Key Takeaways
- The DOL’s new regulation defining fiduciary advice to include one-time recommendations has been stayed, but advisers who make ongoing individualized recommendations to ERISA-governed retirement plans, participants in those plans, and IRA owners continue to be fiduciaries subject to fiduciary standards. Those standards—prudence and loyalty—can be called a best interest standard.
- However, the SEC’s fiduciary standard for one-time recommendations by investment advisers continues to apply. The SEC position is most recently documented in its Commission Interpretation Regarding Standard of Conduct for Investment Advisers. The SEC said that the investment adviser duties of care and loyalty—taken together–are a best interest standard.
- The best interest standard for both broker-dealers and investment advisers has been further defined by the SEC Staff in its Bulletin entitled Standards of Conduct for Broker-Dealers and Investment Advisers Account Recommendations for Retail Investors.
- In addition, one-time recommendations of insurance products are regulated by state insurance departments and almost all of the states have adopted NAIC Model Regulation #275, “Suitability in Annuity Transactions”, either verbatim or in large part, for recommendations of annuities. The NAIC has referred to this as a best interest standard.
- This post discusses the basic requirements for a best interest process for making recommendations to ERISA-governed retirement plans, participants in those plans, and IRA owners.
- Note that Reg BI and the NAIC model rule do not apply to recommendations to retirement plans, but do apply to participants and IRA owners, including rollover recommendations and recommendations to transfer IRAs.
If you study the rules of the various standard-setters, a pattern emerges about their expectations for the process for developing a best interest recommendation. The DOL and SEC are consistent in that regard, while the NAIC model rule is less demanding, as explained later in this article.
There are four steps in a best interest process. For our purposes, let’s use rollover recommendations as an example:
- The first step is to obtain information about the investor’s current circumstances. Both the DOL and SEC staff have said that a best interest process requires that an advisor consider whether it is in the best interest of the participant to stay in the plan. However, the NAIC model rule does not impose that best interest requirement.
At the least, under the DOL and SEC standards an advisor would need to obtain information about the investments, services and expenses in the plan.
(Note, I am using “advisor” generically to include fiduciary advisors, investment advisers, representatives of broker-dealers, and insurance producers.)
- Next the advisor should develop a profile of the needs and circumstances of the participant. The profile should include the information that a knowledgeable person would consider material to making a particular recommendation. Obviously, that can vary on a variety of factors, such as the age and objectives of the investor, among other things.
- The advisor should then consider the available investments, annuities, services, costs, etc., that match up with the needs and circumstances of the participant as reflected in the profile.
- In the fourth, and final, step the advisor needs to determine which alternative—in this hypothetical case, the plan or the rollover IRA—is in the best interest of the participant and recommend that option. This would include, at the least, consideration of the participant’s profile and a comparative analysis of the investments, services, and expenses in the plan and the IRA (that is, the individual retirement account or individual retirement annuity—sometimes referred to as a qualified annuity).
The DOL’s view of that approach is best documented in its 2021 “New Fiduciary Advice Exemption: PTE 2020-02 Improving Investment Advice for Workers & Retirees Frequently Asked Questions” (see Q&A 15).
The SEC staff’s view of that approach for both investment advisers and broker-dealers is found in its Bulletin “Standards of Conduct for Broker-Dealers and Investment Advisers Account Recommendations for Retail Investors” (see Q&A 4).
On the other hand, the NAIC model rule requires that a producer making an annuity recommendation “Have a reasonable basis to believe the recommended option effectively addresses the consumer’s financial situation, insurance needs and financial objectives over the life of the product, as evaluated in light of the consumer profile information;…” (see Section 6.A.(1)(a)(iii)). So, while the analysis requires consideration of the annuities available to the producer, it does not require a producer to recommend that the participant leave the money in the plan, even if that is in the best interest of the participant.
Interestingly, the differences between the SEC and NAIC requirements mean that the recommendation of a “securities annuity” (e.g., a variable annuity or a registered index-linked annuity) requires consideration of whether it is in the best interest of a participant to leave the money in the plan, while the recommendation of an “insurance only annuity” (such as a traditional annuity or a fixed indexed annuity) does not require that analysis.
Concluding thoughts
The term “best interest” is being used by different regulatory organizations to mean different things. That is unfortunate because of the confusion it will likely cause for consumers.
In my view, a true best interest process requires an analysis of the options available to the investor and a recommendation of the option which is best for the investor.
