Reg BI applies to rollover, account recommendations
Change in final rule has support from SEC’s critics.
Stakeholders predicted the finalized form of Regulation Best Interest, the Securities and Exchange Commission rule on broker-dealer conduct, would remain largely unchanged from last year’s proposed version of the rule. But one aspect of the rule the SEC did change covers retirement plan rollovers to IRAs, recommendations on workplace plan distributions, and recommendations to place investors in brokerage or advisory accounts.
“After careful consideration of comments and feedback, the Commission has modified the rule text to state that an ‘investment strategy involving securities’ includes ‘account recommendations’,” the rule states.
“We interpret ‘account recommendations’ to include recommendations by broker-dealers of securities account types generally, as well as recommendations to roll over or transfer assets from one type of account to another (e.g., workplace retirement plan account to an IRA,” write regulators.
That clarification was sought by broker-dealers, and importantly, a majority of the SEC’s Investor Advisory Committee, the 22-member panel established under the Dodd-Frank Act that includes industry executives, consumer advocates, pension fund investment officers, and the SEC’s own investor advocate.
“The distinction the SEC was seeking to make, and it is one we agree with, is that the recommendation of whether to roll over should be subject to the standard, and not just the recommendation of specific securities to invest in once the decision to roll over has already been made,” said Barbara Roper, director of investor protection at the Consumer Federation of America, and a member of SEC’s Investor Advisory Committee.
‘Huge inclusion’
Roper and CFA’s endorsement of folding recommendations on account types and IRA rollovers within the best interest requirement is notable. CFA and other consumer advocate groups are highly critical of Reg BI because it does not enforce a uniform fiduciary standard on brokers and investment advisors, and they have suggested the final rule could be subject to a legal challenge.
Irrespective of the debate over whether Reg BI goes far enough to protect retail investors from conflicted advice, brokers’ requirement to apply the best interest standard to account and rollover recommendations stands to substantially impact financial services providers.
As of the end of 2018, IRAs held $8.8 trillion in assets, or about one-third of the $27.1 trillion retirement market. IRA assets have increased an average of 10 percent a year over the past quarter century, according to the Investment Company Institute.
The growth of IRA assets has been fueled by rollovers from workplace retirement plans, ICI data shows. In mid 2018, 42.6 million, or 33 percent of the country’s total households, reported owning an IRA. Among those households with rollovers in traditional IRAs, 57 percent had only rollover money in their accounts, meaning they have never made other contributions to their IRAs.
As baby boomers continue to retire, those numbers can be expected to grow, and quickly.
“It’s a huge inclusion,” said Kevin Walsh, a principal with The Groom Law Group, of the SEC including rollovers under the best interest standard. “The change to recommendations on account type means Reg BI expressly applies to IRA rollovers.”
Critics of Reg BI allege it fails to materially increase FINRA’s suitability standard. Brokers will be able to continue to offer conflicted advice under the new standard so long as those conflicts are disclosed, they argue.
In 2013, FINRA issued a regulatory notice to brokers on IRA rollover recommendations, and made rollovers an examination priority in 2014.
In its final rule, the SEC explained how rollover recommendations under Reg BI will differ from the suitability standard.
FINRA’s suitability standard applied to rollovers that involved securities transactions, but not necessarily to rollover recommendations that did not involve a securities transaction, the SEC said.
“To the extent that broker-dealers and their associated persons currently make recommendations to open an IRA or to participate in an IRA rollover that do not involve securities transactions under the baseline, Regulation Best Interest should result in IRA and IRA rollover recommendations to retail customers that are more efficient because they will be in the retail customer’s best interest regardless of whether or not they involve securities transactions,” according to analysis in SEC’s final rule.
In expanding Reg BI to include account recommendations, regulators noted the Investor Advisory Committee’s concerns that brokers and advisers “have a strong economic incentive to recommend investors roll over plan assets into an IRA or otherwise transfer assets to open an account with the broker-dealer or investment adviser.
According to Groom Law Group’s Walsh, Reg BI significantly expands oversight of IRA rollover recommendations compared to FINRA’s suitability standard.
“It’s a real extension of the suitability standard because it gets at brokers’ ability to break apart different recommendations,” said Walsh.
“Under suitability, FINRA’s guidance considered concerns that it was regulating recommendations on something other than a security transaction,” he added. “FINRA narrowed its view because its jurisdiction applied only to securities transactions.”
Under FINRA’s oversight, a broker could conceivably recommend a rollover without selling a security and not be beholden to the suitability standard. The broker could then sell securities in the IRA at a later time.
Under Reg BI, that potential regulatory side-step will not be available, said Walsh.
READ MORE:
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Suitability plus? Lawyers say SEC proposal lacks clarity
CFA Institute says SEC has immediate authority to clarify broker roles
Will Reg BI preempt state fiduciary rules?