New SEC Reg BI Guidance Adds More Color to ‘Care Obligations’

The Securities and Exchange Commission on April 20 issued new guidance in the form of a staff bulletin to assist broker-dealers and investment advisers in addressing their care obligations when providing advice to retail investors.

The bulletin, which is the third in a series[1] and includes 20 questions and answers, focuses primarily on the care obligation of Regulation Best Interest (Reg BI) for broker-dealers and the duty of care under the Investment Advisers Act of 1940 (the IA fiduciary standard) for investment advisers.

The SEC notes that, 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.

“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 bulletin emphasizes.  

To provide more context in that regard, the Q&As are divided into five parts addressing:

• To what extent financial professionals need to understand the investment or investment strategy they are advising on or recommending;
• To what extent professionals need to understand the retail investor’s investment profile;
• Whether and how firms and professionals should develop and evaluate reasonably available alternatives;
• What considerations should be given to complex or risky products; and
• What considerations should be given concerning recommendations and advice by dual registrants.

No One and Done

In perusing the various questions, the SEC’s bulletin reconfirms that gathering information for a retail investor’s investment profile is not a one-and-done exercise. The bulletin explains that BDs and IAs must have sufficient information to make a recommendation or provide advice in the investor’s best interest.

“What constitutes sufficient information may change based on the investments or investment strategy being recommended or advised, or where the firm is aware or has reason to be aware that information in the investment profile has changed (e.g., birth of a child, marriage/divorce, retirement) or contains information that is inconsistent (e.g., a profile that contains multiple investment objectives that appear inconsistent with each other),” the bulletin states.  

As such, BDs generally should make a reasonable effort to ascertain information regarding an existing retail investor’s investment profile prior to the making of a recommendation. Similarly, IAs generally must update the client’s investment profile to maintain an understanding of the client’s objectives and adjust the advice to reflect any changed circumstances, the bulletin notes.

Investment Menus

For situations where a firm has a limited menu of investments and whether a professional must consider all of them when evaluating reasonably available alternatives, the staff says that it depends.

“[C]ertain investments on that limited menu that can be made available to retail investors in general may be inconsistent with an individual retail investor’s investment profile, such that the investments are not reasonable alternatives for that particular retail investor,” the bulletin notes.

Consequently, the staff believes that IAs who are engaged in providing ongoing investment advice, in particular, should periodically consider whether the options they make available to their clients are sufficient to meet their clients’ best interest, and whether there are other options available that may better serve their clients.   

Dual Registrants

For situations where a retail investor holds both brokerage and advisory accounts, the staff believes a dually registered firm or dually licensed financial professional should consider whether an investment recommendation is better suited for the investor’s brokerage account or advisory account.

“In the staff’s view, this process should include consideration of the difference in reasonably expected total costs depending on whether the investment or investment strategy is held in the retail investor’s brokerage or advisory account, including but not limited to any account level costs, such as commissions, advisory fees on assets under management, or, as relevant, tax consequences, over the expected life of the investment,” the bulletin explains.

For example, it notes that a retail investor whose objective is to buy and hold a long-term investment may be better off paying a one-time commission to a broker-dealer for the purchase of that investment rather than paying an ongoing advisory fee merely to hold the same investment. 

Going Forward

The SEC notes that the bulletin should be read in conjunction with Reg BI and the specific Commission releases discussing Reg BI and the IA fiduciary standard. In addition, the SEC notes that the staff has made available other resources, including staff FAQs, risk alerts and other releases highlighting compliance practices and staff observations.

The bulletin comes as the SEC steps up its enforcement of Reg BI. For instance, last June the Commission announced that it charged a registered BD and five of its representatives for failing to comply with Reg BI in several ways, including the care obligation.   

Moreover, the SEC’s exam priorities released at the start of the year also advise that the Commission will continue to address standards-of-conduct issues for BDs and RIAs to ensure that retail investors are receiving recommendations in their best interests. In this regard, the SEC notes that BDs and dually registered RIAs are an area of continued interest, as are affiliated firms with financial professionals that service both brokerage customers and advisory clients.