On June 30, 2020, the SEC adopted a set of new rules called Regulation Best Interest. These new rules emphasize transparency in the securities industry. They also aim to increase the likelihood that investors have all of the information they need to make informed decisions about their investments. But as Senator Elizabeth Warren pointed out in 2018, Regulation BI still does not require brokers to act as fiduciaries, i.e., in their client’s best interest. The fiduciary rule still only applies to Registered Investment Advisors (RIAs).

Material Facts and Scope

Short of requiring brokers to act as fiduciaries, Regulation BI aims to dissuade brokers from putting their own interests ahead of their clients’. Under Regulation BI, when a broker or an RIA recommends a security, they must disclose:

  1. All material facts related to the scope and terms of the relationship with the retail customer.
  1. All material facts relating to conflicts of interest that are associated with the recommendation.

The scope includes information about whether the financial adviser will monitor the account. Material facts cover information about the compensation the financial adviser receives in exchange for recommending a security or any minimum size requirements for a brokerage account.

Investors may be surprised to learn that brokers did not already have to uphold these standards. Before Regulation BI, brokers had more wiggle room when deciding which securities to recommend. Brokers might recommend securities for the sake of their own commissions, instead of a reasonable belief that an investment would produce favorable returns for their customers.

Granted, before Regulation BI, brokers still had to consider the “suitability” of certain trades — FINRA Rule 2111 defines suitable trades as securities that take into account the investor’s risk tolerance, age, tax status, investment objectives, investment time horizon, and financial situation. Brokers did not, however, have to reveal to investors how much they were being paid in commissions, nor any connection they might have that might sway their recommendations.

Brokers, Registered Investment Advisors, and Financial advisors: What’s the Difference?

  • Brokers register with the Financial Industry Regulatory Authority (FINRA) and must have their license registered with a firm in order to serve as an intermediary between investors and stock exchanges. Brokers can place trades and recommend securities, but they are not technically licensed to dispense investment advice.
  • Registered Investment Advisors (RIAs) are fiduciaries, meaning they are required to act in their client’s best interest and disclose any information that might influence an investor’s decision. This rule only applied to defined contribution retirement accounts, like 401(k)s and IRAs, and did not apply to securities in regular brokerage accounts. RIAs register their licenses with the SEC or the state regulator, depending on how much money they manage.
  • It’s important to note that many registered brokers are also registered as investment advisers.

Regulation BI General Obligation Rules

These rules are designed to make sure the financial adviser does not put their own financial interests before the investor. These are the four obligations that must be met when a broker or an RIA recommends a security:

  1. Disclosure Obligation: Brokers must disclose how much they’re being paid, as well as the capacity in which the broker is acting.
  • Care obligation: A broker-dealer must exercise reasonable diligence, care, and skill.
  • Conflict of Interest Obligation: The broker-dealer (also known as the firm, or the financial services institution) must establish, maintain, and enforce written policies and procedures designed to eliminate conflicts of interest.
  • Compliance Obligation: Broker-dealers must establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest.

Recommendation Definitions

The SEC defines a “recommendation” as anything that an investor could interpret as a “call to action” that would “reasonably influence an investor to trade a particular security or group of securities.” It also refers to any actions taken to further investment objectives, including opening new brokerage accounts or rolling over one type of investment product into another.

Form CRS: Client Relationship Summary

Regulation BI introduced the Client Relationship Summary (CRS), which will make it more difficult for brokers and firms to keep their past disciplinary histories from investors. Until recently, it was the investor’s responsibility to research a financial adviser’s disciplinary history.

Certain broker-dealers have plenty of reason to keep information about disciplinary histories to themselves. In 2017, Reuters published a review of BrokerCheck, the public broker record maintained by FINRA. It showed that 48 broker-dealers have particularly high concentrations of brokers with disciplinary histories. You can see that list of broker-dealers in the Reuters report. It’s safe to say that broker-dealers who routinely hire brokers with disciplinary histories have benefited from this lack of transparency.

Regulation BI isn’t a magic bullet that will solve investor’s problems. In August 2020, just a couple of months after the SEC adopted Regulation BI, The Wall Street Journal reported that approximately 1,300 brokerages and financial advisory firms incorrectly stated on their Form CRS that neither they nor their associated financial professionals had blemishes on their official records. These omitted disclosures included serious infractions, including forgery and fraud. Clearly, the SEC will need to continue to monitor financial firms and investment professionals to ensure that the new rules work as intended.

What Can I Do if My Financial Adviser Broke Regulation BI Rules?

Now that there is a stricter set of rules to follow, investors should be able to more easily demonstrate that their broker did not recommend suitable investments. If you are concerned that your financial adviser did not meet the obligation requirements under Regulation BI, you should reach out to the securities attorneys of Fitapelli Kurta for a free case evaluation. Call (212) 658-1500 or email info@fkesq.com

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