Staff at the Securities and Exchange Commission (SEC) issued a bulletin Thursday addressing standards of conduct for broker-dealers and investment advisers in addressing their care obligations under Regulation Best Interest (Reg BI) and the Investment Advisers Act.
Reg BI, which took effect in 2020, requires financial professionals to act in the best interests of a customer when offering investment strategies involving securities. Compliance with the rule was highlighted by the SEC earlier this year as an area of examination priority in 2023 after examiners in January issued a risk alert listing deficiencies they found in broker-dealer’s efforts under the rule.
A key tenet of Reg BI is its care obligations, which require investment advisers to:
- Understand the potential risks, rewards, and costs associated with a product, investment strategy, account type, or series of transactions;
- Have a reasonable understanding of the retail investor’s investment profile; and
- Have a reasonable basis to conclude the recommendation or advice provided is in the investor’s best interest.
“Whether a recommendation or advice satisfies the care obligations is an objective evaluation, turning on the facts and circumstances of the particular recommendation or advice and the investment profile of the particular retail investor at the time the recommendation is made or when the advice is provided,” the SEC bulletin said. “When adopting and implementing reasonably designed policies and procedures regarding their care obligations, broker-dealers and investment advisers should tailor those policies and procedures, taking into consideration their particular business models and relationships with retail investors.”
The bulletin asked and addressed 20 questions regarding care obligations, including factors to consider in understanding an investment strategy, how and when to gather information for a retail investor’s investment profile, and when to consider reasonably available alternatives during the advisement period. Of note in this latter section was advice regarding complex or risky products, including crypto asset securities, and what it means to apply heightened scrutiny toward such products.
The bulletin also made clear a firm’s compliance procedures regarding the care obligations aren’t enough to protect the individual adviser from liability—financial professionals “remain responsible for personally understanding an investment or investment strategy before they recommend or provide advice with regard to that investment or investment strategy.”
The SEC in June announced its first enforcement action alleging violations of Reg BI by five brokers at California-based Western International Securities.