On the surface, the SEC’s recent adoption of Regulation Best Interest (Reg BI) is a win for retail investors.
The standard, which went into effect on June 30, 2020, requires broker-dealers to consider the “best interest” of their clients when making recommendations, including those involving securities transactions, investment strategies, account types and more. Beyond that, advisors must now put in writing the services they’re providing and how they’re charging for them.
It’s all about advisors conducting themselves in ways that are to the benefit of their clients rather than putting their own interests first, and being open and transparent about it.
Makes sense. But there’s a blind spot in Reg BI that’s actually going to hurt more investors than it helps, while creating new compliance headaches.
Low-cost, low-quality
At the end of the day, all it’s really going to do is prompt broker-dealers to document why their commission-based products are better and lead RIAs, who are not commission based, to a higher focus on low fees. The former will dilute the fiduciary claims of fee-based advisors while the latter will move them towards products that are easier to explain.
The latter focus on fees won’t do anything to remove truly poor products from the market. That’s because there is a long list of factors that determine whether or not an investment product is “good” for the client or not. Fees are just one aspect of this. It could be the spread. It could be whether or not it’s trading at a discount. It could be volume, asset size, how long it’s been around or more.
Low fees don’t always equate to the “best” investments for a particular client. They may, but they also may not. Usually, all they are is inexpensive, but they’re easy to recommend in an environment where advisors are required to prove client best interest.
That’s what I worry Reg BI will force advisors and asset managers to do more of. Move the industry toward only low-cost, low-quality solutions simply because cost is higher visibility and quality is hard to explain and show.
The answer, then, lies in making investment “quality” more visible than it is today and reshape distribution mechanisms in the investment management industry that is more quantitative and scientific. Here’s how technology tools can help advisors deliver better outcomes and truly be client-driven while being compliant and not just compliance-driven.
Make investment “quality” easier to show clients
Use newer fintech workflows for fund discovery and diligence to include all of the different factors that matter to you and your clients in order to recommend those that stand out, all documented to meet Reg BI requirements. These searches can go far beyond just fees, to include asset classes, sustainability initiatives, geographic regions and more, all visible in ways that haven’t been possible before.
Scale your practice
Personalization has become a critical differentiator for many advisors, because what is in the best interest of one client is not always in the best interest of another. But, under the terms of Reg BI, if you want to create bespoke solutions for clients, you’re going to have to effectively increase minimums at the same time. The only way that you can spend the same amount of time and create bespoke solutions for many more people is to use some sort of technological leverage like the tools offered by Magnifi.
Prove what you’re recommending
At the core of Reg BI is documentation. Advisors now must show their clients exactly what they’re recommending as well as why they’ve chosen it. Beyond fees, this can be difficult to do with many investment products. But tools such as fund selectors bring together all of the different aspects of a particular investment and document it all, showing the client exactly why you’re recommending it to them.
Upgrade the advisor-client relationship
What used to be more of a one-way conversation “I know your goals, your expectations and your risk tolerance, here’s the portfolio for you” can become more engaging and educational under Reg BI. Because you can still sell commission products under Reg BI, you just need to disclose them and make sure are the best particular product for your client. When this happens, retail investors will learn more about what they’re buying and you can take on more of a guidance role, strengthening your overall relationship with the client.
The real issue with Reg BI isn’t that it is a bad regulation, but an incomplete one. Broker-dealers and advisors simply don’t have the tools they need today in order to truly comply with the spirit of the rule.
Under these conditions they’re far more likely to simply recommend something because it’s easier to explain to the client, even if it isn’t the best product for them. When that happens, everyone loses.
Dr. Vinay Nair is on the finance faculty at Wharton and has started, is an advisor or board member in several companies linking financial services and technology.
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