Category Archives: SEC

Best Interest Standard of Care for Advisors #12

Regulation Best Interest: An Overview of the Changes.

The SEC has issued its final Regulation Best Interest (Reg BI), Form CRS Regulation, RIA Interpretation and Solely Incidental Interpretation. I am discussing the SEC’s guidance in a series of articles entitled “Best Interest Standard of Care for Advisors.”


The SEC’s Reg BI establishes a best interest standard of care for investment recommendations to retail customers by broker-dealers and their registered representatives. In addition, Reg BI requires new disclosures and mitigation of advisor’s financial conflicts of interest. The SEC also issued an Interpretation of the Standard of Conduct for Investment Advisers, which clarified the SEC’s position on a number of issues related to the fiduciary standard and conflicts of interest for RIAs. There were two other pieces of guidance: the Form CRS Regulation (which requires a simplified front-end disclosure by broker-dealers and investment advisers); and the Solely Incidental Interpretation for limited discretion and monitoring of accounts by broker-dealers.

A starting point for understanding the requirements of Reg BI (which are applicable on June 30, 2020) is to compare it to existing standards, e.g., the suitability rule. In its release for the final regulation, the SEC did just that. Here it is in the SEC’s words (with my comments added):

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Best Interest Standard of Care for Advisors #11

Regulation Best Interest: An Overview of the Requirements

The SEC has issued its final Regulation Best Interest (Reg BI), Form CRS Regulation, RIA Interpretation and Solely Incidental Interpretation. I am discussing the SEC’s guidance in a series of articles entitled “Best Interest Standard of Care for Advisors.”

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The SEC’s Reg BI establishes a best interest standard of care for investment recommendations to retail customers by broker-dealers and their registered representatives. In addition, Reg BI requires new disclosures and mitigation of advisor’s financial conflicts of interest. The SEC also issued an Interpretation of the Standard of Conduct for Investment Advisers, which clarified the SEC’s position on a number of issues related to the fiduciary standard and conflicts of interest for RIAs. There were two other pieces of guidance: the Form CRS Regulation (which requires a simplified front-end disclosure by broker-dealers and investment advisers); and the Solely Incidental Interpretation for limited discretion and monitoring of accounts by broker-dealers.

My last two posts, Best Interest for Advisors #9 and #10, focused on the requirement in Reg BI that a recommendation to a retail customer must include consideration of the cost of the investment or strategy. I started with that issue because I believe that it will be highly impactful over the long run. However, this article starts at the beginning . . . an overview of the changes made by Reg BI. In the release to the final regulation, the SEC explained Reg BI’s requirements (applicable on June 30, 2020):

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If The SEC Is Telling You To Ask Your Financial Advisor These Questions, You Probably Should

The SEC has issued a four-part rules package for broker-dealers and investment advisers that includes the new Form CRS Regulation. The regulation requires broker-dealers and investment advisers to give short disclosure documents to all customers and potential customers beginning June 30, 2020.

The rule also requires that the new disclosure document provide investors with a series of questions that they should ask their adviser. Don’t you think you should know what those questions are . . . before you’re asked? The questions and my comments are in an article I wrote for my Forbes blog.

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Best Interest Standard of Care for Advisors #8

Senior Clients: The SEC is looking at practices of RIAs

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 eighth of the series about Best Interest Standard of Care for Advisors.

The SEC has initiated examinations of investment advisers concerning their practices in working with Senior Clients. According to the SEC, a “ ‘Senior Client’ is defined as any retail advisory client who is age 62 or older, retired, or transitioning to retirement, including accounts of deceased clients, and retail clients in joint accounts with at least one individual meeting this definition.”

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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.

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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).

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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.

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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.”

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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.

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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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