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Regulating Broker-Dealer Investment Recommendations—Laying the Groundwork for the Next Financial Crisis


Securities and Exchange Commission Regulation Best Interest (RBI) sought to mitigate or remove conflicts of interest on the part of broker-dealers that receive transaction-based commissions. As this Article demonstrates, RBI will effectively force broker-dealers to abandon such compensation arrangements in favor of fixed-fee arrangements. This will reduce investment choices, limit access to personalized professional investment advice and adversely affect the quality of services.

More significantly, RBI provides incentives for broker-dealers to hold customer funds in low return cash accounts that can be exploited through so-called “carry” trades. The financial services industry is already restructuring in order to capture the value of such trades, at the expense of retail investors. As was the case during the financial crisis of 2008, those investments will implode during a market meltdown. This will likely cause the failure of many large financial institutions, absent a massive, politically unpalatable government bailout.

RBI will also cause investors to be steered into cookie cutter accounts that will result in a dangerous concentration of investment assets, as occurred with subprime mortgages in the run up to the Financial Crisis of 2008. The liquidation of concentrated assets in a market panic will have a cascading effect that will force market prices into a downward spiral. This will wreak havoc in the financial markets. The coronavirus securities market selloff in March 2020 proved, if proof is needed, that market selloffs are inevitable. The next such event will only be accentuated by the panicked liquidation of RBI induced portfolio concentrations.