SEC Staff Provide Guidance on Care Obligations for Broker-Dealers and Investment Advisers

SEC staff provided new guidance for broker-dealers and investment advisers on meeting their Regulation Best Interest and duty of care obligations.

SEC staff identified several common components for both broker dealers and investment advisers. They include (i) understanding associated risks, rewards and costs of an investment product, (ii) having a reasonable understanding of a retail investor’s investment profile, including the investor's financial situation and needs, and (iii) examining available alternatives in order to conclude that the advice provided is in the investor's best interest.

To facilitate broker-dealers and investment advisers meeting their care obligations, SEC recommended:

  • Understanding the Investment or Investment Strategy. SEC staff said that investment professionals should (i) understand the investment or investment strategy they are recommending, including associated factors such as the objectives of an investment or its key characteristics, (ii) consider costs, and (iii) have an understanding of each investment or investment strategy rather than relying solely on a firm’s list of approved investments for retail investors.
  • Understanding the Retail Investor’s Investment Profile. SEC staff defined "investment profile" as the information that investment professionals should have about the retail investor after using "reasonable efforts." Staff called it a "critical step" in satisfying the care obligation. Further, staff said: (i) that gathering information for an investment profile is not a "once-and-done" exercise due to investments, investment strategies and investor profiles being subject to change; and (ii) that when examining a retail investor’s tax status in order to provide recommendations or advice, investment professionals should evaluate whether a "tax-advantaged option" is in the best interest of the retail investor.
  • Available Investment Alternatives. Staff said that investment professionals should consider investment alternatives to ensure that a recommendation is in the best interest of a retail investor. Staff advised investment professionals to implement a process to identify and assess available alternatives to an investment product or service. If an investment firm uses an "open architecture framework" (i.e., business models that are broad in scope), then firms may choose not to evaluate every possible alternative available. Separately, staff said that an investment firm’s reliance on a "limited menu of investments," is justifiable on a case-by-case basis, but that generally investment professionals should be familiar with each of the investments available. Additionally, staff made clear that (i) only recommending the "most appropriate" available option from a limited menu of investments does not satisfy an investment professional’s care obligations, (ii) investment products that are "not identical may still be comparable" for purposes of being identified as alternative investment options, (iii) risks, rewards and costs associated with investment alternatives should always be considered and (iv) even though it is not required, not documenting the process for making certain investment recommendations may create difficulties for investment professionals if they need to prove compliance with their obligation of care.
  • Complex or Risky Products. Staff recommended (i) identifying examples of complex or risk products that may require investment professionals to apply "heightened scrutiny" when advising or recommending the products to investors and (iii) outlining procedures for offering complex or risky product recommendations and advice.
  • Dual Registrants. SEC staff recommended that dually licensed registrants consider whether a brokerage or advisory account is more appropriate for a retail investor.

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