Key to complying with Reg BI: Make a reasonable effort to act in the client’s best interest

SEC official: 'Can I demonstrate how I got to this recommendation?'

The Securities and Exchange Commission’s investment advice reform regulatory package requires that financial advisers take costs into account and consider a range of available alternatives for investment recommendations to clients.

The rules don’t provide details on how to take those steps — or any others — to comply with the new rules, the centerpiece of which is Regulation Best Interest to raise the broker advice standard.

It all boils down to “reasonableness,” said Emily Westerberg Russell, chief counsel in the SEC Division of Trading and Markets, at a Financial Industry Regulatory Authority Inc. conference in Washington. “Is there a reasonable basis to believe that the recommendation is [in the client’s] best interest based on the facts and circumstances at the time the recommendation is made?”

The SEC rule, known as Reg BI, is meant to set a higher bar than the current suitability rule that governs advisers and make it parallel to the fiduciary duty that investment advisers will continue to meet under SEC reform.

Brokerages have until June 30 to implement Reg BI. The measure does not define what “best interest” means, nor does it lay out how brokers should mitigate conflicts of interest. Ms. Russell acknowledged there will be gray areas when determining whether advice was given in the best interests of clients.

“It’s not always going to be a black and white, yes, no decision,” she said. “What I would ask myself in situations that might be close calls: Can I demonstrate how I got to this recommendation and how it’s reasonable?”

One area where this approach will be tested is in evaluating whether clients were put in the right kind of accounts — brokerage or advisory — and whether they received sound advice on rolling over retirement funds from a 401(k) to an individual retirement account.

“These account recommendations happen at a critical moment in an investor’s relationship with a broker-dealer,” Ms. Russell told an audience of nearly 500.

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Evan Charkes, managing director and associate general counsel at Bank of America, said the firm is setting up a system to document how Merrill Lynch financial advisers discuss fees and services when opening accounts and how the decision was made.

“We built into our enrollment process the financial adviser demonstrating that particular rationale,” Mr. Charkes said on the panel with Ms. Russell at the Finra conference.

Stephen Youhn, chief compliance officer at ProEquities Inc., said his firm also will track account-opening decisions.

“We need to document more clearly why you’re making a brokerage or advisory [account] recommendation,” he said on a conference panel.

During the rollover process, Merrill Lynch will have its advisers document the questions they cover with clients and will review the answers with the client.

“That’s something that will help us document, if challenged, why we thought a rollover was in the client’s best interest,” Mr. Charkes said.

As June 30 draws closer, firms will continue to grapple with Reg BI compliance.

“It’s a challenge,” Michelle Kelly, senior vice president and associate general at LPL Financial, said at the conference. “It’s hard to know if you’re meeting the requirements.”

The SEC is trying to help firms align their policies and procedures with Reg BI, Ms. Russell said. The agency is taking questions from the financial industry.

“We’re looking through them to find places where we can provide additional clarity to assist firms with compliance,” she said in an interview.