Heightened Duty of Care Under Regulation Best Interest

By Katie Black

Investors often face overwhelming decisions in deciding if and how to enter the market. In addition to the types of investments in which they might be interested, retail investors must also determine who they trust to help them invest their money. By adopting changes to its program of Regulation Best Interest, announced as of June 2019, the United States Securities and Exchange Commission (“SEC”) is working to implement industry-wide protocols that give investors more security in and knowledge of the firms with which they might choose to invest. Set to go into effect on September 10, 2019, the new Regulation Best Interest rule bolsters the standard of conduct broker-dealers owe their retail investor customers through a two-pronged “general obligation” of requiring heightened protection of their customers’ best interests, while also mandating thorough disclosure policies regarding broker-dealer conflicts of interest.

Though the Regulation Best Interest rule acknowledges the fundamental conflict of interest that occurs given the commissions received as compensation in the relationship between a broker-dealer and their investor customers, the rule endeavors to mitigate conflicts of interest that arise when broker-dealers recommend specific investment-related actions for their clients. More specifically, the SEC breaks the Regulation Best Interest rule down into four “component obligations”: disclosure, care, conflict of interest, and compliance.

The disclosure component requires broker-dealers to be up-front with their customers about any investment recommendations, as well as the relationship that broker-dealer has with the customer they are advising. Relative to this process, broker-dealers must disclose costs, services, and limitations regarding their position as investment brokers. Further, the disclosure obligation facilitates enforcement of the conflict of interest and compliance obligations, which call for the creation of and strict adherence to protocols and procedures to disclose and mitigate any conflicts of interest that exist regarding broker-dealers and the investment recommendations they may make.

In addition to the disclosure-related obligations is the new care obligation, which creates a heightened standard of “diligence, care, and skill” in broker-dealer engagements with their investor clients. Moreover, under Regulation Best Interest, broker-dealers are charged with a renewed duty to consider their clients’ exposure to risk, balance that against the potential for reward, and factor in the potential costs that may come of any investment recommendation.

Ultimately, the Regulation Best Interest rule serves to better inform investors, as well as ensure broker-dealer compliance with higher standards of care relative to their clients. Broker-dealers must comply with this Regulation Best Interest mandate by June 30, 2020 at the latest, which gives broker-dealers just over a year from the rule’s announcement to bring their practices into compliance with the new standards.