Regulation Best Interest, RIA Interpretation and Consideration of “Account Types” (Part 4)

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.”

In my last three posts (Best Interest for Advisors #25, #26 and #27), I have discussed the SEC guidance for broker-dealers and investment advisers about recommendations of “account types.” The articles explained that investment advisers are subject to the best interest standard for recommending account types (since July of last year) and broker-dealers will be subject to the new best interest rules for recommending account types beginning June 30 of this year. Those articles discussed the rule, the definition of account types, and the process required to evaluate account types.  This article discusses examples given by the SEC about the application of the best interest standard when considering account types.

Let’s pick up near the end of my last article, where I quoted from the SEC’s discussion 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. 

Comment: In other words, a dually registered advisor must consider all of the reasonably available account types offered by the broker-dealer and the RIA firm even if those two firms are not related. And, of course, the dually registered advisor must recommend the account type that is in the best interest of the investor. (I use “investor” in this article to mean any client of an investment adviser and retail customers of broker-dealers.)

The SEC then gives these examples:

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).  

On the other hand, it may not be in the retail customer’s best interest to recommend a brokerage account where the retail customer plans to engage in at least a moderate level of trading and prefers to pay for advice in connection with such trading on the basis of a consistent recurring monthly or annual charge.  

Furthermore, where a retail customer holds a variety of investments, or prefers differing levels of services (e.g., both episodic recommendations from a broker-dealer and continuous advisory services including discretionary asset management from an investment adviser), it may be in the retail customer’s best interest to recommend both a brokerage and an advisory account.

Comment: Thus, the needs of the investor dictate the account type, but where there is more than one account type that could match those needs, other factors, such as costs, must be considered. And, of course, if the expenses of a particular account type are so high that another account type with lower expenses would better accommodate the objectives of the investor, the expenses could be a deciding factor.

The SEC then gives an example of an advisor who is not dually registered:

Similarly, where the financial professional is only registered as an associated person of a broker-dealer (regardless of whether that broker-dealer entity is a dual-registrant or affiliated with an investment adviser), he or she would need to take into consideration only the brokerage accounts available.  However, even if a broker-dealer only offered brokerage accounts, the associated person would nevertheless need to have a reasonable basis to believe that the recommended account was in the best interest of the retail customer.

For example, if the retail customer were seeking a relationship where the financial professional would have unlimited investment discretion (i.e., having responsibility for a customer’s trading decisions), the associated person would not have a reasonable basis to believe that a brokerage account was in the best interest of the retail customer. Thus, as with limited product menus, a limited selection of account types would not excuse a broker-dealer from making a recommendation not in the best interest of the retail customer.

Comment: In other words, if an advisor only represents a broker-dealer, and the broker-dealer does not have an account type that meets the needs of the investor (based, e.g., on the investor’s profile), the advisor cannot recommend other account types offered by the broker-dealer and must inform the investor that the advisor’s firm doesn’t have a type of account that corresponds to the investor’s needs and objectives. Of course, the reverse is also true. If an advisor, who only represents an RIA doesn’t have a “best interest” account type for a particular investor, that must be acknowledged.

Concluding Thoughts: The application of the best interest standard to the recommendation of account types is new. Broker-dealers and investment advisers need to identify all of their account types and then develop policies, procedures, training and supervision to reasonably implement this new requirement.

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.