Regulation Best Interest: Rollover Recommendations and Mitigation of Advisor Incentives (Rollovers Part 7)

The SEC has issued its final Regulation Best Interest (Reg BI), Form CRS Rule, RIA Interpretation and Solely Incidental Interpretation. I am discussing the SEC’s guidance in a series of articles entitled “Best Interest Standard of Care for Advisors.”

This is the 7th of my series of articles about rollover recommendations and rollover education under the SEC’s Regulation Best Interest and its Interpretation for Investment Advisers. (For the first six, see Best Interest for Advisors #’s 15, 16, 17, 18, 19 and 20.)

This article deals with the Reg BI requirement that broker-dealers mitigate the incentives that might induce their advisors to make rollover recommendations that are not in the best interest of participants. Specifically, that requirement (which applies on June 30, 2020) is:

Conflict of interest obligation. The broker or dealer establishes, maintains, and enforces written policies and procedures reasonably designed to: . . .

Identify and mitigate any conflicts of interest associated with such recommendations that create an incentive for a natural person who is an associated person of a broker or dealer to place the interest of the broker, dealer, or such natural person ahead of the interest of the retail customer; . . .

As explained in my earlier articles, a rollover recommendation involves a conflict of interest because an advisor will earn money from the rollover IRA if the recommendation is accepted by the participant. (In the most common scenarios, that advisor either will not be earning anything from the plan or, if the advisor works with the plan, the compensation attributable to that participant’s account in the plan will be less than the compensation from the rollover IRA.) As a result there is a conflict of interest due to the incentive for an advisor to recommend a rollover.

If there is any doubt about that, Reg BI specifically lists rollover recommendations as one of the conflicts that must be mitigated.

The new Reg BI rules will require that the incentive be mitigated by the broker-dealer. But, what does that mean?

Thus, whether or not a broker-dealer’s policies and procedures are reasonably designed to mitigate such conflicts will be based on whether they are reasonably designed to reduce the incentive for the associated person to make a recommendation that places the associated person’s or firm’s interests ahead of the retail customer’s interest.

In Reg BI, the SEC gives this guidance on the mitigation of incentives attributable to rollover recommendations:

As discussed above, while not required elements, the Commission believes the following non-exhaustive list of practices could be used as potential mitigation methods for firms to comply with . . . Regulation Best Interest:

  • implementing supervisory procedures to monitor recommendations that are: Near compensation thresholds; near thresholds for firm recognition; involve higher compensating products, proprietary products or transactions in a principal capacity; or, involve the roll over or transfer of assets from one type of account to another (such as recommendations to roll over or transfer assets in an ERISA account to an IRA) or from one product class to another; . . .

But, even that explanation begs the question . . . What conduct should be supervised?

As explained earlier in this series of articles, the SEC has listed some of the criteria to be evaluated as part of a best interest process for developing a rollover recommendation. As a result, the logical answer is that the broker-dealer should supervise (1) that the relevant information was gathered, (2) that it was evaluated taking account the requirements of the best interest standard (for example, is considered with “care, skill and diligence” in the best interest of the participants), and (3) that the recommendation reasonably reflects that information and a best interest recommendation.

However, that is just a logical answer. Unfortunately, the SEC does not specify what conduct is to be supervised. Perhaps the moral of the story is to take a conservative approach until and unless there is further guidance from the SEC or FINRA.

Note for investment advisers: The mitigation requirement does not apply to Registered Investment Advisers or to individual advisers. As a practical matter, though, the outcome may be the same . . . the relevant information should be gathered and evaluated (with “care, skill and diligence”), and the recommendation should be in the best interest of the participant.