SEC's New Best Interest to Protect Investors from Bad Brokers

Does your financial advisor have your best interest in mind?

Many retail investors assume that their stockbrokers will always invest in a way that is most beneficial to the investor. But is that assumption justified?

Until recently, the unfortunate answer has been “no.” Contrary to popular belief among investors, financial advisors have not been legally obligated to put the investors interest above all other considerations. Instead, financial advisors have been required to uphold what is known as the “suitability” standard of investment.

What is the suitability standard of investment advice?

The suitability standard stipulates that whatever investment strategy and products the financial advisor places an investor in, that strategy and those products must be 1) suitable for any investor; and, 2) suitable for that specific investor.

Suitable for any investor

In order for an investment to be suitable for any investor, it must be a legitimate investment. Before recommending any investment, a financial advisor must conduct what is known as “due diligence” on the investment to ensure that is safe and legitimate and does what it says it will do. To understand this baseline of suitability, consider private investments such as an equipment leasing programs, private equity offerings, or startup investments. Often advisors fail even to conduct this basic due diligence and the result is calamitous for investors. This is where the infamous Ponzi Scheme comes in.

Suitable for a specific investor

The second part of the suitability standard involves suitability for the specific investor. While there are a multitude of objectively suitable and legitimate investments out there to choose from, not all of them are appropriate for an individual investors at a given time in their life. This more rigorous and personalized suitability standard requires that financial advisors get to know their client’s investor profile in depth. They must learn the customer’s financial situation, life situation, investment goals, and risk tolerance, among other factors. In doing so, they can best create a “match” between the investor and the investment under consideration.

The best interest standard of investing

Another standard exists beyond the suitability standard. This is known in the securities industry as the “best interest” standard. The best interest standard requires that financial professionals invest only in a way in which the best interest of the investor remains above all other considerations — specifically, above the interest of the advisor his or herself. Until recently, only registered investment advisors, not financial advisor or brokers, have been subject to the best interest standard.

SEC Regulation Best Interest

Last week, the Securities and Exchange Commission (SEC) adopted a rule to protect investors from bad brokers. The “Regulation Best Interest” (or BI) is the SEC’s answer to the Obama administration’s planned “fiduciary rule,” which the Trump administration killed. And SEC Chairman Jay Clayton said Best Interest would “substantially enhance the broker-dealer standard of conduct beyond existing suitability obligations.” But will the Best Interest rule really be in the best interest of investors?

Will the new regulation help investors?

The short answer is, time will tell. Proponents of the new regulation suggest that it will force financial professionals to more careful consider the balance of interests involved in any security transaction. It will also become enforceable in cases where misconduct occurs. Critics of the new regulation say it fails to define its key terms.

In the absence of any better rules and regulations governing financial advisors, Reg. BI is a welcome development in the ongoing and never-ending battle against bad brokers. It gives investors, regulators, and consumer advocates another tools with which to clean up an interest that is notorious for serving itself above the investor.

Pennsylvania & New Jersey Securities Law Firm

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If you or someone you know has been the victim of broker misconduct or investment fraud, please contact our securities attorneys immediately for a free consultation toll-free at 215 462 3330 or by using our online contact form.

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