Ever since the Securities and Exchange Commission came out with its own proposed suitability standard for financial advice in April, the benefit industry has been trying to pick it apart and figure out what broker-dealers and registered investment advisers would have to do to comply with the proposal’s regulation best interest concept.
Regulation best interest requires anyone who advises retail investment accounts to follow a standard of care that falls short of the Department of Labor’s fiduciary rule, which was recently vacated by the Fifth Circuit Court of Appeals.
The big takeaway is that the proposed SEC rules probably don’t apply to advice given to retirement plan sponsors but would apply to advice given to participants in a workplace plan, especially as it pertains to rolling over their retirement accounts into an individual retirement account.
The SEC’s work was mandated by the Dodd-Frank Wall Street Reform Act in July 2010, which asked the SEC to conduct a study on the regulatory standard of care for broker-dealers and investment advisers for providing personalized investment advice and recommendations about securities, says Sandy Grannum, a partner at Drinker Biddle & Reath LLP in New York City and chair of the law firm’s broker-dealer and FINRA group.
In 2011, the SEC completed its report and found that there was public confusion around that standard of care. It recommended a uniform standard of conduct for brokers, dealers and investment advisers when recommending securities to retail customers, saying they should act in the best interest of the customer without regard to the financial interests of the broker-dealer or adviser providing the advice.
Unfortunately, the SEC wasn’t able to come to a consensus on those concepts at that time. In April, the SEC released its proposed rule targeted at broker-dealers and persons associated with broker dealers, investment advisers and the documentation required when dealing with retail clients.
Before the SEC released its proposal, it was reported that the commission was leaning toward a suitability-plus standard for the broker-dealer industry, says Tracey Salmon-Smith, a partner in Drinker Biddle’s broker-dealer and FINRA group. “Something more robust than the current standard in place, but the proposal doesn’t define best interest and lacks some clarity,” she says. “Regulation best interest puts a best interest standard of conduct on broker-dealers but not a standard that rises to the level of fiduciary duty.”
She points out that regulation best interest essentially copies FINRA’s Rule 2111, which is a suitability rule for broker-dealers that requires they have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer.
Drinker Biddle’s attorneys said they don’t believe the rules apply to giving advice to retirement plan sponsors, but they do apply to advice given to participants in a workplace retirement plan who are considering rolling over their assets from a 401(k) or 403(b) plan into an individual retirement account.
“If suitability-plus is the goal of the regulation, hopefully, when we get to the final rule, there will be an explanation of what the ‘plus’ is,” Salmon-Smith says. “But at this point, the rule is again incorporating a suitability standard for broker-dealers.”
Where the SEC’s proposed rulemaking gets confusing is that it uses much of the terminology that was part of the DoL’s fiduciary rule, without saying they want advisers to be fiduciaries.
In its rules regarding registered investment advisers, it says that advisers acting in this capacity must show a duty of care and a duty of loyalty to their clients, says Jim Lundy, a partner in Drinker Biddle & Reath’s Chicago office.
“Duty of care includes duty to make reasonable inquiry into a client’s financial situation, investment experience and objectives and a duty to personalize advice that is suitable and in the best interest of their client. It brings together what we see in regulation best interest and the suitability type aspects of the rule,” he says.
Lundy believes that the SEC’s staff members need to go back and make sure that the rules governing broker-dealers are just as clear and understandable as their guidance regarding RIAs.
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