SEC Staff Bulletin – Standards of Conduct for Broker-Dealers and Investment Advisers Care Obligations

On April 20, 2023, the Securities and Exchange Commission (“SEC”) staff issued “Staff Bulletin: Standards of Conduct for Broker-Dealers and Investment Advisers Care Obligations” (“Bulletin”), which provided further guidance related to the Care Obligation of Regulation Best Interest (“Reg BI”).

In the Bulletin, the SEC staff stated that the Care Obligation has three overarching components:

• Understanding the potential risks, rewards, and costs associated with a recommendation
• Having a “reasonable understanding” of a retail investor’s investment profile
• Based on those understandings and a consideration of reasonably available alternatives, having a reasonable basis to believe the recommendation provided is in the retail investor’s best interest.

The Bulletin addressed the SEC staff’s major care obligation concerns in a question-and-answer format. The primary topics discussed, and the SEC staff’s guidance in relation to them, included the following:

• Understanding the Investment or Investment Strategy
  • Registered representatives (“RRs”) need to understand the risks, rewards, and costs associated with their recommendations.
  • RRs should consider factors such as the following when making a recommendation:
    • The recommendation’s objectives, e.g., income, growth, or taxes
    • The recommendation’s initial and ongoing costs, e.g., sales loads, 12b-1, expense ratios, or CDSC
    • The risks associated with the recommendation, e.g., volatility, liquidity, or early termination
    • The recommendation’s investment performance in various market and economic conditions 
    • The recommendation’s expected returns, losses, and payout
    • Any special or unusual features of the recommendation, e.g., tax advantages or guaranteed payments
    • The investment’s fit with the customer’s other investments
      
      If ongoing monitoring is required, the RR will perform continued analysis of the recommendation after the purchase and over the relationship’s course.
  • As noted above, RRs must consider costs when making a recommendation, understanding that the lowest-cost recommendation may not be the best. For example, RRs might consider costs such as the following:
    • Commissions, markups, markdowns
    • Transaction costs
    • Revenue sharing, 12b-1 fees, advisory fees
    • CDSC or other exit costs
    • Tax considerations
  • In determining a recommendation’s suitability, RRs cannot rely solely on the fact that a product is on a firm’s “recommended list”; they must also understand the various factors listed above. 
• Understanding the Retail Investor’s Investment Profile
  • RRs must obtain sufficient information about the customer to conclude on a reasonable basis that a recommendation is in that customer’s best interest.
  • RRs must collect sufficient information, initially and ongoing, regarding a recommendation to conclude on a reasonable basis that it is in the investor’s best interest.
  • When making a recommendation, RRs should also consider the customer’s level of financial sophistication and whether they make decisions on their own accord or rely on RR advice.
  • RRs should consider whether an existing customer’s circumstances have changed before making subsequent recommendations.
  • If a customer has provided insufficient information regarding their situation, RRs should determine whether they know enough to make a recommendation that is in the customer’s best interest.
  • RRs should consider the customer’s tax status when making a recommendation that features tax advantages to determine if it is in the customer’s best interest.
• Considering Reasonably Available Alternatives
  • As part of their Care Obligation, RRs must consider reasonably available alternatives as they assess whether a recommendation is in a customer’s best interest.
    • RRs should consider reasonably available alternatives early in the recommendation process.
    • RRs must consider risks, rewards, and costs when evaluating reasonably available alternatives.
    • RRs are not required to consider all available alternatives. Still, they should have a reasonable basis to believe they have considered sufficient potential alternatives to conclude that a recommendation is in a customer’s best interest.
    • Some products may be unique and offer specific features for which there are no direct reasonably available alternatives. RRs are not precluded from considering such products if their recommendation can be shown to be in the customer’s best interest.
  • To comply with the care obligation, firms must have a process in place whereby RRs consider reasonably available alternatives.
    • Specifically, firms must provide guidance on how RRs should consider reasonably available alternatives.
    • For firms with limited product menus, RRs may need to be familiar with all available products to determine which ones would be in the customer’s best interest. Relying on having a limited menu alone as a basis to conclude that no reasonably available alternatives exist may not satisfy the care obligation requirements.
    • While RRs are not specifically required to document their analyses of reasonably available alternatives, they may still need to document this review as evidence of their compliance with the care obligation.
• Special Considerations: Complex or Risky Products
  • The SEC staff noted that no prohibition exists on recommending complex or risky products if RRs can determine that such products may be in the customer’s best interest.
  • RRs should be able to demonstrate that a recommendation of a complex or risky product is in the customer’s best interest in light of the customer information and the product features described previously.
  • Firms must have “heightened scrutiny” processes in place for complex or risky products when making such recommendations.
• Special Considerations: Recommendations and Advice by Dual Registrants
  • Dually registered persons must consider the type and features of an account when making a recommendation.
  • Dually registered persons must disclose the capacity, e.g., broker-dealer or investment adviser, in which they are acting.
  • Dually registered persons must consider which account type is in a customer’s best interest based on the factors outlined above.

The Bulletin also discussed the similarities between broker-dealers acting in the customer’s best interest and the fiduciary responsibility of investment advisers.

Firms should compare the guidance provided by the SEC staff with their policies and procedures for compliance with the Reg BI and care obligation requirements. In addition, firms should review the training they conduct in relation to the products offered, as well as their RRs’ compliance with the care obligation. 

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