The outcome of a recent jury trial in Manhattan has underscored the importance of the Securities and Exchange Commission's new Regulation Best Interest and the Commission's ongoing commitment to enforcing the standard of investment suitability for retail clients.
In June, jurors returned a verdict in the SEC's favor against a broker charged with excessively trading customer accounts. The SEC alleged Donald J. Fowler used a trading scheme that generated hefty commissions for him, but significant losses for his customers.
Separately, the SEC obtained a final judgment against Gregory T. Dean, Fowler's partner at now-defunct broker-dealer J.D. Nicholas & Associates, Inc., in Syosset, NY. Dean admitted that he knowingly or recklessly made trade recommendations to his customers with no reasonable basis.
The jury found Fowler liable on all counts, finding that he violated the antifraud provisions of the federal securities laws. Dean settled with the SEC on the eve of trial.
The SEC presented evidence at trial that showed the cumulative commissions Fowler charged were so high that investors would have needed to generate, on average, a 142% return simply to break even. Dean and Fowler also made sure that their customers signed margin agreements, which allowed Dean and Fowler to make stock purchases with borrowed money. The 27 customer accounts in question were non-discretionary, but many of the trades were made without client authorization.
Regulation Best Interest: The SEC's New Broker-Dealer Standard Of Conduct
Effective September 10, 2019, the SEC will adopt a rule that establishes a new standard of conduct for broker-dealers when they execute a securities transaction or recommend an investment strategy to a retail client.
Regulation Best Interest supersedes existing suitability standards and aligns the broker-dealer standard of conduct with retail customers' reasonable expectations by requiring broker-dealers, among other things, to act in the best interest of the client at the time the recommendation is made. It's important to note that the standard of conduct established by Regulation Best Interest cannot be satisfied through disclosure alone.
Unlike the previous Know Your Client (KYC) investment suitability test used by broker-dealers, Regulation Best Interest will serve as the new regulatory standard whether a retail investor uses a broker-dealer or an investment advisor, or both. This ensures that retail investors are entitled to recommendations or advice that will place the client's interests - not the interests of the firm or the financial professional first.
The Changing World Of Investment Suitability
This specific example shows the SEC's vigilance to bring a case to trial if the Commission believes it has found a particularly egregious activity. We believe that the SEC will carefully evaluate whether Regulation Best Interest is being embraced or disregarded by financial firms.
The old KYC method of suitability was based on a broker-dealer's knowledge that any investment recommendation or transaction made was reasonable for that client at a given moment in time. Going forward, broker-dealers will have to make certain a client's situation hasn't changed and that the investments in their portfolio are right for them.
A commitment to adopting effective procedures testing and training can protect your firm and help them comply with these new standards.
Let Our Experience Work For You
The best way to protect the firm is to remain vigilant by monitoring trades in client accounts on a regular basis. Jacko Law Group can assist by working with you to employ best practices that help your firm adhere to the new standard of Regulation Best Interest. For assistance in reviewing and updating your firm's policies and procedures, contact the attorneys at Jacko Law Group, PC, here.
- Managing Partner and CEO
Michelle L. Jacko, Esq. is the Managing Partner and CEO of Jacko Law Group, PC, which offers corporate and securities legal services to broker-dealers, investment advisers, investment companies, hedge/private funds and ...
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