Investing

How SEC’s New ‘Reg BI’ Rule Impacts Your Retirement Investments

Imagine just moving to a new city and getting sick. You don’t have a medical relationship established yet, but you need to see a doctor right away.

You call a doctor to tell him of your urgent need. Before you even begin to list your symptoms, he stops you short. He warns you he has a conflict of interest because, if he sees you as a patient, he’ll have to charge you a fee.

“Is the fee reasonable?” you instinctively respond.

“Yes, it’s pretty much the same all the other doctors around here charge,” says the doctor.

“So, what’s the conflict?” you ask.

“Well,” says the doctor, a bit baffled by your question, “as I said, you will be paying me a fee.”

You conclude the doctor is a bit “off,” and politely move to the next name on the list. It turns out, each and every doctor reports the same conflict of interest. It’s not that they’re getting kick-backs for prescribing medication. It’s simply because they aren’t giving away their services for free.

Does this sound silly to you? Don’t laugh. This may be your experience going forward when trying to find a professional to advise you on your retirement assets.

It’s called “Regulation Best Interest” (or “Reg BI”). It’s a new rule from the Securities and Exchange Commission. Though promulgated more than a year ago, anyone offering professional investment advice had until June 30th, 2020 to comply with its requirements. Among the “conflicts of interest” advisors will need to disclose include the fact you will pay them a fee if they manage your IRA for you.

“Reg BI took effect at the end of June and it is designed for people who are in the securities business to act in the best interests of the customer when making a securities recommendation, as well as disclosing the relationship between the advisor and the firm,” says Michael Gerstman, CEO of Gerstman Financial Group, LLC in Dallas. “This will impact retirement savers particularly when it comes to rollovers of qualified assets to IRAs. The regulation states that the client’s interests must come first.”

Technically called “Part 3” of Form ADV (a.k.a. “Form CRS”), Reg BI requires more disclosures than those required in Part 2 of Form ADV (and, in some cases, a repetition of those disclosures already disclosed in Part 2).

“The new disclosures required by Reg BI (Form CRS and the Recommendation Disclosure) provide key information about working with financial professionals, and the firms that employ them, regarding how they work, fees and expenses, and potential conflicts of interest,” says Paul Swanson, VP Intermediary Distribution at CUNA Mutual Retirement Solutions in West Chester, Pennsylvania. “The four ‘obligations’ (Care, Disclosure, Conflict of Interest, Compliance) of Reg BI reinforce the goals of ensuring the advice given to customers is not tainted by conflicts of interest and that such advice is directly related to the customer’s needs, financial circumstances and objectives.”

The roots of Reg BI stem from the noble purpose of regulators to level the playing field between SEC Registered Investment Advisers (RIAs) and brokers. It follows on the heels of the Department of Labor’s now vacated 2016 Conflict of Interest (a.k.a. “Fiduciary”) Rule that applied to ERISA plans. (The DOL has since produced a new Fiduciary Rule for ERISA plans intended to conform to the SEC’s Reg BI).

“Essentially, investment advisers were always required to act in their client’s best interests,” says Stacey S. Hyde of Envision Financial Planning in Memphis. “Brokers were only required to offer suitable investments. Reg BI requires that brokers and advisers disclose conflict of interests and put their fees in plain English. However, Reg BI does not apply to employer sponsored retirement plans. It does apply to SEP IRA’s and Solo 401k’s.”

Prior to Reg BI, RIAs fell under the “fiduciary” (i.e., “best interest”) standard while brokers were allowed to abide by only a “suitability” (i.e., not necessarily “best interest,” just not “unsuitable”) standard. The more rigorous fiduciary standard of RIAs often placed them at a competitive disadvantage to brokers. Complicating matters was a decades-old decision by the SEC to allow brokers to co-register as RIAs.

“Reg BI changes the focus from simple suitability to what is in the best interest of your client,” says Michele Lee Fine, Founder and CEO of Cornerstone Wealth Advisory in Jericho, New York. “Is this the best solution to achieve a desired outcome? Retirement savers should be getting guidance from their advisers that is rooted in a broader requirement of research and due diligence in order to make their final recommendations.”  

The most glaring difference between the fiduciary standard and the suitability standard is that the latter permitted self-dealing conflicts of interest. For example, a broker could recommend “suitable” but not “best interest” investment products even though the broker received a compensation bonus in doing so. It’s like doctors prescribing inferior medication because the drug company offered them a kick-back.

“The SEC’s new Reg BI has an impact on all investors and emphasizes the importance of having a true fiduciary (advisers who are required to put their clients’ interests ahead of their own),” says Anderson Lafontant, Senior Advisor at Miracle Mile Advisors in Los Angeles. “Reg BI is recognizing the issues that often arise when clients work with broker-dealers, such as conflicts of interest, increased fees, promoting products, etc.”

The fear of non-compliance by the effective date has caused some financial service providers to change to more client-friendly business models.

“The new regulations are sparking some moves by brokers to lower commissions and reduce some high-cost funds,” says Dennis Morton, Jr., Founder and Principal at Morton Brown Family Wealth in Allentown, Pennsylvania. “This is great news as cost is one aspect of investing that is in the client’s control. Retirement savers can better compare the costs and services of multiple providers as they choose an adviser.”

If you are considering leaving your company retirement plan, the environment may be a little safer thanks to Reg BI.

“Reg BI impacts retirement savers in a generally positive way,” says Jason Field, Financial Advisor at Van Leeuwen & Co. in Princeton, New Jersey. “The main point of the regulation is to make investments and advice more transparent. Individuals saving for retirement can take advantage of this by carefully examining the disclosures, required by the regulation, for ‘red flags.’ Some of these would include excessive fees charged, conflicts of interest between the financial professional and the recommended investment or advice, or any services a professional says they are providing, but are not.”

As you approach retirement, you will be pressed with many important matters. All will seem critical. All will place the burden of choice upon you. None, however, will compare with how you handle your nest egg.

“The most material financial decision that some people make in their lifetime is whether to roll assets out of a workplace retirement plan to an IRA,” says Robert Sichel, Partner at K&L Gates in New York City. “Reg BI applies to account recommendations, such as a recommendation to roll over assets from a workplace retirement plan to an IRA. Retirement savers should be aware that broker-dealers can recommend proprietary products under certain conditions.”

The SEC is hoping many investors will see Reg BI as something that is truly in their best interest. “Regulatory Best Interest should provide some added peace of mind to retirement savers in that they will have an even closer watchful eye over the overall performance of the plans they are offered for their future savings,” says Ryan Moore, founder and CEO of Kingman Financial Group in San Antonio.

Reg BI was designed to give you greater transparency in comparing competing service providers.

“Overall, it helps ensure that retail customers make informed decisions about recommendations that are provided by financial professionals using their best judgement about meeting the customer’s needs,” says Swanson.

But that’s not to say the new regulation won’t make matters more confusing. To some extent, Reg BI may institutionalize conflict of interest fees as some brokers may feel mere disclosure permits them to continue to engage in the practice.

On the other hand, RIAs may now have to disclose their own “conflict of interest” – the fact they’re not giving away their services for free.

Does it make sense to you that both of these “conflicts of interest” be treated equally?

One may lead you to taking the wrong pill. The other is designed only to cure what ails you.

Between the two, which doctor would you choose?

This article was originally published on Forbes

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