SEC Issues New Reg BI Guidance

The Securities and Exchange Commission released guidance Thursday for advisors and brokers on meeting their care obligations when providing investment advice and recommendations to retail investors.

In its new guidance, released in Q&A form, SEC staff focuses primarily on the Care Obligation of Regulation Best Interest for broker-dealers and the duty of care enforced under the Investment Advisers Act of 1940 for investment advisors.

This is the agency’s third bulletin on Reg BI, which the agency says is guidance and does not create new regulations or rewrite existing ones. SEC staff guidance, according to SEC officials, can also not be the basis for an enforcement action.

The first one addressed account recommendations, such as rollovers. The second one, issued last April, focused on identifying and addressing conflicts.

The care obligations, the SEC explains, generally includes three overarching and intersecting components:

• Understanding the potential risks, rewards and costs associated with a product, investment strategy, account type or series of transactions;
• Having a reasonable understanding of the specific retail investor’s investment profile; and
• Based on the understanding of the first two elements, having a reasonable basis to conclude that the recommendation or advice provided is in the retail investor’s best interest.

The bulletin, for instance, defines “investment profile,” and how it helps brokers and advisors satisfy their care obligation.

The term “investment profile” refers to information that the firm or financial professional generally should make reasonable efforts to ascertain about the retail investor, the agency explains.

“Obtaining and then evaluating information about the retail investor’s investment profile is a critical step to satisfying your care obligation,” the SEC states.

The agency also explains that while costs are always a “relevant factor to consider when recommending or providing advice on investments or investment strategies, they should not be the only consideration, and a firm or financial professional cannot satisfy its obligations simply by recommending the lowest cost option.”

The firm and financial professional, the agency explained, “must always consider cost as a factor when providing a recommendation or advice to a retail investor,” the guidance states.

In the SEC’s view, “the firm and financial professional should consider the total potential costs when evaluating whether the recommendation or advice is in a retail investor’s best interest, including direct and indirect costs that could be borne by the retail investor.”

For instance, when determining whether an investment or investment strategy is in the investor’s best interest, the guidance states, a firm and financial professional should consider the potential costs, such as:

• commissions, markups or markdowns, and other transaction costs; sales loads or charges;
• advisory or management fees;
• other fees or expenses that may affect a retail investor’s return (such as Rule 12b-1 fees, other administrative and service fees, revenue sharing, and transfer agent fees);
• the trading and other costs associated with an investment strategy.

The guidance also states that brokers and advisors should not rely solely on their firm’s approved list of investments for retail investors.

“Although firms have duties under their care obligations, including a general responsibility to understand the investments or investment strategies that they are recommending or on which they provide advice, financial professionals also have this responsibility,” the guidance states.

While firms should generally help ensure financial professionals “have sufficient information and training to understand the investments and investment strategies they recommend or advise on,” the agency explains, “financial professionals cannot satisfy their own care obligations by solely relying on the efforts of others at their firm.”

Financial professionals, the agency warns, “remain responsible for personally understanding an investment or investment strategy before they recommend or provide advice with regard to that investment or investment strategy.”

Reasonable Alternatives

Issa Hanna, partner at Eversheds Sutherland’s New York office, told ThinkAdvisor Friday in an email that, with this new guidance, “it’s the first time we’ve seen any substantial guidance on the topic of consideration of reasonably available alternatives since the SEC adopted Reg BI.”

In Reg BI’s adopting release, the agency said that a broker-dealer generally should consider reasonably available alternatives as part of determining whether it has a reasonable basis to believe that a recommendation is in the best interest of its retail customer.

“We have seen the staff communicate some of these concepts in the course of examinations (particularly, the expectation that firms provide financial professionals with specific direction on the alternatives to consider as part of a reasonably available alternatives analysis), but some of the concepts are new to us,” Hanna said.

For instance, “it is worth calling out specifically the staff’s view here that the consideration of reasonably available alternatives should begin early in the process of formulating a recommendation or providing advice rather than as a retroactive exercise after the financial professional has already decided what to recommend or advise.”

Likewise, Hanna added, “the staff’s view that it is ‘particularly important’ to document the basis for a reasonably available alternatives analysis when the recommendation poses a conflict for the firm or the financial professional is also something new, and potentially with broad implications because of how broadly it is worded.”

For instance, “there is no qualifier on the use of the word ‘conflict’ (i.e., it does not seem to be limited to a conflict that would be material to the consideration of the different alternatives),” Hanna said.

(Photo: Diego Radzinschi/ALM)