personalized investment advice to clients and focusing on broker-
dealer business model).
    \73\ See, e.g., Letter from David Certner, Legislative Counsel &
Legislative Policy Director, Government Affairs, AARP (Sept. 6,
2017) (``AARP Letter'') (``Adoption of a uniform standard that would
apply to both broker-dealers and investment advisers when providing
personalized investment advice to retail customers, as contemplated
by Section 913. . . . is of critical importance and long
overdue.''); PIABA Letter (``The lack of a uniform standard of
conduct creates a discrepancy between the law and investors'
reasonable expectations.''); Letter from Barbara Novick, Vice
Chairman, and Nicole Rosser, Vice President, BlackRock, Inc. (Aug.
7, 2017) (``BlackRock Letter'') (supporting a best interest standard
that applies to all types of retail accounts); Letter from Ronald J.
Kruszewski, Chairman & CEO, Stifel, Nicolaus & Co. (July 25, 2017)
(``Stifel Letter'') (supporting a single standard of care applicable
to both brokerage and advisory accounts, while recognizing the
inherent differences between these relationships); Letter from
Christopher Jones, Executive Vice President of Investment Management
and Chief Investment Officer, Financial Engines (Oct. 11, 2017)
(``Financial Engines Letter'') (recommending harmonization of the
standards applicable to broker-dealers and investment advisers to
advance ``high-quality, unconflicted advice''); Letter from Gretchen
Cepek, Senior Vice President and General Counsel and Stewart D.
Gregg, Senior Counsel, Allianz Life Insurance Company of North
America (Oct. 13, 2017) (``Allianz Letter'') (supporting a uniform
``best interest'' standard of conduct applicable to both broker-
dealers and investment advises providing services to retail
investors).
---------------------------------------------------------------------------

    In addition to this statement, Chairman Clayton and the staff have
continually engaged in other outreach, including meetings with retail
investors, investor advocacy groups, and industry participants, to
better understand these issues.
    Commenters have also expressed their views on the effects of the
DOL Fiduciary Rule and the related PTEs--both in terms of benefits and
drawbacks--on brokerage advice relationships, at least with respect to
retirement advice. Among other things, some commenters asserted that,
because of complex and burdensome requirements imposed as part of the
BIC Exemption, and the associated litigation risk, broker-dealers are
changing the types of products and accounts offered to retirement
investors, and focusing on products or accounts with compliance-
friendly fee structures, such as level fees or lower-cost products
(e.g., eliminating the provision of advice in IRA brokerage accounts
and shifting these accounts to asset-based accounts).\74\ Commenters
expressed concerns that retirement investors will be harmed through
reduced product choice, increased cost for retirement advice (if
shifted to fee-based arrangements that may be more costly for buy-and-
hold investors, or if there are increases in account minimums for
commission-based accounts), or lost or restricted access to advice (if
investors have small account balances or cannot otherwise afford a fee-
based arrangement or the increased cost of a commission-based
account).\75\

Other commenters have noted, however, that such outcomes are not
mandated by the DOL Fiduciary Rule, any market disruptions will be
addressed by the market, and overall, the adjustment to the DOL
Fiduciary Rule has been positive for retirement investors, as the rule
has resulted in lower fees, advice in the best interest, and minimized
conflicts in advice provided to individuals,\76\ including, for
example, the development of new product offerings such as ``clean
shares'' that do not have any sales loads, charges or other asset-based
fee for sales or distribution.\77\
---------------------------------------------------------------------------

    \74\ See, e.g., BlackRock Letter; ICI August 2017 Letter.
    \75\ See, e.g., Letter from Kevin Carroll, Managing Director and
Associate General Counsel, SIFMA (July 21, 2017) (``SIFMA 2017
Letter'') (stating that the impact of the new DOL Fiduciary Rule has
been to significantly shift IRAs from brokerage accounts to advisory
accounts, from personal service to call centers or the internet, and
to limit the products and fee arrangements available to IRAs);
BlackRock Letter (stating that some financial services firms have
indicated that they would not offer or would limit IRA brokerage
platforms because of the compliance complexities of the BIC
Exemption provisions that would go into effect on January 1, 2018
[now delayed until July, 2019], as well as the risk of class
action); ICI August 2017 Letter (stating that the DOL Fiduciary Rule
and related exemptions is ``limiting retirement savers' choices,
restricting their access to information they need for retirement
planning, and increasing costs, particularly for those savers who
can least afford it''); Letter from Dave Paulsen, Executive Vice
President and Chief Distribution Officer, Transamerica (Nov. 20,
2017) (``[A]s a result of the DOL Rule, many broker-dealers are no
longer selling variable annuities in an IRA, but continue to sell
variable annuities to retail investors.'').
    \76\ See, e.g., AARP Letter.
    \77\ See id. See also Letter from AFL-CIO, AFSCME, Alliance for
Retired Americans, et al. (Aug. 21, 2017) (``AFL-CIO Letter'');
Letter from Aron Szapiro, Director of Policy Research, Morningstar,
Inc. (Sept. 11, 2017) (``Morningstar Letter'').
---------------------------------------------------------------------------

B. General Objectives of Proposed Approach

    In developing this proposal, we considered the variety of products
and services, including the types of advice, that broker-dealers
provide to investors; the characteristics of investors who utilize
brokerage services; the associated cost and relative affordability of
such services; the embedded compensation conflicts associated with
these products and services; and the potential impact of such conflicts
on investor outcomes (such as evidence suggestive that the failure to
apply a ``best interest'' obligation to conflicted advice has resulted
in investor harm).\78\ We also considered the regulatory landscape
applicable to broker-dealers under the Exchange Act and SRO rules and
the investor protections provided when broker-dealers recommend
securities transactions or investment strategies to retail customers,
and any differences between those protections provided for broker-
dealer services under other regulatory regimes, particularly those that
would exist under the DOL Fiduciary Rule and the BIC Exemption.
---------------------------------------------------------------------------

    \78\ See, e.g., Economic Policy Institute Letter; CFA 2017
Letter; IAC Recommendation.
---------------------------------------------------------------------------

    We also considered retail customer confusion about the obligations
broker-dealers owe when making recommendations and how that confusion
may ultimately translate into or exacerbate the potential for investor
harm (such as through a misalignment of investor expectations regarding
the level of protection received and the level of protection actually
provided).\79\ We also recognized the importance of providing, to the
extent possible, clear, understandable, and consistent standards for
brokerage recommendations across a brokerage relationship (i.e., for
both retirement and non-retirement purposes) and better aligning this
standard with other advice relationships (e.g., a relationship with an
investment adviser).\80\ We also sought to preserve--to the extent
possible--investor choice and access to existing products, services,
service providers, and payment options. We sought to avoid a lack of
clarity or consistency in the applicable standards and a lack of
coordination among regulators, which could ultimately undermine
investor choice and access and create legal uncertainty in developing
effective compliance programs.
---------------------------------------------------------------------------

    \79\ Id.
    \80\ See, e.g., Letter from Richard Foster, Senior Vice
President and Senior Counsel for Regulatory and Legal Affairs,
Financial Services Roundtable (Oct. 17, 2017) (``FSR Letter'')
(``FSR strongly believes a single standard for broker-dealers
servicing both retirement and non-retirement assets is in the best
interest of retail customers, because it would reduce customer
confusion and ultimately provide customers a higher-level of
service. A single standard also would avoid the cost of developing
and implementing compliance and supervisory programs around
different standards of conduct.''); Morningstar Letter
(``Morningstar believes that investors' confusion about standards of
conduct applicable to different kinds of relationships is likely to
continue for some time, and disclosures alone will not clarify those
standards for many investors. . . . Further, even among experienced
investors who hold investments outside of retirement accounts, most
investors do not understand the distinctions between broker-dealers
and Registered Investment Advisors and the conflicts of interest
some financial advisors may have when recommending investments'');
TIAA Letter (``Investors should understand the standards of conduct
that apply to the financial advisers who give them advice--but
today's disparate standards can easily lead to investor
confusion.''); IAA Letter (``An equally stringent standard is also
necessary to reduce confusion for investors and ensure that they do
not bear the burden of having uncertainty about the standard of
conduct that applies to the investment professional they choose.'');
PIABA Letter.
---------------------------------------------------------------------------

    At the same time, we are sensitive to the potential risk that any
additional regulatory burdens may cause investors to lose choice and
access to products, services, service providers, and payment
options.\81\ In particular, we sought to preserve the ability of
investors to pay for advice in the form of brokerage commissions.
Various commenters asserted that the commission-based model may be more
appropriate for many investors,\82\ and we believe that such investors
may prefer a commission-based brokerage

relationship over a fee-based account.\83\ We also share concerns
raised by commenters about retail customers losing access to advice
they receive through recommendations from broker-dealers, or if advice
from broker-dealers is effectively eliminated, particularly as not all
such customers have the option to move to fee-based accounts.\84\
---------------------------------------------------------------------------

    \81\ See, e.g., SIFMA 2017 Letter; BlackRock Letter; ICI August
2017 Letter; Franklin Templeton Letter (``[W]hile asset-based fees
are appropriate in many circumstances, for some investors--such as
long-term, `buy-and-hold' investors--a transaction-based charge can
result in substantial savings. According to the Investment Company
Institute, investors who plan to hold fund shares for longer than
five years would end up with a higher account balance under a
commission-based approach that charges a 2.5 percent front-end fee
(plus an ongoing 12b-1 fee) than investors paying a 1 percent per
year asset-based fee.'')
    \82\ See, e.g., USAA Letter (``USAA has deep reservations about
any standard of conduct that serves to advantage fee-based accounts
and serves to disadvantage other types of accounts and product
choices. Put simply, a fee-based model may not always be appropriate
for lower-balanced accounts. In many cases, these accounts will be
better served by straight-forward investments in mutual funds or
exchange-traded funds, without such accounts being assessed an
ongoing management fee.''); Letter from Stephen McManus, Senior Vice
President and General Counsel, State Farm Mutual Automobile
Insurance Company (Aug. 21, 2017) (``State Farm Letter'') (``Long a
mainstay of the financial services industry, sales commissions are
frequently preferred by middle-income consumers whose `buy-and-hold'
strategy does not require the continuous investment advice that is
more suited to a percentage fee based on assets under management.
This preference also reflects the fact that the payment of
commission-based compensation--tied as it is to a particular
transaction--is easy for consumers to understand and, in e.g., many
cases, represents good value for smaller or low-volume accounts.'').
See Letter from Sharon Cheever, Senior Vice President and General
Counsel, Pacific Life Insurance Company (Oct. 16, 2017) (``Pacific
Life Letter'') (``There is a common misconception that a fee-based
compensation model is somehow better for the consumer, in part,
because it is allegedly cheaper and less likely to lead to conflicts
of interest. This unfair discrimination against the commission-based
compensation model is truly unfounded. The expense to the client in
terms of actual money paid on an on-going basis, and thus, `fee-
drag' on their investment return, will often be more with the fee-
based compensation model. For example, annuities by nature are long-
term investments, and with the fee-based compensation model, the
adviser charges a certain percentage (1%) or dollar amount each year
for the management of the investment. Compare this to the
commission-based compensation model, where there is typically a
larger percentage charged upfront (e.g., 5-6%), and you can see that
the longer term the investment, the more expensive a fee-based
compensation model can be for the client.''); Carl B. Wilkerson,
Vice President and Chief Counsel, Securities & Litigation, American
Council of Life Insurers (Oct. 3, 2017) (``ACLI Letter'')
(``Recurrent annual fees may be ill-suited to individuals with
moderate assets needing little annual advice, and may exceed the
total value of a commissioned-based adviser.''). See also FINRA
Notice to Members 03-68, Fee-Based Compensation (Nov. 2003).
    \83\ See Foy, Michael, ``What's at stake for forward-thinking
firms,'' Fiduciary Roulette, J.D. Power, available at http://www.jdpower.com/resource/wealth-management-fiduciary-roulette
(visited January 31, 2018) (finding that 59% of investors who
currently pay commissions ```probably would not' or `definitely
would not' stay with their current firm if required to switch to a
fee-based arrangement''). Irrespective of any real or perceived
investor preference, the last 12 years have seen a decline in the
number of broker-dealers from over 6,000 in 2005 to less than 4,000
in 2016, alongside a simultaneous increase in the number of
Commission-registered investment advisers from approximately 9,000
in 2005 to over 12,000 in 2016. The Commission understands that
firms have transitioned to fee-based retail business in an effort
to, among other things, provide stability, increase profitability,
lower perceived regulatory burden, provide more or better services
to retail investors, and reduce or eliminate conflicts of interest.
See discussion Section IV.C.1.c, infra.
    \84\ See supra note 74; see also USAA Letter (``It is critical
that a uniform standard does not impose excessive legal and
compliance burdens on such firms, which would effectively incent
firms to curtail or even close services to these investors. A
standard that effectively bans or incents firms to abandon certain
business models will harm retail investors, especially our men and
women in uniform, by raising their costs, reducing their choices,
and restricting their access to needed investment advice.'');
Franklin Templeton Letter (``At the same time, broker-dealers should
not be subject to overly prescriptive requirements or to enforcement
through private litigation from the professional plaintiff's bar.
This will only lead to additional costs and a decrease in the
availability of investment choices and advice to those retail
investors who need it most.'').
---------------------------------------------------------------------------

    After extensive consideration of these issues, we are proposing to
enhance existing broker-dealer conduct obligations when they make
recommendations to a retail customer. For such recommendations, the
proposed rule would require a broker-dealer ``to act in the best
interest of the retail customer . . . without placing the financial or
other interest of the [broker-dealer] making the recommendation ahead
of the interest of the retail customer.''
    The proposed best interest obligation for broker-dealers set forth
in Regulation Best Interest builds upon, and is tailored to, existing
broker-dealer relationships and regulatory obligations under the
federal securities laws and SRO rules. In particular, the existing
rules of various SROs served as an important point of reference for our
proposal. However, we tailored and enhanced these requirements to the
specific proposed best interest obligation we are seeking to establish.
Our proposal also takes into consideration and draws on (to the extent
appropriate) the principles of the obligations that apply to investment
advice in other contexts, including those described above. We
preliminarily believe it makes more sense to build upon this regulatory
regime, rather than to create a completely new standard or simply adopt
obligations and duties that have developed under a separate regulatory
regime to address a different type of advice relationship.
    We believe this approach would have several benefits. First, it
would enhance the quality of recommendations provided by broker-dealers
to retail customers. Second, it would enhance disclosure, helping
retail customers evaluate recommendations received from broker-dealers,
and reducing confusion regarding the nature of the broker-dealer
relationship. Third, it would facilitate more consistent regulation of
similar activity, drawing from key principles underlying the fiduciary
obligations that apply to investment advice in other contexts. Fourth,
it would better align the legal obligations of broker-dealers with
investors' expectations.
    We also believe that the best interest obligation we are proposing
today would help preserve investor choice and access to affordable
investment advice and products that investors currently use. As
discussed below, Regulation Best Interest would only apply when a
broker-dealer is making a recommendation to a retail customer about a
securities transaction or an investment strategy involving securities.
The regulation would not apply to the provision of services that do not
involve or are distinct from such a recommendation, including, but not
limited to, executing an unsolicited transaction for a retail customer,
or to a broker-dealer that is dually-registered as an investment
adviser (a ``dual-registrant'') when making a recommendation in its
investment adviser capacity.\85\ In this way, our proposed best
interest obligation should enhance investor protection while generally
preserving (to the extent possible) the range of choice and access--
both in terms of services and products--that is available to brokerage
customers today.
---------------------------------------------------------------------------

    \85\ See infra Section II.C.4. for further discussion.
---------------------------------------------------------------------------

    We recognize that as a result of the enhanced obligations that
would apply, some broker-dealers may determine that it is not cost-
effective to continue to recommend certain products or services to
retail customers (because, for example, of the difficulty in mitigating
certain compensation related conflicts). Others may pass along the
costs to retail customers. Some retail customers may seek out a
different advice relationship that better suits their preferences after
receiving the required disclosures. As discussed in more detail in
Section IV, we preliminarily believe that any such impacts that the
proposed regulatory changes may have on retail customer access to and
availability of investment advice, and the costs to broker-dealers,
would be justified by the benefits of the enhancements to investor
protection. We also believe that for both retail customers and broker-
dealers the potential costs would be less--and the benefits would be
greater--than under the potential regulatory alternatives we
considered.\86\
---------------------------------------------------------------------------

    \86\ See Section IV.
---------------------------------------------------------------------------

    In proposing Regulation Best Interest, we are not proposing to
amend or eliminate existing broker-dealer obligations, and compliance
with Regulation Best Interest would not alter a broker-dealer's
obligations under the general antifraud provisions of the federal
securities laws. Regulation Best Interest applies in addition to any
obligations under the Exchange Act, along with any rules the Commission
may adopt thereunder, and any other applicable provisions of the
federal securities laws and related rules and regulations.\87\
Furthermore, we do not believe proposed Regulation Best Interest would
create any new private right of action or right of rescission, nor do
we intend such a result.\88\
---------------------------------------------------------------------------

    \87\ For example, any transaction or series of transactions,
whether or not subject to the provisions of Regulation Best
Interest, remain subject to the antifraud and anti-manipulation
provisions of the securities laws, including, without limitation,
Section 17(a) of the Securities Act of 1933 (``Securities Act'') [15
U.S.C. 77q(a)] and Sections 9, 10(b), and 15(c) of the Exchange Act
[15 U.S.C. 78i, 78j(b), and 78o(c)] and the rules thereunder.
    \88\ Regulation Best Interest is being proposed, in part,
pursuant to the authority provided by Section 913(f) of the Dodd-
Frank Act and Section 15(l) of the Exchange Act. Neither Section
913(f) nor Section 15(l), by its terms, creates a new private right
of action or right of rescission.
---------------------------------------------------------------------------

    Scienter would not be required to establish a violation of
Regulation Best Interest. One key difference and enhancement resulting
from the obligations imposed by Regulation Best Interest as compared to
a broker-dealer's existing suitability obligations under the antifraud
provisions of the federal securities laws, is that a broker-dealer
would not be able to satisfy its Care Obligation discussed in Section
D.2 through disclosure alone.
    Similarly, the existing rules of various SROs served as an
important point of reference for our proposal. However, we tailored and
enhanced these existing

SRO requirements to the specific proposed best interest obligation we
were seeking to establish. As a result, we recognize that there may be
overlapping regulatory requirements applicable to the same activity. We
are mindful of potential regulatory conflicts or redundancies and have
sought in proposing Regulation Best Interest to avoid such conflicts
and minimize redundancies, but consistent with our goal of establishing
a best interest obligation for broker-dealers. Overall, we believe that
proposed Regulation Best Interest is generally designed to be
consistent with and build upon the relevant SRO requirements.\89\
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    \89\ Generally, when a requirement of proposed Regulation Best
Interest is based on a similar SRO standard, we would expect--at
least as an initial matter--to take into account the SRO's
interpretation and enforcement of its standard when we interpret and
enforce our rule. At the same time, we would not be bound by an
SRO's interpretation and enforcement of an SRO rule, and our policy
objectives and judgments may diverge from those of a particular SRO.
Accordingly, we would also expect to take into account such
differences in interpreting and enforcing our rules. We have taken
the same approach in other rulemakings that include requirements
based on a similar SRO standard. See, e.g., Exchange Act Release No.
77617 (Apr. 14, 2016), 81 FR 29960, 29997 (May 13, 2016) (``Business
Conduct Standards Adopting Release'').
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    We wish to underscore that proposed Regulation Best Interest
focuses on specific enhancements to the broker-dealer regulatory
regime, in light of the unique characteristics of the brokerage advice
relationship and associated services that may be provided, and
therefore would be separate and distinct from the fiduciary duty that
has developed under the Advisers Act. Further, we do not intend that
Regulation Best Interest, including the associated obligations, have
any impact on the Commission's or its staff's interpretations of the
scope or nature of an investment adviser's fiduciary obligations.\90\
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    \90\ See Proposed Commission Interpretation Regarding Standard
of Conduct for Investment Advisers; Request for Comment on Enhancing
Investment Adviser Regulation, Release No. IA-4889, File No. S7-09-
18 (``Fiduciary Duty Interpretive Release'').
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II. Discussion of Regulation Best Interest

A. Overview of Regulation Best Interest

    The Commission is proposing a new rule, referred to as Regulation
Best Interest, to establish an express best interest obligation that
would apply to broker-dealers when making a recommendation of any
securities transaction or investment strategy to a retail customer. The
proposed best interest obligation, which is set forth in proposed
paragraph (a)(1), would require a broker-dealer, when making a
recommendation, ``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 a natural person who is an
associated person of a broker or dealer making the recommendation ahead
of the interest of the retail customer.'' Regulation Best Interest
would specifically provide that this best interest obligation shall be
satisfied if:
     The broker, dealer or natural person who is an associated
person of a broker or dealer, prior to or at the time of the
recommendation, reasonably discloses to the retail customer, in
writing, the material facts relating to the scope and terms of the
relationship with the retail customer and all material conflicts of
interest that are associated with the recommendation (the ``Disclosure
Obligation'');
     The broker, dealer or natural person who is an associated
person of a broker or dealer, in making the recommendation, exercises
reasonable diligence, care, skill, and prudence to: (1) Understand the
potential risks and rewards associated with the recommendation, and
have a reasonable basis to believe that the recommendation could be in
the best interest of at least some retail customers; (2) have a
reasonable basis to believe that the recommendation is in the best
interest of a particular retail customer based on the retail customer's
investment profile and the potential risks and rewards associated with
the recommendation; and (3) have a reasonable basis to believe that a
series of recommended transactions, even if in the retail customer's
best interest when viewed in isolation, is not excessive and is in the
retail customer's best interest when taken together in light of the
retail customer's investment profile (herein, ``Care Obligation'');
     The broker or dealer establishes, maintains, and enforces
written policies and procedures reasonably designed to identify and at
a minimum disclose, or eliminate, all material conflicts of interest
that are associated with recommendations; and
     The broker or dealer establishes, maintains, and enforces
written policies and procedures reasonably designed to identify and
disclose and mitigate, or eliminate, material conflicts of interest
arising from financial incentives associated with such recommendations
(the last two together, the ``Conflict of Interest Obligations'').
    We preliminarily believe that establishing an express best interest
obligation and defining it in this manner would enhance the quality of
recommendations provided, and would align broker-dealers' obligations
more closely with retail customers' reasonable expectations.\91\ The
best interest obligation, including the specific component obligations,
that we are proposing today would address certain conflicted
recommendations and set a clear minimum standard for broker-dealer
conduct. Specifically, we believe that it would improve investor
protection and the regulation of broker-dealer recommendations in four
key ways.
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    \91\ See, e.g., Letter from David Certner, Legislative Counsel &
Legislative Policy Director, Government Affairs, AARP (Sept. 6,
2017) (``AARP'') (``Investors expect financial intermediaries to be
required to act in their (the customer's) best interest.'').
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    First, it fosters retail customer awareness and understanding by
requiring disclosure of the material facts relating to the scope and
terms of the relationship with the retail customer.
    Second, it is designed to enhance provisions under the federal
securities laws relating to the quality of broker-dealer
recommendations by establishing an express Care Obligation that sets
forth minimum professional standards that encompass and go beyond
existing suitability obligations under the federal securities laws, and
could not be satisfied through disclosure alone.\92\
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    \92\ See supra note 7.
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    Third, it enhances the disclosure of material conflicts of
interest. This would help educate retail customers about those
conflicts, and help them evaluate recommendations received from broker-
dealers.
    Fourth, it establishes obligations that require mitigation, and not
just disclosure, of conflicts of interest arising from financial
incentives associated with the recommendation (such as compensation
incentives, incentives to recommend proprietary products, and
incentives to effect transactions in a principal capacity).
    Taken together, we preliminarily believe these enhancements will
improve investor protection by minimizing the potential harmful impacts
that broker-dealer conflicts of interest may have on recommendations
provided to retail customers. Furthermore, it is our understanding that
many broker-dealers support the establishment of a best interest
standard.\93\
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    \93\ See, e.g., SIFMA 2017 Letter.
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    As discussed in more detail below, in developing proposed
Regulation Best Interest, the Commission has drawn from principles that
apply to investment advice under other regulatory regimes--most notably
SRO rules, state common law, the Advisers Act, and any duties that
would apply to broker-dealers as a

result of the DOL Fiduciary Rule and the related PTEs (most notably,
the BIC Exemption)--with the goal of both establishing greater
consistency in the level of protection provided across registered
investment advice relationships (while having the specific regulatory
obligations for broker-dealers and investment advisers reflect the
structure and characteristics of their relationships with retail
customers) and easing compliance with Regulation Best Interest where
these other overlapping regulatory regimes are also applicable.
    In particular, as a threshold matter, it is worth noting that, in
determining how to frame proposed best interest obligation, we
considered the ``best interest'' standards outlined in other contexts,
in particular the standard set forth in Section 913(g) of the Dodd-
Frank Act \94\ and the 913 Study recommendation,\95\ as well as the
DOL's ``best interest'' Impartial Conduct Standard, even though we are
not proposing a uniform fiduciary standard under Section 913(g).\96\
Our proposed definition differs from the wording of these standards by
replacing the phrase ``without regard to the financial or other
interest'' with the phrase ``without placing the financial or other
interest . . . ahead of the interest of the retail customer.'' We are
proposing this change as we are concerned that inclusion of the
``without regard to'' language could be inappropriately construed to
require a broker-dealer to eliminate all of its conflicts (i.e.,
require recommendations that are conflict free), \97\ and we believe
that our proposed formulation appropriately reflects what we believe is
the underlying intent of the ``without regard to . . .'' formulation.
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    \94\ Pursuant to Section 913(g) of the Dodd-Frank Act, ``[t]he
Commission may promulgate rules to provide that the standard of
conduct for all brokers, dealers, and investment advisers, when
providing personalized investment advice about securities to retail
customers . . . shall be to act in the best interest of the customer
without regard to the financial or other interest of the broker,
dealer, or investment adviser providing the advice.'' 15 U.S.C. 80b-
11(g)(1); 15 U.S.C. 78o(k)(1). Section 913(g) also provides that
``[s]uch rules shall provide that such standard of conduct shall be
no less stringent than the standard applicable to investment
advisers under Sections 206(1) and 206(2) [of the Advisers Act].''
Id.
    \95\ See infra Section II.D.2.d.2 for a further discussion of
how proposed Regulation Best Interest compares to the 913 Study
recommendations.
    \96\ As discussed supra note 88, Regulation Best Interest is
being proposed, in part, pursuant to the authority provided by
Section 913(f) of the Dodd-Frank Act, which provides the Commission
discretionary authority to ``commence a rulemaking, as necessary or
appropriate to the public interest and for the protection of retail
customers (and such other customers as the Commission may by rule
provide), to address the legal or regulatory standards of care for
brokers, dealers . . . [and] persons associated with brokers or
dealers . . . for providing personalized investment advice about
securities to such retail customers.'' In doing so, the Commission
is required to consider the findings, conclusions and
recommendations of the 913 Study.
    \97\ Some commenters raised similar concerns of potential
confusion and uncertainty regarding the expectations associated with
including this phrase in the best interest obligation. See, e.g.,
SIFMA 2017 Letter; T. Rowe Letter; Letter from Jason Chandler, Group
Managing Director, Head of Investment Platforms and Solutions Wealth
Management Americas, and Micheal Crowl, Group Managing Director,
General Counsel, UBS Group Americas and Wealth Management Americas,
UBS AG (July 21, 2017) (``UBS Letter'').
    Other commenters, however, expressed support for a ``best
interest'' obligation that included that the ``without regard to
phrase.'' See, e.g., Letter from Christine L. Owens, Executive
Director, National Employyment Law Project (Oct. 20, 2017); PIABA
2017 Letter; Wells Fargo Letter; AARP Letter.
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    We understand that, like other investment firms, broker-dealers
have conflicts of interest, in particular financial interests, when
recommending transactions to retail customers. Certain conflicts of
interest are inherent in any principal-agent relationship. We do not
intend for our standard to prohibit a broker-dealer from having
conflicts when making a recommendation. Nor do we believe that is the
intent behind the ``without regard to'' phrase, as included in Section
913 of the Dodd-Frank Act or recommended in the 913 Study, as is
evident both from other provisions of Section 913 that acknowledge and
permit the existence of financial interests under that standard, and
how our staff articulated the recommended uniform fiduciary
standard.\98\ Among other things, Dodd-Frank Act Section 913(g)
expressly provides that the receipt of commission-based compensation,
or other standard compensation, for the sale of securities shall not,
in and of itself, violate any uniform fiduciary standard promulgated
under that subsection's authority as applied to a broker-dealer.\99\
Moreover, Section 913(g) does not itself require the imposition of the
principal trade provisions of Advisers Act Section 206(3) on broker-
dealers.\100\ In addition, Dodd-Frank Act Section 913 provides that
offering only proprietary products by a broker-dealer shall not, in and
of itself, violate such a uniform fiduciary standard, but may be
subject to disclosure and consent requirements.\101\ We believe that
these provisions make clear that the overall intent of Section 913 was
that a ``without regard to'' standard did not prohibit, mandate or
promote particular types of products or business models, and preserved
investor choice among such services and products and how to pay for
these services and products (e.g., by preserving commission-based
accounts, episodic advice, principal trading and the ability to offer
only proprietary products to customers).\102\
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    \98\ See discussion infra Section II.D.2.d.2.
    \99\ See Exchange Act Section 15(k)(1) and Advisers Act Section
211(g)(1). See also 913 Study at 113.
    \100\ Id. Advisers Act Section 206(3) prohibits an adviser from
engaging in a principal trade with an advisory client, unless it
discloses to the client in writing before completion of the
transaction the capacity in which the adviser is acting and obtains
the consent of the client to the transaction.
    \101\ Id.
    \102\ See 913 Study at 113.
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    In lieu of adopting wording that embodies apparent tensions, we are
proposing to resolve those tensions through another formulation that
appropriately reflects what we believe is the underlying intent of
Section 913: That a broker-dealer should not put its interests ahead of
the retail customer's interests when making a recommendation to a
retail customer. In other words, the broker-dealer's financial interest
can and will inevitably exist, but these interests cannot be the
predominant motivating factor behind the recommendation. Our proposed
language makes this intention clear by stating a broker-dealer and its
associated persons are not to put their interests ahead of the retail
customer's interests. We request comment below, however, on whether our
proposed rule should instead incorporate the ``without regard to''
language set forth in Section 913 and the 913 Study recommendation,
which we believe would also generally correspond to the DOL's language
in the BIC Exemption, but interpret that phrase in the same manner as
the ``without placing the financial or other interest . . . ahead of
the interest of the retail customer'' approach set forth above.
    We also appreciate the desire for clarity regarding the
interpretation of our proposed best interest obligation. In the
discussion that follows, we are addressing these concerns by providing
clarity about the requirements imposed by the proposed best interest
obligation, and offering guidance on how a broker-dealer could comply
with these requirements.
    Specifically, to provide assistance to broker-dealers complying
with the requirements of Regulation Best Interest, the Commission's
proposal: (1) Provides guidance setting forth our preliminary views of
what the best interest obligation would require, generally; (2) defines
the key terms and scope of the proposed best interest obligation; and
(3) specifies by rule the specific components with which a broker-
dealer

would be required to comply to satisfy its best interest obligation.

B. Best Interest, Generally

    Proposed Regulation Best Interest uses the term ``best interest''
in several places. Under proposed paragraph (a)(1), broker-dealers
would be required to ``act in the best interest of the retail customer
. . . without placing the financial or other interest of'' the broker-
dealer making the recommendation ``ahead of the interest of the retail
customer.'' This general requirement would be satisfied through
compliance with the four specific components of Regulation Best
Interest set forth in paragraph (a)(2): The Disclosure Obligation
described in Section II.D.1, the Care Obligation described in Section
II.D.2 and the two prongs of the Conflict of Interest Obligations
discussed in Section II.D.3. In addition, the term ``best interest'' is
included in the Care Obligation, which would require, among other
things, a broker-dealer to ``have a reasonable basis to believe that
the recommendation could be in the best interest of at least some
retail customers,'' to ``have a reasonable basis to believe that the
recommendation is in the best interest of a particular retail customer
based on that retail customer's investment profile and the potential
risks and rewards associated with the recommendation,'' and ``have a
reasonable basis to believe that a series of recommended transactions,
even if in the retail customer's best interest when viewed in
isolation, is not excessive and is in the retail customer's best
interest.''
    The proposed best interest obligation, as defined by the
Disclosure, Care, and Conflict of Interest Obligations below,
encompasses and goes beyond a broker-dealer's existing suitability
obligations.\103\ As previously noted, one key difference between the
Care Obligation imposed by Regulation Best Interest and the suitability
obligation derived from the antifraud provisions of the federal
securities laws is that the antifraud provisions require an element of
fraud or deceit, which would not be required under Regulation Best
Interest. More specifically, the Care Obligation could not be satisfied
by disclosure. Second, as discussed below, our proposed interpretation
of the Care Obligation would make the cost of the security or strategy,
and any associated financial incentives, more important factors (of the
many factors that should be considered) in understanding and analyzing
whether to recommend a security or an investment strategy. Third,
beyond the Care Obligation, Regulation Best Interest imposes Disclosure
and Conflict of Interest Obligations that are intended to manage the
potential impact that broker-dealer conflicts of interest may have on
their recommendations.
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    \103\ See discussion infra Section II.D.
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    We are not proposing to define ``best interest'' at this time.
Instead, we preliminarily believe that whether a broker-dealer acted in
the best interest of the retail customer when making a recommendation
will turn on the facts and circumstances of the particular
recommendation and the particular retail customer, along with the facts
and circumstances of how the four specific components of Regulation
Best Interest are satisfied. Furthermore, in the discussion below and
in our discussion of each of these specific obligations, we provide
further guidance regarding our views of how a broker-dealer could act
in the best interest of the retail customer, including how a broker-
dealer could make a recommendation in the ``best interest,'' and how it
compares to existing broker-dealer obligations.
    As a threshold matter, we recognize that it may be in a retail
customer's best interest to allocate investments across a variety of
investment products, or to invest in riskier or more costly products.
We do not intend to limit through proposed Regulation Best Interest the
diversity of products available, the higher cost or risks that may be
presented by certain products, or the diversity in retail customers'
portfolios. This proposal is not meant to effectively eliminate
recommendations that encourage diversity in a retail customer's
portfolio through investment in a wide range of products, such as
actively managed mutual funds, variable annuities, and structured
products. We recognize that these and other products that may involve
higher risks or cost to the retail customer may be suitable under
existing broker-dealer obligations. We believe these products could
likewise continue to be recommended under Regulation Best Interest, if