Global Trustee and Fiduciary Services News and Views Issue 50

Global Trustee and Fiduciary Services News & Views | Issue 50 | 2018 79 customers at the time the recommendation is made. In addition, the recommendation must not place the interests of the broker-dealer ahead of the retail customer’s interests. 4 Although the “best interest” standard is not specifically defined in the proposal, the SEC’s proposal provides that compliance with each of the following conditions would satisfy the best-interest standard: • Disclosure . At the time the recommendation is made, the broker-dealer must reasonably disclose to the retail customer, in writing, the material facts relating to the scope of the brokerage relationship, including all material conflicts of interest that are associated with the securities recommendation. 5 • Care . In making the recommendation, the broker-dealer must exercise reasonable care. The SEC clarified that reasonable care must be taken to ensure that the broker-dealer has a reasonable belief that: the recommendation could be in the best interest of at least some retail customers; the recommendation is in the best interest of a particular retail customer based on that customer’s investment profile and the potential risks and rewards associated with the recommendation; and a series of recommended transactions, even if in the retail customer’s best interest when viewed in isolation, is not excessive and is in the retail customer’s best interest when taken together in light of the retail customer’s investment profile. 6 • Conflict of interest . Broker-dealers must establish and maintain written policies and procedures to identify and disclose or eliminate material conflicts of interest associated with a recommendation. Broker- dealers also must establish, maintain, and enforce written policies and procedures reasonably designed to identify and disclose and mitigate, or eliminate, material conflicts of interest arising from financial incentives associated with such recommendations. 7 Regulation BI would thus require broker-dealers to perform enhanced suitability reviews of recommended securities transactions. By design, portions of the proposed Regulation BI language is taken directly from the existing suitability rule administered by the Financial Industry Regulatory Authority, Inc. (FINRA), Rule 2111, applicable to broker-dealers. However, in addition to a broker-dealer’s existing suitability obligations, which arguably already impose a best-interest standard for recommended transactions in many respects, Regulation BI also imposes separate disclosure and conflict mitigation requirements. For instance, the disclosure requirements would go beyond the summary provided under proposed Form CRS, and would require more specific fee disclosures and a more comprehensive disclosure of material conflicts of interest. In addition, broker- dealers would be required to mitigate conflicts of interest related to their financial incentives, including conflicts associated with sales contests or special trips and awards for selling certain investment products. How must broker-dealers address conflicts that create financial incentives? As noted above, the third and final prong of Regulation BI relates to broker-dealers’ conflicts of interest. Under this, a broker-dealer is required to establish, maintain, and enforce written policies and procedures to deal with two types of conflicts — general conflicts and conflicts arising from financial incentives.