With Reg BI rules going live in less than two weeks, advisors be wary of rolling clients' 401(k)s or IRAs into high-risk Covid-related products, SEC Chairman Jay Clayton said.
Clayton recommended the added care as broker-dealers prepare to implement Regulation Best Interest—the sweeping new standard of conduct for registered reps and advisors when making retail recommendations—beginning June 30.
“It is clear to me that some of the investments and strategies being marketed to Main Street investors are complex and risky, including certain of those that are marketed as responsive to the effects of Covid-19, provide significantly leveraged exposure (and risk) through the use of options, futures and other derivatives or through the use of margin and have complex structures that may not be easily understood by Main Street investors,” Clayton said in a statement released yesterday.
“I am concerned that recommendations of these investments and strategies may not be in the best interest of significant portions of our Main Street investors. Unfortunately, certain other investments, including some marketed as Covid-19-driven, may be simply fraudulent as the commission has charged in recent enforcement actions,” he said.
When making investment recommendations to a retail investor under Reg BI, a broker-dealer cannot put his or her interests ahead of the interests of customers. The broker-dealer also is required to take into account each investor’s investment horizon, needs and objectives, investment experience and risk tolerance.
Given the continuing fallout of Covid-19, the global economic shutdown and continued market volatility, “the current and future needs and expectations of many of our Main Street investors, as well as the risks they face, have changed significantly. For example, Main Street investors may have greater needs for cash and liquidity as a result of a change in employment or other circumstances,” Clayton said.
Under Reg BI, Clayton said broker-dealers, reps and advisors should ensure that given the current conditions, they take extra care if they are making the following recommendations or advice to a retail investor:
• Rollovers and withdrawals from 401(k) and other plans. Clayton called the new rule’s application to retirement plan and IRA rollovers “one of the most significant enhancements over the status quo.” The fact that Congress recently gave investors more flexibility to take withdrawals from retirement accounts underscores the need for firms to ensure that recommendations for roll-overs and withdrawals meet Reg BI obligations, he said.
The CARES Act allows eligible participants in tax-advantaged retirement plans to take early distributions of up to $100,000 during this calendar year without being subject to early withdrawal penalties. A recent SEC investor alert noted that some promoters are using this change to recommend investors take CARES Act withdrawals from retirement plans to invest in high-risk or even fraudulent schemes.
• Complex or risky products. Clayton urged broker dealers to carefully review any addition of complex and risky products, including less liquid investments or leveraged products that rely on derivatives strategies to enhance returns. Firms will be responsible for ensuring all product they add to their platforms are in the best interests of investors, he said. “For example, inverse or leveraged exchange-traded products may not be in the best interest of a retail investor absent an identified, short-term, investor-specific trading objective,” Clayton said.