SEC’s Reg BI Adds Unexpected Fiduciary Hurdle for Retirement Advisors

Regulation Best Interest (or “Reg BI”, as it is often referred to) is officially here, and along with it comes a new regime of fiduciary level compliance requirements that will apply to certain broker-dealers and investment advisors.

While many advisors who provide retirement-related advice may be inclined to gloss over the new rule, the DOL has indicated that its forthcoming revamped fiduciary rule will follow along the same lines as the SEC rule—meaning that nearly all advisors will soon need to become familiar with a fairly uniform set of principles. Importantly, Regulation Best Interest unexpectedly will apply to some retirement plan rollover transactions, so that understanding these new rules will be critical to advisors who provide clients with certain rollover-related advice.

What Is Regulation Best Interest?

Under Regulation Best Interest, certain broker-dealers and other investment advisors are now required to eliminate conflicts of interests, or are required to disclose those conflicts on a new Form CRS and take steps to mitigate the impact of those conflicts. Form CRS is a short—no more than four-page—summary detailing the relationship between the advisor and client, the applicable standard of conduct under Reg-BI and the fees and compensation structure generally associated with the relationship. Form CRS must also contain a section detailing the firm’s disciplinary history and direct the client where to look for additional relevant information.

In many cases, broker-dealers and investment firms will have to reevaluate their compensation structures in order to eliminate certain contests, quotas and other rewards that encourage advisors to promote a certain security or class of securities without real consideration of whether the particular transaction is in the client’s best interest.

To comply with the rule, broker-dealers must conduct a reasonable analysis to first understand the potential risks and rewards associated with any given transaction or recommendation involving securities. In order to make a recommendation to the client, that analysis must conclude that the particular transaction or series of transactions is in the client’s best interests.  Further, in considering all costs and benefits of a transaction, the broker-dealer must have a reasonable basis to believe that the transaction does not put the advisor’s own best interests ahead of the client’s interests.

Regulation Best Interest also—and surprisingly–clearly states that this best interest standard will now apply to advisors who provide recommendations with respect to rollovers from employer-sponsored retirement plans into IRAs.

Application to Retirement Plan Rollover Transactions

Advisors who make recommendations regarding rollover of retirement assets will now be required to comply with Regulation Best Interest and establish that the rollover was in the client’s best interest.

Establishing that the rollover transaction was in the client’s best interests can be accomplished in a number of ways, including by showing that the advisory services provided by the advisor with respect to the rollover IRA add value as a tool for meeting the client’s goals. This may be the case even if the fees associated with the IRA are higher than those in the employer plan, as the rule clearly states that fee levels are not the only relevant consideration.  In other situations, investment options or investment mix in the rollover IRA may better suit the client’s goals.

Generally, broker-dealers who make rollover recommendations must consider several non-exhaustive factors listed in the rule itself, including: (1) fees and expenses, (2) available services in both plans, (3) available investment options, (4) availability of penalty-free withdrawals from the accounts, (5) how required minimum distribution (RMD) rules can impact the client’s goals, (6) whether the plan provides any level of creditor protection, (7) whether the plan permits holding of employer stock, and (8) any additional special features of the initial account.

As the rule stands, it seems that there may be much ambiguity in the analytic process that advisors must now undertake to determine whether the rollover transaction is in any given client’s best interests. Ultimately, the SEC may provide additional guidance on the best interest standard with respect to rollovers.  In the alternative, the SEC’s eventual enforcement of the rule may provide clarity for advisors.

Conclusion

Although the contours of the DOL’s response to Regulation Best Interest—and follow up to their original fiduciary rule—are currently unknown, DOL officials have indicated that their rule will correspond to the SEC rule. Therefore, while the current SEC rule may not apply to all retirement plan advisors, most should expect to become subject to a similar rule in the coming months.

• Read previous coverage of the DOL fiduciary rule in Advisor’s Journal.
• For in-depth analysis of the prohibited transaction rules, see Advisor’s Main Library.
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