News & Insights

Sec Updates Standards Of Conduct For Broker-Dealers And Investment Advisors

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:

  • Understanding the potential risks, rewards, and costs associated with a product, investment strategy, account type, or series of transactions;
  • Having a reasonable understanding of the specific retail investor’s investment profile;
  • Based on the understanding of the first two elements, as well as a consideration of reasonably available alternatives, having a reasonable basis to conclude that the recommendation or advice provided is in the retail investor’s best interest.

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.