SEC Staff Provide Advice on Standards of Conduct for Brokers and Investment Advisors for Accounts and Rollover Recommendations to Retail Investors | Goodwin
Staff of the United States Securities and Exchange Commission recently issued a newsletter recalling the standards of conduct applicable to broker-dealers and investment advisers when making account recommendations to retail investors. Brokers are subject to the Best Interest Regulation (Reg. BI). Investment advisers are subject to the fiduciary standard (IA fiduciary standard) under the Investment Advisers Act of 1940 (Advisers Act). The standards of conduct are separate, but in staff’s view, both “include the obligation to act in the best interests of the retail investor and not to put one’s own interests ahead of those of the retail investor. “. In particular, SEC staff believe that the two standards “produce substantially similar results in terms of the ultimate responsibilities owed to retail investors.”
The bulletin includes several questions and answers on this topic and sets out factors companies should consider before making account and rollover recommendations, cost considerations in account recommendations, and examples of practices that can help companies to fulfill their obligations in terms of managing conflicts of interest. associated with account recommendations. Here is a summary of staff opinions:
- Obligations of dual-licensed finance professionals when recommending accounts to potential retail investors
- Applicable standard of conduct: The required standard depends on the capacity in which the staff acts (ie broker, investment adviser or both). Since investment advisers must comply with the anti-fraud provisions of the Advisers Act in relation to current and potential clients, Reg. BI and Advisor Law may apply in many cases when dual licensed staff are evaluating an account type recommendation for current and potential retail investors.
- Capacity Disclosure: Brokers and investment advisers have an obligation to disclose all material facts relating to their relationship with retail investors, including the capacity in which a financial professional acts. If the capacity in which a financial professional will act has not been established, then before or at the time of the recommendation, financial professionals must inform the retail investor that both standards of conduct apply. Companies are expected to provide clear guidance to finance professionals through policies and procedures and other instructions on how to disclose capacity to retail investors.
- Consideration of reasonably available alternatives: Financial professionals of brokers and investment advisers must have a reasonable basis to believe that an account is in the best interests of a retail investor before making an account recommendation. This means that, subject to eligibility requirements, dual-licensed finance professionals must consider both brokerage accounts and retail investor advisory accounts when evaluating types. of accounts. Staff argues that finance professionals “cannot recommend an account that is not in the best interest of a retail investor based solely on [their] company’s limited product menu” or the limitations associated with their license. “Any limitations on the types of accounts considered, in the opinion of staff, are material facts that should be disclosed (along with other relevant material facts, including services, fees, and conflicts of interest) to retail investors.
- Factors to consider before making an account recommendation
- Establish a reasonable basis for an account recommendation: Both Reg. BI and the IA fiduciary standard require that a reasonable basis for an account recommendation be established based on “a reasonable understanding of the retail investor’s investment profile and account characteristics”. Therefore, a firm and its financial professionals are required to obtain and evaluate sufficient information about a retail investor to ensure that the recommendation is not based on materially inaccurate or incomplete information. See the table below for examples of characteristics to consider in order to establish a reasonable basis for believing that a recommendation is in the best interest of a retail investor.
- Information not available: Staff believe that firms and their financial professionals should generally decline to make account recommendations until sufficient information is obtained about a retail investor such that it is reasonable to believe that a account recommendation is in the best interest of the investor. If a company and its finance professionals “decide not to obtain or evaluate information that would normally be contained in an investor profile, staff believe [the firm] should consider documenting the basis of [its] belief that such information is not relevant in light of the facts and circumstances of the particular account recommendation. »
- Considering Costs in Account Recommendations
- Costs are always a relevant factor to consider when recommending an account. If a higher fee account is recommended, a financial professional must have a reasonable basis to believe that the account recommendation is in the retail investor’s best interest” based on other factors and in light the particular circumstances and needs of the retail investor”. Special features or other potential benefits should be considered along with the needs, investment objectives and preferences of the investor. See the table below for examples of costs to consider when recommending an account and other factors to consider in addition to cost. Notably, the SEC “has pursued lawsuits against investment advisers for recommending higher-cost products to clients when similar lower-cost products were available.”
- Retirement Account Rollover Recommendations
- Additional factors to consider when making a rollover recommendation in order to have a reasonable basis to believe that a recommendation is in the best interest of the retail investor. A financial professional must have a reasonable basis to believe that the rollover and recommended account is in the best interest of the retail investor. See the table below for specific factors to consider relevant to rollovers in light of the retail investor’s investment profile, among others. To the extent that a business is relying on the United States Department of Labor (DOL) Prohibited Transaction Exemption 2020-02, it should also consult the DOL’s guidance on factors to consider in making a recommendation. bearing and relevant documentation requirements.
- Leave retail investor investments in employer-sponsored plans. Staff believe that finance professionals should “consider the alternative of leaving [a] the retail investor’s investments in their employer’s plan, where it is an option”, in order to have a reasonable basis to believe that a rollover recommendation is in the best interest of the retail investor and does not not put the interests of the financial professional or the business before those of the retail investor. This means that businesses and their finance professionals will need to obtain information about a retail investor’s existing plan, including the costs associated with the options available in the investor’s current plan, in order to assess a recommendation of transferring assets out of an employer’s plan or between individual retirement accounts.
- Retail investor preference and impact on account recommendations
- Where a retail investor expresses a preference for a particular type of account, a financial professional must nonetheless have a reasonable basis to believe that the account recommendation is in the retail investor’s best interest based on an understanding reasonableness of the retail investor’s investment profile and account characteristics, among others. While a retail investor’s preference should be considered, reasonably available alternatives should also be evaluated in order to reasonably believe that a recommendation is in the retail investor’s best interest. Staff believe that a company and its financial professionals “would not be required to refuse to accept [an] direction of the investor” to open an account contrary to the recommendation of a financial professional. Staff seem to draw a distinction between an investor’s preference and an investor’s instructions. Firms and their finance professionals should ensure that the rationale for opening an account for a retail investor is properly documented, including whether a retail investor has expressed an account preference or provided a directive/ instruction.
- Firm documentation of account recommendation base
- Staff have stressed throughout the bulletin the importance of documenting the basis for recommendations, not only to be able to periodically assess the adequacy and effectiveness of policies and procedures, but also to demonstrate compliance with retail investors. This is particularly interesting given that in Reg. BI adopting the publication, the SEC “determined not to require broker-dealers to document the basis of any recommendation,” but instead encouraged broker-dealers to take a risk-based approach when deciding to document certain recommendations. The SEC has not addressed these documentation requirements/suggestions for investment advisers. Both Reg. BI and the Advisors Act require that written compliance policies and procedures be established, maintained and enforced, and that they are reasonably designed to ensure compliance with Reg. BI, in the case of brokers, to prevent violations of the Advisors Act, including the IA fiduciary standard, in the case of investment advisors.
- Examples of practices that can help companies meet their obligations to address conflicts of interest associated with account referrals
- The table below includes a non-exhaustive list of practices that companies can consider. In particular, staff strongly encourage companies to eliminate or mitigate any incentives that may encourage account recommendations that would put the interests of the company or its financial professionals ahead of those of a retail investor. Notably, the SEC settled an enforcement action regarding compensation incentives for financial professionals making account recommendations.
. Staff noted in the bullet point that “it can be difficult for a company to periodically assess the adequacy and effectiveness of its policies and procedures or demonstrate compliance with its obligations to retail investors without documenting the basis of certain recommendations.