On April 20, 2023, the Securities and Exchange Commission (”SEC)
released a staff bulletin regarding the standards of conduct for broker-dealers
and investment advisors. The bulletin is focused primarily on the Care
Obligation of Regulation Best Interest (“Reg BI”) for broker-dealers and the
duty of care enforced under the Investment Advisers Act of 1940 (the “IA
fiduciary standard”) for investment advisers (together, “care obligations”). Both
Reg BI for broker-dealers and the IA fiduciary standard for investment advisers
are drawn from key fiduciary principles that include an obligation to act in
the retail investor’s best interest and not to place their own interests ahead
of the investor’s interest. The care obligations generally include three components:
Under the care obligations, investment advisers,
broker-dealers, and their financial professionals need to understand the
investments and investment strategies on which they provide advice and
recommendations before advising on or recommending them to retail investors. The
following is a non-exhaustive list that the SEC believes are some of the
important factors that may be relevant to consider as part of evaluating the
potential risks, rewards, and costs of an investment or investment strategy: (1)
the objectives of the investment strategy; (2) the initial and ongoing costs of
the investment strategy; (3) the investment strategy’s key characteristics and
risks (such as liquidity or volatility); (4) the investment strategy’s likely
performance in a variety of market and economic conditions; (5) the expected returns;
(6) any special or unusual features of the investment strategy; and (7) role of
the investment strategy within the context of the investor’s investment portfolio.
According to the SEC, the firm and
financial professional should consider the total potential costs when
evaluating whether the recommendation or advice is in a retail investor’s best
interest, including direct and indirect costs that could be borne by the retail
investor.
Although firms have a general responsibility to understand
the investments or investment strategies that they are recommending or on which
they provide advice, financial professionals also have this responsibility. Financial
professionals cannot satisfy their own care obligations by solely relying on
the efforts of others at their firm. Rather, financial professionals remain responsible
for personally understanding an investment strategy before they recommend or
provide advice regarding the same.
Obtaining and evaluating information about the retail
investor’s investment profile is also a critical step to satisfying the care
obligations. As part of establishing a reasonable understanding of the retail
investor’s investment profile, the SEC indicates that broker-dealers and
investment advisors generally should seek to obtain and consider: the 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 objective and
financial goals; and any other information the retail investor may disclose in
connection with the recommendation or advice.
In addition, broker-dealers and investment advisers may need
to update the investor’s investment profile to comply with their respective
obligations. Broker-dealers generally should make a reasonable effort to
ascertain information regarding an existing retail investor’s investment profile
prior to the making of a recommendation on an “as needed” basis—that is, where
a broker-dealer knows or has reason to believe that the customer’s investment
profile has changed, it must periodically attempt to update customer account information
consistent with existing Exchange Act books and records requirements.
In the Reg BI Adopting Release, the SEC made clear that a
broker-dealer generally should consider reasonably available alternatives as
part of determining whether it has a reasonable basis to believe that a recommendation
is in the best interest of its retail customer. According to the SEC, it would be
difficult for firms and their financial professionals to form a reasonable
basis to believe a recommendation or advice is in the retail investor’s best
interest without considering alternatives that are reasonably available to
achieve the investor’s investment objectives. This is a key component of
satisfying the care obligations of broker-dealers and investment advisers.
The SEC’s staff bulletin also provides guidance with respect to complex or risky financial products, as well as recommendations and advice by dual registrants. The main point of the SEC’s staff bulletin as it pertains to broker-dealers and investment advisors is that enforcement of Regulation Best Interest is becoming a higher priority for the SEC. We encourage all our broker-dealer and financial advisor clients to read the SEC’s April 20, 2023, Bulletin.
