Category Archives: best interest

Alert: FINRA’s 529 Plan Share Class Initiative to Self-Report

FINRA is taking the position that broker-dealers need to evaluate the long-term costs of different share classes in 529 plans. In effect, FINRA is imposing a “best interest” standard on 529 recommendations. For a description of FINRA’s expectations and its new self-disclosure program, here is an article by several of our Drinker Biddle attorneys, including me: FINRA’s 529 Plan Share Class Initiative to Self-Report

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Best Interest Standard of Care for Advisors #7

What Does Best Interest Mean . . . In the Real World? (Part 4)

I am writing two series of articles that together are called “The Bests.” One is about Best Practices for plan sponsors, while the other is about the Best Interest Standard of Care for advisors. Each series is numbered separately to make it easier to identify the subject that is most relevant to you.

This is the seventh of the series about the Best Interest Standard of Care.

In my last three posts (Best Interest Standard of Care for Advisors #4 and #5 and #6), I discuss the Best Interest standard of care and its practical application. This article discusses a novel approach for compliance with the fiduciary standard for the selection of investments for 401(k) plans. All the more interesting, the approach was part of an opinion of the U.S. First Circuit Court of Appeals.

In October 2018, the First Circuit considered an appeal of a 401(k) case where Putnam Investments, and its fiduciaries, were the defendants. At one point, the defendants argued that, if the court found fiduciary liability under the facts of the case, it would discourage employers from adopting 401(k) plans. The Court of Appeals responded by saying:

“While Putnam warns of putative ERISA plans foregone for fear of litigation risk, it points to no evidence that employers in, for example, the Fourth, Fifth, and Eighth Circuits [which found that similar facts could result in liability], are less likely to adopt ERISA plans.”

The opinion went on to describe a “safe harbor” from fiduciary liability:

“Moreover, any fiduciary of a plan such as the Plan in this case can easily insulate itself by selecting well-established, low-fee and diversified market index funds. And any fiduciary that decides it can find funds that beat the market will be immune to liability unless a district court finds it imprudent in its method of selecting such funds, and finds that a loss occurred as a result. In short, these acts are not matters concerning which ERISA fiduciaries should cry ‘wolf.’”

I think it goes without saying that the court’s language was gratuitous . . . and it is a bit disturbing for judges to give investment advice.

Nonetheless, there is a point to be made. That is, at least from this Court’s perspective, the starting point is to consider index funds. Then, plan fiduciaries should seek to identify other funds, including actively managed funds, that can reasonably be expected to match or outperform the index funds. (Note that I say index funds, rather than indexes. That’s because an index fund, subject to its expense ratio, is the investable version of an index.)

In some ways, this is not different from what is commonly done. Based on my participation as a lawyer in plan committee meetings, the investment reports that advisors give to plan committees typically compare the plans’ mutual funds to appropriate indices. And, if there is sustained underperformance vis-a-vis the index, the advisors usually recommend that a fund be removed.

However, it is more complicated than that. For example, other factors can be considered, such as volatility. A less volatile investment may be more appropriate for a retirement plan and particularly for a plan covering employees who aren’t experienced investors. Also, a particular index may not be an appropriate benchmark for certain mutual funds.

In the final analysis, the issue is whether a plan committee engaged in a prudent process to select the investments; it is not whether the process predicted the best future outcome. Nonetheless, the process must have an intended outcome, and it is not unreasonable to conclude that one objective of the process is to select investments that are anticipated to outperform a comparable index fund.

Advisors and plan sponsors shouldn’t be fearful of selecting actively managed funds where there is a reasonable basis to believe that the performance of those funds will, over time, equal or exceed that of comparable index funds. So long as the process is prudent, the fiduciaries will have satisfied their legal responsibilities.

To automatically receive these articles in your in box, you can sign up on my blog at http://fredreish.com/insight/. Just enter your name and email address under the “sign up for our e-newsletter” option, and click on the button to subscribe.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

 

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Best Interest Standard of Care for Advisors #6

What Does Best Interest Mean . . . In the Real World? (Part 3)

I am writing two series of articles that together are called “The Bests.” One is about Best Practices for plan sponsors, while the other is about the Best Interest Standard of Care for advisors. Each series is numbered separately to make it easier to identify the subject that is most relevant to you.

This is the sixth of the series about the Best Interest Standard of Care.

In my last two posts (Best Interest Standard of Care for Advisors #4 and #5), I discussed the definition of the Best Interest standard of care, with a particular focus on the duty to exercise care, skill, prudence and diligence in developing recommendations for investors. Those articles commented on the consistency in the Best Interest and fiduciary standards being developed by the SEC and several states (including New York), as well ERISA’s duty of care and duty of loyalty.

Bests #9 discussed the similarities of the standards of care and Bests #10 talked about the consideration of costs. This article focuses on considerations of the quality of the products and services and on portfolio investing.

Under ERISA’s fiduciary rules, advisors are required to use generally accepted investment theories and prevailing investment industry practices, based on factors such as the needs and circumstances of the investor and the purpose for the investment recommendation. While there is not an explicit definition of “generally accepted investment theories,” the most accepted investment theory is Modern Portfolio Theory. Generally stated, Modern Portfolio Theory contemplates a diversified portfolio of investments that are not highly correlated with each other. Thus, while there may be cases where non-diversified recommendations could be made, the starting point—and the general rule—is that a Best Interest advisor should recommend a balanced portfolio that is appropriate for the investor. It is fair to say that Best Interest advice mandates the use of a balanced portfolio, absent circumstances that would reasonably justify an exception.

The second subject of this article is greater emphasis on the quality of investments, products and services imposed by the Best Interest standard. For example, an advisor (and his or her supervisory entity) would need to consider the financial stability of an insurance company when recommending an annuity. Similarly, an advisor would need to consider the quality of the investment manager in recommending a mutual fund or collective trust.

Think about it. While many similar investments may be suitable for a particular investor, a critical distinguishing factor—in addition to cost—between different investments is the quality of the investment management. Where an advisor is required by a Best Interest standard to (1) act with care, skill, prudence and diligence in determining which investments to recommend, and (2) to act in the best interest of the investor, it seems fairly obvious that the result of that process would be a high-quality, reasonably-priced investment. For example, with mutual funds or collective trusts, it would mean that the investment managers had superior skills and research and that their track record supported that conclusion. In other words, it involves both a qualitative and a quantitative analysis. The qualitative analysis would look both backwards and forwards. By backwards, I mean that the investment managers would have demonstrated that they are able to produce superior results. By forward looking, I mean that the investment advisory organization would be likely to continue to produce those results into the future. That involves consideration of the investment managers, the support staff–including analysts, the stability of the organization, the experience in managing in that style, and so on. On the other hand, the quantitative analysis is primarily backward looking. It would be historical performance measured against appropriate benchmarks, diversification, volatility, and so on. In effect, it would be historical numbers that measure important attributes of past performance.

The considerations for annuities are similar, in the sense that the quality and strength of the organization—that is, the insurance company—are critical factors. Is the insurance company financially stable and likely to continue to be so in the future? For example, where an annuity is recommended, the payments may extend 20 or 30 years, or more, into the future. Based on today’s financial data and the quality of the management of the insurance company, is it likely that the company will be there to make the annuity payments when due?

It is critical that advisors and their firms understand and evaluate these issues. Compliance requires nothing less.

While much of the burden of compliance falls on individual advisors, the responsibility can be shared with their firms. For example, a broker-dealer can vet the financial stability of the insurance companies that can be recommended by its advisors. In turn, if the advisors understand that process, and reasonably conclude that it is adequate they can adopt it as their own and use it as a basis for recommending those products where they satisfy the Best Interest standard for the customer. In other words, the responsibilities discussed in this article can be satisfied collaboratively by the combined efforts of the firm and the individual.

To automatically receive these articles in your in box, you can sign up on my blog at http://fredreish.com/insight/. Just enter your name and email address under the “sign up for our e-newsletter” option, and click on the button to subscribe.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

 

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Best Interest Standard of Care for Advisors #5

What Does Best Interest Mean . . . In the Real World? (Part 2)

I am writing two series of articles that together are called “The Bests.” One is about Best Practices for plan sponsors, while the other is about the Best Interest Standard of Care for advisors. Each series is numbered separately to make it easier to identify the subject that is most relevant to you.

This is the fifth of the series about the Best Interest Standard of Care.

My last article, Best Interest Standard of Care for Advisors #4, discussed different definitions of a “best interest” standard of care. The point of that article is that, while there may be slight differences in the wording, the rules converge to require that an advisor (and the advisor’s supervisory entity) act with care, skill, diligence and prudence to make recommendations that are in the best interest of the investor. This article discusses how the standard applies to specific circumstances.

As background, there are three parts to any best interest standard. The first is that the advisor engage in a process–carefully, skillfully, diligently and prudently–to develop the recommendation. That process is measured by an objective standard . . . what are the relevant factors that a knowledgeable professional advisor would consider and how would that hypothetical advisor evaluate those factors. The second is that the advisor act with loyalty to the investor. The advisor cannot put his interests ahead of the investor’s. The third is that the recommendation appropriately consider the investor’s profile (e.g., the needs and circumstances of the investor).

Let’s focus on the first part–the process and the relevant factors.

In its proposed Regulation Best Interest (Reg BI), the SEC said that its best interest standard for broker-dealers elevates (as compared to the suitability standard) the importance of costs. That is consistent with the fiduciary standard in ERISA’s prudent man rule. And, in my opinion, it is consistent with the fiduciary standard for registered investment advisers (RIAs). In other words, the new best interest “world” is placing greater emphasis on costs as a “relevant” factor for determining whether a recommendation satisfies that standard. Obviously, the requirement is that costs (and the impact of those costs on an investor’s returns), among other things, must be objectively and prudently considered (and given appropriate weight).

Using mutual funds as an example, that means that advisors need to make sure that the expense ratios of recommended mutual funds are reasonable. For example, the best interest standard would generally require that an advisor recommend the lowest cost share class of a mutual fund that is available to the advisor and the investor. Depending on the circumstances, that could mean a particular share class for one investor, but a different share class of the same mutual fund for another investor (for example, if a share class requires a threshold investment amount).

Here’s another example of the consideration of costs in a best interest process for different investors.

If a retail (e.g., IRA) investor’s time horizon is for the long term, e.g., for retirement investing, and therefore it is contemplated that the mutual fund could be held for decades, it is likely to be cheaper to use A shares with a front end load (as opposed to C shares). However, if an investor’s time horizon for holding a fund is short term, it will likely be less expensive to hold a C share. A “best interest” analysis requires that an advisor consider the investor’s needs and circumstances in determining which recommendation would result in a lower cost to the investor based on, among other things, the holding period. This point is not limited to considerations of A shares versus C shares. The issue is bigger than that—and involves careful consideration of costs, considering the alternatives, based on an investor’s needs, circumstances, investment horizon and other relevant factors.

Similarly, where an advisor is managing an account for an investor, it may or may not be in their investor’s best interest to choose NTF (No Transaction Fee) mutual funds. In that case, if the investor’s anticipated holding period is short term, the NTF funds will likely produce a lower cost and, therefore, may be in the best interest of the investor. However, if the investor anticipates holding the mutual funds for the long term, it would ordinarily be more cost-effective to pay a transaction fee, in exchange for a lower expense ratio.

Those are examples of how a “best interest” advisor would consider the “relevant” factors in developing a recommendation.

That’s it for this article . . . but my next post will discuss other best interest considerations.

To automatically receive these articles in your in box, you can sign up on my blog at http://fredreish.com/insight/. Just enter your name and email address under the “sign up for our e-newsletter” option, and click on the button to subscribe.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

 

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Best Interest Standard of Care for Advisors #4

What Does “Best Interest” Mean? (Part 1)

I am writing two series of articles that together are called “The Bests.” One is about Best Practices for plan sponsors, while the other is about the Best Interest Standard of Care for advisors. Each series is numbered separately to make it easier to identify the subject that is most relevant to you.

This is the fourth of the series about the Best Interest Standard of Care.

“Best Interest” has become part of the American lexicon . . . as an aspirational goal or a demanding standard—depending on the point of view. But, what does best interest mean? It may mean different things to different people . . . and perhaps even to different regulators. However, I believe that most people would agree on the definition in this article.

As I read the guidance issued by the Department of Labor (DOL), the Securities and Exchange Commission (SEC), and New York State, there are actually two different best interests. The first is a standard of care and the second is a duty of loyalty. Of the two, the duty of loyalty is the easiest to define because, in all of the guidance it boils down to a requirement that an advisor cannot put his interest ahead of the investor’s.

The best interest duty of care is more complicated. The only agency that has offered a full definition is the DOL in its vacated Best Interest Contract Exemption. That definition was:

Investment advice is in the ‘‘Best Interest’’ of the Retirement Investor when the Adviser and Financial Institution providing the advice act with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, without regard to the financial or other interests of the Adviser, Financial Institution or any Affiliate, Related Entity, or other party. [Emphasis added.]

 The SEC provided a partial definition in its proposed Regulation Best Interest, but the definition is, to a degree, circular:

 The best interest obligation . . . shall be satisfied if: The broker, dealer, or natural person who is an associated person of a broker or dealer, in making the recommendation exercises reasonable diligence, care, skill, and prudence to:… Have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer based on that retail customer’s investment profile and the potential risks and rewards associated with the recommendation; . . . [Emphasis added.]

 New York State has adopted a best interest regulation for insurance and annuity products:

 The producer, or insurer where no producer is involved, acts in the best interest of the consumer when . . . the producer’s or insurer’s recommendation to the consumer reflects the care, skill, prudence, and diligence that a prudent person acting in a like capacity and familiar with such matters would use under the circumstances then prevailing.

If you look closely at the DOL’s best interest standard, you can see that it has three parts. The first is the requirement for a prudent process, that is, that the advisor act carefully, skillfully, diligently and prudently as a knowledgeable professional to develop the recommendation. The second is that the recommendation be based on the needs and circumstances of the investor, which in the case of ERISA, is the plan or participant. The third is a requirement that the advisor be loyal to the investor and not place his interest ahead of the investor’s.

The duty of care in the SEC’s proposed Reg BI and the New York standard also requires that an advisor exercise care, skill, diligence and prudence in developing a recommendation for an investor or, in the case of New York, an insured.

Because of the identical language in all three rules—the requirement to act with care, skill, diligence and prudence, it is likely that the three standards of care will be interpreted similarly. Since ERISA has a developed history through litigation and regulatory guidance, it would likely be the primary source for interpreting and applying that standard. Looking at the ERISA history, a careful, skillful, diligent and prudent advisor would engage in a thoughtful process to gather the information relevant to making a decision (that is, information that would be material to a knowledgeable person) and would then evaluate that information in light of the needs and circumstances of the investor. That process would be measured by the objective standard of a knowledgeable professional.

Stated differently, it appears that these best interest standards require that advisors engage in a thoughtful, professional process to obtain and evaluate the information needed to make a recommendation that is in the best interest of the investor. ERISA calls that a prudent process.

In a nutshell, the best interest standards are more demanding than the current suitability standards. That is particularly true of the weight to be given to costs and compensation. The SEC made that point in its discussion in Regulation Best Interest. However, I believe that it also increases the responsibility of advisors to consider the quality of the products and services being recommended, for example, the quality of the mutual fund managers and the financial stability of insurance companies.

To automatically receive these articles in your in box, you can sign up on my blog at http://fredreish.com/insight/. Just enter your name and email address under the “sign up for our e-newsletter” option, and click on the button to subscribe.

 The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

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Best Interest Standard of Care for Advisors #3

SEC Best Interests . . . When? And What About the DOL

I am writing two series of articles that together are called “The Bests.” One is about Best Practices for plan sponsors, while the other is about the Best Interest Standard of Care for advisors. Each series is numbered separately to make it easier to identify the subject that is most relevant to you.

This is the third of the series about the Best Interest Standard of Care.

The Regulatory Agendas for the SEC and DOL were recently issued. Both have plans for guidance by September of 2019, but the anticipated timing of the guidance has, by and large, been misinterpreted. To understand what I mean, read on.

The SEC’s Agenda said that Final Action on the Regulation Best Interest proposal for broker-dealers and the Interpretation of Standard of Conduct for investment advisers would be “09/00/2019.”

Similarly, the Department of Labor Agenda said that there would be a final rule on the “Fiduciary Rule and Prohibited Transaction Exemptions” with the date of “09/00/2019.”

Let’s start with the dates. For those inclined towards conspiracy theories, it was interpreted to mean that the DOL and SEC were conspiring to issue combined and comprehensive new fiduciary/best interest rules. But, that doesn’t make any sense. While the two regulators are certainly communicating with each other, that doesn’t mean that there is behind-the-scenes plotting and planning.

Another interpretation was that the SEC and DOL were both going to issue guidance in September 2019. But that’s not right either. This is the short term agenda for the government fiscal year that ends in September, 2019. The September dates just mean that both regulators are planning on getting out their guidance during the upcoming government fiscal year.

Here’s my bet on what the dates will really be. Based on meetings with the SEC, it appears that Reg BI and the RIA Interpretation are moving along towards completion. That probably means that the final rules will be completed near the end of the first quarter or early in the second quarter of 2019. There will then be a delayed implementation date. That could be January 1, 2020, or even later, e.g., one year after the final rule is published.

As a word of warning, though, the SEC takes the position that most of the guidance in the RIA Interpretation reflects the Commission’s view of the current requirements for RIAs. There are only three true proposals in the Interpretation and none of those deal with the standard of care.

What about the DOL? I believe that the DOL’s guidance will be sequential rather than concurrent. By that I mean that the DOL’s guidance will probably be, to a large degree, based on the SEC’s final rules. As a result, their guidance will follow the SEC’s, rather than being released at the same time.

I think the DOL guidance will, at the least, include a new class exemption to cover prohibited transactions resulting from nondiscretionary fiduciary investment advice. It would replace the joint DOL/IRS non-enforcement policy (Field Assistance Bulletin 2018-02). My best guess is that it would include, as some of its conditions, compliance with parts of Reg BI and perhaps even the RIA Interpretation. But, I think that it will also include the Impartial Conduct Standards, that is, adhering to the DOL’s best interest standard, receiving no more than reasonable compensation, and making no materially misleading statements.

It’s less clear what the DOL plans to do about the fiduciary rule. There may be nothing. On the other hand, there may be some tinkering, for example, saying that a fiduciary under the securities law is also a fiduciary under ERISA. That would obviously cover RIAs. However, I don’t see any possibility that the Department would re-propose the vacated Fiduciary Rule or anything close to it.

Caveat: The future in unknowable. The educated guesses in this article are just that . . . “guesses.” But they are educated by experience and information. Don’t take them to the bank, but don’t toss them out either.

To automatically receive these articles in your in box, you can sign up on my blog at http://fredreish.com/insight/. Just enter your name and email address under the “sign up for our e-newsletter” option, and click on the button to subscribe.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

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Best Interest Standard of Care for Advisors #2

I am writing two series of articles that together are called “The Bests.” One is about Best Practices for plan sponsors, while the other is about the Best Interest Standard of Care for advisors. Each series is numbered separately to make it easier to identify the subject that is most relevant to you.

This is the second of the series about the Best Interest Standard of Care.

In my last post, I discuss the remarkable similarities among the SEC’s proposed Regulation Best Interest, the SEC’s proposed Interpretation for investment advisors, the DOL’s Best Interest standard of care (which is a combination of ERISA’s prudent man rule and duty of loyalty), and the New York State Best Interest standard for sales of annuities and insurance products. All of those rules require that advisors act with care, skill, prudence and diligence, and that they place the interests of the investor ahead of their own.

In the first post, I conclude that the Best Interest standard requires the following:

  • A careful and skillful professional process measured by the objective standard of a knowledgeable and experienced advisor; and
  • A duty of loyalty to the investor.

This post discusses the type of process that would satisfy the Best Interest standard for all of those rules. However, since the process is not well defined (other than in guidance under ERISA), some of the suggestions in the post may, in fact, be Best Practices. Let me define that term. “Best Practices” means that the advisor is doing more than is required by the law. While Best Interest may be required, Best Practices is not; it is voluntary. As a result, Best Practices are for advisors who desire to excel, while Best Interest is for advisors who want to be compliant.

In my view, a combination of Best Interests and Best Practices suggests that advisors should use the following process:

  • Gather the information that is relevant to providing Best Interest advice. (“Relevant” means the information that is necessary to develop a recommendation that is appropriate for the investor. A synonym in this circumstance would be “material” information. If information about the needs and circumstances of the investor could affect the recommendation, then it is material and relevant).
  • Consider the types of investments (and insurance products) and strategies that are appropriate for the investor based on the analysis of the investor’s profile (that is, based on analysis of the relevant information). In effect, this step is the formulation of a strategy for the investor based on the products and services available to the advisor. While there may be some flexibility if the advisor only has access to limited types of products, that flexibility is limited, in the sense that any recommendation will still be measured by the Best Interest standard of care.
  • Select the particular investments, insurance products and services that will be recommended to the investor, that is, that will populate and implement the investment strategy. As the SEC said in its proposed guidance, while cost and compensation are not the only factors to be considered, their significance is enhanced under the SEC proposals. In other words, they are major considerations. Another obvious important consideration is the quality of the product. That includes the “management” of the product, for example, the investment advisor for a mutual fund, the investment manager for an investment service, and the insurance company issuing an annuity contract or life insurance policy.

I suspect that, if an advisor gets into trouble because of his or her recommendations, it will be the result of an inappropriate (and perhaps unsuitable) strategy, excessive costs and compensation, or inferior quality of the “manager” of the product.

That begs the question of, how does an advisor demonstrate a Best Interest process? Other than for the DOL and ERISA plans, there is not a requirement to maintain documentation of the process. However, it probably goes without saying that a well-documented process is good risk management (and, for that matter, that a well-documented process is likely to be a prudent process).

In the next year or two, the SEC may enhance its guidance to further define the processes that are needed to satisfy its Best Interest standard. More certainly, though, the SEC, FINRA, DOL and New York State regulators will, in due course—perhaps over the next three years or so—begin their enforcement activities. Unfortunately, it’s possible that we may see “regulation by enforcement,” meaning that the holes in the guidance are filled in by the enforcers, rather than the regulators.

To automatically receive these articles in your in box, you can sign up on my blog at http://fredreish.com/insight/. Just enter your name and email address under the “sign up for our e-newsletter” option, and click on the button to subscribe.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

 

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Best Interest Standard of Care for Advisors #1

What is the Best Interest Standard of Care?

I am writing two series of articles that together are called “The Bests.” One is about Best Practices for plan sponsors, while the other is about the Best Interest Standard of Care for advisors. Each series is numbered separately to make it easier to identify the subject that is most relevant to you.

This is the first of the series about the Best Interest Standard of Care.

For this inaugural article, let’s talk about the meaning of “Best Interest.”

There are at least four Best Interest standards. (While “best interest” can also refer to management of conflicts of interest, this article is about the best interest standard of care.)

  • ERISA’s best interest standard of care for plan sponsors and fiduciary advisors for private sector retirement plans. (While ERISA doesn’t literally have a best interest standard—because the Best Interest Contract Exemption was vacated by the 5th Circuit Court of Appeals, that best interest standard was a combination of ERISA’s prudent man rule and duty of loyalty which, of course, are still in the law. As a result, I will use the term to refer to the combination of ERISA’s prudent man rule and duty of loyalty.)
  • The SEC’s proposed best interest standard for broker-dealers in its Regulation Best Interest.
  • The best interest standard in the SEC’s proposed “Interpretation” for investment advisers.
  • The New York State Best Interest standard for recommendations of life insurance policies and annuity contracts.

Let’s look at how each of those are defined.

  • The ERISA Best Interest Standard for Retirement Plans (copied from the Best Interest Contract Exemption):

Investment advice is in the ‘‘Best Interest’’ of the Retirement Investor when the Adviser and Financial Institution providing the advice act with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, without regard to the financial or other interests of the Adviser, Financial Institution or any Affiliate, Related Entity, or other party.

  • The SEC’s Proposed Best Interest Standard for Broker-Dealers:

The best interest obligation . . . shall be satisfied if: The broker, dealer, or natural person who is an associated person of a broker or dealer, in making the recommendation exercises reasonable diligence, care, skill, and prudence to:… Have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer based on that retail customer’s investment profile and the potential risks and rewards associated with the recommendation; . . .

A broker, dealer, or a natural person who is an associated person of a broker or dealer, when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer, shall act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker, dealer, or natural person who is an associated person of a broker or dealer making the recommendation ahead of the interest of the retail customer.

  • The SEC’s Proposed Best Interest Standard for Investment Advisers:

The SEC proposal did not include a definition of best interest. However, the SEC proposal reaffirms that investment advisers are fiduciaries for their clients and includes the best interest standard as a part of the RIA fiduciary duty. It seems inconceivable that the best interest standard for investment advisers would be lower than that same standard for broker-dealers. And, since the SEC uses the same label—“best interest”—for both investment advisers and broker-dealers, the likelihood is that the standard is the same. (In some ways, though, those best interest rules are different, for example, the RIA best interest standard applies to a much wider range of advice and includes monitoring.)

  • The New York State Best Interest Standard:

The producer, or insurer where no producer is involved, acts in the best interest of the consumer when . . .

the producer’s or insurer’s recommendation to the consumer reflects the care, skill, prudence, and diligence that a prudent person acting in a like capacity and familiar with such matters would use under the circumstances then prevailing. Only the interests of the consumer shall be considered in making the recommendation. The producer’s receipt of compensation or other incentives permitted by the Insurance Law and the Insurance Regulations is permitted by this requirement provided that the amount of the compensation or the receipt of an incentive does not influence the recommendation; and . . .

I have highlighted language in each of the definitions. My purpose is to emphasize how similar the standards are. All of the Best Interest standards seem to require a process. That is, how can an advisor be careful, skillful, prudent and diligent without engaging in a process? In my view, there are several steps to that process. The first is determining the needs and circumstances of the investor; the second is evaluating the investment or insurance strategies in light of those needs; and the third is a consideration of the costs and quality of the investment and insurance products that are being considered. The gathering and analysis of that relevant information must be done carefully and skillfully based on a hypothetical knowledgeable and experienced advisor. In other words, the standard is not the ability of a particular advisor, but instead the industry expectations of professional advisors. The evaluation and performance of the advisor is based on that objective standard.

In addition, each of the definitions requires that an advisor place the interests of the investor ahead of the interests of the advisor. The Best Interest standard imposes a duty of loyalty on the advisor.

“Best Interest” does not mean that an advisor must pick the best investment or insurance product. However, it does impose a higher duty than suitability in the development of recommendations, and it may prove to be more demanding than many people expect. It does mean that quality and costs are more significant considerations than they are under the suitability standard.

To automatically receive these articles in your in box, you can sign up on my blog at http://fredreish.com/insight/. Just enter your name and email address under the “sign up for our e-newsletter” option, and click on the button to subscribe.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

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