The Litigation Risks of the Care Obligation of SEC Reg BI

Reg BI's requirement that "broker-dealers must weigh the potential risks, rewards, and costs of a particular security or investment strategy in light of" the customer's investment profile adds another dimension of litigation risk. The investment profile must include the customer's "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 customer may disclose. "Broker-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 customer.

The SEC's position that a "broker-dealer should consider 'reasonably available alternatives' as part of having a 'reasonable basis to believe'" that the recommendation is in the customer's best interest adds additional risk. Although Reg BI does not require an evaluation of every possible alternative or the recommendation of the "best" alternative, disputes may arise over whether there was an appropriate assessment of reasonably available alternatives and over the adequacy of the supervision of this obligation.

Good contemporaneous documentation will be a key strategy for avoiding increased liability under Reg BI because whether the recommendation is in the customer's best interest and did not place the broker-dealer's interests ahead of those of the customer will be "based on information reasonably known" to the advisor "at the time the recommendation is made."

Because disputes over the recommendation will often occur years later when circumstances have changed and memories have faded, comprehensive contemporaneous documentation of the information known at the time of the recommendation as well as the analyses of costs, reasonably available alternatives, and other best-interest factors done prior to the recommendation will be key to defending the claim and mitigating exposure.

Although not required, the SEC notes that "broker-dealers may wish to consider documenting the basis for determining that the recommendation" is in the customer's best interest "when it is not evident from the recommendation itself."  This documentation will be particularly important if the recommended security costs more than the alternatives or results in greater remuneration to the firm or advisor.

Pete Tepley is a commercial litigation attorney with RumbergerKirk. He represents securities broker dealers, including clearing brokers, and their registered representatives in customer, employment, and industry disputes in FINRA arbitrations as well as in state and federal courts. Pete is the Chair of RumbergerKirk's Diversity and Inclusion Committee. He can be reached at (205) 721-2816 or [email protected]. 

Meredith Jowers Lees is a commercial litigation attorney with extensive experience in securities and financial litigation at RumbergerKirk. She represents broker-dealers, including clearing brokers, in state and federal court and in FINRA arbitration in a wide variety of disputes including customer claims, raiding claims, violations of non-competition agreements, employment disputes, member-to-member claims, fraud claims, suitability claims, churning claims, and trust-related claims. Meredith can be reached at (205) 721-2815 or [email protected].