Under Regulation Best Interest (Reg BI), the SEC imposes a best interest standard on account recommendations by broker-dealers.  This is because recommending an account type is viewed by the SEC as recommending an investment strategy involving securities.  The SEC imposes a similar best interest standard on registered investment advisers under the SEC’s Interpretation Regarding Standard of Conduct for Investment Advisers (the RIA Interpretation).

The DOL also imposes a best interest standard under its prohibited transaction exemption (PTE) 2020-02 (Improving Investment Advice for Workers & Retirees) (the PTE), which allows broker-dealers and their registered representatives to receive conflicted compensation resulting from non-discretionary fiduciary investment advice about a change of account types for a retirement plan or an IRA.

To satisfy these rules, broker-dealers, including dual registrant broker-dealers (collectively “advisors”), need to understand what constitutes an “account type” and the best interest standard for recommending one.

What is an Account Type

The DOL provides very little guidance on what constitutes an account type.  PTE 2020-02 merely states that the financial institution must –

document the specific reasons that any recommendation to roll over assets…from one type of account to another (e.g., from a commission-based account to a fee-based account) is in the Best Interest of the Retirement Investor.

Based on this language, the DOL identifies by example two account types – commission-based and fee-based accounts.  However, that does not mean those are the only two account types that the DOL has in mind.

In contrast, the SEC is far more specific in its description of account types.  While acknowledging that a brokerage account is a different account type from an advisory account, the SEC observes that different account types may exist within those two broad categories.  The SEC points out that the differences in features, products and services offered under the account must also be considered and each may constitute a different account type.  Under Reg BI and the Frequently Asked Questions on Reg BI, the SEC provides the following examples of different account types for a brokerage account:

• Education accounts – e.g., 529 plans and tax-free Coverdell accounts;
• Retirement accounts – e.g., IRA, Roth IRA or SEP-IRA accounts;
• Specialty accounts – e.g., cash or margin accounts, accounts with access to Forex or options trading; and
• Accounts with different levels of services – e.g., access to online trading, different product offerings.

This suggests that a similar analysis should be applied to advisory accounts.  Advisory accounts may also have different features and levels of services, which will likely cause them to be treated as separate account types.  While not entirely clear, advisors should, at the least, consider whether a recommendation is to a new account type if the services are different; the products are different; the costs are different; the potential risk is materially different; and/or the tax attributes of the account are different.

Best Interest Standard

The best interest process imposed by the SEC under Reg BI and the RIA Interpretation is very similar to the best interest process required by the DOL under PTE 2020-02.  See our recent post about the SEC and DOL requirements for rollover recommendations.  This means that in order for an account type to be in the customer’s best interest, the advisor needs to consider relevant factors about the account to ensure those factors align with the customer’s investment profile and needs.  The SEC points out that relevant factors include services and products provided in the account – for example, access to online trading and access to products with break points.

The SEC further explains that if an advisor is dually registered, then the advisor needs to consider the full spectrum of accounts offered – both brokerage and advisory – and recommend the one that is in the best interest of the retail investor.  If the advisor is only registered as an associated person of a broker-dealer and can only offer the accounts and services of the broker-dealer, the advisor needs to have a reasonable basis to believe that the recommended brokerage account is in the customer’s best interest.  If, for example, the customer wants to delegate unlimited investment discretion over trading decisions to the advisor, the advisor would not have a reasonable basis to believe the brokerage account is in the customer’s best interest.

Conclusion

To comply with these rules, broker-dealers should establish a process to identify separate account type offerings based on differences in products, features and services and develop policies and procedures to evaluate each account based on the customer’s financial needs and investment profile.  Broker-dealers should also train and supervise advisors to carry out these processes and procedures and, for risk mitigation, to document the evaluation process.