Meeting Reg BI’s care obligations may require financial advisors to consider one million data points per day

Since the introduction of Regulation Best Interest (Reg BI) by the SEC earlier this year, there are several important changes for Broker-Dealers (B-D’s) and their representatives.

The overarching goal of Reg BI is to enhance the broker-dealer standard of conduct beyond existing suitability obligations and make it clear that a B-D may not put its financial interests ahead of the interests of a retail investor when making recommendations.

One of the 4 pillars of Reg BI is the Care Obligation which requires B-D’s and their representatives to analyze whether the security is in the best interest of the investor. Brokers must also “exercise reasonable diligence, care, and skill when making a recommendation to a retail customer.” To exercise reasonable due diligence, care and skill, a broker should:

• Understand the potential risks, rewards and costs associated with the recommendation.
• Have a reasonable basis to believe that product recommendations are in the investor’s best interest.
• Consider “Reasonably Available Alternatives” when making an investment recommendation.

Let’s consider a typical day in the life of an investment advisor. As part of their range of client activities, an advisor evaluates or makes five investment recommendations each day. This advisor’s dealer has an open architecture product shelf of approximately 35,000 investment fund products.

To meet the Care Obligation under Reg BI, this advisor must consider a minimum of six data or suitability fields when considering reasonably available alternatives (RAA) including fees, risk, performance, time horizon, share class and fund series. This will require processing over 1 million data points every day (5 recommendations x 35,000 products x 6 suitability points).

Every industry faces enormous challenges in converting this growing volume of data into actionable insights. The wealth industry, already awash in data, is at the forefront of this data explosion. There are two strategies to tackle this new regulatory challenge: introduce new manual processes or leverage technology.

Several major dealers have implemented new processes that require their advisors to document their RAA analysis. One dealer has a 48-hour peer review of each recommendation to ensure that their recommendations are compliant. These manual efforts introduce significant delays in making client recommendations and they are ultimately insufficient in terms of true data analysis.

While the human brain has enormous storage capacity — between 10 and 100 terabytes — the actual capacity for our brains to process information is much slower. Estimates of brain processing capacity is approximately 50 bits or 6 bytes per second. In the simple example cited above, this analysis would take an advisor 5.5 days to complete!

Leveraging technology in this situation reduces both time delay and risk. Product comparison applications that are designed to support RAA generate results in a matter of seconds.

Another vital and often overlooked technology benefit is the recordkeeping of this data. Going back to our advisor example above and extrapolating this data management challenge over a one-year period requires managing 250,000,000 data points. Furthermore, when you consider that dealers might employ thousands of advisors and have a regulatory data retention obligation of six years…you get the picture.

We outlined the virtues of the hybrid advisor model in several previous articles. Our Reg BI obligations are yet another example of the incredible power of combining technology and human advice. Let technology do what no human is capable of — processing millions of data points instantaneously — while humans do what no technology is capable of: building client relationships based on human understanding, empathy and optimism.

 

Article by: David Reeve, CEO of InvestorCOM

 

Tags: data challenge, financial advisor, investment recommendations, Reg BI