Best Interest Standard of Care for Advisors #25
Tuesday, February 25, 2020

Regulation Best Interest, RIA Interpretation and Consideration of “Account Types” (Part 1)

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.”


Regulation Best Interest (Reg BI) and the Interpretation Regarding Standard of Conduct for Investment Advisers (RIA Interpretation) require that broker-dealers  and investment advisers evaluate the account types their firms offer—in light of the investor’s investment profile—to make a best interest recommendation. In other words, both types of firms, and their advisors, must first consider the account type that is appropriate for the investor. That raises the obvious question of “What is an account type?”

Before answering that question, let’s look at what the SEC said about the need to consider account types as a part of a best interest process.

First, the SEC requires in Reg BI that broker-dealers:

A broker, dealer, or a natural person who is an associated person of a broker or dealer, when making a recommendation of any securities transaction or investment strategy involving securities (including account recommendations) to a retail customer, shall act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker, dealer, or natural person who is an associated person of a broker or dealer making the recommendation ahead of the interest of the retail customer.

Then, in the RIA Interpretation for investment advisers, the SEC explained:

An adviser’s fiduciary duty applies to all investment advice the investment adviser provides to clients, including advice about investment strategy, engaging a sub-adviser, and account type. Advice about account type includes advice about whether to open or invest through a certain type of account (e.g., a commission-based brokerage account or a fee-based advisory account) and advice about whether to roll over assets from one account (e.g., a retirement account) into a new or existing account that the adviser or an affiliate of the adviser manages. In providing advice about account type, an adviser should consider all types of accounts offered by the adviser and acknowledge to a client when the account types the adviser offers are not in the client’s best interest.

So, it’s clear that recommendations about “account types” by broker-dealers (beginning June 30, 2020) will be subject to the best interest standard and that recommendations of account types by investments advisers are also subject to a best interest standard (that applied beginning July 12, 2019).

But, what is an account type?

In its guidance the SEC states, in several places, that a recommendation of advisory services and brokerage services are account type recommendations. Similarly, the SEC explicitly states in multiple places that recommendations of rollovers from retirement plans to IRAs are account type recommendations. But, what else falls under that heading? The answer is “A lot more than you might think.”

In Reg BI, the SEC said:

In addition to brokerage versus investment advisory accounts, there are also many options or account types within brokerage accounts. For example, brokerage accounts can includeEducation accounts (e.g., 529 Plans and tax-free Coverdell accounts); retirement accounts (e.g., IRA, Roth IRA, or SEP–IRA accounts); and specialty accounts (e.g., cash or margin accounts, and accounts with access to Forex or options trading). Different brokerage accounts can also offer different levels of services, such as access to online trading, or can offer different products, for example, in higher dollar amount accounts (e.g., access to products with break-points).

In its Frequently Asked Questions on Regulation Best Interest, the SEC repeated and amplified its description of account types:

Q: What account recommendations are covered by Regulation Best Interest?

A: Regulation Best Interest expressly applies to account recommendations including recommendations of securities account types generally (e.g., to open an IRA or other brokerage account, or an advisory account), as well as recommendations to roll over or transfer assets from one type of account to another (e.g., from a workplace retirement plan account to an IRA).

There are many options or account types within brokerage accounts. For example, brokerage accounts can include: education accounts (e.g., 529 Plans and tax-free Coverdell accounts); retirement accounts (e.g., IRA, Roth IRA, or SEP-IRA accounts); and specialty accounts (e.g., cash or margin accounts, and accounts with access to Forex or options trading). Different brokerage accounts can also offer different levels of services, such as access to online trading, or can offer different products, for example in higher dollar amount accounts (e.g., access to products with break-points). The staff notes that these are just some examples of brokerage accounts that could be recommended to a retail customer, and to which Regulation Best Interest would apply.

The type of securities account recommended is an investment strategy that has the potential to greatly affect retail customers’ costs and investment returns. For example, different types of securities accounts can offer different features, products, or services, some of which may—or may not—be in the best interest of certain retail customers. Accordingly, the staff reminds broker-dealers that the term “investment strategy” (which includes account recommendations) is to be interpreted broadly. Further, account recommendations will almost always involve a “securities transaction” (such as a securities purchase, sale, or exchange), and thus would generally be subject to Regulation Best Interest in any case.

While these examples were in guidance for broker-dealers, some of the account types also apply to investment advisers. Investment advisers should consider all of the programs offered to investors and all of the accounts with defined purposes (e.g., IRA, 529) and then think even more broadly about services associated with different programs and defined purpose accounts. If the services for an account can vary significantly, those could easily be considered different account types.

Bottom line, what does this mean in terms of compliance? It means that broker-dealers and RIAs have processes for advisors to consider each of the account types offered by their firms and to have a best interest process for determining which account type(s) are in the best interest of each investor.

But, even before the processes can be determined, there needs to be a list of each account type. Then the analytical process for recommending each one, and one over the others, can be determined. Fortunately, there are services that will help with many of the best interest processes for accounts and investments.

After the accounts are identified and the processes are determined, the hard work of developing written policies and procedures, training and implementation can begin.

But, this is only part of the story. There are additional rules, including special considerations for dually licensed professionals and dual-registrant firms. That will be covered in my next article.

 

NLR Logo

We collaborate with the world's leading lawyers to deliver news tailored for you. Sign Up to receive our free e-Newsbulletins

 

Sign Up for e-NewsBulletins