Reg. BI – The Care Obligation, Part 4

In addition to addressing the three components, the SEC’s Small Entity Compliance Guide for Reg. BI also addresses some more over-arching questions. When we mention a “customer” below, because this is Reg. BI you can assume we’re talking about a retail customer.

1. Does a broker-dealer need to consider every possible alternative when making a recommendation?[1]

No. If you’re an associated person, you should consider any reasonably available alternatives offered by your firm in determining whether you have a reasonable basis for making the recommendation. What is “reasonably available” depends, as it always does, on the facts and circumstances at issue at the time of the recommendation.

2. Are there specific factors a broker-dealer should consider when making account type recommendations, or recommendations to open an IRA, or to roll over assets into an IRA?

For account type recommendations, you should generally consider:

• the services and products provided in the account;

• the projected cost to the customer;

• available alternatives;

• the services requested by the retail customer; and

• the customer’s investment profile.

When making recommendations to open an IRA, or to roll over assets into an IRA, you should consider a variety of factors including:

• fees and expenses;

• level of services available;

• available investment options;

• ability to take penalty-free withdrawals;

• application of required minimum distributions;

• protections from creditors and legal judgments;

• holdings of employer stock; and

• any special features of the existing account.

3. Are there special considerations when broker-dealers recommend securities or investment strategies that are complex or risky?

When recommending securities or investment strategies that are complex, such as inverse or leveraged exchange-traded products, you should take particular care to make sure you understand the terms, features, and risks so you can establish a reasonable basis to recommend the product to retail customers generally. Then you must weigh the potential risks, rewards, and costs in light of the particular customer’s investment profile.

So you should understand that inverse and leveraged exchange-traded products that are reset daily may not be in the best interest of retail customers who plan to hold them for longer than one trading session, particularly in volatile markets. Further, these products may not be in the customer’s best interest without an identified, short-term, customer-specific trading objective.

Similarly – and this should probably go without saying – when recommending potentially-high risk products, such as penny stocks or other thinly-traded securities, you should generally apply heightened scrutiny to whether those investments are in your customer’s best interest.

4. Is a broker-dealer required to recommend the lowest-cost security or investment strategy?

No. While you have to understand and consider cost when making a recommendation, it is only one factor. So you would not satisfy the Care Obligation by simply recommending the least expensive or least remunerative security without any further analysis. Depending on the facts and circumstances, you may be able to recommend a more expensive security or investment strategy if other factors reasonably allow you to believe it is in your customer’s best interest, based on that customer’s investment profile.

[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.