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Compliance April 20, 2023
SEC Updates Guidance on Adviser Investment Obligations
The latest guidance adds teeth to initial Regulation Best Interest, passed in 2019.
Reported by Paul Mulholland
The U.S. Securities and Exchange Commission on Thursday released more guidance to investment advisers and broker/dealers regarding their obligations to retail investors when recommending investment products.
The bulletin builds on a 2019 Regulation Best Interest rule created under a Republican-led SEC describing the key obligations advisers have when giving investment advice and recommendations to clients.
Thursday’s guidance, coming in the form of a 20-question FAQ, explained that advisers must have a comprehensive understanding of the investment they are recommending and cannot rely on an approved investment list from their firm. Specifically, they must consider factors such as client objectives, the investment’s expected performance, risks, unusual features, costs and the client’s profile and time horizon. The bulletin said that costs are always relevant to a recommendation and can include fees, commissions and tax considerations.
Familiarity with a client’s profile should include information on their debts and financial situation, other investments, liquidity needs, time horizon and other factors. These factors need to be evaluated on a continuing basis, since they can easily change over time. According to the SEC, if some information cannot be obtained, the adviser “should generally decline to provide such recommendations or advice until you obtain the necessary investor information.”
Some advisers may only have a limited number of investments they can offer a client, which, according to the SEC, does not permit an adviser to provide advice that is in the client’s best interest. “A firm and its financial professionals cannot rely on a limited menu to justify recommending an investment or providing advice that does not satisfy the obligation to act in a retail investor’s best interest,” the SEC wrote.
Advisers must also consider the client they are advising in terms of the complexity of the investment offering, according to the bulletin.
“In addition to developing an understanding of the product, firms and their financial professionals should obtain information about the retail investor that supports a conclusion that a complex or risky product is in that retail investor’s best interest,” the SEC wrote.
The regulator addressed financial professionals who are licensed as both a broker/dealer and an adviser. The bulletin said that such a person must disclose in which capacity they are working, and different obligations may “be triggered at different times.”
The guidance is the third from the SEC building on the initial best interest rule and the Investment Advisers Act of 1940; it had issued an interpretative bulletin in 2022 noting that practically all financial professionals have at least some conflict of interest when working with retail investors, and they should be proactive in avoiding those conflicts.
In June 2022, the regulator brought the first charges under the regulation against broker/dealer Western International Securities Inc., alleging it failed to act in the best interest of customers when the firm allegedly sold them more than $13 million in unrated, high-risk bonds. The case is currently in U.S. District Court for the Central District of California.
