Interesting example...
By Cailie Currin, President / CEO
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In a September 9, 2020, piece in the National Law Review by Fred Reish titled Regulation Best Interest: Best Interest and Suitability – How They Differ (Part 1), there is an interesting example posed that highlighted to me a key difference between the approach taken by Reg BI and NY’s Regulation 187 Suitability and Best Interests in Life Insurance and Annuity Transactions.
Mr. Reish looks at the Reg BI mandate that consideration of cost be included in an evaluation of a recommendation as part of meeting the Care Obligation. His example is:
A broker-dealer offers two S&P 500 index funds with essentially no differences except that one has a 50-basis point expense ratio and the other has a 75-basis point expense ratio. While it is theoretically possible that some difference in features or benefits could justify the additional cost, no examples come to mind in this case. Remember, the issue is whether it would be in the best interest of a retail investor to recommend the more expensive 75 bps version.
He specifically notes that, “The only difference, from the customer’s perspective, is that one is more expensive than the other, meaning that the return for the customer will be lower.” Without stating whether it is his opinion, Reish states:
One might argue that the broker-dealer and its advisor should be able to recommend the more expensive option if it pays more compensation and if the additional compensation is reasonable. However, the adopting releases for the proposed and final Reg BI focus on the best interest of the customer. As a result, the likely interpretation of Reg BI is that the lower cost alternative should be recommended, assuming that the investment is otherwise identical.
Reg 187, if it applied to this transaction, would leave no doubt as to the outcome. NY’s concept of best interest includes that only the interests of the consumer can be considered (§224.4(b)(1)). There is no room for an argument that the higher compensation is reasonable and therefore possibly acceptable. Disclosure of the higher compensation cannot cure any consideration. The agent under NY’s standard cannot even consider his or her own compensation in making a recommendation.
I put forward this similar example, but focus on Reg 187’s standard:
An insurance agent offers two annuities with absolutely no difference in the cost, features and benefits from the consumer’s perspective and the issuing carriers each have the same rating. The only difference between the two relates to the compensation. To make it a more extreme example, let’s say even the amount of compensation is the same, but one company has, in the agent’s experience, paid more quickly than the other.
Under Reg 187, if the agent considers the fact that payment is likely to be faster with one company than the other and recommends the quick-payer’s annuity product, there is a violation of the duty of producers with respect to sales transactions in NY. This is so even though the products are identical from the consumer’s perspective. In the Reg BI example, the higher expense ratio will make the customer’s return lower. That is not the case here. The practice of paying compensation faster does not in any way impact the performance of the product from the NY consumer’s perspective. But the “consideration” of that fact by the agent constitutes a breach of the Reg 187 duty of care.
Of course, it is rarely, if ever, true that two products are identical from the consumer’s perspective. There will almost always be some feature or benefit that is different in some way – after all, that is what much of market competition is about. But thinking about this extreme example illustrates the importance of documenting the features of the product that are the basis for the recommendation. Only if there is substantial documentation of the required basis for a recommendation will a producer be able to rebut an assertion that the impermissible basis – compensation – was “considered.”