1.888.397.9867 •
Securities, Options and Futures Consultants

STOCK ISSUES

SEC Regulation Best Interest

SEC Regulation Best Interest (Regulation BI) requires that "A broker, dealer or a natural person who is an associated person of a broker or dealer, when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer, shall act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker, dealer, or natural person who is an associated person of a broker or dealer making the recommendation ahead of the retail customer." This best interest obligation is satisfied if obligations of 1) disclosure, 2) care, 3) conflicts of interest and 4) compliance are adequately met. It also explicitly applies to recommendations regarding brokerage accounts which presumably applies to their establishment and maintenance.

The first thing to notice about the SEC standard — like the older National Association of Securities Dealers (now FINRA) suitability standard — is that it applies to situations in which a recommendation is being made. A second is that it applies only at the time a recommendation is made, and creates no ongoing duty in the general case. The SEC standard also does not deal directly with the level of sophistication of the investor or the amount of control the broker, dealer or associated person exercises over the account although some particularization is possible based on the retail customer investment profile gathered from the customer. This profile includes, but is not limited to, customer age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance and any other information disclosed by the customer in response to broker enquiry. However, so far as the regulation stands, the broker owes the duty of best interest to every customer (which is not further defined) in recommending a transaction or investment strategy.

This differs from, say, the widely-adopted New York fiduciary standard noted above where a general fiduciary duty is owed only to those where the broker has control over the account or, in certain circumstances, to those where it can be said that the broker has de facto control. Where the New York fiduciary standard is narrow in the case of an sophisticated investor having control of his own account and is often said to involve only the duty to give such a customer best execution on his transactions, Regulation BI imparts broader duties such as the need to recognize, and then mitigate, or eliminate, material conflicts of interest. While SEC press releases and the like, as well as the general "feel" of Regulation BI and its surrounding atmosphere, suggest broad interpretation of its four requirements for satisfaction noted above, it remains to be seen what future arbitration panels and courts will make of the regulation and its legislative intent for sophisticated investors. This, of course, with its attendant costs and uncertainty for future claimants or plaintiffs, must be worked out in future arbitrations or court cases.

A second comparison of Regulation BI is to the fiduciary standard applicable to investment advisers under the 1940 Investment Advisers Act who have a continuing duty to act as a fiduciary to their clients where Regulation BI generally applies only at the time of a transaction. Critics of the SEC have argued that the standard should be the same based in part on provisions of the Dodd-Frank Wall Street Reform & Consumer Protection Act (See Securities Rules and Regulations for more on both Acts).

Related to all this and adding to the confusion relating to fiduciary duty is the tendency of certain brokerage firms to use terms like "financial advisor" in referring to their brokers whose role is primarily sales oriented. While this has long been recognized as leading to great customer confusion, the SEC has failed to act in this area in spite of an earlier court order to rectify the problem. The possibility for the retail customer to obtain relief from broker use of titles unrelated to actual function seems unobtainable.

A final comment: Regulation BI applies to retail investor accounts. While that is a great expansion over the DOL fiduciary standard which was to apply only to retirement accounts it does not reach so far as customer business accounts which achieve no new protection under Regulation BI.