U.S. Securities and Exchange Commission staff recently published a bulletin reiterating the standards of conduct applicable to broker-dealers and investment advisers when making account recommendations to retail investors. Broker-dealers are subject to Regulation Best Interest (Reg. BI). Investment advisers are subject to the fiduciary standard (IA fiduciary standard) under the Investment Advisers Act of 1940 (Advisers Act). The standards of conduct are separate, but in the staff's view both "include an obligation to act in the retail investor's best interest and not to place their own interests ahead of the investor's interest." In particular, SEC staff believe that both standards "yield substantially similar results in terms of the ultimate responsibilities owed to retail investors."
The bulletin is comprised of several questions and answers on this matter and sets forth factors firms should consider before making account and rollover recommendations, considerations of costs in account recommendations, and examples of practices that can assist firms in satisfying their obligations to address conflicts of interest associated with account recommendations. Below is a summary of the staff's views:
- Obligations of dually licensed financial professionals
when recommending accounts to prospective retail investors
- Applicable standard of conduct: The required standard depends on the capacity in which the personnel are acting (i.e., broker-dealer, investment adviser, or both). Because investment advisers must comply with the antifraud provisions of the Advisers Act in connection with current and prospective clients, both Reg. BI and the Advisers Act may apply in many cases when dually licensed personnel assess an account type recommendation for current and prospective retail investors.
- Disclosure of capacity: Both broker-dealers and investment advisers have an obligation to disclose all material facts related to their relationship with retail investors, including the capacity in which a financial professional is acting. If the capacity in which a financial professional will be acting has not been established, then prior to or at the time of the recommendation, financial professionals must disclose to the retail investor that both standards of conduct apply. Firms are expected to provide clear guidance to financial professionals via policies and procedures and other instructions regarding how to disclose capacity to retail investors.
- Consideration of reasonably available alternatives: Financial
professionals of both broker-dealers and investment advisers must
have a reasonable basis to believe that an account is in a retail
investor's best interest before making an account
recommendation. This means that, subject to eligibility
requirements, dually-licensed financial professionals must consider
both brokerage and advisory accounts for retail investors when
evaluating account types. The staff maintains that financial
professionals "cannot recommend an account that is not in a
retail investor's best interest solely based on [their]
firm's limited product menu" or limitations associated
with their licensing. "Any limitations on account types
considered, in the staff's view, are material facts that should
be disclosed (along with other relevant material facts, including
services, fees, and conflicts of interest) to retail
investors."
- Factors to consider before making an account
recommendation
- Establishing a reasonable basis for an account recommendation: Both Reg. BI and the IA fiduciary standard require that a reasonable basis for an account recommendation be established based on "a reasonable understanding of the retail investor's investment profile and the account characteristics." Consequently, a firm and its financial professionals are required to obtain and evaluate enough information about a retail investor to ensure that the recommendation is not based on materially inaccurate or incomplete information. See the table below for examples of characteristics to consider in order to establish a reasonable basis to believe a recommendation is in a retail investor's best interest.
- Unavailable information: The staff believes that firms and
their financial professionals should generally decline making
account recommendations until sufficient information is obtained
about a retail investor such that a reasonable belief can be
established that an account recommendation is in an investor's
best interest. If a firm and its financial professionals
"determine not to obtain or evaluate information that would
normally be contained in an investor profile, the staff believes
[the firm] should consider documenting the basis for [its] belief
that such information is not relevant in light of the facts and
circumstances of the particular account recommendation."
- Consideration of costs in account
recommendations
- Costs are always a relevant factor to consider when making
account recommendations. If a higher cost account is recommended, a
financial professional must have a reasonable basis to believe that
the account recommendation is in the retail investor's best
interest "based on other factors and in light of the
particular situation and needs of the retail investor."
Special features or other potential benefits should be considered
along with the investor's needs, investment objectives, and
preferences. See the table below for examples of costs to consider
when recommending an account and other factors to consider along
with costs. Notably, the SEC "has pursued enforcement actions
against investment advisers for recommending higher-cost products
to clients when similar, lower-cost products were
available."
- Costs are always a relevant factor to consider when making
account recommendations. If a higher cost account is recommended, a
financial professional must have a reasonable basis to believe that
the account recommendation is in the retail investor's best
interest "based on other factors and in light of the
particular situation and needs of the retail investor."
Special features or other potential benefits should be considered
along with the investor's needs, investment objectives, and
preferences. See the table below for examples of costs to consider
when recommending an account and other factors to consider along
with costs. Notably, the SEC "has pursued enforcement actions
against investment advisers for recommending higher-cost products
to clients when similar, lower-cost products were
available."
- Retirement account rollover recommendations
- Additional factors to consider when making a rollover recommendation in order to have a reasonable basis to believe a recommendation is in the retail investor's best interest. A financial professional must have a reasonable basis to believe that the rollover and the account being recommended are in the retail investor's best interest. See the table below for specific factors to consider relevant to rollovers in light of the retail investor's investment profile, among other things. To the extent a firm relies on U.S. Department of Labor (DOL) Prohibited Transaction Exemption 2020-02, it should also consult the DOL's guidance on factors to consider in making a rollover recommendation and relevant documentation requirements.
- Leaving retail investor investments in employer plans. The
staff believes that financial professionals must "consider the
alternative of leaving [a] retail investor's investments in
their employer's plan, where that is an option," in order
to have a reasonable basis to believe that a rollover
recommendation is in the retail investor's best interest and
does not place the financial professional's or firm's
interests ahead of the retail investor's interest. This means
that firms and their financial professionals will have to obtain
information about a retail investor's existing plan, including
the costs associated with the options available in the
investor's current plan, in order to assess a recommendation to
transfer assets out of an employer's plan or between individual
retirement accounts.
- Retail investor preference and impact on account
recommendations
- Where a retail investor expresses a preference for a particular
type of account, a financial professional must nevertheless have a
reasonable basis to believe that the account recommendation is in
the retail investor's best interest based on a reasonable
understanding of the retail investor's investment profile and
the account characteristics, among other things. While a retail
investor's preference should be considered, reasonably
available alternatives must also be evaluated in order to
reasonably believe that a recommendation is in the retail
investor's best interest. It is the staff's view that a
firm and its financial professionals "would not be required to
refuse to accept [an] investor's direction" to open an
account contrary to a financial professional's recommendation.
The staff seems to draw a distinction between an investor's
preference and an investor's instructions. Firms and their
financial professionals should take care to ensure that the
rationale for opening an account for a retail investor is
adequately documented, including whether a retail investor
expressed an account preference or provided a
directive/instruction.
- Where a retail investor expresses a preference for a particular
type of account, a financial professional must nevertheless have a
reasonable basis to believe that the account recommendation is in
the retail investor's best interest based on a reasonable
understanding of the retail investor's investment profile and
the account characteristics, among other things. While a retail
investor's preference should be considered, reasonably
available alternatives must also be evaluated in order to
reasonably believe that a recommendation is in the retail
investor's best interest. It is the staff's view that a
firm and its financial professionals "would not be required to
refuse to accept [an] investor's direction" to open an
account contrary to a financial professional's recommendation.
The staff seems to draw a distinction between an investor's
preference and an investor's instructions. Firms and their
financial professionals should take care to ensure that the
rationale for opening an account for a retail investor is
adequately documented, including whether a retail investor
expressed an account preference or provided a
directive/instruction.
- Firm documentation of the basis for account
recommendations
- The staff emphasized throughout the bulletin the importance of
documenting the basis for recommendations, not only to be able to
periodically assess the adequacy and effectiveness of policies and
procedures, but also to demonstrate compliance with obligations to
retail investors.1 This is particularly interesting
given that in the Reg. BI adopting release the SEC "determined
not to require broker-dealers to document the basis for any
recommendations," but instead encouraged broker-dealers to
take a risk-based approach when deciding whether to document
certain recommendations. The SEC has not addressed these
documentation requirements/suggestions for investment advisers.
Both Reg. BI and the Advisers Act require that written compliance
policies and procedures be established, maintained, and enforced,
and be reasonably designed to achieve compliance with Reg. BI, in
the case of broker-dealers, to prevent violations of the Advisers
Act, including the IA fiduciary standard, in the case of investment
advisers.
- The staff emphasized throughout the bulletin the importance of
documenting the basis for recommendations, not only to be able to
periodically assess the adequacy and effectiveness of policies and
procedures, but also to demonstrate compliance with obligations to
retail investors.1 This is particularly interesting
given that in the Reg. BI adopting release the SEC "determined
not to require broker-dealers to document the basis for any
recommendations," but instead encouraged broker-dealers to
take a risk-based approach when deciding whether to document
certain recommendations. The SEC has not addressed these
documentation requirements/suggestions for investment advisers.
Both Reg. BI and the Advisers Act require that written compliance
policies and procedures be established, maintained, and enforced,
and be reasonably designed to achieve compliance with Reg. BI, in
the case of broker-dealers, to prevent violations of the Advisers
Act, including the IA fiduciary standard, in the case of investment
advisers.
- Examples of practices that can assist firms in
satisfying their obligations to address conflicts of interest
associated with account recommendations
- The table below includes a non-exhaustive list of practices firms can consider. In particular, the staff strongly encourages firms to eliminate or mitigate incentives that may encourage account recommendations that would place the interests of the firm or its financial professionals ahead of the interest of a retail investor. Notably, the SEC settled an enforcement action concerning compensation incentives for financial professionals making account recommendations.
| Topic | Examples, Factors, and Considerations Related to
Account and Rollover Recommendations and Associated Obligations |
| Examples of investor and account characteristics to consider |
Investor characteristics: The staff believes that firms and their personnel should at least consider the following characteristics of a retail investor:
Account characteristics: The staff believes that firms and their personnel should at least consider the following characteristics in order to establish a reasonable understanding of the characteristics of a particular type of account and whether these factors are consistent with a retail investor's investment profile and stated investment goals:
|
| Examples of costs and other factors to consider when recommending an account |
The staff's view is that firms and their personnel should at least consider the total potential costs, including indirect costs that could be borne by a retail investor, when evaluating whether an account is in a retail investor's best interest, including the following examples:
"When applicable, cost of an account also includes fees associated with the investment products that are available through the account, such as the internal expenses of funds, including management fees, distribution and servicing fees, and the costs of investing in funds, including front-end and back-end fees." Firms and their personnel should also consider an investor's anticipated time horizon when evaluating the potential impact of certain costs on the investor's account (e.g., distribution and servicing fees and transaction costs related to purchasing fund shares). "[T]he investor's need for certain services or certain types of investment products or strategies that are only available in certain account types; the account's characteristics, including any special or unusual features requested by the retail investor, such as tax advantages; potential benefits and risks; time horizon; and anticipated composition of investments in the investment account." |
| Additional factors to consider when making a rollover recommendation |
The staff believes that firms and their personnel should at least consider the following factors when making a rollover recommendation to a retail investor:
|
| Examples of practices that can assist firms in meeting their obligations to address conflicts of interest associated with account recommendations |
|
Footnote
1. Staff noted in the bullet that "it may be difficult for a firm to assess periodically the adequacy and effectiveness of its policies and procedures or to demonstrate compliance with its obligations to retail investors without documenting the basis for certain recommendations."
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
