Reg. BI – The Care Obligation, Parts 2 and 3

The second component[1] of Reg. BI’s Care Obligation requires a broker-dealer to have a reasonable basis to believe the recommendation:

• is in the best interest of a particular retail customer based on

  • that retail customer’s investment profile and

  • the potential risks, rewards, and costs associated with the recommendation, and

• does not place the interest of the broker-dealer ahead of the interest of the retail customer

Most of the phrases in that formulation are pretty self-explanatory. But the retail customer’s investment profile might benefit from some expansion. The SEC defines it to include at least these aspects of the retail 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 the retail customer might disclose to the broker in connection with a recommendation.

In short, your recommendation has to take those factors into account for the actual retail customer before you, regardless of whether the recommendation would be appropriate for “any” retail customer under the Care Obligation’s first component.

The third component of the Care Obligation requires a broker-dealer to consider a series of transactions together. Specifically, when recommending a series of transactions, you must have a reasonable basis to believe the whole series is not excessive, even if each transaction is in your customer’s best interest when viewed in isolation. So a recommendation to buy AAPL and sell GOOG in one month could be wholly appropriate, but a recommendation to buy AAPL and sell GOOG fifty times over the same month might not be in the customer’s best interest. It probably isn’t.

The requirement applies regardless of whether you exercise actual or de facto control over a customer’s account. What counts as a “series” of recommended transactions naturally depends on the facts and circumstances at issue. It always does!

[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.