Fiduciary Rule Myths

MYTH:  “Advisors must recommend the best available investment.”

We recently pointed out that under the DOL fiduciary rule, it’s a myth that advisors have to recommend the lowest cost investment. They don’t.

Here’s another myth about investment recommendations that isn’t true: advisors have to recommend the best investment to their customers. Presumably, this comes up because of the Impartial Conduct Standards in the Best Interest Contract Exemption (BICE). One of the requirements in those Standards is that a recommendation be in the best interest of the customer. This best interest requirement may lead some to think that advisors have to meet an essentially impossible standard. As with a lowest-cost recommendation, however, a mandate to recommend the best investment is a myth…it just isn’t true. Even the DOL has said so:

“…the Department also confirms that the Best Interest standard does not impose an unattainable obligation on Advisers and Financial Institutions to somehow identify the single ‘best’ investment for the Retirement Investor out of all the investments in the national or international marketplace, assuming such advice were even possible.” (Preamble to the BIC Exemption, 81 Fed. Reg. 21002, at page 21029)

(The DOL references “Advisers and Financial Institutions” here because both the individual advisor who deals with the customer and the broker-dealer are fiduciaries for purposes of an investment recommendation.)

To be entitled to compensation, broker-dealers and their advisors who work with plans and IRAs need to comply with the BICE conditions that are also in effect. This means adhering to the Impartial Conduct Standards, which require that:

  • Compensation paid to the broker-dealer and advisor is reasonable.
  • Recommendations must be in the best interest of the customer.
  • Communications with the customer may not be misleading.

The “best interest” requirement says that the recommendation must (i) be prudent, (ii) take into account relevant information about the customer, and (iii) put the customer’s interests above those of the broker-dealer and the advisor.

Looking at each of these requirements, to be prudent, the advisor and the broker-dealer must engage in a prudent process to develop investment recommendations. The customer information is similar, if not identical, to FINRA’s “know your customer” rules. And the final requirement – the “duty of loyalty” – mandates that the broker-dealer and the advisor put the financial interests of the retirement investor ahead of their own. (However, that does not override the ability to receive reasonable compensation.)

The DOL explained the best interest standard in the context of investment recommendations this way:

“…the best interest standard set out in the exemption, incorporates two fundamental and well established fiduciary obligations: The duties of prudence and loyalty. Thus, the advice fiduciary’s obligation under the Best Interest standard is to give advice that adheres to professional standards of prudence, and to put the Retirement Investor’s financial interests in the driver’s seat, rather than the competing interests of the Adviser or other parties.” (BIC Preamble at page 21029)

To understand “best interest,” the DOL has said that firms and advisors should look to court cases and the DOL guidance on the meaning of the ERISA prudent man rule. The cases and guidance say that in developing a prudent recommendation, advisors and broker-dealers need to focus on process:

  • Gather relevant information about the customer—this should be part of the suitability analysis in any case, though a prudent or best-interest process requires more than the suitability standard. Gather information about the product or investment strategy being considered.
  • Assess the information carefully, taking into account the purpose for which the investment is being made (e.g., long-term growth or retirement income).
  • Make a recommendation that is “informed” (by the information) and “reasoned” (based on the assessment).
  • Remember to document the process in case you need to prove compliance later on.

This is what it takes to make a prudent fiduciary decision. Essentially, by following these steps, an advisor should be able to make a best interest recommendation for the customer.

As the DOL said, recommending the “best” investment is an unattainable standard—a myth. Instead, the best interest standard says that the advisor and broker-dealer have to give careful consideration to relevant information about the investment and the customer, and set aside their own interests, in making a recommendation. They have to be prudent, not perfect.

The material contained in this communication is informational, general in nature and does not constitute legal advice. The material contained in this communication should not be relied upon or used without consulting a lawyer to consider your specific circumstances. This communication was published on the date specified and may not include any changes in the topics, laws, rules or regulations covered. Receipt of this communication does not establish an attorney-client relationship. In some jurisdictions, this communication may be considered attorney advertising.

About the Author: Fred Reish

Fred Reish represents clients in fiduciary issues, prohibited transactions, tax-qualification and Department of Labor, Securities and Exchange Commission and FINRA examinations of retirement plans and IRA issues.

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