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Friday, July 19 2019

Regulation Best Interest

For all intent and purposes, the DOL Rule was an absolute mess; a thousand pages of convoluted lawyer language. I don’t know why, but at this point in my life I am still shocked and amazed when our government issues regulation that contain hundreds of pages of language, written by attorneys, that in most cases, requires a written interpretation by the issuing agency just so those who have to comply will be able to understand the regulation, and attempt to be in compliance. Well, it has happened again.

In June 2019 the SEC voted to adopt Regulation Best Interest (“Reg BI”). I am not going to summarize the seven hundred and some odd pages of the summary release to explain the six page Reg BI amendment to the Securities Exchange Act of 1934, that includes the form and function of the Customer Relationship Summary (Form CRS), but will attempt to point out what I feel to be of great importance to the adviser community, based off information obtained during a recent securities regulation compliance conference.

One area where many advisers seem to really not want focus is suitability; they just don’t collect adequate written suitability information, they argue the client doesn’t want to provide the requested information, they’ve known the client for years and know everything about them and there is no need to have them complete a suitability questionnaire, etc. In order to ensure compliance with Reg BI, collecting, maintaining and updating adequate suitability information from its clients is going to be paramount in order to comply. Per the SEC, “As fiduciaries, investment advisers owe their clients a duty to provide only suitable investment advice. This duty generally requires an investment adviser to determine that the investment advice it gives to a client is suitable for the client, taking into consideration the client’s financial situation, investment experience, and investment objectives.” The SEC does not prescribe by rule what has to be collected in order to evidence the client’s financial situation, investment experience and investment objectives. Therefore, one should assume that that there should be significant, and up to date, suitability information on file for each client to be able to defend oneself against a complaint, or a regulator, when asked about the suitability of any investment in any client account.

It was noted at the conference that in regard to Reg BI, it’s not always what you do that is in your client’s best interest, but what you don’t do. As an example, if an adviser has a specific investment stysle, and there is a large net worth, prospective client whose objectives and risk tolerance do not meet the adviser’s investment style and strategies, the adviser should not take the individual on as a client. As another example, if an adviser indicates that they tailor client portfolios, and they have multiple client’s whose objectives and risk range from income and conservative to growth and aggressive, all of those clients should not hold the same positions in their accounts. If they are, the accounts better be allocated in a manner where it can be argued that the accounts are being managed in accordance with the clients’ needs.

And finally, for all who were under the impression that the DOL Fiduciary Rule was dead, it is, sort of. For those advisers whose business is largely made from rolling individuals out of employee sponsored retirement plans to qualified accounts managed by the adviser, Reg BI will function in essentially the same way. Going forward, advisers are going to have to be extremely diligent in conducting due diligence of each prospect’s qualified plan, detailing the differences between being in a qualified plan compared to an individually managed qualified account, disclose the difference in cost in detail and explain the benefits, such as sponsored plan protection from creditors, bankruptcy proceedings, and civil lawsuits, over an individually managed qualified account. All due diligence and client disclosures will need to be documented in writing and maintained in order to evidence to the regulators that the adviser is abiding by its fiduciary duty and in compliance with Reg BI. And as in the paragraph above, it is extremely important that the adviser not roll a client over from a sponsored plan to a qualified account under their management if there is not sufficient evidence to prove that it will be more profitable to the client; just having access to more products is no longer going to be an acceptable reason.

The struggle is real folks. The regulators have been fairly lenient in these areas in the past. We are now dealing with a market saturated with financial service providers and a social security system that is well short of being funded and not being used for what it was intended. The regulators are now forced to focus on ensuring the investing public’s retirement funds stay in their pockets and grow and not be swallowed up by fees and expenses. So make sure that when dealing with clients and prospects that client accounts are actually being managed according to their objectives and needs and that you are only taking on those prospects for whom your services are truly suitable and in their best interest.

– Written by: Steven Horn, Red Oak Compliance — Senior Consultant