On April 20, 2023 the Securities and Exchange Commission (SEC) issued a staff bulletin to reiterate the standards of conduct broker-dealers and investment advisers are being held to in regard to Care Obligations when advising retail investors. The bulletin, the latest of three, aims to set expectations the SEC will hold regulators to concerning Care Obligations within Regulation Best Interest (Reg BI).
The bulletin is written in Q&A style, featuring 20 questions with their respective answers. It comes as a follow-up to the two previous bulletins that addressed account recommendations and how to properly manage conflicts of interest under Reg BI.
SEC officials are stressing that the requirements outlined in all three bulletins are not ‘check-the-box’ exercises and that compliance with the requirements should happen before recommendations are made, not after.
Here are our top takeaways:
Understand What you Sell
The first four questions of the bulletin pertain to understanding the investment options and strategies that are being recommended, claiming that brokers and advisors have a duty to fully grasp the “potential risks, rewards and costs associated with a product, investment strategy, account type or series of transactions.” The SEC goes on to say that without in-depth knowledge about products and/or strategies, there’s no way to reasonably believe that what brokers and advisors are recommending truly aligns with the best interest of the retail investor.
Understand Who you Sell to
Brokers and advisors must also have “a reasonable understanding of the specific retail investor’s investment profile, which generally includes the retail 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 objectives and financial goals; and any other information the retail investor may disclose,” the SEC stated.
Consider the Reasonable Available Alternatives
As part of determining whether there is an adequate belief that brokers and advisors are acting in the best interest of retail investors, the SEC states that reasonable available alternatives should always be considered when making recommendations. In doing so, financial professionals would be fulfilling what the SEC views as an inherent aspect of complying with the Care Obligations, stating that “‘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.”
Apply Heighted Scrutiny to Complex Products
Firms and financial professionals should apply “heightened scrutiny” when considering whether a complex or risky product is in a retail investor’s best interest. Examples of risky or complex products include inverse or leveraged exchange‑traded products, investments traded on margin, derivatives, crypto asset securities, penny stocks, private placements, asset‑backed securities, volatility‑linked exchange‑traded products, and reverse‑convertible notes. The staff recommends that firms establish procedures specifically designed to address recommendations, or advice about, complex or risky products. This includes due diligence processes, appropriate training and supervision.
For training on Complex Products, Reg BI, and Supervision, visit our Firm Element catalog here.
To read the full staff bulletin, click here.