Regulation Best Interest: Education vs. Recommendation (Rollovers Part 2)

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.”

In my last post, Best Interest for Advisors #15, I discussed the “best interest” standard for broker-dealers and their advisors and how it applies to rollover recommendations. (Keep in mind that Reg BI doesn’t apply until June 30, 2020.)

Until then the suitability standard applies and it only covers recommendations that involve securities transactions, for example, recommendations to rollover from a 401(k) plan, which requires that a participant liquidate the securities in his 401(k) account. When Reg BI applies, all rollover recommendations from all plans (e.g., including pension plans—where the participant doesn’t liquidate investments in order to rollover and non-ERISA plans, such as government plans).

The key word is “recommendation.” If the broker-dealer and its advisors educate and provide information, but don’t recommend that the participant rollover his money, the best interest standard doesn’t apply. In other words, the SEC, much like the DOL and FINRA, agrees that education is not a recommendation. Of course, if the educational conversations and materials are biased towards a rollover, it could be viewed as a disguised recommendation. That will be gauged, at least partially, by the written materials provided to the participant, the training materials for advisors, and the scripts, if any, that are given to the advisors.

The SEC discussed the possibility that “education” can cross the line and become a recommendation in a footnote:

“While this descriptive information would be treated as ‘‘education’’ rather than a ‘‘recommendation,’’ we caution broker-dealers to ensure that communications by their associated persons intended as ‘‘education’’ do not cross the line into ‘‘recommendations.’’ See FINRA Regulatory Notice 13–45.”

The SEC amplified on that concept by saying:

“See FINRA Regulatory Notice 11–25, Know Your Customer and Suitability—New Implementation Date for and Additional Guidance on the Consolidated FINRA Rules Governing Know-Your-Customer and Suitability Obligations (May 2011) at FAQ 9 (‘‘It is important to note, however, that the suitability rule would not apply to a firm’s explanation of a strategy falling outside the safe-harbor provision if a reasonable person would not view the communication as a recommendation. Accordingly, the suitability rule would cover a firm’s recommendation that a customer purchase securities using margin, whereas the rule generally would not cover a firm’s brochure that simply explains the risks and benefits of margin without suggesting that the customer take action.’’).”

As the highlighted language suggests, a brochure or other written materials, if properly done, would support a finding that the communications were education and information and not recommendations.

The threshold decision for broker-dealers is whether to allow rollover recommendations or whether to limit their advisors to providing education. I have broker-dealer clients that are allowing recommendations and others that only permit education. The key is to consider the pros and cons of those alternatives, and then to develop the systems, training and supervision to support the decision.

Needless to say, that is a difficult decision to make. Some of my broker-dealer clients have opted for the educational approach because of the difficulty of obtaining and evaluating the information required for making a rollover recommendation. But most have decided to allow rollover recommendations and are developing (or acquiring) systems to help obtain and evaluate the necessary data. For a discussion on the information needed for the best interest rollover analysis, see Best Interest for Advisors #15.

My next article will cover the SEC’s discussion of education and information, as opposed to recommendation.

The material contained in this communication is informational, general in nature and does not constitute legal advice. The material contained in this communication should not be relied upon or used without consulting a lawyer to consider your specific circumstances. This communication was published on the date specified and may not include any changes in the topics, laws, rules or regulations covered. Receipt of this communication does not establish an attorney-client relationship. In some jurisdictions, this communication may be considered attorney advertising.

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