SEC Staff Provides Guidance on Broker-Dealer and Investment Adviser Standards of Conduct For Account and Rollover Recommendations to Retail Investors

U.S. Securities and Exchange Commission staff recently published a bulletin reiterating the standards of conduct applicable to broker-dealers and investment advisers when making account recommendations to retail investors. Broker-dealers are subject to Regulation Best Interest (Reg. BI). Investment advisers are subject to the fiduciary standard (IA fiduciary standard) under the Investment Advisers Act of 1940 (Advisers Act). The standards of conduct are separate, but in the staff’s view both “include an obligation to act in the retail investor’s best interest and not to place their own interests ahead of the investor’s interest.” In particular, SEC staff believe that both standards “yield substantially similar results in terms of the ultimate responsibilities owed to retail investors.” 

The bulletin is comprised of several questions and answers on this matter and sets forth factors firms should consider before making account and rollover recommendations, considerations of costs in account recommendations, and examples of practices that can assist firms in satisfying their obligations to address conflicts of interest associated with account recommendations. Below is a summary of the staff’s views:

1. Obligations of dually licensed financial professionals when recommending accounts to prospective retail investors
   • Applicable standard of conduct: The required standard depends on the capacity in which the personnel are acting (i.e., broker-dealer, investment adviser, or both). Because investment advisers must comply with the antifraud provisions of the Advisers Act in connection with current and prospective clients, both Reg. BI and the Advisers Act may apply in many cases when dually licensed personnel assess an account type recommendation for current and prospective retail investors.
   • Disclosure of capacity: Both broker-dealers and investment advisers have an obligation to disclose all material facts related to their relationship with retail investors, including the capacity in which a financial professional is acting. If the capacity in which a financial professional will be acting has not been established, then prior to or at the time of the recommendation, financial professionals must disclose to the retail investor that both standards of conduct apply. Firms are expected to provide clear guidance to financial professionals via policies and procedures and other instructions regarding how to disclose capacity to retail investors.
   • Consideration of reasonably available alternatives: Financial professionals of both broker-dealers and investment advisers must have a reasonable basis to believe that an account is in a retail investor’s best interest before making an account recommendation. This means that, subject to eligibility requirements, dually-licensed financial professionals must consider both brokerage and advisory accounts for retail investors when evaluating account types. The staff maintains that financial professionals “cannot recommend an account that is not in a retail investor’s best interest solely based on [their] firm’s limited product menu” or limitations associated with their licensing. “Any limitations on account types considered, in the staff’s view, are material facts that should be disclosed (along with other relevant material facts, including services, fees, and conflicts of interest) to retail investors.”
     
     
2. Factors to consider before making an account recommendation
   • Establishing a reasonable basis for an account recommendation: Both Reg. BI and the IA fiduciary standard require that a reasonable basis for an account recommendation be established based on “a reasonable understanding of the retail investor’s investment profile and the account characteristics.” Consequently, a firm and its financial professionals are required to obtain and evaluate enough information about a retail investor to ensure that the recommendation is not based on materially inaccurate or incomplete information. See the table below for examples of characteristics to consider in order to establish a reasonable basis to believe a recommendation is in a retail investor’s best interest.
   • Unavailable information: The staff believes that firms and their financial professionals should generally decline making account recommendations until sufficient information is obtained about a retail investor such that a reasonable belief can be established that an account recommendation is in an investor’s best interest. If a firm and its financial professionals “determine not to obtain or evaluate information that would normally be contained in an investor profile, the staff believes [the firm] should consider documenting the basis for [its] belief that such information is not relevant in light of the facts and circumstances of the particular account recommendation.”
     
     
3. Consideration of costs in account recommendations
   • Costs are always a relevant factor to consider when making account recommendations. If a higher cost account is recommended, a financial professional must have a reasonable basis to believe that the account recommendation is in the retail investor’s best interest “based on other factors and in light of the particular situation and needs of the retail investor.” Special features or other potential benefits should be considered along with the investor’s needs, investment objectives, and preferences. See the table below for examples of costs to consider when recommending an account and other factors to consider along with costs. Notably, the SEC “has pursued enforcement actions against investment advisers for recommending higher-cost products to clients when similar, lower-cost products were available.”
     
     
4. Retirement account rollover recommendations
   • Additional factors to consider when making a rollover recommendation in order to have a reasonable basis to believe a recommendation is in the retail investor’s best interest. A financial professional must have a reasonable basis to believe that the rollover and the account being recommended are in the retail investor’s best interest. See the table below for specific factors to consider relevant to rollovers in light of the retail investor’s investment profile, among other things. To the extent a firm relies on U.S. Department of Labor (DOL) Prohibited Transaction Exemption 2020-02, it should also consult the DOL’s guidance on factors to consider in making a rollover recommendation and relevant documentation requirements.
   • Leaving retail investor investments in employer plans. The staff believes that financial professionals must “consider the alternative of leaving [a] retail investor’s investments in their employer’s plan, where that is an option,” in order to have a reasonable basis to believe that a rollover recommendation is in the retail investor’s best interest and does not place the financial professional’s or firm’s interests ahead of the retail investor’s interest. This means that firms and their financial professionals will have to obtain information about a retail investor’s existing plan, including the costs associated with the options available in the investor’s current plan, in order to assess a recommendation to transfer assets out of an employer’s plan or between individual retirement accounts.
     
     
5. Retail investor preference and impact on account recommendations
   • Where a retail investor expresses a preference for a particular type of account, a financial professional must nevertheless have a reasonable basis to believe that the account recommendation is in the retail investor’s best interest based on a reasonable understanding of the retail investor’s investment profile and the account characteristics, among other things. While a retail investor’s preference should be considered, reasonably available alternatives must also be evaluated in order to reasonably believe that a recommendation is in the retail investor’s best interest. It is the staff’s view that a firm and its financial professionals “would not be required to refuse to accept [an] investor’s direction” to open an account contrary to a financial professional’s recommendation. The staff seems to draw a distinction between an investor’s preference and an investor’s instructions. Firms and their financial professionals should take care to ensure that the rationale for opening an account for a retail investor is adequately documented, including whether a retail investor expressed an account preference or provided a directive/instruction.
     
     
6. Firm documentation of the basis for account recommendations
   • The staff emphasized throughout the bulletin the importance of documenting the basis for recommendations, not only to be able to periodically assess the adequacy and effectiveness of policies and procedures, but also to demonstrate compliance with obligations to retail investors.^[1] This is particularly interesting given that in the Reg. BI adopting release the SEC “determined not to require broker-dealers to document the basis for any recommendations,” but instead encouraged broker-dealers to take a risk-based approach when deciding whether to document certain recommendations. The SEC has not addressed these documentation requirements/suggestions for investment advisers. Both Reg. BI and the Advisers Act require that written compliance policies and procedures be established, maintained, and enforced, and be reasonably designed to achieve compliance with Reg. BI, in the case of broker-dealers, to prevent violations of the Advisers Act, including the IA fiduciary standard, in the case of investment advisers.
     
     
7. Examples of practices that can assist firms in satisfying their obligations to address conflicts of interest associated with account recommendations
   • The table below includes a non-exhaustive list of practices firms can consider. In particular, the staff strongly encourages firms to eliminate or mitigate incentives that may encourage account recommendations that would place the interests of the firm or its financial professionals ahead of the interest of a retail investor. Notably, the SEC settled an enforcement action concerning compensation incentives for financial professionals making account recommendations.

Topic	Examples, Factors, and Considerations Related to Account and Rollover Recommendations and Associated Obligations
Examples of investor and account characteristics to consider	Investor characteristics: The staff believes that firms and their personnel should at least consider the following characteristics of a retail investor: Financial situation (including current income) and needs; investments; assets and debts; marital status; tax status; age; investment time horizon; liquidity needs; risk tolerance; investment experience; investment objectives and financial goals; any other information the retail investor may disclose to you in connection with an account recommendation; anticipated investment strategy (e.g., buy and hold versus more frequent trading); level of financial sophistication; preference for making their own investment decisions or relying on advice from a financial professional; and the need or desire for account monitoring or ongoing account management. Account characteristics: The staff believes that firms and their personnel should at least consider the following characteristics in order to establish a reasonable understanding of the characteristics of a particular type of account and whether these factors are consistent with a retail investor’s investment profile and stated investment goals: Services and products provided in the account (including ancillary services provided in conjunction with an account type, account monitoring services, etc.); the projected costs to the retail investor; alternative account types available; and whether the account offers the services requested by the retail investor.
Examples of costs and other factors to consider when recommending an account	The staff’s view is that firms and their personnel should at least consider the total potential costs, including indirect costs that could be borne by a retail investor, when evaluating whether an account is in a retail investor’s best interest, including the following examples: Account fees (e.g., asset-based, engagement, hourly), commissions and transaction costs (e.g., markups and markdowns), tax considerations, as well as indirect costs, such as those associated with payment for order flow and cash sweep programs. “When applicable, cost of an account also includes fees associated with the investment products that are available through the account, such as the internal expenses of funds, including management fees, distribution and servicing fees, and the costs of investing in funds, including front-end and back-end fees.” Firms and their personnel should also consider an investor’s anticipated time horizon when evaluating the potential impact of certain costs on the investor’s account (e.g., distribution and servicing fees and transaction costs related to purchasing fund shares). “[T]he investor’s need for certain services or certain types of investment products or strategies that are only available in certain account types; the account’s characteristics, including any special or unusual features requested by the retail investor, such as tax advantages; potential benefits and risks; time horizon; and anticipated composition of investments in the investment account.”
Additional factors to consider when making a rollover recommendation	The staff believes that firms and their personnel should at least consider the following factors when making a rollover recommendation to a retail investor: Costs; level of services available; features of the existing account, including costs; 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.
Examples of practices that can assist firms in meeting their obligations to address conflicts of interest associated with account recommendations	Avoid compensation thresholds that disproportionately increase compensation through openings of certain account types; Adopt and implement policies and procedures reasonably designed to minimize or eliminate incentives, including both compensation and non-compensation incentives, for employees to favor one type of account over another; Implement supervisory procedures to monitor recommendations that involve the rollover or transfer of assets from one type of account to another (e.g., recommendations to roll over or transfer assets in an ERISA account to an IRA); and Adjust compensation for financial professionals who fail to adequately manage conflicts of interest associated with account recommendations.

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[1]. Staff noted in the bullet that “it may be difficult for a firm to assess periodically the adequacy and effectiveness of its policies and procedures or to demonstrate compliance with its obligations to retail investors without documenting the basis for certain recommendations.”