The New “Best Interest Rule” – Reg. BI – Protects Investors From Bad Recommendations
Investors hire financial professionals for sound advice about how to reach their goals and trust those professionals to always act in their best interest; that is, for the benefit of the investor, not the financial advisor. Surprisingly, until June 30, 2020, there was no Best Interest Rule in place. Stockbrokers and financial advisors are now held to a higher degree of care in their dealings with the investors they serve. In many cases, stockbrokers and investment advisors are held to a Fiduciary Standard; that is, the highest standard of care requiring them to act with the utmost loyalty and care and to act with prudence and not engage in any speculation with respect to a client’s funds entrusted to them. Regardless, all brokers and investment advisors have a duty to act with a reasonable standard of care; when they fail to do so, it amounts to negligence.
Until recently, FINRA Rule 2111, the Suitability Rule, was the basis underlying the most common investor claim at common law for Breach of Fiduciary Duty, Negligence, and Breach of Contract for failure to follow FINRA and other industry rules and regulations in broker-customer disputes. FINRA has now eliminated the Suitability Rule to the extent it is inconsistent with the new SEC Regulation BI-The Best Interest Rule, a higher standard of care, in making recommendations to retail customers only.
Under the new rule, the SEC and FINRA will still require its members in every retail broker-customer relationship to not only assess what the investor’s goals are, as well as his/her risk tolerance, but also consider many other factors (age, financial situation and needs, tax status, investment experience, investment time horizon, other investment holdings, time horizon, liquidity needs, etc.) relevant to the investment or investment strategy recommendation being made and make sure that recommendation not only matches the investor’s profile but to make sure the investment recommendation is in the best interest of the individual retail customer.
In other types of relationships, such as with entities and institutional investors, the duty to only recommend investments and/or strategies in which the broker or advisor has a reasonable basis to believe is suitable for the customer based upon the information obtained remains the standard.
The unsuitable recommendation under either Regulation BI-The Best Interest Rule or FINRA Rule 2111 can be in relation to purchase, sale, or even advice to hold an investment or engage an investment strategy that is not in the customer’s best interest or unsuitable, such as investing on margin, using options, or excessively trading (churning) securities in an account.
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Churning is never in the best interest of customers; it is also a quantitative suitability issue. Until Regulation BI-The Best Interest Rule, courts and arbitrators could only find churning when a broker exercises control (by agreement or de facto control) over the investment decisions in an account and purchases stocks or recommends that you excessively purchase and sell stocks for the stockbroker’s benefit; i.e., commissions! Pursuant to Regulation BI-The Best Interest Rule, proof of control is no longer required. Churning is considered by many to be one of the most egregious forms of stockbroker fraud.
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