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Thursday, September 24, 2020

Stock tips and socializing can get BDs and RIAs in trouble with Reg-BI

Stock tips and socializing can get BDs and RIAs in trouble with Reg-BI

Here’s the situation:

You just sank an 8-footer to save par and close out the front nine with a couple of clients. The sun burned off the layer of morning moisture that rested on top of the grass when you teed off.

After you shove your trusty bronze blade putter you’ve had since high school, you and your client take your seats in the golf cart. Then, as you drive past the clubhouse to the 10th hole tee box, he asks you whether he should be shorting Tesla.

“Sure,” he says, “Ol’Musky is a miracle-worker, but maybe we should shift some of my exposure to an ETF or something. What do you think?”

It’s an innocuous question, but does Regulation Best Interest require you, an RIA or BD, to exercise discretion? Must an RIA or BD meet all the Best Interest Obligations even in casual conversations?

Whereas what constitutes a recommendation as “best interest” will be more clear in time, the SEC is quite explicit about this type of interaction.

The location has no bearing on a recommendation.

Ultimately, “whether your communication is subject to Regulation Best Interest depends on whether you make a ‘recommendation’ not on the location or setting of the communication.” (SEC)

The SEC only cares about recommendations that involve “use”. During an audit, they’ll be looking for justification and due diligence around each transaction and client recommendation. “Using” a recommendation can involve the following as a result of the recommendation:

1) the retail customer opens an account, regardless of whether the BD or RIA receives compensation

2)  the retail customer has an existing account with the broker-dealer and receives a recommendation from the broker-dealer, regardless of whether the broker-dealer receives or will receive compensation, directly or indirectly, as a result of that recommendation

3)  the broker-dealer receives or will receive compensation, directly or indirectly as a result of that recommendation, even if that retail customer does not have an account at the firm.

Ask yourself two questions to see if a conversation qualifies as a recommendation

  1. Could this interaction be viewed as a “call to action” about the recommendation?
  2. Is the conversation or recommendation contextualized to the person’s financial position?

If the answer to either is “yes”, then it is most likely required to fall under the terms of Reg-BI.

Not all interactions will qualify as a recommendation. A conversation that leads to an exchange of business cards does not necessarily constitute a recommendation.

Exercising Fiduciary Caution will show you are trustworthy

Generally speaking, in regards to the solicitations of investing advice, it is safe for BD or RIA to exercise caution by offering to review an individual’s financial circumstances to make sure they are looking at the recommendation correctly.

Abiding by best-interest obligations at all times and disclosing those restrictions in social interactions will show that you take your occupation seriously and are a trustworthy consultant.  

As with other key distinctions in Reg-BI, where it’s made and what constitutes a recommendation will become more defined as violations occur and set precedents in court.

This blog is dedicated to providing RIAs and BDs with news they need to stay up to date with compliance. Check out our full Reg-BI compliance guide by clicking the link below and check our blog for a CRS Form checklist and defining “best interest”.

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