How Do B/D & RIA Standards of Care Differ?

The SEC’s proposed Regulation Best Interest (“Reg BI”) for broker-dealers and the Interpretation Regarding Standard of Conduct for Investment Advisers both have a best interest standard of care – that suggests that broker-dealers and RIAs will be governed in the same way.  Not so.

That, according to the most recent blog post by noted ERISA attorney Fred Reish (his 95th of his “interesting angles” on the subject of the fiduciary reg, for those of you keeping score at home).

Reish explains that while the RIA best interest standard applies to all advice to all clients, Reg BI only applies to securities recommendations made by broker-dealers to retail customers.

He goes on to note that, using the SEC’s language, the Reg BI standard applies to a broker-dealer “when making a recommendation of any securities transaction or investment strategy involving securities,” though as he explains it doesn’t apply to recommendations about which account type to use, unless the recommendation involves securities transactions. He notes that, on the other hand, RIAs are governed by the best interest standard of care when recommending account types.

Reish cites similarities in how the standard applies to recommendations of distributions from retirement plans or to the recommendation of transfers of IRAs (noting parenthetically that plan participants and IRA owners are the “retail customers” covered by Reg BI), though a recommendation of a transfer of an IRA or a distribution from a plan would only be covered by Reg BI if the recommendation involved a “securities transaction or investment strategy involving securities.”

As regards a recommendation to take a distribution from a 401(k) plan, Reish says that implicitly includes a recommendation to liquidate the investments in the participant’s account in order to take a cash distribution (which would be covered by the best interest standard of care), and a second recommendation about how to invest the rollover IRA in securities (which would also be subject to Reg BI and the best interest standard).

Reish says that the best interest standard would not apply to recommendations to plans that are not participant directed, for example a recommendation to take a distribution from a defined benefit pension plan or a cash balance pension plan, because the participant does not have the ability to liquidate plan investments.

On the other hand, Reish explains that a recommendation by an RIA to take a distribution from any type of plan would be covered by the best interest standard, as would a recommendation about the investments in the rollover IRA.

As for transfers of IRAs, Reish writes that the same “securities transaction” limitation applies to recommendations by broker-dealers, and thus when a representative of a broker-dealer recommends that an IRA be transferred to the broker-dealer, and the IRA is transferred without the liquidation of securities, there would not be a recommended securities transaction – and thus, the best interest standard of care would not apply.

All told, Reish concludes that there are two basic points. First that the best interest standard of care for broker-dealers is much more limited than the one for RIAs. Second, that the SEC’s proposals are not clear on several major points – but and perhaps more importantly, as Reish explains in an additional comment, Reg BI is (just) a proposal by the SEC to impose a higher standard of care on broker-dealers, and will not apply until it is finalized – perhaps a year and a half or two years from now.

On the other hand, the RIA Interpretation is, for the most part, an interpretation of the current rules – and Reish concludes – as a result, RIAs should pay close attention to the RIA Interpretation.

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