Some have questioned whether the Securities and Exchange Commission’s (SEC’s) Regulation Best Interest (Reg. BI), which established an enhanced standard of conduct for broker-dealers when making securities recommendations to retail investors, has fully addressed the problem of conflicted investment advice being offered to retirement savers.
The short answer is no, it has not. Even if Reg. BI is implemented and enforced in a way that maximizes its potential investor protections, the rule still leaves retirement savers susceptible to conflicted advice that is not in their best interests in a number of critical ways. Therefore, for the following reasons, it is still necessary to update the DOL fiduciary rule to ensure that all retirement savers receive investment advice that’s in their best interest.
BI generally doesn’t apply to recommendations made to retirement plans.
As sponsors of workplace retirement plans, employers are responsible for constructing the plan menu of investment options from which their workers select to build their portfolios. Because workers are often limited to the investment options that their employers choose for the plan menu, workers depend on their employers to make careful and sound decisions about those investment options. Unfortunately, many employers do not have particular expertise in choosing plan menus. After all, most employers are small businesses whose main job is not setting up and administering retirement plans. Because small to medium sized employers are not typically retirement plan experts, they often rely on the investment recommendations of financial firms and their professionals who provide services to their plan.[i]
However, Reg. BI only applies to recommendations made to an individual retail customer and does not apply to advice given to workplace retirement plans. Thus, a financial professional offering advice to an employer operating a retirement plan would be free to give costly, harmful advice to the employer, with no accountability under Reg. BI for doing so. As a result, employers, who receive conflicted advice would be more likely to offer more costly or poorer performing retirement plan options to their workers. Put simply, retirement savers that end up with higher-cost or lower-quality options would retire with less money than they otherwise would have or would have to work longer to hit their savings goals. And even small differences in costs or performance can add up over time. For example, a 1% annual reduction in returns, over the course of 35 years, could reduce the saver’s account balance at retirement by 28 percent. This could mean profound differences in financial stability and quality of life for retirees.
The SEC’s adopting release for Reg. BI specifically highlighted this gap in which retirement plans do not receive Reg. BI’s protections. The release suggested it expected the DOL to fill this gap by updating its fiduciary rule.[ii] We agree that the DOL must now ensure that employers receive the same high level of protections as retail investors when receiving investment recommendations from financial professionals.
BI doesn’t apply when a financial professional is recommending non-securities.
Many retirement savers who turn to financial professionals for investment advice receive advice to purchase investments that are not securities. However, Reg. BI only applies to recommendations involving securities, which means that Reg. BI doesn’t apply when financial professionals recommend non-securities products, including certain insurance and annuities products,[iii] commodities, real estate, or cryptocurrencies, to the extent those are not considered securities. As a result, retirement savers don’t receive Reg. BI’s protections when financial professionals recommend such products.
So, for example, if an insurance professional recommends that a retirement saver purchase a fixed indexed annuity, because a fixed indexed annuity is not regulated as a security, that recommendation would not be subject to Reg. BI. Therefore, none of the protections that Reg. BI provides would apply to this recommended transaction.
Similarly, if a financial professional recommended that a retirement saver purchase bitcoin in their retirement account, because bitcoin is not regulated as a security, that recommendation would not be subject to Reg. BI. Therefore, none of the protections that Reg. BI provides would apply to this recommended transaction.
Retirement savers should receive the same high level of protections regardless of the type of product they purchase, but these gaps leave retirement savers exposed to receiving harmful advice regarding non-securities products. The DOL is the only agency that can fill this gap for all products that are recommended to retirement savers.
Given that Reg. BI does not apply to all instances when retirement savers receive investment advice, and the profound negative impacts that bad advice can have on their savings, the need for DOL to update its fiduciary rule remains. All retirement savers should receive the protections and benefits of best interest advice, regardless of the capacity in which they receive investment advice or the kind of product they purchase.
[i] See, e.g., American Retirement Association, https://www.sec.gov/comments/s7-07-18/s70718-4767567-176840.pdf (“Broker-dealers routinely advise fiduciaries of small retirement plans concerning the investments that will be made available to participants under such plans. Like individual investors, most small plan business owners acting as retirement plan fiduciaries are not sophisticated investors. Most simply do not have retirement plan investment expertise.”).
[ii] See Regulation Best Interest: The Broker-Dealer Standard of Conduct, at footnote 254, https://bit.ly/3B1IgwW (“Although workplace retirement plans are not generally covered by the definition of retail customer in by Regulation Best Interest, based on preliminary discussions with DOL staff, we understand that the DOL is considering regulatory options in light of the Fifth Circuit’s decision vacating the DOL Fiduciary Rule, including the types of protections available to such workplace retirement plans and their representatives.”).
[iii] The standards that do apply to annuity recommendations, including the new model “best interest” standard adopted by the National Association of Insurance Commissioners, offer weaker investor protections than Reg BI. [Link to NAIC Fact Sheet]