Did Your Financial Advisor Violate the SEC’s Best Interest Rule?

Financial advisors have long been told to act in the best interests of the client. Potential investments or securities presented should be vetted and evaluated for suitability before an advisor offers them to a customer as a recommendation.

In 2022, the SEC implemented Regulation Best Interest (nicknamed “Reg BI”) to further refine exactly what financial advisors are required to consider when making recommendations. Reg BI applies to both brokers and investment advisors. It also goes beyond FINRA’s suitability rule, which does not contain any explicit requirements for the customer’s best interest. However, anything less can be a breach of fiduciary duty.

Before this regulation was implemented, the benchmark for advisors was simply “suitability.” There was no requirement for a customer’s best interest if the recommendations were equally suitable. Investment advisors were free to suggest suitable recommendations and frequently didn’t disclose the cost or how it would benefit them financially, such as bonuses or higher commissions. They were not always bound by a “fiduciary standard,” which required them to place their customers’ interests above their own. That changed with Regulation Best Interest.

This new SEC regulation establishes a standard of conduct that requires financial advisors to adhere to the client’s best interest. They are required to complete a thorough due diligence to vet any recommendations prior to recommendation. These reviews are made according to each individual customer’s investment profile and objectives, risk tolerance, age, and other factors that affect the recommendation for any specific customer.

They should also disclose any conflicts of interest or financial incentives they receive for making this recommendation. The advisor should, at the very least, make a complete and fair disclosure to the customer of the conflict of interest so that the customer can make an informed decision.

What this means is that if your investment objective is conservative with a low risk tolerance, your advisor should frequently not be steering you towards alternative investments, non-traded REITS, and so-called “pot stocks” (marijuana investments). If they do suggest these or other non-standard investments without fully disclosing the risks involved—especially if they’re not registered with the SEC or traded—they are not acting in your best interest.

Reg BI is also having a big impact on cases involving churning or actively traded accounts where financial advisors engage in substantial trading in order to generate significant fees and costs for themselves. These types of cases are frequently characterized as a fraud and most major brokerage firms have compliance programs in place to detect and prevent financial advisors from churning a customers account. However, commissions and markups can be very profitable for a brokerage firm and when done on margin can dramatically increase the risk of a portfolio. However, this type of activity is a violation of Reg BI and these losses are appropriate claims in FINRA arbitration.

This a person who is a federally registered investment adviser and is generally paid by fees, not by commission, and would therefore be subject to Reg BI. They are also prohibited from buying any securities for their own accounts before they purchase them for clients, or making trades that net higher commissions for themselves or their investment firms.

Brokers are not necessarily fiduciaries unless they are registered, and have completed federal and state requirements for becoming one under the Investment Advisers Act of 1940. Firms or sole practitioners who make securities recommendations must register with the SEC and/or their state securities regulator are considered a fiduciary. This includes brokers who are also registered investment advisors, but not brokers or broker-dealers who aren’t.

How do you know if someone is a fiduciary? You can ask, of course, and you can also ask about their pay structure as well as other business relationships. Someone paid on commission is not acting as a fiduciary. However they are paid, they are still required to consider the client first. Also, investors can check the SEC and/or FINRA’s website to view the financial advisors license, past customer complaints and other basic information.

Most investors assume that their fiduciary or financial advisor is acting in their best interest with both trading and recommendations. They also assume that the advisor has researched and vetted everything that they recommend and made the recommendation with them in mind. Regular readers of this blog understand that this isn’t always the case.

When a financial advisor acts in their own best interests, rather than yours, chances are they’ve violated Reg BI with unethical behavior. This can take many forms, including:

• Promised returns—no one can guarantee a specific amount of return, and past performance is not a predictor of future results. FAs use historical information on different investments to make a prediction on where they might go. If your FA is suggesting changes to your portfolio’s allocation to create higher returns, ask them to explain the likelihood of that action.
• Lack of transparency—not being entirely clear about your investments or indicating their involvement with that investment (conflict of interest.)
• Modifications of performance reporting—your reports should be consistent and detail exactly how your investments are performing. Changing the reporting may make the advisor look good but conceal your account’s actual performance, good or bad. Ask to review prior clients’ reporting and statements to get an idea of what you can expect prior to signing up.
• Excessive use of jargon—if you find yourself wondering what your financial advisor just said, ask. Acronyms and phrases that aren’t well known may be a warning sign, especially if they’re not explained clearly. You have the right to understand their fee structure, process for investment, and philosophy for investment before agreeing to anything.
• Focusing on products instead of advice—if your advisor consistently recommends something specific that doesn’t necessarily fit your investment objectives, there’s a good chance there is a commission or other financial incentive for them to sell something.

You should be able to ask your investment advisor about anything you don’t understand.

Should a financial advisor intentionally fail to act in your best interest, they may have violated Reg BI—especially if you’ve experienced losses because of their recommendations. You may have the option to recover some or all your investment through a FINRA arbitration action.

If you believe your investment advisor has not complied with Regulation BI, speak with a Silver Law attorney to discuss your case.

Silver Law Group represents investors in securities and investment fraud cases. Our lawyers are admitted to practice in New York and Florida and represent investors nationwide to help recover investment losses due to stockbroker misconduct. If you have any questions about how your account has been handled, call to speak with an experienced securities attorney. Most cases are handled on a contingent fee basis, meaning that you won’t owe us until we recover your money for you. Contact us today at (800) 975-4345 and let us know how we can help.