Since Regulation Best Interest’s (Reg BI) June 30, 2020 compliance date, the Division of Examinations of the Securities and Exchange Commissions (the Division) has been busy implementing examinations of broker-dealers to assess compliance with the regulation. The Division is planning to include Reg BI compliance into future examinations of broker-dealers. Therefore, the Division issued a Risk Alert on January 30, 2023 calling attention to deficiencies found during broker-dealer compliance examinations, as well as certain inadequate practices that might lead to deficiencies. Broker-dealers should pay attention to the issues identified by the SEC so that they do not expose themselves to regulatory trouble later down the line.
Some of the exposed weaknesses and deficiencies regarding the Reg BI Care Obligation1 involved inadequate written policies that directed financial professionals to document the basis for their recommendations but failed to state when doing so is required or which information is needed. Under Reg BI, financial professionals are required to make account recommendations that are in the best interest of the retail investor. Doing so is especially important when a financial professional is recommending a significant financial transaction to a retail investor, like an account rollover recommendation.
When making a rollover recommendation, a financial professional should consider several factors, which include but are not limited to the following: cost of services available, features in existing accounting, available investment options, ability to take penalty-free withdrawals, application of required minimum distributions, protection from creditors and legal judgments, and holdings of employer stock.
The Adopting Release of Reg BI (the Adopting Release), does not require that broker-dealers document the basis for their recommendations, but says a broker-dealer “may wish” to document the basis for a recommendation in certain contexts, such as a recommendation of a “complex product” or a recommendation that may seem “inconsistent with a retail customer’s investment objective on its face.” Adopting Release at 272-3. The Adopting Release encourages broker-dealers to take a “risk-based approach.” Id. In other words, “figure it out on your own, and fail to document at your own risk!”
Practically speaking, it may be advisable to document rollover recommendations because they are often material to the participant and are based on a complex analysis of plan features, IRA features and retail investor needs and circumstances, and inherently involve material conflicts of interest. In addition, the Department of Labor’s PTE 2020-02 requires that rollover recommendations to tax qualified, ERISA-governed retirement plans be documented and that the participant be given a written explanation of why a rollover is in the best interest of the participant.
The SEC is clear that financial professionals need to recommend the option that is in the best interest of the retail investor/participant, even if that includes recommending that the rollover not be made to an IRA with the broker-dealer. It is important to remember that making a rollover recommendation based solely on a customer’s preference does not satisfy Reg BI because a plan participant likely does not have a full understanding of what is in their best interest. While there is nothing in Reg BI that prohibits a financial professional from opening an account at the customer’s direction (against the professional’s recommendation), the failure to document the basis for opening that account could cause further investigation if the SEC examines the recommendation in the future. (In addition, if the DOL investigates, or the SEC refers the matter to the DOL, an undocumented recommendation would not obtain the relief of PTE 2020-02 and the recommendation could be both a fiduciary breach and a prohibited transaction.)
Broker-dealers beware. When creating written policies and procedures to have your financial professionals comply with Reg BI’s requirements, make sure you take a “risk-based” rather than a “risky” approach. It is always better to err on the side of caution and give your financial professionals specific instructions on when (often!) and how (very detailed!) they should document the basis for their rollover recommendations.
 Care Obligation requires broker-dealers to “exercise reasonable diligence, care, and skill when making a recommendation to a retail customer.” Adopting Release at 13-14.
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