A Transaction Cost Assessment of SEC Regulation Best Interest

Johnsen, D. Bruce

The U.S. Securities and Exchange Commission (“SEC”) is required to provide an economic analysis of proposed regulations and to show they plausibly meet a cost-benefit test. It recently proposed Regulation Best Interest (RBI) to replace the longstanding suitability rule for securities brokers when providing their retail clients with incidental investment advice. Despite a dearth of empirical support, the proposing release concludes that a best interest standard would better mitigate the conflicts of interest brokers face between providing their clients with impartial advice and inflating their own compensation. The empirical vacuum is a result of the SEC’s failure to ask the right economic questions, which Nobel laureate Ronald Coase raised over half a century ago: why does the rule of liability matter? What transaction costs prevent parties–who in this setting negotiate face-to-face–from correcting any market failure through private ordering? This essay provides a transaction cost assessment of RBI and concludes that a far more thorough economic analysis is necessary to justify imposing a best interest standard on retail brokers.

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December 3, 2019