“Best Interest” has become part of the American lexicon... as an aspirational goal or a demanding standard — depending on the point of view. But, what does best interest mean?
In a recent blog post, noted ERISA attorney Fred Reish identifies two different best interests: the first a standard of care and the second a duty of loyalty. Of the two, he finds the duty of loyalty to be the easiest to define because, he explains, “in all of the guidance it boils down to a requirement that an advisor cannot put his interest ahead of the investor’s.”
On the other hand, Reish concludes that the best interest duty of care is more “complicated,” in that the only agency that has offered a full definition is the Labor Department in its (now) vacated Best Interest Contract Exemption. He reminds us that that definition was:
Investment advice is in the ‘‘Best Interest’’ of the Retirement Investor when the Adviser and Financial Institution providing the advice act with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, without regard to the financial or other interests of the Adviser, Financial Institution or any Affiliate, Related Entity, or other party.
Reish acknowledges that the Securities and Exchange Commission provided a partial definition in its proposed Regulation Best Interest, but argues that that definition is, “to a degree, circular” (in that the advice is provided by someone who “exercises reasonable diligence, care, skill, and prudence to: … Have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer…”. He also notes similar language in the language New York State has adopted for insurance and annuity products.
In all three standards, he notes, there is identical language, specifically a requirement to act with care, skill, diligence and prudence, and thus, he argues, “it is likely that the three standards of care will be interpreted similarly.” Moreover, Reish concludes that since ERISA has a developed history through litigation and regulatory guidance, it would likely be the primary source for interpreting and applying that standard.
Then, with an eye toward that history, he explains that a “careful, skillful, diligent and prudent advisor would engage in a thoughtful process to gather the information relevant to making a decision (that is, information that would be material to a knowledgeable person) and would then evaluate that information in light of the needs and circumstances of the investor” – a process, he states, that would be measured by the objective standard of a knowledgeable professional.
In a nutshell, Reish notes that the best interest standards are more demanding than the current suitability standards, particularly as it relates to the weight to be given to costs and compensation, and a point that he writes the SEC made in its discussion of the Regulation Best Interest. However, Reish concludes by stating his belief that it also increases the responsibility of advisors to consider the quality of the products and services being recommended, for example, the quality of the mutual fund managers and the financial stability of insurance companies.