Articles Posted in Reg BI

On January 30, 2023, the United States Securities and Exchange Commission (“SEC”) published a Risk Alert including its observations from Broker-Dealer Examinations Related to Regulation Best Interest (“Reg BI”).  The risk alert highlights deficiencies observed during regulatory examinations, as well as weak practices by broker-dealers that could result in deficiencies.

Reg BI requires that brokerage firms and brokers act in the best interest of a retail customer at the time of a recommendation to purchase, sell, or hold a security or investment strategy.  The broker-dealer and broker must place their retail customers’ interest ahead of their own financial interest.  The standard of care also applies to recommendations of account types.

Reg BI requires compliance with four component obligations:

Earlier this week, FINRA released its 2021 Report on Risk Monitoring and Examination Activities. The Report replaced two of FINRA’s prior publications – FINRA’s Examination Findings and Observations Report and FINRA’s Risk Monitoring and Examination Priorities Letter. The Report provided an in-depth look at FINRA’s priorities, recommended best practices for broker-dealer members, and regulatory findings. The Report reiterated FINRA’s commitment to protecting senior and vulnerable investors and highlighted several important areas of interest that directly affect retail investors, including:

  • Regulation Best Interest (Reg BI)
  • Communications with the Public

An in and out trading strategy refers to short-term trading in an investor’s account. In other words, buying in and selling out of securities in a short period of time with no real basis for the stockbroker’s recommendation in either the suitability of the securities or the trading strategy.

In and out is a trading strategy that is commonly associated with day trading. While the strategy may be suitable for some investors or desired by other investors, it is a highly speculative trading strategy for most retail investors. A staple of the strategy is that it generates fees and commissions for the stockbroker and the broker-dealer while costing the investor money. Generally, the investor will be hit with high per-trade transaction costs and even principal losses if the stockbroker is selling investments at a loss in order to engage in the strategy. In and out trading is not appropriate for most investors, and stockbrokers should, at a minimum, have a reasonable basis to recommend this strategy to a particular investor.

Under FINRA rules, a stockbroker is required to perform reasonable due diligence to understand two key areas: 1) the stockbroker’s in and out trading strategy recommendation and 2) the impact the stockbroker’s recommendation has on the account’s ability to turn a profit. To do so, it must assess the cumulative impact that commissions and fees associated with an in and out trading strategy will have on an investor’s ability to earn a profit. Failure to observe these considerations about the quantitative suitability of the trades may lead to investor claims against a stockbroker for unsuitable and excessive trading. Investors may also have a failure to supervise claim against the broker-dealer firm if the trading activity in an account warranted further review by a supervisor, if the trading exceeded turnover and cost-to-equity ratios, and if the broker-dealer failed to take action or ignored its own system’s alerts.

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