SEC Weighs In on Fiduciary Investment Advice

In financial services industry news circles, the discussion surrounding fiduciary standards for investment advisors and broker/dealers is not new. The years-long saga of the U.S. Department of Labor’s (DOL) Best Interest Contract exemption—a proposed rule that was conceived to address conflicts of interest in providing investment advice—dominated headlines through its ultimate demise in March 2018. And now, the Securities and Exchange Commission (SEC), the government agency that is responsible for protecting investors, has unveiled its own much-anticipated fiduciary rule that governs both the retail investment and employer-sponsored retirement plan marketplaces.

The SEC’s rule, called Regulation Best Interest (or Reg BI, as it is frequently referred to) received a favorable 3–1 vote on June 5, 2019. According to an SEC press release announcing the vote, the commission will install a “package of rulemakings and interpretations designed to enhance the quality and transparency of retail investors’ relationships with investment advisers and broker-dealers.” Reg BI was essentially created to establish a new fiduciary standard for investment advisors and broker/dealers, many of which offer investment advice services to employer-sponsored retirement plans and the participants who hold accounts within those plans.

Potential Impact to Retirement Plans
A critical provision of Reg BI covers how investment advice is furnished to owners of retirement accounts, in particular 401(k) accounts. It includes when advisors suggest rolling over assets from a workplace retirement plan to an IRA, as well as when they recommend distributing assets from a 401(k) account. Under Reg BI, such advice must be given in the client’s best interest and include the following obligations:

Disclosure obligation. Material facts must be disclosed about the broker/dealer-client relationship and recommendations, including specific disclosures about the capacity in which the broker is acting, fees, the type and scope of services provided, conflicts, limitations on services and products, and whether the broker/dealer provides monitoring services.

Care obligation. Broker/dealers must exercise reasonable diligence, care, and skill when making a recommendation to a retail customer. They must understand potential risks, rewards, and costs associated with the recommendation. Then they must consider these factors in light of the retail customer’s investment profile and make a recommendation that is in the customer’s best interest while also considering the costs of the recommendation.

Conflict of interest obligation. The broker/dealer must establish, maintain, and enforce written policies and procedures reasonably designed to identify and, at a minimum, disclose or eliminate conflicts of interest. This obligation specifically requires policies and procedures that are created to:

  • Mitigate conflicts that create an incentive for the firm’s financial professionals to place their interest or the interests of the firm ahead of the retail customer’s interest
     
  • Prevent material limitations on offerings, such as a limited product menu or offering only proprietary products, from causing the firm or its financial professionals to place their interest or the interests of the firm ahead of the retail customer’s interest
     
  • Eliminate sales contests, sales quotas, bonuses, and noncash compensation that are based on the sale of specific securities or specific types of securities within a limited period of time

Compliance obligation. Broker/dealers must establish, maintain, and enforce policies and procedures reasonably designed to achieve compliance with Reg BI as a whole.

Next Steps
Firms must comply with Reg BI starting on June 30, 2020. Industry experts have warned, however, that, similar to the precursor DOL Conflict of Interest rule, Reg BI is likely to garner significant partisan political resistance and could face legal challenges. The DOL has also signaled its intention to author its own version of a new fiduciary rule, in concert with the SEC, that will align with Reg BI’s mandates (although those efforts could be hindered by the recent resignation of Labor Secretary Alexander Acosta). It is important for retirement plan fiduciaries to keep a watchful eye on developments related to Reg BI and remember that the selection of service providers, such as financial advisors and broker/dealers, to provide investment recommendations must be approached with care and prudence.