Tips for Updating Your Compliance Program: Fiduciary Standard

Compliance officers face the thankless task each year of reviewing their policies and procedures to determine their adequacy and effectiveness, as required by Advisers Act Rule 206(4)-7. This review entails updating the firm's compliance program to reflect changes to relevant regulations and new regulatory guidance, and confirming the program is appropriately followed by the firm.  

We’ve compiled a series of tips to help you focus on the U.S. Securities and Exchange Commission (SEC) focus areas for 2023. You can read our previous tips here:  

• Tip 1: Get ready for SEC focus on hedge clauses in advisory agreements
• Tip 2: Keep tabs on Continuing Education requirements
• Tip 3: Update your compliance program to address the SEC Risk Alert about MNPI compliance issues
• Tip 4: Prepare for an SEC examination focused on Marketing Rule compliance 
• Tip 5: Update Your Compliance Program to Prevent Identity Theft Under Regulation S-ID 
• Tip 6: Environmental, Social, and Governance (ESG)
• Tip 7: Electronic Communications
• Tip 8: Prohibited Transaction Exemption
• Tip 9: Conflicts of Interest

Tip #10 – Review your Account Recommendation Process to Meet the Fiduciary Standard

In the Staff Bulletin: Standards of Conduct for Broker-Dealers and Investment Advisers Account Recommendations for Retail Investors (the “Bulletin”), the SEC Staff has set the bar high for investment professionals dealing with retail clients. This Bulletin, along with a second one addressing conflicts of interest (discussed supra), was developed at SEC Chair Gary Gensler’s request “to help insure investment professionals live up to” their obligations under Regulation BI and the Commission Interpretation Regarding Standard of Conduct for Investment Advisers (the “Fiduciary Interpretation”).  

This Bulletin provides practical guidance on the factors investment professionals should consider when making account recommendations. We outline a few highlights to consider below.

Our guidance

• Draft guidelines for refusing potential clients. The Bulletin stresses that investment professionals should match advisory services and investment products offered to clients based on their needs and preferences. If no match exists, the firm should consider turning away that client and documenting the interaction.  
• Know when to say no. The Bulletin recommends investment professionals gather the relevant data before making an account recommendation, including the retail investor's financial situation (including current income) and needs, investments, assets and debts, marital status, tax status, age, investment time horizon, liquidity needs, risk tolerance, investment experience, investment objectives, and financial goals. According to the SEC staff, the investment professional cannot provide a recommendation if the investor does not provide the answers needed.   
• Education is key. Training investment professionals is critical to ensure they make the right account recommendations and document them appropriately. Don't assume that a quick PowerPoint presentation is going to suffice.  
• Document, document, document. The SEC staff expects documentation to support account recommendations. In the staff’s view, “it may be difficult for a firm to assess periodically the adequacy and effectiveness of its policies and procedures or to demonstrate compliance with its obligations to retail investors without documenting the basis for certain recommendations.” Investment professionals should consider the products and services provided in the account, the potential costs to the retail investor, and alternative account types available. The investment professional must also determine whether the recommended account is consistent with the client’s investment profile and stated goals. Firms should consider the best way to capture these elements, such as a checklist or account recommendation form. 
• Consider costs. Firms should keep written records supporting recommendations for higher-cost products, especially if lower-cost products are available. Additionally, the SEC staff includes many examples of the types of costs to be evaluated as part of the process, including account fees (e.g., asset-based, engagement, hourly), commissions and transaction costs, tax considerations, and indirect costs such as payment for order flow and cash sweep products. The evaluation should also include indirect costs such as fund management, distribution and servicing fees, and transaction costs. Firms should consider maintaining records showing their evaluation of investment products' direct and indirect costs. 
• The customer is not always right. Firms and their investment professionals cannot rely solely on a retail investor's preference without discussing other reasonably available alternatives, including the type of account that is in the client's best interest based on the information provided. If the client directs the firm to open an account contrary to the recommendation, the firm "would not be required to refuse to accept the investor's direction." 
• Get a second set of eyes. Another best practice recommended by the Bulletin is for firms to "implement supervisory procedures to monitor recommendations that involve the rollover or transfer of assets from one type of account to another (such as recommendations to roll over or transfer assets in an ERISA account to an IRA). Firms should consider the best way to supervise account rollovers, such as requiring manager approval before account opening. Alternatively, the firm could adopt a policy that prevents opening an account if the financial professional does not provide the required documentation, a/k/a NIGO (not in good order). Remember that although compliance officers can test the process after the fact, supervision is management's responsibility.

How we help  

We can help you to navigate the evolving regulatory landscape while considering the complexity of your firm’s unique compliance requirements. Introducing ACA Signature, a scalable solution curated to suit your firm’s unique compliance needs. ACA Signature provides financial firms with scalable consulting solutions that can be paired with innovative technology and managed services for staying on top of regulatory and daily obligations. Our team of regulatory experts can build, enhance, or manage your compliance program, helping to mitigate risks and increase operational efficiency.

Designed by former regulators and compliance experts, ACA Signature provides services and solutions tailored to fulfill your firm’s ongoing compliance obligations. Our team includes former SEC, FINRA, FCA, NFA, CFTC, and state regulators along with former Chief Compliance Officers and senior compliance managers from prominent financial institutions in the industry. With over 20 years’ experience in the compliance industry, ACA is synonymous with quality compliance support. 

Reach out to your ACA consultant, or contact us to find out how ACA Signature can help transform your firm’s compliance program.

Listen to our 2023 Regulatory Outlook webcast on demand

We recently hosted a webcast to review the regulatory changes that will likely have implications on compliance programs in 2023, and provide recommendations to prepare for these changes. Our experts discussed rule proposals and adoption, examination and enforcement trends, and regulatory guidance. Watch our webcast for more insights to help you prepare your compliance program for this year’s focus areas.

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