Security and Exchange Commission (SEC) is proposing a rule which would create a standard of conduct for the broker-dealers. This rule, called Regulation Best Interest, aims at addressing the concerns over conflicts of interests for broker-dealers who provide investment advice to retail customers. Broker-dealers play a critical role in assisting Americans plan and organize their financial lives by saving and investing wisely to have financial independence in the long run. The broker-dealers advise how Americans can invest their savings wisely and get reasonable returns on the investments (Regulation Best Interest, 2018). There exists a principle-agent relationship between broker-dealers and retail customers. It is expected that the broker-dealers should work for the interests of their clients by acting in good faith. However, in most cases, they are tempted to perform for their interests rather than those of their clients. Yes, I agree with the proposal by SEC to establish Regulation Best Interest to deal with conflict of interests for broker-dealers who offer investment advice to retail customers. This rule is formulated in response to market failure resulting from externalities.
It is important to recognize that even a free-market economy cannot correct itself. Therefore, markets need to be regulated effectively by the government before any growth inequity can be realized. Market failures occur when private individuals or organizations operating in unregulated market economy fail to attain the required level of efficiency in the use and allocation of resources. The failures become eminent where the firms and individuals lack definite property rights over goods or resources. Under such circumstances, the market fails due to the existence of externalities in which case the operations or productive activities of an individual or firm affect other individuals whose welfare or best interests are not considered during such actions. Based on this understanding, economic crimes, fraud and productive activities that have led to various financial crises across the globe are failures mostly associated with exteralities. A good example is Bernie Madoff’s Ponzi scheme that caused investors to lose billions of dollars. Despite SEC’s regulatory efforts, it is surprising that the scammer could not be trapped by the regulator. This begs the question as to whether SEC officials are competent enough to implement any new rule.
In an effort to curb market failures due to such exteralities, SEC introduced the Regulation Best Interest rule in order to disclose to the public who the regulators are and their corresponding subjects and what the standards may be. The rule makes people believe that they are safe in the hands of brokers who will always be acting in the customers’ best interest. However, from a subtle level, it is notable that SEC actually renamed the “suitability” standard a “best interest” standard, a move that does not alter the typical obligations of a broker to its customers. The predatory sale activities of brokers may not necessarily be twisted by the Best Interest rule to be carried out more efficiently.
Despite the weaknesses that were revealed in the way SEC handled previous cases and how it failed to bring culprits like Madoff to book, the three elements embodied in the Regulation Best Interest rule, if fully implemented as required, will definitely act as effective regulatory measures that could curb market failures. Through disclosure, diligence and care, and elimination of conflicts of interest, compliant individuals and firms would pose a lower risk to investors and the market.
Regulation Best Interest (83FR21574). (2018). Retrieved from Securities and Exchange Commission website: https://www.federalregister.gov/documents/2018/05/09/2018-08582/regulation-best-interest