SEC's Regulation BI Increases Suitability Standards For Broker-Dealers
The SEC recently announced the passing of a new rule to the SEC Act of 1934 (full release available here). Regulation BI (“Best interest”) effectively imposes increased suitability standards for broker-dealers with the aim of further protecting retail investors and improving clarity among firms so retail clients can make more informed decisions when selecting a brokerage. This increased standard of conduct requires that broker-dealers put investor’s interests before any self/financial interests. When providing investment recommendations, a broker-dealer must satisfy 4 specific obligations. Per the SEC, those obligations are as follows:
(1) Disclosure Obligation: Provide certain prescribed disclosure before or at the time of the recommendation, about the recommendation and the relationship between the retail customer and the broker-dealer. Items requiring disclosures include: Fees, scope of services and any limitations on recommendations. It’s also important to note, the SEC was quick to highlight that simple disclosure alone is not sufficient to meet the standard of conduct set forth by the new rule.
(2) Care Obligation: Exercise reasonable diligence, care, and skill in making the recommendation. This obligation requires broker-dealers to consider viable investment alternatives, and requires firms to take a wholistic view when approaching any series of transactions, to determine whether the investment is collectively excessive (even if each individual transaction is deemed to be in the investors’ best interest). Unlike the fiduciary obligations under the Advisers Act where the duty to advise and monitor is ongoing, the duties owed to retail investors under Regulation BI are not ongoing, but rather owed at the time the recommendation is made.
(3) Conflict Of Interest Obligation: Establish, maintain, and enforce policies and procedures reasonably designed to address conflicts of interest. These conflicts of interest include, but are not limited to: potential compensation related conflicts (including bonuses and sales incentives), and non-cash compensation conflicts.
(4) Compliance Obligation: Establish, maintain, and enforce policies and procedures reasonably designed to achieve compliance with Regulation Best Interest
With regulation BI increasing the potential for liability and SEC enforcement actions, broker-dealers should revisit their professional liability and D&O policies paying particular attention to the following. Are the policy’s limits adequate (keeping in mind defense costs will erode the overall available limit)? Is coverage being provided for costs associated with the correction of trade errors? Is the firm comfortable with any sublimit or separate retention that might apply? Are all product offerings being covered or are there any problematic product-specific exclusions or carve outs? To what degree is the insurer providing coverage for regulatory actions? Does the policy contain coverage for investigations, pre-claim inquiries and any regulatory or administrative proceedings? Or is there a regulatory exclusion?