‘Reasonably available alternatives’ must be vetted to comply with SEC's Reg BI
Technology will be a B-D's ‘friend’ in complying with Reg BI by July 1 to satisty Care Obligation, rollover recommendation rules.
Recently, Morningstar reached out to about 100 individual brokers to gauge their firms’ progress in complying with Regulation Best Interest by the July 1 compliance date. In January, the Securities and Exchange Commission said it would not be moving the scheduled July 1 compliance date for Reg BI, which is designed to raise the standard of care to retail investors above FINRA’s suitability standard.
About a third of those brokers were unaware, or unsure, of any measures their firms had taken relative to product line-ups in the run-up to July.
Related: Reish: Broker-dealers already behind the ball in prepping for Reg BI
With about three-and-a-half months left to go time, different firms are taking different paths to compliance, said Matt Radgowski, head of advisor solutions at Morningstar.
“We’re seeing a flurry of new activity,” he said, suggesting industry may have been collectively sitting on its hands up until recently.
Many broker-dealers—even the largest with the most resources—are first focusing on complying with Form CRS, companion regulation designed to help retail investors pick a financial services firm.
Arguably, complying with Form CRS is an easier lift than complying with Reg BI, which will require brokers to be able to prove to regulators—and no doubt attorneys—that their recommendations were executed in the best interest of their clients.
“With any regulation, you have to demonstrate the workflow is in compliance,” said Radgowski. “To do that at scale is going to require technology—which will definitely be a friend to broker-dealers.”
Reasonably available alternatives
The SEC’s regulation does not prohibit brokers from recommending proprietary products. Nor does it say the lowest cost products have to be recommended to assure a product is sold in an investor’s best interest.
So if a broker can recommend her firm’s proprietary products, even if they are more expensive, how is she to prove her client’s interests were put before her own?
The answer could be found in Reg BI’s Care Obligation—one of the four component obligations to the overall rule.
In a compliance guide, the SEC said, “You should consider reasonably available alternatives (RAAs), if any, offered by your broker-dealer in determining whether you have a reasonable basis for making the recommendation.”
“The RAA is amplified in FINRA’s description of what an exam question may look like,” said Radgowski.
The SEC says determining reasonable alternatives will depend on the “facts and circumstances at the time of the recommendation.”
Radgowski interprets that to mean a comparison of performance, cost, and risk – information Morningstar is, of course, in the business of providing.
Morningstar—and others, notes Radgowski—is in the process of building new workflows on top of existing capabilities specifically to satisfy the reasonably available alternatives component of Reg BI’s Care Obligation.
Among other tools, Morningstar is developing a filter for RRAs that can be tailored to specific broker-dealer product offerings. The technology will then document the selection process, and generate a FINRA review report. The products will be ready by June 30, said Radgowski.
How to prove your rollover recommendation satisfies the best interest
The SEC’s final rule included a critical addition: Recommendations to roll over assets from a 401(k) to an IRA will have to be in investors’ best interest and satisfy Reg BI.
The new requirement comes as thousands of new rollover clients feed the market every day with the retirement of baby boomers. By the end of 2018, IRAs held $8.8 trillion in assets, growth that has largely been fueled by rollovers. According to the Investment Company Institute, of 42.6 million IRAs, 57 percent held only rollover money.
Even consumer-advocate critics of Reg BI were supportive of the inclusion of rollovers under the regulation. For brokers, the bottom line is that recommending a rollover can’t be done without documented reasoning for doing so.
The question will be how to mitigate regulatory risk in executing a rollover, and how to prove the advice was made in customers’ best interest.
“A lot will depend on how the SEC and FINRA choose to enforce the rule on rollovers,” said Radgowski. “But there will be ways to minimize the risk.”
Most critically, brokers will need specific information on the 401(k) plans in question, specifically the investment options and the all-in cost of staying in the plan. Tech workflows will be able to put that data at brokers’ fingertips. But brokers will also have to offer, and document, additional services to prove rollover costs are justifiable.
“In our eyes, it’s really important brokers incorporate additional interactions that take place outside of the 401(k), and other services specific to the IRA to minimize their risk,” added Radgowski.
Radgowski doesn’t expect rollover flows will be staunched under the rule, but he does expect the care—and work load—behind the recommendations to increase.
“Rollovers will continue, given the holistic planning advisors and brokers are already taking, but the speed with which they are executed will decrease,” he added.
Regulators have said that at the outset, their examination focus will be on the work broker-dealers are doing to comply with Reg BI, more than lowering the hammer where implementation may be inadvertently insufficient.
“It’s really important firms demonstrate progress toward compliance,” said Radgowski. “That means a clear plan that includes changes to work flow, enhancements to work flow, and the ability to document them.”
Waiting, or counting on the largesse or lethargy of regulators, is not a strategy.
“There seems to be an acknowledgement from regulators that as long as you are demonstrating a plan toward compliance, they will work with you. But that doesn’t mean you can wait,” added Radgowski. “You will want to be as prepared as possible by June 30.”
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