The Securities and Exchange Commission published new guidance Thursday around the standards of conduct for broker/dealers and investment advisors, focusing specifically on the care obligations in Regulation Best Interest and the fiduciary standard.
Such care obligations, which include understanding the potential risks, rewards and costs of a product or investment strategy, having a reasonable understanding of the client’s investment profile, and a consideration of reasonably available alternatives, have increasingly been the subject of recent enforcement actions, an SEC official describing the bulletin said.
In fact, the SEC’s first Reg BI enforcement case was a violation of the rule’s care obligations. Last June, the regulator charged Western International Securities, a Pasadena, Calif.-based dual registrant, and five of its reps for recommending and selling a high-risk debt security to retail investors and retirees.
The staff bulletin is the third in a series that began last year.
One area the SEC focuses on is the “consideration of reasonably available alternatives,” which means that broker/dealers and advisors must evaluate other investments and investment types before making a recommendation. And that doesn’t just mean considering alternative share classes of a particular product.
“Moreover, in the view of the staff, consideration of reasonably available alternatives should begin early in the process of formulating a recommendation or providing advice rather than as a retroactive exercise undertaken after the firm or financial professional has already decided what to recommend or what advice to provide,” the bulletin states.
And while considering “reasonably available alternatives” is not explicit for investment advisors in the same way it is for brokers/dealers under Reg BI’s auspices, advisors should see Reg BI’s mandates as a “useful framework” to meet care obligations, the bulletin states.
The contents of the bulletin wouldn’t be revelatory for compliance officials in the weeds of the rule’s requirements, according to an SEC official, but for firms with small staffs, it could provide helpful details, particularly as the SEC’s enforcement wing focuses more on care obligation violations.
“Although the specific application of Reg BI and the IA fiduciary standard may differ in some respects and be triggered at different times, in the staff’s view, they generally yield substantially similar results in terms of the ultimate responsibilities owed to retail investors,” the bulletin read.
The SEC official stressed that the guidance does not (and could not) expand Reg BI’s scope, and that the guidance in staff bulletins could not be used as the basis for charging firms with regulatory violations.
According to the guidance, Reg BI considers mulling reasonably available alternatives “an inherent aspect” of fulfilling best interest obligations, and stressed that brokers shouldn’t be seeking those alternatives after they’ve already decided what to recommend to a client.
While determining how to best find alternatives remains a case-by-case basis for the commission, the guidance suggested brokers start with a broad array of strategies “generally consistent” with the client’s profile, and to narrow from there (though brokers and advisors aren’t required to consider every possible alternative).
The staff acknowledged there wasn’t always a one-to-one comparison available for complex or risky products.
“However, the staff believes that products that are not identical may still be comparable to each other for purposes of identifying them as reasonably available alternatives based on the retail investor’s investment profile, among other factors,” the bulletin read.
The bulletin reiterated guidance on a number of requirements for brokers, including that cost is always a relevant (though not the only) factor when determining whether a recommendation is in the client’s best interest, and that gathering information on a client’s investment profile is not a “one-and-done exercise.”
The commission released its first staff bulletin related to Reg BI obligations in March 2022, followed by the August release of a bulletin centered on the rule’s Conflict of Interest obligation. Currently, the SEC has no plans to release additional bulletins, according to the SEC official.