Staff Bulletin: Standards of Conduct for Broker-Dealers and Investment Advisers Care Obligations

[1] This staff bulletin and other staff documents (including those cited herein) represent the views of the staff of the Securities and Exchange Commission (“Commission”) and are not a rule, regulation, or statement of the Commission. The Commission has neither approved nor disapproved the content of these documents and, like all staff statements, they have no legal force or effect, do not alter or amend applicable law, and create no new or additional obligations for any person.

[2] For purposes of this staff bulletin, we use the term “retail investor” to mean any person who qualifies as a “retail customer” as defined in Exchange Act rule 15l-1(b)(1), or a natural person client of an investment adviser.

[3] This staff bulletin is expressly limited in scope to the duties owed by a broker-dealer or investment adviser, including their financial professionals, when providing recommendations or investment advice to retail investors. We do not address, for example, other care obligations of investment advisers, such as the duty to seek best execution of a client’s transactions where the adviser has the responsibility to select broker-dealers to execute client trades, the duty to provide advice and monitoring over the course of the client relationship, or an adviser’s care obligations when providing impersonal advice. Commission Interpretation Regarding Standard of Conduct for Investment Advisers, Investment Advisers Act Release No. 5248, 84 FR 33669, 33669 n.7, 33672 (June 5, 2019) (“Fiduciary Interpretation”). Although an investment adviser’s fiduciary duty applies to all advisory clients (whether retail investors or otherwise) and applies to the entire advisory relationship, the adviser’s duties when providing advice to retail investors is the focus of this bulletin. Reg BI’s obligation to act in the best interest of the retail customer, however, applies only when making a recommendation of a security or investment strategy involving securities (including account recommendations) to a retail customer for personal, family, or household use. Exchange Act rule 15l-1; Regulation Best Interest: The Broker-Dealer Standard of Conduct, Exchange Act Release No. 86031, 84 FR 33318, 33320-21 (June 5, 2019) (“Reg BI Adopting Release”). Although this obligation is comprised of four component obligations—Care, Disclosure, Conflict of Interest, and Compliance—except where expressly noted, this bulletin is focused on the Care Obligation only.

[4] An investment adviser’s fiduciary duty under the Investment Advisers Act of 1940 (“Advisers Act”) comprises a duty of care and a duty of loyalty, and the adviser’s obligation to act in the best interest of its client is an overarching principle that encompasses both duties. Fiduciary Interpretation, supra note 3, at 33671. Reg BI’s obligation to act in the retail customer’s best interest is satisfied only by complying with each of the rule’s four component obligations: Disclosure, Care, Conflict of Interest, and Compliance. Exchange Act rule 15l-1; Reg BI Adopting Release, supra note 3, at 33320-21.

[5] Reg BI’s Care Obligation requires broker-dealers and their financial professionals to have a reasonable basis to believe that a recommendation of a securities transaction or investment strategy involving securities (including account recommendations) could be in the best interest of at least some retail investors. Exchange Act rule 15l-1(a)(2)(ii)(A). An investment adviser’s duty of care requires conducting a reasonable investigation into the investment sufficient not to base the advice on materially inaccurate or incomplete information. Fiduciary Interpretation, supra note 3, at 33672, 33674.

[6] Exchange Act rule 15l-1(a)(2)(ii)(B)-(C); Reg BI Adopting Release, supra note 3, at 33379, 33492; Fiduciary Interpretation, supra note 3, at 33673; see also Staff Bulletin: Standards of Conduct for Broker-Dealers and Investment Advisers Account Recommendations for Retail Investors, available at https://www.sec.gov/tm/iabd-staff-bulletin (“Staff Bulletin on Account Recommendations”) (listing examples of investor characteristics to consider to have a reasonable basis to believe the account recommendation is in the retail investor’s best interest).

[7] See Reg BI Adopting Release, supra note 3, at 33381 (stating that considering reasonably available alternatives is an “inherent aspect of making a ‘best interest’ recommendation, and is a key enhancement over [then-] existing broker-dealer suitability obligations,” explaining “this concept has been applied in the context of guidance regarding suitability and heightened supervision of complex products”); see also O.N. Investment Management Company, Investment Advisers Act Release No. 5944 (Jan. 11, 2022) (investment adviser violated its duty of care obligations when it “failed to consider alternative, lower-fee . . . money market funds” that were readily available to the adviser when it purchased other money market funds for its clients that generally resulted in revenue sharing being paid to the adviser or its affiliate), available at https://www.sec.gov/litigation/admin/2022/ia-5944.pdf (settled action); Rothschild Investment Corp., Investment Advisers Act Release No. 5860 (Sept. 13, 2021) (adviser violated its duty of care obligations when it recommended money market funds that resulted in revenue sharing but “failed to consider alternative funds with similar strategies” that were available to the adviser and which had lower costs and higher yields), available at https://www.sec.gov/litigation/admin/2021/34-92951.pdf (settled action); Cowen Prime Advisors, LLC, Investment Advisers Act Release No. 5874 (Sept. 27, 2021) (same), available at https://www.sec.gov/litigation/admin/2021/ia-5874.pdf (settled action).

[8] Exchange Act rule 15l-1(a)(2)(ii)(B)-(C). Under Reg BI, the Care Obligation also applies to a series of recommended transactions. Exchange Act rule 15l-1(a)(2)(ii)(C) (requiring broker-dealers and their financial professionals to have “a reasonable basis to believe that a series of recommended transactions, even if in the retail customer’s best interest when viewed in isolation, is not excessive and is in the retail customer’s best interest when taken together in light of the retail customer’s investment profile and does not place the financial or other interest of the broker, dealer, or such natural person making the series of recommendations ahead of the interest of the retail customer.”); see also Reg BI Adopting Release, supra note 3, at 33384. An investment adviser’s duty to provide advice that is in the best interest of the client includes the duty to provide advice that is suitable for the client. Fiduciary Interpretation, supra note 3, at 33672. Additionally, “an investment adviser must have a reasonable belief that the advice it provides is in the best interest of the client based on the client’s objectives.” Id. at 33673.

[9] Reg BI requires broker-dealers and their financial professionals to act in the best interest of retail investors at the time the recommendation is made. See Exchange Act rule 15l-1(a)(1) (emphasis added). See also Reg BI Adopting Release, supra note 3, at 33326 (noting that determining whether a broker-dealer’s recommendation satisfies the Care Obligation will be an objective evaluation turning on the facts and circumstances of the particular recommendation and the particular retail customer); Fiduciary Interpretation, supra note 3, at 33672-33673 (stating that in order to provide investment advice that is in the best interest of the client, an investment adviser must have a reasonable understanding of the client’s objectives based on the specific facts and circumstances). The duty of care for investment advisers includes, among other things, the duty to provide advice and monitoring over the course of the relationship. Id. at 33672.

[10] Reg BI’s Compliance Obligation requires broker-dealers to establish, maintain and enforce written policies and procedures reasonably designed to achieve compliance with Reg BI. See Exchange Act rule 15l-1(a)(iv); also Reg BI Adopting Release, supra note 3, at 33386 (stating “broker-dealers should have flexibility to tailor their policies and procedures to their particular business model, focusing on specific areas of their business that pose the greatest risk of noncompliance and greatest risk of potential harm to retail customers as opposed to a detailed review of each recommendation.”). A broker-dealer must have policies and procedures reasonably designed to comply with Reg BI and when adopting those policies and procedures should consider the nature of that firm’s operations and how to design such policies and procedures to prevent violations from occurring, detect violations that have occurred, and to correct promptly any violations that have occurred. See Exchange Act rule 15l-1(a)(iv); see also Reg BI Adopting Release, supra note 3, at 33397 (stating “[a] firm's compliance policies and procedures should be reasonably designed to address and be proportionate to the scope, size, and risks associated with the operations of the firm and the types of business in which the firm engages.”). Rule 206(4)-7 under the Advisers Act requires investment advisers to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act, which include preventing breaches of the fiduciary standard in violation of Section 206 of the Advisers Act. “Each adviser should adopt policies and procedures that take into consideration the nature of that firm’s operations” and “should first identify conflicts and other compliance factors creating risk exposure for the firm and its clients in light of the firm's particular operations, and then design policies and procedures that address those risks.” Compliance Programs of Investment Companies and Investment Advisers, Investment Advisers Act Release No. 2204 (Dec. 17, 2003), 68 FR 74714, 74716 (Dec. 24, 2003) (footnotes omitted), available at https://www.govinfo.gov/content/pkg/FR-2003-12-24/pdf/03-31544.pdf.

[11] See Reg BI Adopting Release, supra note 3; Fiduciary Interpretation, supra note 3.

[12] See SEC Spotlight, Regulation Best Interest, Form CRS and Related Interpretations, available at https://www.sec.gov/regulation-best-interest. The staff of the Divisions of Trading and Markets and Investment Management have previously published staff bulletins that discuss examples of practices that can assist firms in meeting their obligations relating to account type recommendations and conflicts of interest. See Staff Bulletin on Account Recommendations, supra note 6; Staff Bulletin: Standards of Conduct for Broker-Dealers and Investment Advisers Conflicts of Interest, available at https://www.sec.gov/tm/iabd-staff-bulletin-conflicts-interest.

[13] See Reg BI Adopting Release, supra note 3, at 33376; Fiduciary Interpretation, supra note 3, at 33674.

[14] See Exchange Act rule 15l-1(a)(2)(ii)(A); Reg BI Adopting Release, supra note 3, at 33376-77; Fiduciary Interpretation, supra note 3, at 33674 (“A reasonable belief that investment advice is in the best interest of a client also requires that an adviser conduct a reasonable investigation into the investment sufficient not to base its advice on materially inaccurate or incomplete information. … The cost (including fees and compensation) associated with investment advice would generally be one of many important factors—such as an investment product’s or strategy’s investment objectives, characteristics (including any special or unusual features), liquidity, risks and potential benefits, volatility, likely performance in a variety of market and economic conditions, time horizon, and cost of exit—to consider when determining whether a security or investment strategy involving a security or securities is in the best interest of the client.”). The Commission has brought enforcement actions when investment adviser representatives lacked a reasonable understanding of an investment’s risks and key attributes. See, e.g., Frontier Wealth Management, LLC and Shawn Sokolosky, Investment Advisers Act Release No. 5847 (September 3, 2021) (settled action) (Sokolosky made unsuitable recommendations to clients in part because he “did not adequately understand the Feeder Fund’s trading strategy, underlying investments, and risks.”); cf. UBS Financial Services, Inc., Investment Advisers Act Release No. 6060 (June 29, 2022) (settled action) (UBS violated § 206(2) where its advisory representatives lacked “a reasonable belief that the advice they provided . . . was in the best interest of their clients” because the representatives did not sufficiently “understand the significant downside risk” of the complex options strategy they recommended).

[15] It will be generally necessary for an adviser to a retail investor to update the investor’s investment profile in order to maintain a reasonable understanding of the investor’s objectives and adjust the advice to reflect any changed circumstances; such updating would not be needed with one-time investment advice. Fiduciary Interpretation, supra note 3 at 33673 and n.37. In addition, an adviser may provide comprehensive, discretionary advice in an ongoing relationship with a retail investor that includes obligations such as monitoring and periodic adjustments of the client’s portfolio. Id. at 33671-33672. While broker-dealers generally are not required to monitor accounts, where a broker-dealer agrees to provide the retail customer with specified account monitoring services, such an agreement will result in buy, sell or hold recommendations subject to Reg BI, even when the recommendation to hold is implicit at the time the agreed-upon monitoring occurs. See Reg BI Adopting Release, supra note 3, at 33325, 33340-41.

[16] See Reg BI Adopting Release, supra note 3, at 33376. Broker-dealers also have a duty to investigate the truth of their representations pursuant to the general antifraud provisions of the federal securities laws. See, e.g., Hanly v. SEC, 415 F.2d 589, 596 (2d Cir.1969) (“A broker . . . has a duty to investigate the truth of the representations he makes to clients, because, by virtue of his title, clients are entitled to presume that the representations made were the result of reasonable investigation.”). Fiduciary Interpretation, supra note 3, at 33674 (footnotes omitted) (“A reasonable belief that investment advice is in the best interest of a client also requires that an adviser conduct a reasonable investigation into the investment sufficient not to base its advice on materially inaccurate or incomplete information. We have taken enforcement action where an investment adviser did not independently or reasonably investigate securities before recommending them to clients.”).

[17] See generally Reg BI Adopting Release, supra note 3, at 33376; Fiduciary Interpretation, supra note 3, at 33674; Staff Bulletin on Account Recommendations, supra note 6 (discussing examples of factors to consider when making account recommendations).

[18] See Fiduciary Interpretation, supra note 3, at 33672; Reg BI Adopting Release, supra note 3, at 33325, 33340-41.

[19] See Exchange Act rule 15l-1(a)(2)(ii) (requiring consideration of cost under Reg BI’s Care Obligation); see also Fiduciary Interpretation, supra note 3, at 33674 (cost would generally be one of many important factors to consider when determining if a security or investment strategy is in the client’s best interest). See also Staff Bulletin on Account Recommendations, supra note 6 (stating “you must always consider cost as a factor when making an account recommendation.”). The Commission has brought enforcement actions against investment advisers for recommending higher-cost products, which generally paid revenue sharing to the adviser or the adviser’s affiliate to clients when similar, lower-cost products were available. See In the Matter of Centaurus Financial, Inc., Investment Advisers Act Release No. 5744 (June 2, 2021), available at https://www.sec.gov/litigation/admin/2021/ 34-92095.pdf (settled action); In the Matter of Cowen Prime Advisors, LLC, Investment Advisers Act Release No. 5874 (Sept. 27, 2021), available at https://www.sec.gov/litigation/admin/2021/ia-5874.pdf (settled action); In the Matter of O.N. Investment Management Company, Investment Advisers Act Release No. 5944 (Jan. 11, 2022), available at https://www.sec.gov/litigation/admin/2022/ia-5944.pdf (settled action); In the Matter of Rothschild Investment Corp., Investment Advisers Act Release No. 5860 (Sept. 13, 2021), available at https://www.sec.gov/litigation/admin/2021/34-92951.pdf (settled action).

[20] See Exchange Act rule 15l-1(a)(2)(ii) and Fiduciary Interpretation, supra note 3, at 33674. See also Staff Bulletin on Account Recommendations, supra note 6 (stating the staff believes firms and financial professionals “should consider the total potential costs when evaluating whether an account is in a retail investor’s best interest, including indirect costs that could be borne by the retail investor.”).

[21] See Staff Bulletin on Account Recommendations, supra note 6 (providing examples of costs to consider when making account recommendations). An adviser would not satisfy its fiduciary duty to provide advice that is in the client’s best interest by simply advising its client to invest in the lowest cost (to the client) or least remunerative (to the investment adviser) investment product or strategy without any further analysis of other factors in the context of the portfolio that the adviser manages for the client and the client’s objective. See Fiduciary Interpretation, supra note 3 at 33674. Similarly, a broker-dealer would not satisfy the Care Obligation by simply recommending the least expensive or least remunerative security without any further analysis of the investment or investment strategy and the retail investor’s investment profile. Reg BI Adopting Release, supra note 3, at 33380-81. In Reg BI the Commission emphasized the requirement to consider costs in light of other factors and the retail customer’s investment profile while noting cost should never be the only consideration. See Reg BI Adopting Release, supra note 3, at 33326; Exchange Act rule 15l-1(a)(2)(ii).

[22] Exchange Act rule 15l-1(a)(2)(ii)(A) (imposing this obligation on broker-dealers and their financial professionals). The Commission has brought enforcement actions when investment adviser representatives lacked a reasonable understanding of an investment’s risks and key attributes. See, e.g., Frontier Wealth Management, LLC and Shawn Sokolosky, Investment Advisers Act Release No. 5847 (September 3, 2021) (settled action) (Sokolosky made unsuitable recommendations to clients in part because he “did not adequately understand the Feeder Fund’s trading strategy, underlying investments, and risks.”); cf. UBS Financial Services, Inc., Investment Advisers Act Release No. 6060 (June 29, 2022) (settled action) (UBS violated § 206(2) where its advisory representatives lacked “a reasonable belief that the advice they provided . . . was in the best interest of their clients” because the representatives did not sufficiently “understand the significant downside risk” of the complex options strategy they recommended).

[23] Exchange Act rule 15l-1(a)(2)(iv); Reg BI Adopting Release, supra note 3, at 33398 (explaining that a reasonably designed compliance program generally would include, among other things, training); Fiduciary Interpretation, supra note 3, at 33674 (noting that investment advisers are required to conduct a reasonable investigation into the investment sufficient not to base its advice on materially inaccurate or incomplete information).

[24] Importantly, once you have obtained and evaluated sufficient information about the retail investor’s investment profile, in the staff’s view, only then is it possible for you to assess whether the particular recommendation or advice is in the retail investor’s best interest. Reg BI Adopting Release, supra note 3, at 33379 (“[b]roker-dealers must obtain and analyze enough customer information to have a reasonable basis to believe that the recommendation is in the best interest of the particular retail customer.”). This includes using the investment profile, among other factors discussed below, in determining the scope of available alternatives. See Reg BI Adopting Release, supra note 3, at 33381 (explaining “[w]hat will be a reasonable determination of the scope of alternatives considered will depend on the facts and circumstances, at the time of the recommendation, including both the nature of the retail customer and the retail customer’s investment profile”). For investment advisers, “[t]he duty to provide advice that is in the best interest of the client based on a reasonable understanding of the client’s objectives is a critical component of the duty of care.” Fiduciary Interpretation, supra note 3, at 33673. An investment adviser generally should make a reasonable inquiry into a client’s investment profile in developing a reasonable understanding of the client’s objectives.

[25] Reg BI Adopting Release, supra note 3, at 33379; Fiduciary Interpretation, supra note 3, at 33673-33674 (stating that in addition to the investment profile, whether advice is in a client’s best interest must be evaluated in the context of the client’s portfolio, and that an adviser generally should apply heightened scrutiny to various high risk or complex investments or investment strategies (derivatives, penny stocks or other thinly traded securities, inverse or leveraged exchange-traded products) and investment strategies (hedging, purchasing on margin, short-term trading)).

[26] See Exchange Act rule 15l-1(b)(2) (defining “retail customer investment profile” for purposes of Reg BI); Reg BI Adopting Release, supra note 3, at 33492; Fiduciary Interpretation, supra note 3, at 33673 (listing types of information—generally similar to those appearing in Reg BI’s definition of retail customer investment profile—that advisers would generally need to know to provide a comprehensive financial plan to a client). See also Staff Bulletin on Account Recommendations, supra note 6 (providing examples of investor characteristics to be considered to have a reasonable basis to believe an account recommendation is in the retail investor’s best interest).

[27] Reg BI Adopting Release, supra note 3, at 33379 (declining to include additional factors in the definition of “retail customer investment profile,” noting that the list of factors in the definition is non-exhaustive and broker-dealers can consider additional factors as appropriate under the unique facts and circumstances of each recommendation, such as based on the unique nature of its particular securities products, investment strategies, and retail customers); Fiduciary Interpretation, supra note 3, at 33673-33674 (identifying additional considerations regarding investment characteristics (such as liquidity and leverage) and investment strategies (such as hedging or purchasing on margin) that may be appropriate for clients with investment profiles that include a high risk tolerance and significant investment experience). The significance of specific types of retail investor information generally will depend on the facts and circumstances of the particular case, including the nature and characteristics of the investment or investment strategy at issue. Reg BI Adopting Release, supra note 3, at 33379. For investment advisers, the amount and type of information obtained for an investment profile is viewed in the context of the agreed-upon scope of the relationship and, accordingly, may involve consideration of a subset of the relevant factors depending on the services to be provided and the duration of the relationship. Fiduciary Interpretation, supra note 3 at 33673 (“How an adviser develops a reasonable understanding [of a client’s investment objectives] will vary based on the specific facts and circumstances, including the nature of the client, the scope of the adviser-client relationship, and the nature and complexity of the anticipated investment advice. In order to develop a reasonable understanding of a retail client’s objectives, an adviser should, at a minimum, make a reasonable inquiry into . . . the retail client’s ‘investment profile.’ . . . Whether the advice is in a client’s best interest must be evaluated in the context of the portfolio that the adviser manages for the clients and the client’s objectives.”).

[28] For more information on account recommendations, see Staff Bulletin on Account Recommendations, supra note 6 (stating that “[t]he staff also believes that you should consider, without limitation, the retail investor’s: anticipated investment strategy (e.g., buy and hold versus more frequent trading); level of financial sophistication; preference for making their own investment decisions or relying on advice from a financial professional; and the need or desire for account monitoring or ongoing account management.”).

[29] Reg BI Adopting Release, supra note 3, at 33379; Fiduciary Interpretation, supra note 3, at 33673.

[30] Reg BI Adopting Release, supra note 3, at 33379.

[31] See Exchange Act rule 17a-3(a)(17); Reg BI Adopting Release, supra note 3, at 33398.

[32] Fiduciary Interpretation, supra note 3, at 33673. The frequency with which such updates should occur will turn on the facts and circumstances, including whether the adviser is aware of events that have occurred that could render inaccurate or incomplete the investment profile on which the adviser currently bases its advice. Id. For instance, in the case of a financial plan where the investment adviser also provides advice on an ongoing basis, a change in the relevant tax law or knowledge that the client has retired or experienced a change in marital status could trigger an obligation to make a new inquiry.

[33] Reg BI Adopting Release, supra note 3, at 33379 (stating “[b]roker-dealers must obtain and analyze enough customer information to have a reasonable basis to believe that the recommendation is in the best interest of the particular retail customer.”). Staff Bulletin on Account Recommendations, supra note 6 (stating “[y]ou . . . must obtain and evaluate enough information about the retail investor to have a reasonable basis to believe the account recommendation is in the best interest of that retail investor and that your recommendation is not based on materially inaccurate or incomplete information.”). See also supra note 8.

[34] Fiduciary Interpretation, supra note 3, at 33673 (“[I]t will generally be necessary for an adviser to a retail client to update the client’s investment profile in order to maintain a reasonable understanding of the client’s objectives and adjust the advice to reflect any changed circumstances.”) and n.37 (“We believe that any obligation to update a client’s investment profile, like the nature and extent of the reasonable inquiry into a retail client’s objectives, turns on what is reasonable under the circumstances.”); Reg BI Adopting Release, supra note 3, at 33379 (stating “where retail customer information is unavailable despite a broker-dealer's reasonable diligence, the broker-dealer should carefully consider whether it has a sufficient understanding of the retail customer to properly evaluate whether the recommendation is in the best interest of that retail customer.”); Staff Bulletin on Account Recommendations, supra note 6 (explaining that if information is unavailable “the staff believes you should carefully consider whether you have a sufficient understanding of the investor to evaluate if any account recommendation is in that investor’s best interest.”).

[35] Reg BI Adopting Release, supra note 3, at 33379; Staff Bulletin on Account Recommendations, supra note 6.

[36] See Reg BI Adopting Release, supra note 3, at 33379 (stating that “consistent with existing obligations, where a broker-dealer determines not to obtain or analyze one or more of the factors specifically identified in the definition of ‘Retail Customer Investment Profile,’ the broker-dealer should document its determination that the factor(s) are not relevant components of a retail customer's investment profile in light of the facts and circumstances of the particular recommendation.” (citing FINRA Rule 2111.04)); Staff Bulletin on Account Recommendations, supra note 6.

[37] See Fiduciary Interpretation, supra note 3, at 33673 (noting tax status as one of a range of personal and financial types of information included in a client’s investment profile); Reg BI Adopting Release, supra note 3, at 33379.

[38] Under Reg BI, a retail investor’s investment profile is defined to include tax status. See Exchange Act rule 15l-1(b)(2). Thus, the Care Obligation requires a broker-dealer to have a reasonable basis to believe that an IRA or IRA rollover is in the best interest of the retail customer at the time of the recommendation, taking into consideration the retail investor’s investment profile and other relevant factors, as well as the potential risks, rewards, and costs of the IRA or IRA rollover compared to the investor's existing 401(k) account or other circumstances. See Reg BI Adopting Release, supra note 3, at 33383. For investment advisers, whether the advice is in a client’s best interest must be evaluated in the context of the portfolio that the adviser manages for the client and the client’s objectives. Fiduciary Interpretation, supra note 3, at 33673.

[39] See Reg BI Adopting Release, supra note 3, at 33381.

[40] Id.

[41] See Fiduciary Interpretation, supra note 3, at 33676, n.58 (“We believe that while full and fair disclosure of all material facts relating to the advisory relationship or of conflicts of interest and a client’s informed consent prevent the presence of those material facts or conflicts themselves from violating the adviser’s fiduciary duty, such disclosure and consent do not themselves satisfy the adviser’s duty to act in the client’s best interest.”).

[42] See, e.g., O.N. Investment Management Company, Investment Advisers Act Release No. 5944 (Jan. 11, 2022) (adviser violated its duty of care obligations when it “failed to consider alternative, lower-fee . . . money market funds” that were readily available to the adviser when it purchased other money market funds for its clients that generally resulted in revenue sharing being paid to the adviser or its affiliate), available at https://www.sec.gov/litigation/admin/2022/ia-5944.pdf (settled action); Rothschild Investment Corp., Investment Advisers Act Release No. 5860 (Sept. 13, 2021) (adviser violated its duty of care obligations when it recommended money market funds that resulted in revenue sharing but “failed to consider alternative funds with similar strategies” that were available to the adviser and which had lower costs and higher yields), available at https://www.sec.gov/litigation/admin/2021/34-92951.pdf (settled action); Cowen Prime Advisors, LLC, Investment Advisers Act Release No. 5874 (Sept. 27, 2021) (same), available at https://www.sec.gov/litigation/admin/2021/ia-5874.pdf (settled action).

[43] For broker-dealers, the Commission views such a consideration as an inherent aspect of making a “best interest” recommendation. See Reg BI Adopting Release, supra note 3, at 33381. As noted, the Commission has brought enforcement actions in certain circumstances when an investment adviser failed to consider available alternatives. See supra note 39.

[44] See id.

[45] See id.

[46] See id.

[47] See Reg BI Adopting Release, supra note 3, at 33381. See also In the Matter of Educators Financial Services, Inc., Investment Advisers Act Release No. 5836 (Aug. 27, 2021), available at https://www.sec.gov/litigation/admin/2021/ia-5836.pdf (settled action) (finding, among other things, that an investment adviser failed to adopt and implement written compliance policies and procedures reasonably designed to prevent violations of the Advisers Act when it breached its duty of care by failing to “consistently evaluate whether there were available lower-cost share classes” for certain clients); cf. also Advisers Act rule 206(4)-7.

[48] See supra note 14.

[49] See Reg BI Adopting Release, supra note 3, at 33381 (noting that, under Reg BI’s Compliance Obligation, a broker-dealer should have a reasonable process for establishing and understanding the scope of “reasonably available alternatives” that would be considered by particular associated persons or groups of associated persons (e.g., groups that specialize in particular product lines) in fulfilling the reasonable diligence, care, and skill requirements under the Care Obligation). See also generally Advisers Act rule 206(4)-7 (requiring investment advisers registered or required to be registered under the Advisers Act to adopt and implement written compliance policies and procedures reasonably designed to prevent violations of the Advisers Act, which include preventing breaches of the IA fiduciary standard in violation of section 206 of the Advisers Act). Similarly, Reg BI’s Compliance Obligation requires broker-dealers to establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Reg BI.

[50] See id.

[51] The Commission used the term “open architecture” in the Reg BI adopting release “to mean a firm’s product menu that includes both third-party and proprietary products, or [where] a firm offers a large range of products to their retail customers that are not limited, for example, to a small list of approved managers or funds (i.e., a product menu that is not limited to proprietary products or otherwise constrained to certain retail customers or registered representatives).” Reg BI Adopting Release, supra note 3, at 33372 n.554.

[52] See Reg BI Adopting Release, supra note 3, at 33381.

[53] See id. (“a broker-dealer does not have to conduct an evaluation of every possible alternative, either offered outside of the firm (such as where the firm offers only proprietary or other limited range of products) or available on the firm’s platform”).

[54] Under Reg BI, the Commission stated, “[w]hat will be a reasonable determination of the scope of alternatives considered will depend on the facts and circumstances, at the time of the recommendation, including both the nature of the retail customer and the retail customer’s investment profile, and the particular associated persons or groups of associated persons that are providing the recommendations.” See Reg BI Adopting Release, supra note 3, at 33382.

[55] Id.

[56] While Reg BI does not require an evaluation of alternatives offered outside the firm, when a broker-dealer materially limits its product offerings to certain proprietary or other limited menus of products, it must still comply with the Care Obligation—even if it has disclosed and taken steps to prevent the limitation from placing the interests of the broker-dealer ahead of the retail customer, as required by Reg BI’s Disclosure and Conflict of Interest Obligation—and thus could not use its limited menu to justify recommending a product that does not satisfy the obligation to act in a retail customer’s best interest. See Reg BI Adopting Release, supra note 3, at 33326; see also Fiduciary Interpretation supra note 3, at 33676 (“a dual registrant acting in its advisory capacity should disclose any circumstances under which its advice will be limited to a menu of certain products offered through its affiliated broker-dealer or affiliated investment adviser.”).

[57] See Reg BI Adopting Release, supra note 3, at 33326.

[58] Under Reg BI, broker-dealers must understand the potential risks, rewards, and costs associated with a recommendation. See Exchange Act rule 15l-1(a)(2)(ii)(A). See also Fiduciary Interpretation, supra note 3, at 33674 (“[t]he cost (including fees and compensation) associated with investment advice would generally be one of many important factors—such as an investment product’s or strategy’s investment objectives, characteristics (including any special or unusual features), liquidity, risks and potential benefits, volatility, likely performance in a variety of market and economic conditions, time horizon, and cost of exit—to consider when determining whether a security or investment strategy involving a security or securities is in the best interest of the client.”) [emphasis added]. Further, as noted, the Commission has brought enforcement actions against investment advisers for breaching their duty of care when they failed to consider alternative funds. See, e.g., O.N. Investment Management Company, Investment Advisers Act Release No. 5944 (Jan. 11, 2022) (adviser violated its duty of care obligations when it “failed to consider alternative, lower-fee . . . money market funds” that were readily available to the adviser when it purchased higher-cost funds for its clients that paid revenue sharing to the adviser or an affiliate) (settled action); Rothschild Investment Corp., Investment Advisers Act Release No. 5860 (Sept. 13, 2021) (adviser violated its duty of care obligations when it recommended higher-cost money market funds that paid revenue sharing to the adviser or an affiliate but “failed to consider alternative funds with similar strategies” that were available to the adviser and which had lower costs and higher yields.) (settled action); Cowen Prime Advisors, LLC, Investment Advisers Act Release No. 5874 (Sept. 27, 2021) (same) (settled action).

[59] Reg BI allows a broker-dealer to recommend products that entail higher costs or risks for the retail customer, or that result in greater compensation to the broker-dealer, or that are more expensive, than other products, provided that the broker-dealer complies with the rule’s specific component obligations, including the requirement to make these recommendations exercising reasonable diligence, care, and skill to have a reasonable basis to believe that the recommendation is in the retail customer’s best interest and does not place the broker-dealer’s interest ahead of the retail customer’s interest. See Reg BI Adopting Release, supra note 3, at 33334. See also Fiduciary Interpretation, supra note 3, at 33674 (“[T]he adviser could recommend a higher-cost investment or strategy if the adviser reasonably concludes that there are other factors about the investment or strategy that outweigh cost and make the investment or strategy in the best interest of the client, in light of that client’s objectives.”).

[60] In adopting Reg BI, the Commission determined not to require broker-dealers to document the basis for any recommendations, but encouraged them to take a risk-based approach when deciding whether to document certain recommendations. For example, it stated that broker-dealers may wish to document an evaluation of a recommendation and the basis for the particular recommendation in certain contexts, such as the recommendation of a complex product, or where a recommendation may seem inconsistent with a retail customer’s investment objectives on its face. See Reg BI Adopting Release, supra note 3, at 33360. While the Commission has not addressed documentation of reasonably available alternatives for investment advisers, the staff notes that investment advisers registered or required to be registered are required to maintain certain records related to the adviser’s recommendations and investment advice. See Advisers Act rule 204-2(a)(7) (requiring that investment advisers registered or required to be registered make and keep written communications received or sent by advisers relating to, among other matters, “[a]ny recommendation made or proposed to be made and any advice given or proposed to be given”). See Staff Bulletin on Account Recommendations, supra note 6 (providing staff views on documentation of the basis of account recommendations).

[61] See id.

[62] See Reg BI Adopting Release, supra note 3, at 33378 (stating that broker-dealers may wish to document an evaluation of a recommendation and the basis for the particular recommendation in certain contexts, such as the recommendation of a complex product, or where a recommendation may seem inconsistent with a retail customer’s investment objectives on its face).

[63] See generally Reg BI Adopting Release, supra note 3, at 33376 (discussing recommendations of high-risk products and stating “these products may not be in the best interest of a retail customer absent an identified, short-term, customer-specific trading objective.”); Fiduciary Interpretation, supra note 3, at 33673-33674 (noting that high-risk products, for example inverse or leveraged exchange-traded products that are designed primarily as short-term trading tools for sophisticated investors, “may not be in the best interest of a retail client absent an identified, short-term, client-specific trading objective . . .”).

[64] See Reg BI Adopting Release, supra note 3, at 33376 (“[W]hen a broker-dealer recommends a potentially high risk product to a retail customer—such as penny stocks or other thinly-traded securities—the broker-dealer should generally apply heightened scrutiny to whether such investments are in a retail customer’s best interest.”); Fiduciary Interpretation, supra note 3, at 33673 (“[W]hen an adviser is assessing whether high risk products—such as penny stocks or other thinly-traded securities—are in a retail client’s best interest, the adviser should generally apply heightened scrutiny to whether such investments fall within the retail client’s risk tolerance and objectives.”).

[65] See Reg BI Adopting Release, supra note 3, at 33376; Fiduciary Interpretation, supra note 3, at 33673-33674.

[66] See, e.g., Reg BI Adopting Release, supra note 3, at 33376; Fiduciary Interpretation, supra note 3, at 33673-33674. The Commission has also noted the need to develop a specific understanding of the features of variable annuities. See also Reg BI Adopting Release, supra note 3, at 33376-33377 (noting that, consistent with existing FINRA rules, among other regulatory obligations, that “recommendations of these products would require careful attention and a specific understanding of certain factors, such as whether the product provides tax-deferred growth, or a death or living benefit, before a broker-dealer could establish an understanding of the product, and apply that understanding to a retail customer’s investment profile in making a recommendation”).

[67] See supra note 64.

[68] See Reg BI Adopting Release, supra note 3, at n. 810 (discussing the Compliance Obligation’s affirmative obligation to establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest and how it is similar to the obligation for investment advisers); see also Compliance Programs of Investment Companies and Investment Advisers, IA Release No. 2204 (Dec. 17, 2003) (“IA Release 2204”) at 74728; Questions Advisers Should Ask While Establishing or Reviewing Their Compliance Programs (May 2006), available at https://www.sec.gov/​info/​cco/​adviser_​compliance_​questions.htm. The staff notes that some firms have implemented policies that limit the type of retail investor to whom certain high-risk or complex products can be recommended.

[69] The Commission has brought enforcement actions against registered investment advisers for compliance rule violations relating to the failure to provide adequate training and guidance to financial professionals who recommended complex financial products. See, e.g., In the Matter of Wells Fargo Clearing Services, LLC, and Wells Fargo Advisors Financial Network, LLC, Exchange Act Release No. 88295 (Feb. 27, 2020) (settled action) (dual registrant recommended that many retail investment advisory clients and brokerage customers buy and hold single inverse exchange-traded funds without having adequate compliance policies and procedures and without providing financial advisors proper training and supervision of single-inverse exchange-traded funds), available at https://www.sec.gov/litigation/admin/2020/34-88295.pdf; In the Matter of Summit Financial Group, Inc., Advisers Act Release No. 5626 (Nov. 13, 2020) (settled action) (investment adviser failed to adopt and implement policies and procedures reasonably designed to prevent unsuitable investments in volatility-linked exchange traded products), available at https://www.sec.gov/litigation/admin/2020/ia-5626.pdf.

[70] See Reg BI Adopting Release, supra note 3, at 33321; Fiduciary Interpretation, supra note 3, at 33673-33674.

[71] See Reg BI Adopting Release, supra note 3, at 33360 (encouraging broker-dealers to record the basis for their recommendations, especially more risky products, as a potential way a broker-dealer could demonstrate compliance with the Care Obligation); see also IA Release No. 2204 at 74716 (“. . . an adviser’s policies and procedures, at a minimum, should address . . . consistency of portfolios with clients’ investment objectives . . .”).

[72] Cf. Morgan Stanley Smith Barney, LLC, Investment Advisers Act Rel. No. 4649 (Feb. 14, 2017) (settled action) (finding that Morgan Stanley violated the Advisers Act’s compliance rule in part by failing to implement its policies and procedures requiring its investment advisory representatives to monitor client positions in single-inverse exchange traded products), available at https://www.sec.gov/litigation/admin/2017/ia-4649.pdf; see also Fiduciary Interpretation, supra note 3, at 33675, n.52 and accompanying text (generally discussing policies and procedures with respect to monitoring).

[73] See Reg BI Adopting Release, supra note 3, at 33379; see generally Fiduciary Interpretation, supra note 3, at 33674. Seealso Staff Bulletin on Account Recommendations, supra note 6 (discussing dually licensed financial professionals’ obligations when recommending accounts to prospective retail investor).

[74] See Reg BI Adopting Release, supra note 3, at 33346; Fiduciary Interpretation, supra note 3, at 33674, n.44 (regarding account type recommendations) and at 33675-33676 (regarding the capacity in which the financial professional is acting).

[75] See Reg BI Adopting Release, supra note 3, at 33321; Fiduciary Interpretation, supra note 3, at 33675-33676.

[76] Separately, if a financial professional is only registered as an associated person of a broker-dealer (regardless of whether the financial professional works for a dually registered firm or a broker-dealer affiliated with an investment adviser), the financial professional would need to take into consideration only the brokerage accounts available at the broker-dealer. See Reg BI Adopting Release, supra note 3, at 33340; see also Frequently Asked Questions on Regulation Best Interest (discussing whether an associated person of a broker-dealer that is a dual registrant needs to consider both brokerage and advisory accounts when making an account recommendation), available at https://www.sec.gov/tm/faq-regulation-best-interest#recommendation. Conversely, a financial professional who is only a supervised person of an investment adviser (regardless of whether that advisory firm is a dual registrant or affiliated with a broker-dealer) may only recommend an advisory account the adviser offers when the account is in the client’s best interest. See Fiduciary Interpretation, supra note 3, at 33674, n.44. Finally, a broker-dealer and its financial professionals cannot rely on a limited menu of investment options to justify recommending an investment or providing advice that does not satisfy the obligation to act in a retail investor’s best interest. See Reg BI Adopting Release, supra note 3, at 33326.

[77] Seealso Staff Bulletin on Account Recommendations, supra note 6.

[78] See Reg BI Adopting Release, supra note 3, at 33340 (discussing a dually licensed broker-dealer’s obligation to have a reasonable basis to believe that a recommended account is in the best interest of a retail investor); Fiduciary Interpretation, supra note 3, at 33674, n.44 (“. . . in providing advice to a client or customer about account type, a financial professional who is dually licensed (i.e., an associated person of a broker-dealer and a supervised person of an investment adviser (regardless of whether the professional works for a dual registrant, affiliated firms, or unaffiliated firms)) should consider all types of accounts offered (i.e., both brokerage accounts and advisory accounts) when determining whether the advice is in the client’s best interest.”); see also Staff Bulletin on Account Recommendations, supra note 6 (discussing the obligation of dually licensed firms and financial professionals to consider both advisory and brokerage accounts when recommending an account type).

[79] See Reg BI Adopting Release, supra note 3, at 33383 (“Where the financial professional making the recommendation is dually registered (i.e., an associated person of a broker-dealer and a supervised person of an investment adviser (regardless of whether the professional works for a dual-registrant, affiliated firms, or unaffiliated firms)) the financial professional would need to make [an account type] evaluation taking into consideration the spectrum of accounts offered by the financial professional (i.e., both brokerage and advisory taking into account any eligibility requirements such as account minimums), and not just brokerage accounts.”); Fiduciary Interpretation, supra note 3, at 33674 (“An adviser’s fiduciary duty applies to all investment advice the investment adviser provides to clients, including advice about . . . account type. Advice about account type includes advice about whether to open or invest through a certain type of account (e.g., a commission-based brokerage account or a fee-based advisory account). . . ”).