SEC Raises Standard of Conduct for Broker-Dealer Recommendations, Including Advice on Rollovers

The SEC has adopted a regulation that raises the standard of conduct for broker-dealers when they make certain recommendations to their retail customers. The regulation—known as “Regulation Best Interest”—applies only to brokers, dealers, and natural persons associated with them (collectively, broker-dealers). Broker-dealers typically provide transaction-specific recommendations and receive transaction-based compensation. The regulation does not apply to investment advisers, who typically provide ongoing advice, receive fee-based compensation, and are already subject to a fiduciary duty that includes a similar standard of conduct. For purposes of the regulation, “retail customers” are limited to natural persons (and their legal representatives) who receive recommendations regarding securities transactions or securities investment strategies from a broker-dealer for “personal, family, or household purposes.” Retail customers do not include employees acting on behalf of a business or a benefit plan. Recommendations subject to the regulation expressly include recommendations to roll over or transfer assets in a workplace retirement plan to an IRA, and recommendations to take a plan distribution to open a securities account. The rule is effective September 10, 2019, but compliance will not be required until June 30, 2020.

Regulation Best Interest imposes on broker-dealers an obligation to act in the best interest of their retail customers at the time recommendations are made, without placing their interests ahead of the customer. That obligation is satisfied if four detailed requirements are met.

• Disclosure Obligation. The broker-dealer must provide “full and fair” disclosure of the material facts regarding the scope and terms of the relationship with the retail customer, including fees and costs, any material limitations on the securities or investment strategies that may be recommended (e.g., if recommendations are limited to certain investment types or to proprietary products), and conflicts of interest (e.g., in compensation arrangements).
• Care Obligation. Broker-dealers must use reasonable diligence, care, and skill in dealing with retail customers to understand the recommendation’s potential risks, rewards, and costs and have a reasonable basis for believing that the recommendation is in the customer’s best interest and does not place the broker-dealer’s interest ahead of the customer. A broker-dealer’s understanding must be based on the retail customer’s “investment profile,” which includes a broad list of investment-related information, including the customer’s age, other investments, financial situation, tax status, experience, objectives, liquidity needs, and risk tolerance.
• Conflict of Interest Obligation. Broker-dealers must establish, maintain, and enforce written policies and procedures to identify all conflicts of interest associated with a recommendation, and depending on the conflict, either disclose, mitigate, or eliminate the conflict.
• Compliance Obligation. Broker-dealers must also establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with the regulation.

EBIA Comment: Regulation Best Interest will not have a direct impact on most employers, 401(k) plan fiduciaries, and their advisors because of its focus on retail customers. For example, it will not apply to the advice plan fiduciaries receive regarding the selection and monitoring of 401(k) plan investments because plan fiduciaries are not retail customers. (That advice will continue to be subject to the broker-dealer’s existing obligations under federal securities law and the rules of relevant self-regulatory organizations. Depending on the services provided, broker-dealers may also be plan fiduciaries, although that should occur less frequently now that the DOL’s regulations expanding ERISA’s definition of fiduciary have been vacated (see our Checkpoint article).) But Regulation Best Interest will apply to plan-related investment recommendations that employees may obtain from broker-dealers, such as advice about investments made through a 401(k) plan’s self-directed brokerage window, whether to take a distribution and roll the proceeds to an IRA, and investment choices for a rollover IRA or an HSA. Consequently, employers, fiduciaries, and their advisors should maintain at least some familiarity with SEC rules regulating retail customers. For more information, see EBIA’s 401(k) Plans manual at Sections XII (“Distributions: Code Requirements and Design Choices”), XIV (“Distributions: Rollovers and Taxation”), and XXV.G (“Brokerage Option: Special Issues”). See also EBIA’s Consumer-Driven Health Care manual at Sections XII.O (“Rollovers and Transfers From Other Accounts”) and XVI.D (“Investment of HSA Funds”).

Contributing Editors: EBIA Staff.