broker-dealers Archives - Stoll Berne | Attorneys | Class-Action, Securities, IP, Real Estate, Business Litigation

The Wall Street Journal reported that the SEC is not moving forward on a measure to require broker dealers and investment advisers to vet individual investors before permitting them to trade leveraged and inverse exchange-traded funds. These funds use debt to try to increase returns. But this leveraged approach to investing also increases the size of potential losses.

Many leveraged and inverse exchange-traded funds are complicated investments and difficult to understand. The Wall Street Journal reported that two companies that offer these investment products, Direxion Investments and ProShares considered the SEC’s proposed vetting requirement a threat to their business model. The Wall Street Journal also reported that between March and July, representatives and lobbyists for Direxion and ProShares met or had phone conferences with the SEC nine times.

SEC Commissioner Allison Herren Lee released a statement criticizing the SEC’s decision not to implement the protection for investors. The Commissioner wrote that she was “deeply disappointed in the failure to advance the proposed sales practice rules, which were designed to address the very real investor harms arising from unsuitable purchases and sales of leveraged and inverse ETFs.” The Commissioner further commented that many enforcement cases at the SEC and FINRA “have shown that even investment professionals often lack a basic understanding of these complex products.”

Beginning June 30, 2020, brokerage firms and their associated persons will have to comply with Regulation Best Interest (Reg BI), which sets a new standard of conduct when working with retail investors. The SEC adopted Reg BI, as the name suggests, to require firms and associated persons to work in the best interest of investor customers, not the firm’s own interest. Along with the overarching requirement that broker-dealers put the customer first, Reg BI includes four major obligations: 1) full disclosure of all material facts (such as of fees); 2) care, including exercise reasonable diligence, skill, as well as care, in making investment recommendations; 3) mitigation and control of conflicts of interest; and 4) compliance. Broker-dealers must implement policies and procedures to ensure these obligations are met. The Reg BI duties apply to investment recommendations, investment strategies, and account changes (such as rollovers).

Reg BI largely replaces FINRA’s suitability rule for many investors and is meant to be a heightened standard that firms must meet. The “care” obligation under Reg BI, however, aligns closely with the existing FINRA suitability rule and preserves suitability concepts. For institutional customers, in contrast to retail investors, the suitability rule is still in effect.

Reg BI also bars broker-dealers from using sales contests, sales quotas, bonuses, and other non-cash compensation based on a representative selling a specific investment or type of investment within a defined period of time.