Investment recommendations need not be the cheapest alternative as long as brokers show they have a reasonable basis for the recommendation, according to lawyers.
The Securities and Exchange Commission’s Regulation Best Interest requires brokers to comply with the best interest standard when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer.
“The concept that the SEC stated, both with costs and with reasonably available alternatives, is you don't have to recommend the least expensive or the least remunerative security or investment strategy,” Evan Charkes, associate general counsel at Bank of America, said last week at the Securities Industry and Financial Markets Association’s Compliance & Legal Virtual Forum.
“But you have to have a reasonable basis to believe that it was in the client’s best interest and it's the focus on the reasonable basis to believe that is the critical factor,” he added.
Yoon-Young Lee, a partner at law firm WilmerHale, says one of the practical things firms might want to consider is having a “narrative” that they could present to either the SEC or the Financial Industry Regulatory Authority to explain their processes for the recommendations or costs.
Lee suggested a few points to consider: “Do you have internal or external tools that provide alternatives that can be proposed? Are your advisors using those tools? Are you measuring the use of those tools? [Are you] looking at your internal training materials or guides regarding alternatives or costs?”
“The ability to show that you have a process that ticks off all of the elements that you can find referenced either in the rule or in the adopting release is so important because when the examiners are coming in, they're not looking vaguely at how you’ve implemented the rule,” Lee said.
“They have a checklist, and they're looking through [it] to make sure that they can tick-and-tie what's in the rule with what you've done,” she added.
Meanwhile, Tammy Bawnik, a managing director in the legal department at UBS Financial Services, said firms should also develop procedures to ensure compliance with the Department of Labor’s new definition of “fiduciary” in retirement accounts.
“You have Reg BI, and that applies to all of your retail clients, and then there's this extra layer that you would apply to your retirement plan clients,” Bawnik said.
The Department of Labor is amending the term” fiduciary” to specify when it applies to financial professionals providing paid advice to employee benefit plans and individual retirement accounts under sections of the Internal Revenue Code and the Employee Retirement Income Security Act.
“One key difference is that the retirement investors under Reg BI would be your RIAs, anybody that is an individual,” Bawnik said.
“But something like a qualified plan — a 401(k) plan account, for example — is specifically not a retail investor under Reg BI. Whatever the industry built for complying with all of the disclosure requirements for Reg BI needs to be adjusted to accommodate this new type of client that wasn't considered a retail investor,” she added.
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