Reasonably Available Alternatives: Comparing Apples to Oranges

I have heard, when talking to our clients and other industry professionals, discussion about Reasonably Available Alternatives (RAA) and the question of “what level of alternatives is needed to comply with Reg BI?” I haven’t heard a definitive answer. Some have advocated that it must be done at the account level and others at the specific product level. I would advocate that it must be done at the level that fulfils the care obligation. Yes, an easy out, but if we look at a statement in the most recent staff bulletin, perhaps the most telling statement is: 

“A broker-dealer should have a reasonable process for establishing and understanding” the scope of reasonably available alternatives to be considered in order to fulfill the Care Obligation “  

The key word is “Scope.” What is “the scope”? To fully understand the scope there must be a top-down analysis of all the alternatives available.  

We consider alternatives all day long.

Because there is regulation involved, we think more about the process of considering alternatives because there is an outside influence. But the process of looking at alternatives is something we do all the time. Every time we go to the grocery store, we consider alternatives in terms of costs and features. We do this when we buy cars. We have a natural way of doing it. The idiomatic expression “You can’t compare apples to oranges” may actually be false. You can compare an apple to an orange when you are buying fruit. But if you were going to make a pie this is a different need. When considering making pie you might look to make an apple pie or maybe an orange cream pie. You could compare the benefits of each type of pie and then select apple. Once an alternative type of pie is addressed, you would then move to the second level of alternatives. “What type of apple is best for my apple pie?” You would compare the tart and firm Granny Smith to a Honeycrisp or good old fashioned Red Delicious. Comparing these alternatives would need to factor in the type of apples available to me, due to my location, the season, and what I can afford.  

This example illustrates two key factors when considering alternatives:

• • It must be done based on needs and circumstances

• • It may need to be done and multiple levels 

Reasonably available alternatives can only be done in the context of need.

Needing to make a pie is different than trying to be healthy and get some fruit in my diet. Needing to eat some fruit is an “apples to oranges” comparison. Making an apple pie is not. I could buy the best oranges in the world (or the cheapest ones), but if I am trying to make an apple pie, I missed the point.   

Understanding a customer’s needs in a systematic process and then applying the alternatives is the only way to address Reg BI. Here is the problem. Great financial professionals do this intuitively. With any expert, over the years, they formulate business processes in their practice. They have built internal mental algorithms that can compare customer needs to the products they feel comfortable offering. If you asked a financial professional to explain their mental process, it could be difficult for them to do it. They have done it so much that they “just know.” So, the real issue within the guidelines of Regulation Best Interest is to have a process that allows financial professionals to do what they do best and then help them show their work. The process I propose is a multi-step approach that is easily understood by the customer and can be explained in a repeatable fashion.  

The approach may need to include multiple levels of comparison

Customer needs are not just at one level and the corresponding solutions are at multiple levels. With this in mind, the level of alternatives must be based on the level of need. I would argue that to truly have a process, even though a financial professional knows what they are doing, they must explain at each level why something fits the client’s needs without skipping a step. What is very difficult is to try and compare account level alternatives to product level alternatives. It just doesn’t work. What’s even more important is that trying to compare accounts to products may confuse a customer. The only really viable approach is to break down the process at the levels that make the most sense. 

Alternatives of account types and product categories

Let’s call the comparison of account types or product categories the “apples to oranges” comparison. Based on the customer’s high-level needs, do they need an apple or an orange? A financial professional would determine the customer’s needs and then compare them to the account type. This could be an advisory account, an annuity (not a specific one but an annuity), an alternative investment and others. To do this, a financial professional must understand the benefits and costs of these alternatives generally. We know that annuities may provide protection of principal but there can be inherent costs and limits to access of funds. An advisory account may provide greater investment options and the flexibility to leverage the expertise of the best investment minds. Pure cost minimization could point to buy and hold strategies or limited investments that reduce cost. 

At the account level, the comparison of a special fee to specific fees is difficult because the products offer such vast differences in features and the fee structures are different. So, the comparison is based on what these alternatives offer and then provides a clear disclosure of the range of fees that could be incurred. Using food yet again, lobster costs more than a hot dog. But who can compare the succulent difference of butter dipped Lobster vs a hot dog? But on the other hand, I might prefer a hot dog in hand with a beer at the ballpark.  

Alternative Account Programs

Alternatives at the product level.

Potential Solutions

Lots of Notes

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The solution is to provide a process that allows Reasonably Available Alternatives to be compared against the customer needs. This in most cases will require the financial professional to compare and present alternatives at multiple levels.

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Resources:

https://www.sec.gov/tm/standards-conduct-broker-dealers-and-investment-advisers#_ftn39