Best Interest Standard of Care for Advisors #27

Regulation Best Interest, RIA Interpretation and Consideration of “Account Types” (Part 3)

The SEC has issued its final Regulation Best Interest (Reg BI), Form CRS Rule, 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.”


Regulation Best Interest (Reg BI) and the Interpretation Regarding Standard of Conduct for Investment Advisers (RIA Interpretation) require that broker-dealers  and investment advisers evaluate the “account types” their firms offer—in light of the investor’s investment profile—to make a best interest recommendation. In other words, both types of firms, and their advisors, must first consider the account type that is appropriate for the investor.

The first two parts of this series (Best Interest for Advisors #25 and #26) discussed the requirement to recommend the account type that is in the best interest of the investor, what “account type” means, and how the duty differs among broker-dealers, investment advisers and dual registrants. This article discusses the SEC guidance on how to satisfy the Care Obligation for considering which account types are in the best interest of investors.

In Reg BI, the SEC explained the process to be used by broker-dealers. However, there doesn’t seem to be any meaningful difference in how the rule applies to broker-dealers and investment advisers. As a result, investment advisers should use a similar process.

The SEC discussed the general requirement in the Adopting Release:

Thus, the Care Obligation will require a broker-dealer to have a reasonable basis to believe that a recommendation of a securities account type (e.g., brokerage or advisory, or among the types of accounts offered by the firm) is in the retail customer’s best interest at the time of the recommendation and does not place the financial or other interest of the broker- dealer ahead of the interest of the retail customer.

The Adopting Release goes on to explain the process:

We believe broker-dealers would need to consider various factors in determining whether a particular account is in a particular retail customer’s best interest. For example, broker-dealers generally should consider: 

(1) The services and products provided in the account (ancillary services provided in conjunction with an account type, account monitoring services, etc.); 

(2) the projected cost to the retail customer of the account;

(3) alternative account types available; 

(4) the services requested by the retail customer; and 

(5) the retail customer’s investment profile. 

Comment:  Simply stated, an advisor needs to consider (i) the investor’s profile and requests, and compare them to (ii) the available accounts, and the products, services and costs in those account types. That comparison and analysis should produce a recommendation of the account type that is in the best interest of the investor.

The SEC also explains that, in performing the assessment, the weight to be given to the various factors will be customer-specific and must be considered in light of the particular investor.

Moreover, retail customer-specific factors, such as those identified in the definition of ‘‘Retail Customer Investment Profile,’’ may not be applicable or available in every context, and would depend on the facts and circumstances at the time of account type recommendation. For example, one or more factors may have more or less relevance, or information about those factors may not be obtained or analyzed at all where the broker-dealer has a reasonable basis for believing that a particular factor is or is not relevant.

Comment:  This is very much a principles-based approach, as opposed to a rules-based method. As a result, compliance will be evaluated on the basis of the process used to reach a recommendation. For example, were the relevant factors considered; is the weight given to the factors reasonable in light of the particular investor’s profile and requests; and does the decision reflect a reasonable analysis of those factors.

The SEC goes on to explain, in the Adopting Release for Reg BI:

Where the financial professional making the recommendation is dually registered (i.e., an associated person of a broker-dealer and a supervised person of an investment adviser (regardless of whether the professional works for a dual-registrant, affiliated firms, or unaffiliated firms)) the financial professional would need to make this evaluation taking into consideration the spectrum of accounts offered by the financial professional (i.e., both brokerage and advisory taking into account any eligibility requirements such as account minimums), and not just brokerage accounts.

The SEC then gives an example of that requirement:

For example, all other things being equal, it may be in the retail customer’s best interest to recommend a brokerage account to the retail customer who intends to buy and hold a long-term investment (e.g., maintain an account primarily composed of bonds or mutual funds and has a stated buy-and-hold strategy), as opposed to an advisory account (i.e., it may not be in the retail customer’s best interest in this context to pay an ongoing fee for a security that he or she plans to hold to maturity).

Comment:  As this makes clear, an advisor must consider the investor’s needs, always taking into account the cost, and then make a “best interest” recommendation. While cost is not necessarily the determining factor, it can be . . . and in this case was. Good risk management suggests that, if a more expensive account type is recommended, there be specific factors about the account type that overrides the cost differential.

Generally speaking, it’s a good idea to document the process and why the recommendation was made. For example, the SEC said:

As discussed above, where a broker-dealer determines not to obtain or analyze one or more of the factors specifically identified in the definition of ‘‘Retail Customer Investment Profile,’’ the broker-dealer generally should document its determination that the factor(s) are not relevant components of a retail customer’s investment profile in light of the facts and circumstances of the particular recommendation.

In my next article, I will give additional examples of how the SEC says that this requirement applies.

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.

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