Reg. BI – The Care Obligation, Part 1

What does Reg. BI’s Care Obligation mean, anyway?[1] If you’re a broker-dealer, when making a recommendation to a retail customer, you have to exercise reasonable diligence, care, and skill to:

1. understand the potential risks, rewards, and costs associated with the recommendation, and have a reasonable basis to believe that it could be in the best interest of at least some retail customers;

2. reasonably believe the recommendation is in the best interest of a particular retail customer and doesn’t place the B-D’s interest ahead of the customer’s; and

3. reasonably believe that a series of recommended transactions – even if sensible when viewed in isolation – is not excessive and is still in the customer’s best interest when taken together.

First things first. What does the first component require? What constitutes reasonable diligence, care, and skill will vary – of course! – depending on the complexity and risk associated with the recommendation and the B-D’s familiarity with the securities underlying the  recommendation. So the level of diligence etc. etc. required to recommend a fairly standard index fund will be different from that required for an obscure, risky private placement.

When thinking about your responsibilities under this first component of the Care Obligation, here are the factors you should consider:

• the security’s or investment strategy’s:

  • investment objectives;

  • characteristics (including any special or unusual features);

  • liquidity;

  • volatility; and

  • likely performance in a variety of market and economic conditions;

• the expected ROI; and

• any financial incentives to make the recommendation.

If you do think carefully about those things, you should be able to develop a sufficient understanding that lets you reasonably believe the recommendation could be in the best interest of at least some retail customers.

Happily, compliance with the Care Obligation will be evaluated as of the time of the recommendation and not in hindsight.

[1] In Cady’s Regulation Best Interest series, we’ll largely be breaking down the SEC’s Small Entity Compliance Guide into smaller chunks and, we think, easier language.