initial disclosure.\188\
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    \188\ See infra note 216 and accompanying text.
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(2) Fees and Charges
    A broker-dealer's fees and charges that apply to retail customers'
transactions, holdings, and accounts would also be examples of items we
would generally consider to be ``material facts relating to the scope
and terms of the relationship.'' As such, fees and charges would
generally fall under the requirement for written disclosure prior to,
or at the time of, the recommendation. Fees and charges are important
to retail investors,\189\ but many retail investors are uncertain about
the fees they will pay.\190\ Many commenters have stressed the
importance of clear fee disclosure to retail investors.\191\
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    \189\ See Staff of the Securities and Exchange Commission, Study
Regarding Financial Literacy Among Investors as required by Section
917 of the Dodd-Frank Wall Street Reform and Consumer Protection Act
(Aug. 2012), at iv (``With respect to financial intermediaries,
investors consider information about fees, disciplinary history,
investment strategy, conflicts of interest to be absolutely
essential.''), available at https://www.sec.gov/news/studies/2012/917-financial-literacy-study-part1.pdf.
    \190\ See Rand Study, supra note 28, at xix (``In fact, focus-
group participants with investments acknowledged uncertainty about
the fees they pay for their investments, and survey responses also
indicate confusion about the fees.'').
    \191\ See, e.g., Wells Fargo 2017 Letter (recommending
disclosure of fees and the scope of activities, among other
information, as part of a recommended standard of conduct); ACLI
Letter (recommending, among other things, full and fair disclosure
of the recommended product's features, fees, and charges, and fairly
disclosing how and by whom the financial professional is
compensated); SIFMA 2017 Letter (recommending a new broker-dealer
standard of conduct being accompanied by enhanced up-front
disclosure, including information such as the type and scope of
services, and the types of compensation the broker-dealer may
receive and the customer may pay); UBS 2017 Letter (recommending, in
the context of variable compensation received based on a
recommendation, an exemption subject to meeting the new standards of
conduct and providing a disclosure document (similar to Form ADV)
that would include compensation that may be received from clients
and from third parties, material conflicts of interest, and the
types of compensation for the various products and services
available); ICI August 2017 Letter (recommending a best interest
standard including, among other provisions, a requirement to
disclose certain key aspects of a broker-dealer's relationship with
the customer, such as the type and scope of services provided, the
applicable standard of conduct, and the types of compensation it or
its associated persons receive); State Farm 2017 Letter
(recommending a standardized, plain-English disclosure requirement
as a part of a standard of conduct, which would include, among other
information, the services available and applicable fees); Bernardi
Letter (recommending a ``standardized, straightforward, and truthful
disclosure regime'' describing, among other things, all fees and
commissions earned (including direct/indirect fees, and pricing
discounts received)); Vanguard Letter (recommending a standard
including several components such as enhanced disclosure, which
would include the nature and scope of the duty owed to clients and
the types of direct and indirect compensation to be received, among
other things).

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    As described more fully in the Relationship Summary Proposal, the
Relationship Summary is designed to provide investors greater clarity
concerning the principal fees and charges they should expect to pay and
how the types of fees and charges affect the incentives of the firm and
their financial professionals.\192\ However, the proposed Relationship
Summary would focus on general descriptions regarding types of fees and
charges, rather than offer a comprehensive or personalized schedule of
fees or other information about the amounts, percentages or ranges of
fees and charges. Although we are not proposing to mandate the form,
specific content or method for delivering fee disclosure, in
furtherance of the goal of layered disclosure, to meet the Disclosure
Obligation, we would generally expect broker-dealers to build upon the
Relationship Summary, by disclosing additional detail (including
quantitative information, such as amounts, percentages or ranges)
regarding the types of fees and charges described in the Relationship
Summary.\193\
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    \192\ As discussed above, broker-dealers are also currently
subject to a number of specific disclosure obligations when they
effect certain customer transactions, and additional disclosure
obligations under the antifraud provisions of the federal securities
laws. See supra notes 175, 176, 177 and accompanying text. See also
Exchange Act Rules 15g-4 and 15g-5 (prior to effecting a penny stock
transaction, a broker-dealer generally is required to provide
certain disclosures, including the aggregate amount of any
compensation received by the broker-dealer in connection with such
transaction; and the aggregate amount of cash compensation that any
associated person of the broker-dealer has received or will receive
from any source in connection with the transaction). Additional fee
disclosure requirements are also addressed in SRO guidance. See,
e.g., FINRA Regulatory Notice 13-23, Brokerage and Individual
Retirement Account Fees (July 2013) (providing guidance on
disclosure of fees in communications concerning retail brokerage
accounts and IRAs).
    \193\ Specifically, the Relationship Summary requires high level
disclosures (in part, through prescribed statements) concerning
broad categories, but not specific amounts, percentages or ranges of
transaction-based or other fees (including commissions, mark-ups and
mark-downs and sales ``loads''), other account fees and expenses
(including, for example, custodian, account maintenance and account
inactivity fees), and investment fees and expenses for certain
products such as mutual funds and variable annuities.
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(3) Type and Scope of Services
    The type and scope of services a broker-dealer provides its retail
customers would also be an example of what typically would be
``material facts relating to the scope and terms of the relationship,''
and thus would likely need to be disclosed prior to, or at the time of
the recommendation, pursuant to this obligation. More specifically, we
believe broker-dealers should, consistent with the goal of layered
disclosure, build upon their disclosure in the Relationship Summary,
and provide additional information regarding the types of services that
will be provided as part of the relationship with the retail customer
and the scope of those services.
    In particular, in the Relationship Summary, broker-dealers would
provide high level disclosures concerning services offered to retail
investors, including, for example, recommendations of securities,
assistance with developing or executing an investment strategy,
monitoring the performance of the retail investor's account, regular
communications, and limitations on selections of investments.\194\ A
broker-dealer that offers different account types, or that offers
varying additional services to retail customers may not be able, within
the content and space constraints of the Relationship Summary, to
provide the ``material facts relating to the scope and terms of the
relationship'' with the retail customer (which may include further
detail regarding the specific products and services offered in that
retail customer's account,\195\ any limitations on those products or
services, the frequency and duration of those services, and the
standards of conduct that apply to those services). Pursuant to the
Disclosure Obligation, we would generally expect broker-dealers to
disclose these types of material facts concerning the actual services
offered as part of the relationship with the retail customer (i.e.,
specific to the type of account held by the retail customer) in a
separate document or documents.\196\
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    \194\ See Relationship Summary Proposal.
    \195\ Broker-dealers may determine that other services, not
included as part of the Relationship Summary, are also ``material
facts relating to the scope and terms of the relationship,''
including, for example, margin, cash management, discretionary
authority (consistent with the discussion in Section II.F), access
to research, etc.
    \196\ As noted above, we understand that broker-dealers already
typically provide some of these disclosures through various means.
See supra notes 175, 176, 177 and accompanying text.
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b. Material Conflicts of Interest
    The Disclosure Obligation would also explicitly require the broker-
dealer to, prior to or at the time of such recommendation, reasonably
disclose all material conflicts of interest associated with the
recommendation. For purposes of Regulation Best Interest, we propose to
interpret a ``material conflict of interest'' as a conflict of interest
that a reasonable person would expect might incline a broker-dealer--
consciously or unconsciously--to make a recommendation that is not
disinterested. In determining how to interpret what constitutes a
``material conflict of interest,'' we considered the definition of
``material conflict of interest'' as used in BIC Exemption and related
PTEs.\197\ However, we developed this proposed interpretation based on
the Advisers Act as we believe it is appropriate to interpret the term
in accordance with existing and well-established Commission precedent
regarding identification of conflicts of interest for which advisers
may face antifraud liability under the Advisers Act in the absence of
full and fair disclosure.\198\
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    \197\ In the BIC Exemption, a Material Conflict of Interest
exists when an Adviser or Financial Institution has a ``financial
interest that a reasonable person would conclude could affect the
exercise of its best judgment as a fiduciary in rendering advice to
a Retirement Investor.'' See BIC Exemption.
    \198\ See SEC v. Capital Gains Research Bureau, Inc., 375 U.S.
180, 191-92, 194 (1963), (stating that as part of its fiduciary
duty, an adviser must ``fully and fairly'' disclose to its clients
all material information in accordance with Congress's intent ``to
eliminate, or at least expose, all conflicts of interest which might
incline an investment adviser--consciously or unconsciously--to
render advice which was not disinterested'').
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    We believe that this obligation to disclose should only apply to
``material conflicts of interest,'' and not to ``any conflicts of
interest'' that a broker-dealer may have with the retail customer.
Limiting the obligation to ``material'' conflicts is consistent with
case law under the antifraud provisions, which limit disclosure
obligations to ``material facts,'' even when a broker-dealer is in

a relationship of trust and confidence with its customer.\199\ Limiting
disclosure to material conflicts is designed to provide retail
customers with full disclosure of key pieces of information regarding
those conflicts that may affect a recommendation to a retail
customer.\200\ We believe that expanding the scope of the obligation
more broadly to cover any conflicts a broker-dealer may have would
inappropriately require broker-dealers to provide information regarding
conflicts that would not ultimately affect a retail customer's decision
about a recommended transaction or strategy and might obscure the more
important disclosures.
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    \199\ See, e.g., Chasins v. Smith, Barney & Co., 438 F.2d 1167,
1172 (2d Cir. 1970) (``[F]ailure to inform the customer fully of its
possible conflict of interest, in that it was a market maker in the
securities which it strongly recommended for purchase by
[plaintiff], was an omission of material fact in violation of Rule
10b-5.''); United States v. Laurienti, 611 F.3d 530, 541 (9th Cir.
2010) (emphasizing that ``even in a trust relationship, a broker is
required to disclose only material facts'' and that ``materiality is
defined by the nature of the trust relationship between the clients
and the brokers: `This relationship places an affirmative duty on
brokers to use reasonable efforts to give the customer information
relevant to the affairs that have been entrusted to them.''')
quoting United States v. Szur, 289 F.3d 200, 211 (2d Cir. 2002)).
    \200\ This interpretation is consistent with the 913 Study
recommendation. See 913 Study at 112.
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    The Disclosure Obligation applies to any ``material conflict of
interest,'' including those arising from financial incentives. As
discussed below, the proposed Conflict of Interest Obligations would
require a broker-dealer to establish, maintain and enforce written
policies and procedures reasonably designed to: (1) Identify and at a
minimum disclose, or eliminate, all material conflicts of interest
associated with the recommendation; and (2) identify and disclose and
mitigate, or eliminate, material conflicts of interest arising from
financial incentives associated with the recommendation. To the extent
a broker-dealer determines, pursuant to the Conflict of Interest
Obligations, not to eliminate, but to disclose a material conflict of
interest, or to disclose and mitigate a material conflict of interest
that is a financial incentive, this Disclosure Obligation would apply.
    We preliminarily believe that a material conflict of interest that
generally should be disclosed would include material conflicts
associated with recommending: Proprietary products,\201\ products of
affiliates, or limited range of products; \202\ one share class versus
another share class of a mutual fund \203\; securities underwritten by
the firm or a broker-dealer affiliate; the rollover or transfer of
assets from one type of account to another (such as recommendations to
rollover or transfer assets in an ERISA account to an IRA, when the
recommendation involves a securities transaction) \204\; and allocation
of investment opportunities among retail customers (e.g., IPO
allocation). A broker-dealer should also consider whether these
conflicts arise from financial incentives that need to be mitigated, as
discussed in proposed paragraph (a)(2)(iv).
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    \201\ See SIFMA 2017 Letter (``Likewise, consistent with our
prior written advocacy on this issue, the new standard would not
prohibit BDs from offering any of the following, if accompanied by
appropriate disclosure, and the product or service is in the best
interest of the customer: (1) Proprietary products or services
(including those from affiliates); (2) transaction charge-based
accounts (e.g., commissions); (3) complex products (e.g., structured
products, alternative investments such as hedge funds and private
equity funds, etc.); and . . .'').
    \202\ Broker-dealers may offer a limited range of products, for
instance, products sponsored or managed by an affiliate or products
with third-party arrangements (e.g., revenue sharing).
    \203\ See, e.g., IFG Network Sec., Inc., Exchange Act Release
No. 54127 (July 11, 2006) (Commission Decision).
    \204\ For example, firms and their registered representatives
that recommend an investor roll over plan assets to an IRA may earn
commissions or other fees as a result, while a recommendation that a
retail customer leave his plan assets with his old employer or roll
the assets to a plan sponsored by a new employer likely results in
little or no compensation for a firm or a registered representative.
See FINRA Regulatory Notice 13-45.
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    For the avoidance of doubt, the requirement under Regulation Best
Interest that a broker-dealer disclose information about material
conflicts of interest is not intended to limit or restrict a broker-
dealer's obligations under federal securities laws, including the
general antifraud provisions of the federal securities laws, relating
to disclosure of additional information to a customer at the time of
the customer's investment decision.\205\
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    \205\ See Sections 10(b) and 15(c) of the Exchange Act. See,
e.g., Exchange Act Rule 10b-10 (Confirmation of Transactions)
Preliminary Note (requiring broker-dealers to disclose specified
information in writing to customers at or before completion of the
transactions). For example, a broker-dealer may be required to
disclose revenue sharing payments that it or its affiliates may
receive for distributing fund shares from a fund's investment
adviser or others. Those payments provide sales incentives that
create conflicts between broker-dealers' financial interests and
their agency duties to customers. Revenue sharing payments may lead
a broker-dealer to use ``preferred lists'' that explicitly favor the
distribution of certain funds. Revenue sharing payments also may
lead to favoritism that is less explicit but just as real, such as
through broker-dealer practices allowing funds that make revenue
sharing payments to have special access to broker-dealer sales
personnel, and through other incentives or instructions that a
broker-dealer may provide to managers or salespersons. See, e.g., In
re Edward D. Jones & Co, Securities Act Release No. 8520 (Dec. 22,
2004) (broker-dealer violated antifraud provisions of Securities Act
and Exchange Act by failing to disclose conflicts of interest
arising from receipt of revenue sharing, directed brokerage payments
and other payments from ``preferred'' families that were exclusively
promoted by broker-dealer); In re Morgan Stanley DW Inc., Securities
Act Release No. 8339 (Nov. 17, 2003) (broker-dealer violated
antifraud provisions of Securities Act by failing to disclose
special promotion of funds from families that paid revenue sharing
and portfolio brokerage).
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c. Guidance on Reasonable Disclosure
    We are proposing that the Disclosure Obligation would require a
broker-dealer, or natural person who is an associated person of a
broker or dealer to ``reasonably'' disclose material facts, including
material conflicts. In lieu of setting explicit requirements by rule
for what constitutes effective disclosure, the Commission proposes to
provide broker-dealers with flexibility in determining the most
appropriate way to meet this Disclosure Obligation depending on each
broker-dealer's business practices, consistent with the principles set
forth below and in line with the suggestion of some commenters that
stressed the importance of allowing broker-dealers to select the form
and manner of delivery of disclosure.\206\ To facilitate compliance
with this Disclosure Obligation, the Commission is providing
preliminary guidance, as discussed below, on what it believes would be
to ``reasonably'' disclose in accordance with the Disclosure Obligation
by setting forth the aspects of effective disclosure, including the
form and manner of disclosure and the timing and frequency of
disclosure. While the Commission is providing flexibility with regard
to the form and manner of disclosure as well as timing and frequency,
the adequacy of disclosure will depend on the facts and
circumstances.\207\ In order to

``reasonably disclose'' in accordance with this Disclosure Obligation,
a broker-dealer would need to give sufficient information to enable a
retail customer to make an informed decision with regard to the
recommendation.\208\ Disclosures made pursuant to the Disclosure
Obligation must be true and may not omit any material facts necessary
to make the required disclosures not misleading.\209\
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    \206\ See TIAA Letter; Bernardi Letter; ACLI Letter. But see UBS
Letter; Nationwide Letter; FSR Letter (suggesting the SEC require a
disclosure document similar to Form ADV).
    \207\ For example, the Commission has indicated that failure to
disclose the nature and extent of a conflict of interest may violate
Securities Act Section 17(a)(2). See Edward D. Jones & Co., L.P.,
Exchange Act Release No. 50910 (Dec. 22, 2004); Morgan Stanley DW,
Inc., Exchange Act Release No. 48789 (Nov. 17, 2003). In the context
of scalping, it is misleading to disclose that the person making the
investment recommendation ``may'' trade the recommended securities
when in fact the person does so. In SEC v. Blavin, for example, the
Sixth Circuit held that a newsletter publisher could not avoid
liability for scalping under Section 10(b) and Rule 10b-5 of the
Exchange Act by disclosing that it ``may trade for its own
account.'' 760 F.2d at 709-11. The court found that this was a
material misstatement because in fact it did trade for its own
account. See id.; see also SEC v. Gane, 2005 WL 90154 at *14 (S.D.
Fla., Jan. 4, 2005) (``By stating that they, their affiliates,
officers, directors, or employees `may' buy or sell stock in their
Investment Opinions, Southern Financial and Strategic investors
failed to provide adequate disclosure'').
    \208\ See, e.g., De Kwiatkowski, 306 F.3d 1293, supra notes 15
(``the broker . . . is obliged to give honest and complete
information when recommending a purchase or sale.'') and 176; see
also Arleen W. Hughes, Exchange Act Release No. 4048, supra note 143
(finding duty to disclose material facts ``in a manner which is
clear enough so that a client is fully apprised of the facts and is
in a position to give his informed consent'').
    \209\ As noted, Regulation Best Interest applies in addition to
any obligations under the Exchange Act, along with any rules the
Commission may adopt thereunder, and any other applicable provisions
of the federal securities laws and related rules and regulations.
For example, any transaction or series of transactions, whether or
not subject to the provisions of Regulation Best Interest, remain
subject to the antifraud and anti-manipulation provisions of the
securities laws, including, without limitation, Section 17(a) of the
Securities Act [15 U.S.C. 77q(a)] and Sections 9, 10(b), and 15(c)
of the Exchange Act [15 U.S.C. 78i, 78j(b), and 78o(c)] and the
rules thereunder.
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    In addition to providing firms flexibility, we further believe it
is important to require that broker-dealers or natural persons who are
associated persons of the broker-dealer to ``reasonably disclose'' so
that compliance with the Disclosure Obligation will be measured against
a negligence standard, not against a standard of strict liability.\210\
In taking this position, we are sensitive to the potential that, if we
instead proposed an express obligation that broker-dealers ``disclose
material facts relating to the scope and terms of the relationship with
the retail customer and material conflict of interest,'' broker-
dealers, in an effort to avoid any inadvertent failure to disclose this
information as required, could opt to disclose all facts and conflicts
(including those that do not meet the materiality threshold). This
could result in lengthy disclosures that do not meaningfully convey the
material facts and material conflicts of interest and may undermine the
Commission's goal of facilitating disclosure to assist retail customers
in making informed investment decisions.
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    \210\ While we understand that pursuant to the fiduciary duty
under the Advisers Act Section 206(1) and (2), an investment adviser
must eliminate, or at least disclose, all conflicts of interest, as
this duty is derived from the antifraud provisions, it is not a
strict liability standard. See In the Matter of Cranshire Capital
Advisors LLC, Investment Advisers Act Release No. 4277 (Nov. 23,
2015); SEC v. Capital Gains Research Bureau, Inc. In particular,
scienter is required to establish violations of Section 206(1) of
the Advisers Act. SEC v. Steadman, 967 F.2d 636, 641 & n.3 (D.C.
Cir. 1992). However, scienter is not required to establish a
violation of Section 206(2) of the Advisers Act; a showing of
negligence is adequate. See SEC v. Capital Gains Research Bureau,
Inc., 375 U.S. 180, 195 (1963); see also SEC v. Steadman, 967 F.2d
at 643 & n.5; Steadman v. SEC, 603 F.2d 1126, 1132-34 (5th Cir.
1979), aff'd on other grounds, 450 U.S. 91 (1981).
    The DOL Fiduciary Rule also would avoid strict liability, albeit
through a ``good faith'' exemption in its BIC Exemption. Section
II(e)(8), BIC Exemption Release at 21046-21047.
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    Given the unique structure and characteristics of the broker-dealer
relationship with retail customers--including the varying levels and
frequency of recommendations that may be provided, and the types of
conflicts that may be presented--we believe it is important to provide
broker-dealers flexibility in determining the most appropriate and
effective way to meet this Disclosure Obligation, consistent with the
principles set forth below. Accordingly, at this time we are not
proposing to require a standard written document akin to Form ADV Part
2A, as suggested by certain commenters. As discussed in more detail
below, we preliminarily believe that while some forms of disclosure may
be standardized, certain disclosures may need to be tailored to the
particular recommendation, and some disclosures may be addressed
through an initial more generalized disclosure about the material fact
or conflict, followed by specific disclosure at another point.
Accordingly, we have preliminarily determined to provide flexibility in
the form and manner, and timing and frequency, of the disclosure.
(1) Form and Manner of Disclosure
    The Commission believes that disclosure should be concise, clear
and understandable to promote effective communication between a broker-
dealer and retail customer.\211\ Specifically, broker-dealers generally
should apply plain English principles to written disclosures including,
among other things, the use of short sentences and active voice, and
avoidance of legal jargon, highly technical business terms, or multiple
negatives.\212\ Broker-dealers may also, for example, consider whether
the use of graphics could help investors better understand and evaluate
these disclosures. Additionally, we believe that any such disclosure
must be provided in writing in order to facilitate investor review of
the disclosure, promote compliance by firms, facilitate effective
supervision, and facilitate more effective regulatory oversight to help
ensure and evaluate whether the disclosure complies with the
requirements of Regulation Best Interest.\213\ As with other documents
broker-dealers must deliver, broker-dealers would be able to deliver
the disclosure required pursuant to Regulation Best Interest consistent
with the Commission's guidance regarding electronic delivery of
documents.\214\
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    \211\ Exchange Act Section 15(l)(1) and Advisers Act Section
211(h)(1) provide that the Commission shall ``facilitate the
provision of simple and clear disclosures to investors regarding the
terms of their relationships with brokers, dealers and investment
advisers, including any material conflicts of interest.''
    \212\ See Office of Investor Education and Assistance, U.S.
Securities and Exchange Commission, A Plain English Handbook: How to
Create Clear SEC Disclosure Documents (Aug. 1998). See also
Relationship Summary Proposal.
    \213\ We recognize that broker-dealers may provide
recommendations by telephone. In such instances, we believe that a
broker-dealer could meet its obligation to reasonably disclose ``in
writing,'' ``prior to or at the time of such recommendation''
through a variety of approaches, as described infra in Section
II.D.1.c.(2). For example, the broker-dealer may have already
provided relevant disclosures prior to the telephone conversation
(e.g., in a relationship guide, an account opening agreement or
account disclosure). The broker-dealer may also be able to meet the
delivery obligation by sending the relevant disclosure
electronically (e.g., by email) to the retail customer during the
telephone conversation. See also, infra note 216 and accompanying
text, where we explain that we would not consider the disclosure of
capacity at the time of recommendation to also be subject to the
``in writing'' requirement (i.e., a broker-dealer could clarify it
orally, so long as it had previously provided an initial disclosure
setting forth when the broker-dealer is acting in a broker-dealer
capacity and the method it will use to clarify the capacity in which
it is acting at the time of the recommendation).
    \214\ See generally Use of Electronic Media for Delivery
Purposes, Exchange Act Release No. 36345 (Oct. 6, 1995) (``1995
Release'') (providing Commission views on the use of electronic
media to deliver information to investors, with a focus on
electronic delivery of prospectuses, annual reports to security
holders and proxy solicitation materials under the federal
securities laws); Use of Electronic Media by Broker-Dealers,
Transfer Agents, and Investment Advisers for Delivery of
Information, Exchange Act Release No. 37182 (May 9, 1996) (``1996
Release'') (providing Commission views on electronic delivery of
required information by broker-dealers, transfer agents and
investment advisers); Use of Electronic Media, Exchange Act Release
No. 42728 (Apr. 28, 2000) (``2000 Release'') (providing updated
interpretive guidance on the use of electronic media to deliver
documents on matters such as telephonic and global consent; issuer
liability for website content; and legal principles that should be
considered in conducting online offerings).
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    As described above, we are not proposing to specify by rule the
form (e.g., narrative v. graphical/tabular, number of pages, etc.) or
manner (e.g., relationship guide or other written communications) of
disclosure. Given the variety of ways retail customers may communicate
with their broker-dealer, as well as the type of compensation and other
conflicts presented and the variety in the frequency and level of
advice services provided (i.e., one-time,

episodic or on a more frequent basis), we believe that some disclosures
may be effectively provided in a standardized document at the beginning
of the relationship, whereas others may need to be tailored to a
particular recommendation. Accordingly, we preliminarily believe that
broker-dealers should have the flexibility to make disclosures by
various means (e.g., different types of disclosure documents), as
opposed to requiring a single standard written document. As noted,
however, whether there is sufficient disclosure will depend on the
facts and circumstances.
(2) Timing and Frequency of Disclosure
    The Disclosure Obligation would apply ``prior to or at the time
of'' the recommendation. The timing of the disclosure is critically
important to whether it may achieve the effect contemplated by the
proposed rule. Investors should receive information early enough in the
process to give them adequate time to consider the information and
promote the investor's understanding in order to make informed
investment decisions, but not so early that the disclosure fails to
provide meaningful information (e.g., does not sufficiently identify
material conflicts presented by a particular recommendation, or
overwhelms the retail customer with disclosures related to a number of
potential options that the retail customer may not be qualified to
pursue). The timing of the required disclosure should also reflect the
various ways in which retail customers may receive recommendations and
convey orders.\215\
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    \215\ See, e.g., note 160 supra, describing ``check and
application'' arrangements.
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    In light of these goals, we would like to emphasize the importance
of determining the appropriate timing and frequency of disclosure that
may be effectively provided ``prior to or at the time of'' the
recommendation, but which may be achieved through a variety of
approaches: (1) At the beginning of a relationship (e.g., in a
relationship guide, such as or in addition to the Relationship Summary,
or in written communications with the retail customer, such as the
account opening agreement); (2) on a regular or periodic basis (e.g.,
on a quarterly or annual basis, when any previously disclosed
information becomes materially inaccurate, or when there is new
relevant material information); (3) at other points, such as before
making a particular recommendation or at the point of sale; and/or (4)
at multiple points in the relationship or through a layered approach to
disclosure. For example, a broker-dealer may determine that certain
disclosures may be most effective if they are made at multiple points
in the relationship, or, if pursuant to a layered approach to
disclosure, certain material facts are conveyed in a more general
manner in an initial written disclosure and followed by more specific
information in a subsequent disclosure, which may be at the time of the
recommendation \216\ or even after the recommendation (i.e., in the
trade confirmation). Disclosure after the recommendation, such as in a
trade confirmation for a particular recommended transaction would not,
by itself, satisfy the Disclosure Obligation, because the disclosure
would not be ``prior to, or at the time of the recommendation.''
However, a broker-dealer could satisfy the Disclosure Obligation,
depending on the facts and circumstances, if the initial disclosure, in
addition to conveying material facts relating to the scope and terms of
the relationship with the retail customer, explains when and how a
broker-dealer would provide additional more specific information
regarding the material fact or conflict in a subsequent disclosure
(e.g., disclosures in a trade confirmation concerning when the broker-
dealer effects recommended transactions in a principal capacity).We
believe that including in the general disclosure this additional
information of when and how more specific information will be provided
would help the retail customer understand the general nature of the
information provided and alert the retail customer that more detailed
information about the fact or conflict would be provided and the timing
of such disclosure.\217\ As noted above, whether there is sufficient
disclosure in both the initial disclosure and any subsequent
disclosure, will depend on the facts and circumstances.
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    \216\ For example, as discussed above in the discussion of the
disclosure of the capacity in which the broker-dealer is acting, a
broker-dealer may take this type of approach with respect to meeting
its obligation regarding the capacity in which it is acting at the
time of the recommendation. As noted above, we preliminarily believe
that a broker-dealer would satisfy the Disclosure Obligation
expressly by providing written disclosure setting forth when the
broker-dealer is acting in a broker-dealer capacity versus an
advisory capacity and how the broker-dealer will clarify when it is
making a recommendation whether it is doing so in a broker-dealer
capacity versus an advisory capacity. However, one important
distinction is that the written disclosure requirement would apply
to the initial disclosure (i.e., setting forth when the broker-
dealer is acting in a broker-dealer capacity and the method it will
use to clarify the capacity in which it is acting at the time of the
recommendation), but we would not consider the subsequent disclosure
of capacity at the time of recommendation to also be subject to the
``in writing'' requirement (i.e., a broker-dealer could clarify it
orally).
    \217\ The Commission has granted exemptions to certain dual
registrants, subject to a number of conditions, from the written
disclosure and consent requirements of Advisers Act Section 206(3)
(which makes it unlawful for an adviser to engage in a principal
trade with an advisory client, unless it discloses to the client in
writing before completion of the transaction the capacity in which
the adviser is acting and obtains the consent of the client to the
transaction). The exemptions are subject to several conditions,
including conditions to provide disclosures at multiple points in
the relationship, including disclosure that the entity may be acting
in a principal capacity in a written confirmation at or before
completion of a transaction. See, e.g., In the matter of Merrill
Lynch Pierce Fenner & Smith, Incorporated, Investment Advisers Act
Release No. 4595; (Dec. 28, 2016); In the matter of Robert W. Baird
& Co., Incorporated, Investment Advisers Act Release No. 4596 (Dec.
28, 2016); In the matter of UBS Financial Services, Inc., Investment
Advisers Act Release No. 4597 (Dec. 28, 2016); In the matter of
Wells Fargo Advisors, LLC, Wells Fargo Advisors Financial Network,
LLC, Investment Advisers Act Release No. 4598 (Dec. 28, 2016).
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    The Commission anticipates that broker-dealers may elect to make
certain required disclosures of information to their customers at the
beginning of a relationship, such as in a relationship guide, account
agreement, comprehensive fee schedule, or other written document
accompanying such documents. While certain forms of disclosure may be
standardized, certain disclosures may need to be tailored to a
particular recommendation, for example, if the standardized disclosure
does not sufficiently identify the material conflicts presented by the
particular recommendation. Furthermore, additional disclosure may be
needed beyond the standardized disclosure (such as an account
agreement) when any previously provided information becomes materially
inaccurate, or when there is new relevant material information (e.g., a
new material conflict of interest has arisen that is not addressed by
the standardized disclosure). Because the Disclosure Obligation would
apply ``prior to or at the time of'' the recommendation, if a broker-
dealer has previously made the relevant disclosure to the retail
customer (and there have been no material changes to the previously
disclosed information), it would not be expected to repeat such
disclosure at each subsequent recommendation, depending on the facts
and circumstances of the prior disclosure. As noted above, we would
like to emphasize the importance of determining the appropriate timing
and frequency of disclosure. For example, where a significant amount of
time passes between the disclosure and a recommendation, the broker-
dealer generally should determine whether the retail customer should
reasonably be

expected to be on notice of the prior disclosure; if not, the broker-
dealer generally should not rely on such disclosure.
    The Commission preliminarily believes this flexible approach to
disclosure is consistent with the broker-dealers' liabilities or
obligations under the antifraud provisions of the federal securities
laws.\218\
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    \218\ For example, generally, under the antifraud provisions,
whether a broker-dealer has a duty to disclose material information
to its customer depends upon the scope of the relationship with the
customer, which is fact-intensive. See, e.g., Conway v. Icahn & Co.,
Inc., 16 F.3d 504, 510 (2d Cir. 1994) (``A broker, as agent, has a
duty to use reasonable efforts to give its principal information
relevant to the affairs that have been entrusted to it.''). Where a
broker-dealer processes its customer's orders, but does not
recommend securities or solicit customers, then the material
information that the broker-dealer is required to disclose to its
customer is narrow, encompassing only the information related to the
consummation of the transaction. See Press v. Chemical Inv. Servs.
Corp., 166 F.3d 529, 536 (2d Cir. 1999). In such circumstances, the
broker-dealer generally does not have to provide information
regarding the security or the broker-dealer's economic self-interest
in the security. See, e.g., Carras v. Burns, 516 F.2d 251, 257 (4th
Cir. 1975) (broker-dealer not required to volunteer advice where
``acting only as a broker''); Canizaro v. Kohlmeyer & Co., 370 F.
Supp. 282, 289 (E.D. La. 1974), aff'd, 512 F.2d 484 (5th Cir. 1975)
(broker-dealer that ``merely received and executed a purchase order,
has a minimal duty, if any at all, to investigate the purchase and
disclose material facts to a customer''); Walston & Co. v. Miller,
410 P.2d 658, 661 (Ariz. 1966) (``The agency relationship between
customer and broker normally terminates with the execution of the
order because the broker's duties, unlike those of an investment
advisor or those of a manager of a discretionary account, are only
to fulfill the mechanical, ministerial requirements of the purchase
and sale of the security or future contract on the market.'').
    See also Exchange Act Rule 10b-10 (``Rule 10b-10''). Rule 10b-10
requires a broker-dealer effecting customer transactions in
securities (other than U.S. savings bonds or municipal securities)
to provide written notification to the customer, at or before
completion of the transaction, disclosing information specific to
the transaction, including whether the broker-dealer is acting as
agent or principal and its compensation, as well as any third-party
remuneration it has received or will receive. Exchange Act Rules
15c1-5 and 15c1-6 also require a broker-dealer to disclose in
writing to the customer if it has any control, affiliation, or
interest in a security it is offering or the issuer of such
security. The Commission and the SROs have also adopted rules
designed to address conflicts of interest that can arise when
security analysts recommend equity securities in research reports
and public appearances. See Regulation Analyst Certification, or
Regulation AC. Regulation AC requires that broker-dealers include
certifications by the research analyst in research reports and
disclose whether or not the research analyst received compensation
or other payments in connection with his or her specific
recommendations or reviews. See also FINRA Rule 2241 (imposing
requirements on FINRA members to address conflicts of interest
relating to the publication and distribution of equity research
reports).
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d. Consistency With Other Approaches
    We believe that the proposed Disclosure Obligation, in conjunction
with the Relationship Summary and Regulatory Status Disclosure noted
above is consistent with many of the principles underlying the
disclosure recommendation regarding disclosure in the 913 Study and
behind the disclosure obligations of the BIC Exemption--which we
believe is to facilitate disclosure and retail customer understanding
of the key information material to a retail customer's relationship
with a broker-dealer, including the scope and terms of the relationship
and material conflicts of interest --and provides much of the same
information, but in a less prescriptive manner that is designed to
provide firms flexibility in how to satisfy the obligation.
    Specifically, broker-dealers relying on the BIC Exemption to
provide investment advice to retirement accounts would need to do so
pursuant to a written contract that includes specific language and
disclosures, including, among others, provisions: Acknowledging
fiduciary status; committing the firm and the adviser to adhere to
standards of impartial conduct; and warranting the adoption of policies
and procedures reasonably designed to ensure that advisers provide best
interest advice and minimize the harmful impact of conflicts of
interest. The firm would also need to disclose information on the
firm's and advisers' conflicts of interest and the cost of their advice
and provide certain ongoing web disclosures.\219\
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    \219\ See BIC Exemption.
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    As previously noted, the 913 Study recommended that the Commission
engage in rulemaking and/or issue interpretive guidance on the
components of the recommended uniform fiduciary standard: The duties of
loyalty and care.\220\ With respect to disclosure obligations under the
Duty of Loyalty, the 913 Study recommended the Commission facilitate
the provision of uniform, simple, and clear disclosures to retail
customers about the terms of the relationships with broker-dealers and
investment advisers, including any material conflicts of interest. The
913 Study also recommended that the Commission consider disclosures
that should be provided (a) in a general relationship guide akin to
Form ADV Part 2A and (b) more specific disclosures at the time of
providing investment advice, as well as consider the utility and
feasibility of a summary disclosure document containing key information
on a firm's services, fees, and conflicts and the scope of its
services. Finally, the 913 Study recommended the Commission consider
whether rulemaking would be appropriate to prohibit certain conflicts,
to require firms to mitigate conflicts through specific action, or to
impose specific disclosure and consent requirements.\221\
---------------------------------------------------------------------------

    \220\ See 913 Study at 112.
    \221\ See 913 Study at 114-18.
---------------------------------------------------------------------------

    We believe that our proposed Disclosure Obligation, in conjunction
with the Relationship Summary and Regulatory Status Disclosure noted
above, would address many of the underlying concerns of and would
provide customers with substantially similar information as required
under the BIC Exemption and recommended in the 913 Study.
    The Disclosure Obligation under Regulation Best Interest further
builds on and complements the Relationship Summary and Regulatory
Status Disclosure and together, these obligations would clarify the
capacity in which a firm or financial professional is acting, in an
effort to minimize investor confusion, and facilitate greater awareness
of key aspects of a relationship with a firm or financial professional
through a layered approach to disclosure.
e. Request for Comment on Proposed Disclosure Obligation
    The Commission generally requests comment on the Disclosure
Obligation. In addition, the Commission requests comment on the
following specific issues:
     Would the Disclosure Obligation cause a broker-dealer to
act in a manner that is consistent with what a retail customer would
reasonably expect from someone who is required to act in his or her
best interest? Why or why not?
     Should the Commission require new disclosure, beyond that
which is currently required pursuant to common law, and Exchange Act
and SRO rules?
     Should the Commission promulgate more specific disclosure
requirements such as written account disclosure akin to Form ADV Parts
2A and 2B?
     Should the Commission require a specific type or amount of
disclosure? What criteria should determine or inform the type or amount
of disclosure?
     Should the Commission explicitly require that the
disclosure be ``full and fair''? Why or why not?
     Should the Commission require broker-dealers to
``reasonably disclose'' as proposed? Should the Commission provide
additional guidance as to how broker-dealers can meet that standard? If
so, what additional guidance would commenters recommend? Should the

Commission consider a different approach, such as a ``good faith''
exemption? Why or why not?
     Do commenters believe that the Disclosure Obligation
requires disclosure of information that investors would not find
useful? If so, please specify what information and why.
     Is there additional information that investors would find
useful? If so, please specify what information and why.
     The Commission requests comment on existing broker-dealer
disclosure practices. Do broker-dealers currently provide disclosures
that could satisfy this requirement? If so, what types of disclosures
and when/how are they delivered? Do broker-dealers provide customer-
specific disclosures indicating what type of account is held and in
what capacity the firm is acting? If so, how are those disclosures made
(e.g., on account statements) and at what time(s)? How do broker-
dealers provide disclosures when making recommendations on the phone?
Do all broker-dealers provide such disclosures, or only some broker-
dealers? If only some, how many and under what circumstances? Are those
disclosures written and presented in a manner consistent with the
preliminary guidance on disclosure in this release? Please provide
examples.
     Do broker-dealers currently provide more detailed
disclosures than contemplated to be required as part of the
Relationship Summary regarding the nature and scope of services
provided, as well as the legal obligations and duties that apply to
those services? If so, how and when is such disclosure provided (e.g.,
in the account agreement or other document)? Please provide examples.
To what extent do retail customers read and/or understand these
disclosures? How effective are these disclosures and how consistent are
they with the plain language and other principles of reasonable
disclosure described above? How would we ensure that any disclosures
are understood by retail investors?
     Would the Relationship Summary achieve the goal of the
Disclosure Obligation of facilitating the retail customer's awareness
of the material facts relating to the scope and terms of the
relationship with the retail customer and all material conflicts of
interest associated with the recommendation without the additional
Disclosure Obligation? Should the Commission consider permitting
broker-dealers to satisfy their obligations under this requirement
solely by delivering the proposed Relationship Summary? Do commenters
believe the Relationship Summary would ever fulfill the Disclosure
Obligation? When would it? When would it not?
     The Commission has identified certain topics that would
generally be considered material facts relating to the scope and terms
of the relationships (i.e., capacity, fees and services). Do commenters
have examples of other information relating to scope and terms of the
relationship that should be highlighted by the Commission as likely to
be considered material facts that would need to be disclosed? If so,
please provide examples. Should the Commission provide further guidance
on such additional material facts? Should the Commission articulate
these specific material facts (e.g., capacity, fees and services) as
required disclosures in the rule text (e.g., by defining ``material
facts relating to the scope and terms of the relationship'')? Why or
why not?
     Should the Commission require additional disclosures for
dual-registrants, as suggested above, because the Relationship Summary
and Regulatory Status Disclosure for dual-registrants would describe
both brokerage and advisory services/capacities?
     Should the Commission articulate additional requirements
or guidance for a dual-registrant to satisfy the Disclosure Obligation?
If so, what additional requirements or guidance and why? Should dual-
registrants be required to disclose, in writing, each time they change
capacity?
     The Commission proposes to provide flexibility to a
broker-dealer that is a dual-registrant to determine how to disclose
that it is acting in a broker-dealer capacity. How do commenters
anticipate that dual-registrants will meet this obligation?
Specifically, how do commenters expect dual-registrants to meet the
obligation to provide such disclosure ``prior to or at the time of'' a
recommendation in their capacity as a broker-dealer? Should a broker-
dealer be required to make a customer-specific or recommendation-
specific disclosure about the capacity in which it is acting? Should
that disclosure be made on a one-time or ongoing basis? Should the
Commission mandate the form or method of delivery of that disclosure?
For example, should the Commission require broker-dealers to include
the disclosure in account opening forms or periodic statements or in
other documents?
     Does the guidance concerning additional more detailed
disclosures that broker-dealers should consider providing in
furtherance of layered disclosure cause confusion about the level of
disclosure firms are required to make in order to satisfy the
requirement to disclose the terms and scope of the relationship? If so,
how could the Commission clarify this guidance? Would the layered
disclosure approach cause confusion among retail customers?
     The Commission requests comment on existing broker-dealer
practices concerning fee disclosures. What types of fee disclosures do
broker-dealers currently provide? Do broker-dealers currently provide
fee disclosures that could satisfy this requirement? If so, what types
of disclosures and when/how are they delivered? Do broker-dealers
provide customer-specific disclosures indicating what type of fees are
charged, how they are identified (e.g., on account statements?), and
when/if they change? Please provide examples.
     Should the Commission mandate the form, specific content
or method for delivering fee disclosure? Why or why not? Do commenters
believe that disclosure of fees in a uniform manner would be beneficial
for investors? If so, what would be the preferred style of such
disclosure in order to facilitate investor comprehension of such fees?
     The Commission preliminarily believes that broker-dealers
should be required to disclose, at a minimum, the types of fees that
are included in the Relationship Summary. Should the Commission provide
more clarity regarding what types of fees should be disclosed? Should
the Commission add a materiality threshold for fee disclosure?
     Should the Commission mandate a comprehensive fee
schedule? Why or why not? If so, should the Commission mandate the
form, specific content or method of delivering the comprehensive fee
schedule?
     Should broker-dealers be required to update fee
disclosures 30 days or another specified time period before they raise
fees or impose new fees? Should this requirement be limited to material
fees? How should such fees be defined?
     Should broker-dealers be required to use specified terms
to describe certain material fees? If so, what should those specified
terms be?
     As proposed, the rule only requires disclosure to retail
customers who receive recommendations. Should the Commission consider
requiring fee disclosure to all retail customers, including customers
in self-directed brokerage accounts? Why or why not?
     Would self-directed customers benefit from more detailed
fee disclosure? If so, in what form should

the disclosure to self-directed customers be provided, and what should
be the scope of fee information provided?
     Regarding timing of disclosure, the Commission
preliminarily believes that the disclosure should be made ``prior to or
at the time of'' the recommendation. Should the Commission consider a
different timing requirement? For example, should the Commission
require disclosure ``immediately prior to the recommendation''? Should
the Commission instead mandate the timing and frequency of certain
disclosures? If so, which disclosures should be subject to more
specific timing or updating requirements? For example, should the
Commission require annual delivery of certain disclosure, such as fee
disclosures? Why or why not?
     Do commenters agree that in certain circumstances broker-
dealers should be permitted to provide an initial disclosure followed
by more specific disclosure after the recommendation? Why or why not?
Do commenters require more guidance on when this would be permitted? If
so, how could the Commission clarify this guidance?
     Are there services, in addition to those provided as
examples, that should be considered material facts relating to the
scope of terms of the relationships? If so, please explain. Are there
specific types of services that broker-dealers provide that should be
required to be disclosed? If so, which ones?
     Should the Commission require specific disclosures on
products and product limitations? Why or why not?
     Should broker-dealers be subject to more specific
requirements concerning the method of disclosures? If so, what
additional requirements should the Commission consider, and why? If
not, why not? For example, should the Commission impose requirements
concerning prominence or method of delivery?
     Do commenters believe that all disclosures should be made
in writing, as proposed? Should the Commission permit disclosures to be
made orally, so long as a written record of the oral disclosure is made
and retained?
     Should the Commission require that certain disclosures be
made prior to the execution of a transaction? If so, which ones? Why or
why not?
     Should broker-dealers be required to make certain
disclosures before the first recommendation or transaction effected for
a customer? If so, which ones? Why or why not?
     Are there any specific interactions or relationships
between the disclosure requirements under the Disclosure Obligation and
the Relationship Summary that should be addressed?
     Are there any specific interactions or relationships
between the disclosure requirements under the Disclosure Obligation and
the Conflict of Interest Obligations that should be addressed?
     Are there any specific interactions or relationships
between the disclosure requirements in Regulation Best Interest and the
existing general antifraud provisions that should be addressed? Do
commenters believe the general antifraud provisions adequately address
other non-recommendation related conflicts or should Regulation Best
Interest also cover such conflicts?
    The Commission requests comment on the proposed requirement to
disclose all material conflicts of interest associated with the
recommendation.
     Should the Commission require such disclosures?
     Should the Commission use a different interpretation for
what is a ``material conflict of interest''? If so, which one and why?
     Should the Commission define ``material conflicts of
interest'' in terms of an incentive that causes a broker-dealer not to
act in the retail customer's best interest? Why or why not?
     Are there any types of material conflicts that commenters
believe the Commission should require to be disclosed? If so, which
ones and why?
     Are there any material conflicts of interest that
commenters believe cannot be disclosed sufficiently in writing? If so,
which conflicts and why?
     Should the Commission require a specific type or amount of
disclosure? What criteria should determine or inform the type or amount
of disclosure?
     Should the disclosure requirements include quantification
of conflicts of interest, the economic benefits from material conflicts
of interest to firms and their associated persons, or the costs of such
conflicts to retail customers or clients?
     Given the number of dually-registered representatives,
would the existence of written disclosure in Form ADV Part 2B,
including disclosure about financial incentives such as conflicts from
compensation received in association with a broker-dealer, in the
absence of comparable written disclosure expressly relating to other
conflicts that may affect the same representative's recommendations in
a broker-dealer capacity, create a misleading impression about the
representative's conflicts or their potential impact on advice in a
broker-dealer rather than an adviser capacity?
     Are there particular material conflicts arising from
financial incentives or other material conflicts that the Commission
should specifically require a broker-dealer to disclose to a retail
customer? If so, which ones and why? If not, why not? Are there any for
which the Commission should specifically require advance customer
written consent? If so, which and why?
2. Care Obligation
    The Commission proposes to require, as part of Regulation Best
Interest, a Care Obligation that would require a broker-dealer, when
making a recommendation of any securities transaction or investment
strategy involving securities to a retail customer, to exercise
reasonable diligence, care, skill, and prudence to: (1) Understand the
potential risks and rewards associated with the recommendation, and
have a reasonable basis to believe that the recommendation could be in
the best interest of at least some retail customers; (2) have a
reasonable basis to believe that the recommendation is in the best
interest of a particular retail customer based on that retail
customer's investment profile and the potential risks and rewards
associated with the recommendation; and (3) have a reasonable basis to
believe that 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. These
proposed obligations would require a broker-dealer making a
recommendation of a securities transaction or investment strategy
involving securities to a retail customer to have a reasonable basis
for believing that the recommended transaction or investment strategy
is in the best interest of the retail customer and does not put the
financial or other interest of the broker-dealer before that of the
retail customer.\222\ The Care Obligation is intended to incorporate
and enhance existing suitability requirements applicable to broker-

dealers under the federal securities laws by, among other things,
imposing a ``best interest'' requirement which we would interpret to
require the broker-dealer not put its own interest ahead of the retail
customer's interest, when making recommendations.\223\
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    \222\ Under Regulation Best Interest, as proposed, a broker-
dealer's duty to exercise reasonable diligence, care, skill and
prudence is designed to be similar to the standard of conduct that
has been imposed on broker-dealers found to be acting in a fiduciary
capacity. See, e.g., Davis v. Merrill Lynch, Pierce, Fenner & Smith,
Inc., 906 F.2d 1206, 1215 (8th Cir. 1990) (the district court did
not abuse its discretion in instructing the jury that licensed
securities brokers were fiduciaries that owed their customers a duty
of utmost good faith, integrity and loyalty); see also Paine,
Webber, Jackson & Curtis, Inc. v. Adams, 718 P.2d 508, 515-16 (Colo.
1986) (evidence ``that a customer has placed trust and confidence in
the broker'' by giving practical control of account can be
``indicative of the existence of a fiduciary relationship''); SEC v.
Ridenour, 913 F.2d. 515 (8th Cir. 1990) (bond dealer owed fiduciary
duty to customers with whom he had established a relationship of
trust and confidence).
    \223\ In response to Chairman Clayton's Statement, several
commenters supporting a best interest standard for broker-dealers
suggested that the best interest standard be built upon existing
broker-dealer requirements, such as suitability, and include
enhancements to those standards as the Commission sees necessary.
See, e.g., SIFMA 2017 Letter, John Hancock Letter; Fidelity Letter;
Wells Fargo Letter; ICI August 2017 Letter. See also supra Section
II.B.
---------------------------------------------------------------------------

    Although the term ``prudence'' is not a term frequently used in the
federal securities laws,\224\ the Commission believes that this term
conveys the fundamental importance of conducting a proper evaluation of
any securities recommendation in accordance with an objective standard
of care. However, recognizing that the term ``prudence'' is generally
not used under the federal securities laws, we also seek comment below
on whether there is adequate clarity and understanding regarding its
usage, or whether other terms are more appropriate in the context of
broker-dealer regulation.
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    \224\ But see SEC v. Glt Dain Rauscher, Inc., 254 F.3d 852, 853
(9th Cir. 2001) (where, in the context of an underwriter of
municipal offerings who allegedly violated several federal
securities laws, the court held ``that the industry standard of care
for an underwriter of municipal offerings is one of reasonable
prudence, for which the industry standard is one factor to be
considered, but is not the determinative factor''). In addition,
under Section 11(c) of the Securities Act [15 U.S.C. 77k(c)], the
adequacy of an underwriter's due diligence efforts and, in turn, its
ability to establish a due diligence defense is determined by ``the
standard of reasonableness [that] shall be that required of a
prudent man in the management of his own property'' (emphasis
added).
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    Under the Care Obligation, a broker-dealer generally should
consider reasonable alternatives, if any, offered by the broker-dealer
in determining whether it has a reasonable basis for making the
recommendation. This approach would not require a broker-dealer to
analyze all possible securities, all other products, or all investment
strategies to recommend the single ``best'' security or investment
strategy for the retail customer, nor necessarily require a broker-
dealer to recommend the least expensive or least remunerative security
or investment strategy.\225\ Nor does Regulation Best Interest
prohibit, among others, recommendations from a limited range of
products, or recommendations of proprietary products, products of
affiliates, or principal transactions, provided the Care Obligation is
satisfied and the associated conflicts are disclosed (and mitigated, as
applicable) or eliminated, as discussed in Sections II.B. and II.D.2.
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    \225\ See supra Section II.B.
---------------------------------------------------------------------------

a. Understand the Potential Risks and Rewards of the Recommended
Transaction or Strategy, and Have a Reasonable Basis To Believe That
the Recommendation Could Be in the Best Interest of at Least Some
Retail Customers
    Broker-dealers must deal with their customers fairly \226\--and, as
part of that obligation, have a reasonable basis for any
recommendation.\227\ This obligation stems from the broker-dealer's
``special relationship'' to the retail customer, and from the fact that
in recommending a security or investment strategy, the broker-dealer
represents to the customer ``that a reasonable investigation has been
made and that [its] recommendation rests on the conclusions based on
such investigation.'' \228\
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    \226\ See, e.g., Duker & Duker, Exchange Act Release No. 2350,
at *2, 6 SEC. 386, 388 (Dec. 19, 1939) (Commission opinion)
(``Inherent in the relationship between a dealer and his customer is
the vital representation that the customer be dealt with fairly, and
in accordance with the standards of the profession.''). See also
Report of the Special Study of Securities Markets of the Securities
and Exchange Commission, H. Doc. 95, 88th Cong., 1st Sess., at 238
(1963) (``An obligation of fair dealing, based upon the general
antifraud provisions of the Federal securities laws, rests upon the
theory that even a dealer at arm's length impliedly represents when
he hangs out his shingle that he will deal fairly with the
public.'').
    \227\ See Mac Robbins & Co., Exchange Act Release No. 6846, at
*3 (``[T]he making of representations to prospective purchasers
without a reasonable basis, couched in terms of either opinion or
fact and designed to induce purchases, is contrary to the basic
obligation of fair dealing borne by those who engage in the sale of
securities to the public.''), aff'd sub nom., Berko v. SEC, 316 F.2d
137 (2d Cir. 1963).
    \228\ See Hanly, 415 F.2d 596-97 (``A securities dealer occupies
a special relationship to a buyer of securities in that by his
position he implicitly represents that he has an adequate and
reasonable basis for the opinions he renders.''); In the Matter of
Lester Kuznetz, 1986 WL 625417 at *3, Exchange Act Rel. No. 23525
(Aug. 12, 1986) (Commission opinion) (``When a securities salesman
recommends securities, he is under a duty to ensure that his
representations have a reasonable basis.''); see also FINRA
Regulatory Notice 10-22, Obligation of Broker-Dealers to Conduct
Reasonable Investigations in Regulation D Offerings (Apr. 2010).
---------------------------------------------------------------------------

    Paragraph (a)(2)(ii)(A) of proposed Regulation Best Interest, which
is intended to incorporate a broker-dealer's existing obligations under
``reasonable-basis suitability,'' \229\ would require a broker-dealer
to ``exercise reasonable diligence, care, skill, and prudence to . . .
[u]nderstand the potential risks and rewards associated with the
recommendation, and have a reasonable basis to believe that the
recommendation could be in the best interest of at least some retail
customers.'' \230\ This obligation would relate to the particular
security or strategy recommended, rather than to any particular retail
customer.\231\ Without establishing such a threshold understanding of
its particular recommendation, we do not believe that a broker-dealer
could, as required by Regulation Best Interest, act in the best
interest of a retail customer when making a recommendation.
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    \229\ The courts, the Commission, and FINRA have interpreted the
broker-dealer's existing reasonable-basis suitability obligation to
impose a broad affirmative duty to have an ``adequate and reasonable
basis'' for any recommendation that they make. See, e.g., Hanly, 415
F.2d 597; see also SEC v. Hasho, 784 F. Supp. 1059, 1107 (S.D.N.Y.
1992) (``By making a recommendation, a securities dealer implicitly
represents to a buyer of securities that he has an adequate basis
for the recommendation.''); Michael Frederick Siegel, Exchange Act
Rel. No. 58737, at *12-13 (Oct. 6, 2008) (Commission opinion) (``The
suitability rule . . . requires that . . . a registered
representative must first have an `adequate and reasonable basis'
for believing that the recommendation could be suitable for at least
some customers.''); Terry Wayne White, Exchange Act Rel. No. 27895,
at *4, 50 SEC. 211, 212 & n.4 (1990) (Commission opinion) (``It is
well established that a broker cannot recommend any security to a
customer `unless there is an adequate and reasonable basis for such
recommendation. . . .'').
    \230\ Reasonable-basis suitability ``requires that a
representative ensure that he or she has an `adequate and
reasonable' understanding of an investment before recommending it to
customers.'' Richard G. Cody, Exchange Act Release No. 64565, at *12
(May 27, 2011) (Commission opinion, sustaining FINRA findings)
(citing Hanly, 415 F.2d at 597).
    This understanding must include the `` `potential risks and
rewards' and potential consequences of such recommendation.'' See
Richard G. Cody, Exchange Act Release No. 64565, at *12 (May 27,
2011) (Commission opinion, sustaining FINRA findings) (internal
citations omitted), aff'd, Cody v. SEC, 693 F.3d 251 (1st Cir.
2012); F.J. Kaufman and Co. of Virginia and Frederick J. Kaufman,
Jr., Exchange Act Release No. 27535, at *3, 50 SEC. 164 (Dec. 13,
1989) (Commission opinion, sustaining NASD findings) (``[A] broker
cannot determine whether a recommendation is suitable for a specific
customer unless the broker understands the potential risks and
rewards inherent in that recommendation.''). See also FINRA
Regulatory Notice 11-02 (Jan. 2011).
    \231\ See Michael Frederick Siegel, Exchange Act Release No.
58737, at *12-13 (Oct. 6, 2008) (Commission opinion, sustaining NASD
findings), aff'd in relevant part, Siegel v. SEC, 592 F.3d 147 (D.C.
Cir. 2010), cert. denied, 560 U.S. 926 (2010).
---------------------------------------------------------------------------

    To meet this proposed requirement under paragraph (a)(2)(ii)(A), a
broker-dealer would need to: (1) Undertake reasonable diligence (i.e.,
reasonable investigation and inquiry) to understand the potential risks
and rewards of the recommended security or strategy (i.e., to
understand the security or strategy), and (2) have a reasonable basis
to believe that the recommendation could be in the best interest of at
least some retail customers based on that

understanding.\232\ A broker-dealer must adhere to both components to
meet its obligation under proposed paragraph (a)(2)(ii)(A).\233\ Thus,
a broker-dealer could violate the obligation if he or she did not
understand the potential risks and rewards of the recommended security
or investment strategy, even if the security or investment strategy
could have been in the best interest for at least some retail
customers.\234\ In addition, if a broker-dealer understands the
recommended security or investment strategy, he or she must still have
a reasonable basis to believe that the security or investment strategy
could be in the best interest of at least some retail customers.\235\
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    \232\ See paragraph (a)(2)(ii)(A) of Proposed Regulation Best
Interest; see also Cody v. SEC, 693 F.3d 251, 259 (1st Cir. 2012)
(finding that registered representative was responsible for
investigating security that he recommended and failed to have
sufficient understanding of security); F.J. Kaufman, Exchange Act
Release No. 27535, at *3 (``A broker-dealer in his dealings with
customers impliedly represents that his opinions and predictions
respecting a [security] which he has undertaken to recommend are
responsibly made on the basis of actual knowledge and careful
consideration . . . .''); see also FINRA Regulatory Notice 12-25 at
Q22.
    \233\ See FINRA Rule 2110.05(a). See also FINRA Regulatory
Notice 12-25 at Q22 (the ``reasonable-basis obligation has two
components: A broker must (1) perform reasonable diligence to
understand the nature of the recommended security or investment
strategy involving a security or securities, as well as the
potential risks and rewards, and (2) determine whether the
recommendation is suitable for at least some investors based on that
understanding''). In discussing SRO suitability rules, the
Commission has noted that ``the `reasonable-basis' test is subsumed
within the [NASD's] suitability rule. A broker cannot conclude that
a recommendation is suitable for a particular customer unless he has
a reasonable basis for believing that the recommendation could be
suitable for at least some customers.'' Terry Wayne White, Exchange
Act Release No. 27895, at *2, 50 SEC. 211, 212-13 (Apr. 11, 1990)
(Commission opinion, sustaining NASD findings) (citing F.J. Kaufman,
Exchange Act Release No. 27535).
    \234\ See FINRA Regulatory Notice 12-25 at Q22 (noting that the
``reasonable-basis obligation is critically important because, in
recent years, securities and investment strategies that brokers
recommend to customers, including retail investors, have become
increasingly complex and, in some cases, risky. Brokers cannot
fulfill their suitability responsibilities to customers (including
both their reasonable-basis and customer-specific obligations) when
they fail to understand the securities and investment strategies
they recommend. . . .''). Broker-dealers also have additional
specific suitability obligations with respect to certain types of
products or transactions, such as variable insurance products and
non-traditional products, including structured products and security
futures. See, e.g., FINRA Rule 2330, ``Members' Responsibilities
Regarding Deferred Variable Annuities;'' FINRA Rule 2370, ``Security
Futures;'' see also 913 Study at 65-66.
    \235\ See FINRA Regulatory Notice 12-25 at Q22.
---------------------------------------------------------------------------

    In general, what would constitute reasonable diligence under
proposed paragraph (a)(2)(ii)(A) will vary depending on, among other
things, the complexity of and risks associated with the recommended
security or investment strategy and the broker-dealer's familiarity
with the recommended security or investment strategy.\236\ For example,
the cost associated with a recommendation is ordinarily only one of
many factors to consider when evaluating the risks and rewards of a
subject security or investment strategy involving securities. Other
factors may include, but are not limited to, the investment objectives,
characteristics (including any special or unusual features), liquidity,
risks and potential benefits, volatility, and likely performance of
market and economic conditions, the expected return of the security or
investment strategy, as well as any financial incentives to recommend
the security or investment strategy.
---------------------------------------------------------------------------

    \236\ See FINRA Rule 2111.05(a).
---------------------------------------------------------------------------

    While every inquiry will be specific to the broker-dealer and the
investment or investment strategy, broker-dealers may wish to consider
questions such as:
     Can less costly, complex, or risky products available at
the broker-dealer achieve the objectives of the product?
     What assumptions underlie the product, and how sound are
they? What market or performance factors determine the investor's
return?
     What are the risks specific to retail customers? If the
product was designed mainly to generate yield, does the yield justify
the risk to principal?
     What costs and fees for the retail customer are associated
with this product? Why are they appropriate? Are all of the costs and
fees transparent? How do they compare with comparable products offered
by the firm?
     What financial incentives are associated with the product,
and how will costs, fees, and compensation relating to the product
impact an investor's return?
     Does the product present any novel legal, tax, market,
investment, or credit risks?
     How liquid is the product? Is there a secondary market for
the product? \237\
---------------------------------------------------------------------------

    \237\ See NASD Notice to Members 05-26, New Products--NASD
Recommends Best Practices for Reviewing New Products (Apr. 2005).
---------------------------------------------------------------------------

    This list of questions is not meant to be comprehensive, nor should
it substitute for a broker-dealer's own assessment of what factors
should be considered to determine the risks and rewards of a particular
investment or investment strategy. However, it is meant to illustrate
the types of questions and considerations a broker-dealer generally
should consider when developing an understanding of the potential risks
and rewards associated with a recommendation, and when developing a
reasonable basis to believe that the recommended investment or
investment strategy could be in the best interest of at least some
retail customers.\238\ If a broker-dealer cannot establish such a
fundamental understanding of its recommendation (i.e., the risks and
rewards associated with the recommendation, or that the recommendation
could be in the best interest of at least some retail customers), we do
not believe that the broker-dealer could establish that it is acting in
a retail customer's best interest when making a recommendation in
accordance with proposed paragraph (a)(2)(ii)(B) of Regulation Best
Interest.
---------------------------------------------------------------------------

    \238\ See supra note 233.
---------------------------------------------------------------------------

b. Reasonable Basis To Believe the Recommendation Is in the Best
Interest of a Particular Retail Customer
    Beyond establishing an understanding of the recommended securities
transaction or investment strategy, we believe that acting in the best
interest of the retail customer would require a broker-dealer to have a
reasonable basis to believe that a specific recommendation is in the
best interest of the particular retail customer based on its
understanding of the investment or investment strategy under proposed
paragraph (a)(2)(ii)(A), and in light of the retail customer's
investment objectives, financial situation, and needs. Accordingly,
under proposed paragraph (a)(2)(ii)(B), the second obligation would
require a broker-dealer to ``exercise reasonable diligence, care,
skill, and prudence to . . . have a reasonable basis to believe that
the recommendation is in the best interest of a particular retail
customer based on that retail customer's investment profile and the
potential risks and rewards associated with the recommendation.'' Under
this standard, a broker-dealer could not have a reasonable basis to
believe that the recommendation is in the ``best interest'' of the
retail customer, if the broker-dealer put its interest ahead of the
retail customer's interest, as discussed in Section II.B.
    For the reasons set forth below, this proposed obligation is
intended to incorporate a broker-dealer's existing well-established
obligations under ``customer-specific suitability,'' \239\ but

enhances these obligations by requiring that the broker-dealer have a
reasonable basis to believe that the recommendation is in the ``best
interest'' of (rather than ``suitable for'') the retail customer. After
extensive consideration of these existing customer-specific suitability
requirements, we believe that it is appropriate to generally draw and
build upon this existing obligation, as noted below, as the contours of
the obligation are well-defined, and this approach would promote
consistency and clarity in the relevant obligations, and facilitate the
development of compliance policies and procedures for broker-dealers
while also promoting investor protection.
---------------------------------------------------------------------------

    \239\ See, e.g., J. Stephen Stout, Exchange Act Release No.
43410, at *11, 54 SEC. 888, 909 (Oct. 4, 2000) (Commission opinion)
(``As part of a broker's basic obligation to deal fairly with
customers, a broker's recommendation must be suitable for the client
in light of the client's investment objectives, as determined by the
client's financial situation and needs.''); Richard N. Cea, Exchange
Act Release No. 8662, at *7 (Aug. 6, 1969) (Commission opinion)
(``It was incumbent on the salesmen in these circumstances, as part
of their basic obligation to deal fairly with the investing public,
to make only such recommendations as they had reasonable grounds to
believe met the customers' expressed needs and objectives.''). Both
courts and the Commission have found broker-dealers or their
registered representatives liable for making unsuitable
recommendations based on violations of the antifraud provisions of
the federal securities laws. See Brown v. E.F. Hutton Group, 991
F.2d 1020, 1031 (2d Cir. 1993) (``[a]nalytically, an unsuitability
claim is a subset of the ordinary Section 10(b) fraud claim'');
O'Connor v. R.F. Lafferty & Co., 965 F.2d 893 (10th Cir. 1992);
Clark v. John Lamula Investors, Inc., 583 F.2d 594, 599-600 (2d Cir.
1978); Steven E. Louros v. Kreicas, 367 F. Supp. 2d 572, 585
(S.D.N.Y. 2005); Mauriber v. Shearson/American Express, Inc., 567 F.
Supp. 1231 (S.D.N.Y 1983); Steven E. Muth and Richard J. Rouse,
Exchange Act Release No. 52551, 58 SEC. 770 (Oct. 3, 2005)
(Commission opinion). FINRA's suitability rule also imposes a
customer-specific suitability obligation on broker-dealers. See
FINRA Rule 2111.05(b) (``The customer-specific obligation requires
that a member or associated person have a reasonable basis to
believe that the recommendation is suitable for a particular
customer based on that customer's investment profile, as delineated
in Rule 2111(a).'').
---------------------------------------------------------------------------

    Thus, under proposed Regulation Best Interest, the broker-dealer
will be required to have a reasonable basis to believe, based on its
diligence and understanding of the risks and rewards of the
recommendation, and in light of the retail customer's investment
profile, that the recommendation is in the best interest of the retail
customer and does not place the broker-dealer's interest ahead of the
customer's interest. We believe this will enhance the quality of
recommendations, and will improve investor protection by minimizing the
potential harmful impacts that broker-dealer conflicts of interest may
have on recommendations provided to retail customers.
    As described above, the broker-dealer's diligence and understanding
of the risks and rewards would generally involve consideration of
factors, such as the costs, the investment objectives and
characteristics associated with a product or strategy (including any
special or unusual features, liquidity, risks and potential benefits,
volatility and likely performance in a variety of market and economic
conditions), as well as the financial and other benefits to the broker-
dealer.\240\ Thus, in forming a reasonable basis to believe that the
recommended securities transaction or investment strategy is in the
best interest of a particular retail customer, and does not place the
financial or other interest of the broker-dealer ahead of the interest
of the retail customer, the broker-dealer would generally need to
consider these specific product or strategy related factors, as
relevant--and in particular the financial and other benefits to the
broker-dealer--along with the customer's investment profile (as
described below). While the Commission believes these are all important
considerations in analyzing any recommendation made by a broker-dealer,
they are critical considerations in analyzing whether a recommendation
with respect to a particular retail customer's ``best interest.''
---------------------------------------------------------------------------

    \240\ See supra Section II.D.2.a (providing examples of various
factors that could be considered when evaluating the risks and
rewards of a recommended investment or investment strategy).
---------------------------------------------------------------------------

    Under the existing ``customer specific suitability'' obligation, to
determine whether an investment recommendation is suitable for the
customer when evaluated in terms of the investor's financial situation,
tolerance for risk, and investment objectives, broker-dealers have a
duty to seek to obtain relevant information from customers relating to
their financial situations and to keep such information current.\241\
---------------------------------------------------------------------------

    \241\ See Gerald M. Greenberg, Exchange Act Release No. 6320, at
*3, 40 SEC. 133, 137-38 (July 21, 1960) (Commission opinion,
sustaining NASD findings) (holding that a broker-dealer cannot avoid
the duty to make suitable recommendations simply by avoiding
knowledge of the customer's financial situation). Under FINRA's
suitability rule, the broker-dealer has a duty to undertake
reasonable diligence to ascertain the customer's investment profile.
FINRA Rule 2111(a) (``A customer's investment profile includes, but
is not limited to, the customer's age, other investments, financial
situation and needs, tax status, investment objectives, investment
experience, investment time horizon, liquidity needs, risk
tolerance, and any other information the customer may disclose to
the member or associated person in connection with such
recommendation.''); FINRA Regulatory Notice 12-25 at Q15-Q21
(discussing broker-dealer's information-gathering requirements).
---------------------------------------------------------------------------

    The Commission also proposes to include this concept of a
``customer's investment profile,'' consistent with FINRA's suitability
rule.\242\ Specifically, the proposed rule would provide that the
``Retail Customer Investment Profile includes, but is not limited to,
the retail customer's age, other investments, financial situation and
needs, tax status, investment objectives, investment experience,
investment time horizon, liquidity needs, risk tolerance, and any other
information the retail customer may disclose to the broker, dealer, or
a natural person who is an associated person of a broker or dealer in
connection with a recommendation.'' \243\ A broker-dealer would be
required to exercise ``reasonable diligence'' to ascertain the retail
customer's investment profile as part of satisfying proposed paragraph
(a)(2)(i)(B).\244\ When retail customer information is unavailable
despite a broker-dealer's reasonable diligence to obtain such
information, a broker-dealer would have to consider whether it has
sufficient understanding of the retail customer to properly evaluate
whether the recommendation is in the retail customer's best
interest.\245\ A broker-dealer that makes a recommendation to a retail
customer for whom it lacks sufficient information to have a reasonable
basis to believe that the recommendation is in the best interest of
that retail customer based on the retail customer's investment profile
would not meet its obligations under the proposed rule.\246\
---------------------------------------------------------------------------

    \242\ Id.
    \243\ See paragraph (c)(2) of Proposed Regulation Best Interest.
    \244\ See FINRA Regulatory Notice 12-25 at Q16 (outlining what
constitutes ``reasonable diligence'' in attempting to obtain
customer-specific information and that the reasonableness of the
effort also will depend on the facts and circumstances). See also
FINRA Regulatory Notice 11-25, Know Your Customer and Suitability
(May 2011) (``FINRA Regulatory Notice 11-25'').
    \245\ See FINRA Regulatory Notice 11-25 at Q3. While ``neglect,
refusal, or inability of the retail customer to provide or update
any information'' would excuse the broker, dealer, or associated
person from obtaining the information under proposed Rule 17a-
3(a)(25) discussed in Section II.E., it would not relieve a broker-
dealer of its obligation to determine whether it has sufficient
information to properly evaluate whether a recommendation is in the
retail customer's best interest.
    \246\ See FINRA Regulatory Notice 12-25 at Q16 (outlining what
constitutes ``reasonable diligence'' in attempting to obtain
customer-specific information and that the reasonableness of the
effort also will depend on the facts and circumstances).
---------------------------------------------------------------------------

    For clarification, in keeping with the requirement that a
securities-related recommendation must be in the best interest of the
customer at the time it is made, a broker-dealer generally should make
a reasonable effort to ascertain information regarding an existing
customer's investment profile prior to the making of a recommendation
on an ``as needed'' basis--i.e., where a broker-dealer knows or has
reason to believe that the customer's investment profile has
changed.\247\ The reasonableness of a

broker-dealer's effort to collect information regarding a customer's
investment profile information depends on the facts and circumstances
of a given situation, and the importance of each factor may vary
depending on the facts and circumstances of the particular case.\248\
Generally, however, absent information that would cause a broker-dealer
to know or have reason to know that the information contained in a
customer's investment profile is inaccurate, a broker-dealer may
reasonably rely on the information in an existing customer's investment
profile.
---------------------------------------------------------------------------

    \247\ We note that, pursuant to Exchange Act rules, a broker-
dealer must submit to an existing customer his or her account record
or alternative document to explain any terms regarding investment
objectives for accounts in which the member, broker or dealer has
been required to make a suitability determination within the past 36
months. The account record or alternative document must include or
be accompanied by prominent statements on which the customer should
mark any corrections and return the account record or alternate
document to the broker-dealer, and the customer should notify the
broker-dealer of any future changes to information contained in the
account record--including the customer's investment objectives. See
CFR 240.17a-3(a)-17(i)(A), (B)(i), (B)(iii), (D). The accompanying
discussion in the text addresses circumstances where a broker-dealer
generally should make reasonable efforts to ascertain a customer's
investment profile information prior to this 36-month period.
    \248\ See FINRA Regulatory Notice 12-25 at Q16.
---------------------------------------------------------------------------

    We believe our proposed definition of ``retail customer investment
profile'' identifies appropriate factors that should be considered as
part of evaluating a recommendation and whether it is in a retail
customer's best interest, because the factors generally are relevant to
a determination regarding whether a recommendation is in the best
interest of a particular customer (i.e., does the recommendation
comport with the retail customer's investment profile). Furthermore, by
applying a consistent definition across existing suitability
requirements and proposed Regulation Best Interest, we hope to provide
clarity to broker-dealers and maintain efficiencies for broker-dealers
that have already established infrastructures to comply with their
suitability obligations when making recommendations. Finally, we note
that this definition would be consistent with the factors the DOL
identified for consideration as part of a best interest recommendation
under the BIC Exemption: ``the investment objectives, risk tolerance,
financial circumstances and needs'' of a retirement investor.\249\
---------------------------------------------------------------------------

    \249\ See Best Interest Contract Exemption, 81 FR 21002 (Apr. 8,
2016).
---------------------------------------------------------------------------

    We propose to interpret the customer-specific obligation in
paragraph (a)(2)(ii)(B) of proposed Regulation Best Interest consistent
with existing precedent, rules and guidance, but subject to the
enhanced ``best interest'' (rather than ``suitability'') standard.
Thus, as noted above, when considering the factors that comprise a
retail customer's investment profile, the broker-dealer would be
required to consider whether it has sufficient information regarding
the customer to properly evaluate whether a recommendation is in the
best interest of the retail customer without placing the financial or
other interest of the broker-dealer ahead of that particular retail
customer's interests.\250\ As such, the level of importance of each
factor would depend on the facts and circumstances of a particular
recommendation. One or more factors may have more or less relevance--or
may not be obtained or analyzed at all--if the broker-dealer has a
reasonable basis to believe that the factors are not relevant in light
of the facts and circumstances of a particular situation.\251\ For
example, a broker-dealer may conclude that liquidity needs are
irrelevant regarding all customers for whom only liquid securities will
be recommended.\252\
---------------------------------------------------------------------------

    \250\ See FINRA Rule 2111.04.
    \251\ Id.
    \252\ See FINRA Regulatory Notice 11-25 at Q3.
---------------------------------------------------------------------------

    We reiterate that we recognize that it may be consistent with a
retail customer's investment objectives--and in many cases, in a retail
customer's best interest--for a retail customer to allocate investments
across a variety of investment products, or to invest in riskier or
more costly products, such as some actively managed mutual funds,
variable annuities, and structured products. However, in recommending
such products, a broker-dealer must satisfy its obligations under
proposed Regulation Best Interest. Such recommendations would continue
to be evaluated under a fact specific analysis based on the security or
investment strategy recommended in connection with the retail
customer's investment profile, consistent with the proposed best
interest obligation.
    In addition, as discussed above under the proposed obligation in
paragraph (a)(2)(ii)(A), we emphasize that the costs and financial
incentives associated with a recommendation would generally be one of
many important factors--including other factors such as the product's
or strategy's investment objectives, characteristics (including any
special or unusual features), liquidity, risks and potential benefits,
volatility and likely performance in a variety of market and economic
conditions--to consider when determining whether a recommended security
or investment strategy involving a security or securities is in the
best interest of the retail customer.\253\ Thus, where, for example, a
broker-dealer is choosing among identical securities available to the
broker-dealer, it would be inconsistent with the Care Obligation to
recommend the more expensive alternative for the customer.\254\
Similarly, we believe it would be inconsistent with the Care Obligation
if the broker-dealer made the recommendation to a retail customer in
order to: Maximize the broker-dealer's compensation (e.g., commissions
or other fees); further the broker-dealer's business relationships;
satisfy firm sales quotas or other targets; or win a firm-sponsored
sales contest.
---------------------------------------------------------------------------

    \253\ See discussion supra Section II.D.
    \254\ See supra note 106, and accompanying text.
---------------------------------------------------------------------------

    We preliminarily believe that, under this prong of the Care
Obligation, when a broker-dealer recommends a more expensive security
or investment strategy over another reasonably available alternative
offered by the broker-dealer, the broker-dealer would need to have a
reasonable basis to believe that the higher cost is justified (and thus
nevertheless is in the retail customer's best interest) based on other
factors (e.g., the product's or strategy's investment objectives,
characteristics (including any special or unusual features), liquidity,
risks and potential benefits, volatility and likely performance in a
variety of market and economic conditions), in light of the retail
customer's investment profile. When a broker-dealer recommends a more
remunerative security or investment strategy over another reasonably
available alternative offered by the broker-dealer, the broker-dealer
would need to have a reasonable basis to believe that--putting aside
the broker-dealer's financial incentives--the recommendation was in the
best interest of the retail customer based on the factors noted above,
in light of the retail customer's investment profile. Nevertheless,
this does not mean that a broker-dealer could not recommend the more
remunerative of two reasonably available alternatives, if the broker-
dealer determines the products are otherwise both in the best interest
of--and there is no material difference between them from the
perspective of--retail customer, in light of the retail customer's
investment profile.
    Furthermore, we do not believe a broker-dealer could meet its Care
Obligation through disclosure alone. Thus, for example, where a broker-
dealer is choosing among identical securities with different cost
structures,

we believe it would be inconsistent with the best interest obligation
for the broker-dealer to recommend the more expensive alternative for
the customer, even if the broker-dealer had disclosed that the product
was higher cost and had policies and procedures reasonably designed to
mitigate the conflict under the Conflict of Interest Obligations, as
the broker-dealer would not have complied with its Care
Obligation.\255\ Such a recommendation, disclosure aside, would still
need to be in the best interest of a retail customer, and we do not
believe it would be in the best interest of a retail customer to
recommend a higher-cost product if all other factors are equal.
---------------------------------------------------------------------------

    \255\ Id.
---------------------------------------------------------------------------

c. Reasonable Basis To Believe a Series of Recommended Transactions Is
Not Excessive and Is in the Retail Customer's Best Interest
    The third obligation would require a broker-dealer to exercise
reasonable diligence, care, skill, and prudence to have a reasonable
basis to believe that 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. The
proposed requirement is intended to incorporate and enhance a broker-
dealer's existing obligations under the federal securities laws and
incorporate and go beyond FINRA's concept of ``quantitative
suitability.'' We believe it is appropriate to incorporate this
existing, well-established obligation, which would similarly promote
consistency and clarity regarding this obligation. However, we believe
it is appropriate to expand the scope of this requirement by applying
it irrespective of whether a broker-dealer exercises actual or de facto
control over a customer's account, thereby making the obligation
consistent with the current requirements for ``reasonable basis
suitability'' and ``customer specific suitability.'' Accordingly,
Regulation Best Interest would include the existing ``quantitative
suitability'' obligation, but without a ``control'' element.
    Pursuant to the federal securities laws, broker-dealers can violate
the federal antifraud provisions by engaging in excessive trading \256\
that amounts to churning, switching, or unsuitable recommendations.
Churning occurs when a broker-dealer, exercising control over the
volume and frequency of trading in a customer account, abuses the
customer's confidence for the broker-dealer's personal gain by
initiating transactions that are excessive in view of the character of
the account and the customer's investment objectives.\257\ Switching
occurs when a broker-dealer induces a customer to liquidate his or her
shares in a mutual fund or annuity in order to purchase shares in
another mutual fund or annuity, for the purpose of increasing the
broker-dealer's compensation, where the benefit to the customer of the
switch is not justified by the cost of switching.\258\ The Commission
has also found excessive trading as a suitability violation on the
basis that ``the frequency of trading must also be suitable.'' \259\ As
noted above, FINRA's suitability rule also includes a similar concept
known as quantitative suitability.\260\
---------------------------------------------------------------------------

    \256\ Excessive trading is a level of trading unjustified in
light of the customer's investment objectives. See Mihara v. Dean
Witter & Co., Inc., 619 F.2d 814, 821 (9th Cir. 1980).
    \257\ See Carras v. Burns, 516 F.2d 251, 258 (4th Cir. 1975).
The elements of a churning claim brought under the antifraud
provisions include: (1)Eexcessive trading in the account that was
unjustified in light of the customer's investment objectives; (2)
the broker-dealer exercised actual or de facto control over the
trading in the account; and (3) the broker-dealer acted with intent
to defraud or with willful or reckless disregard for the customer's
interests. See Rizek v. SEC, 215 F.3d 157, 162 (1st Cir. 2000). A
broker-dealer churning a customer account may be liable under both
Exchange Act Section 10(b) and Rule 10b-5 thereunder, and/or
Exchange Act Section 15(c), Rules 15c1-2 and/or 15cl-7. See, e.g.,
McNeal v. Paine, Webber, Jackson & Curtis, Inc., 598 F.2d 888, n.1
(2d Cir. 1979) (noting that churning is illegal under the Exchange
Act Sections 15(c)(1) and 10(b) and Rule 10b-5).
    \258\ See, e.g., Russell L. Irish, 42 SEC. 735, 736-40 (1965),
aff'd, Irish v. SEC, 367 F.2d 637 (9th Cir. 1966), cert. denied, 386
U.S. 911 (1967).
    \259\ Edgar B. Alacan, Exchange Act Release No. 49970, at *20,
57 SEC. 715, 736 (July 6, 2004) (Commission opinion) (quoting Sandra
K. Simpson and Daphne Ann Pattee, Exchange Act Release No. 45923, at
*13, 55 SEC. 766, 793-794 (May 14, 2002) (Commission opinion)). See
J. Stephen Stout, Exchange Act Release No. 43410, at *13, 54 SEC.
888, 912 (Oct. 4, 2000) (Commission opinion) (finding turnover in
customer account was unsuitable given customers' investment goals
and needs).
    \260\ See FINRA Rule 2111.05(c) (``Quantitative suitability
requires a member or associated person who has actual or de facto
control over a customer account to have a reasonable basis for
believing that a series of recommended transactions, even if
suitable when viewed in isolation, are not excessive and unsuitable
for the customer when taken together in light of the customer's
investment profile, as delineated in Rule 2111(a).''). Unlike
churning, a violation of quantitative suitability does not require a
showing of wrongful intent. See Cody v. SEC, 693 F.3d 251, 260 (1st
Cir. 2012) (``[W]hile subjective intent is relevant to churning
charges under the antifraud regulation of Rule 10b-5, . . . NASD's
suitability rule is violated when a representative engages in
excessive trading relative to a customer's financial needs . . .
regardless of motivation . . . .'').
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    Under the proposed rule, a broker-dealer must have a reasonable
basis to believe that a series of recommended transactions is not
excessive. Although no single test defines excessiveness, the following
factors may provide a basis for determining that a series of
recommended transactions is excessive: turnover rate,\261\ cost-to-
equity ratio,\262\ and use of in-and-out trading \263\ in a customer's
account. Consideration of turnover rate, cost-to-equity ratio and use
of in-and-out trading is consistent with some of the ways the
Commission, the courts, and FINRA have historically

evaluated whether trading activity is excessive.\264\ These factors can
be indicative of the magnitude of investor harm caused by the
accumulation of high trading costs.
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    \261\ The turnover rate, which is the number of times during a
given period that securities in an account are replaced by new
securities, is a frequently used measure of excessive trading.
Turnover rate is calculated by ``dividing the aggregate amount of
purchases in an account by the average monthly investment. The
average monthly investment is the cumulative total of the net
investment in the account at the end of each month, exclusive of
loans, divided by the number of months under consideration.''
Shearson Lehman Hutton Inc., 49 SEC. 1119, 1122 n.10 (1989). Annual
turnover rates as low as three may trigger liability for excessive
trading. See, e.g., Laurie Jones Canady, 54 SEC. 65, 74 (1999),
Exchange Act Release No. 41250 (Apr. 5, 1999) (annual turnover rates
ranging from 3.83 to 7.28 times held excessive), petition denied,
230 F.3d 362 (DC Cir. 2000); Donald A. Roche, 53 SEC. 16, 22 (1997)
(annual turnover rates of 3.3, 4.6, and 7.2 times held excessive);
Gerald E. Donnelly, 52 SEC. 600, Exchange Act Release No. 36690
(Jan. 5, 1996) (annual turnover rates ranging from 3.1 to 3.8 times
held excessive); John M. Reynolds, 50 SEC. 805 (1991) (annual
turnover rate of 4.81 times held excessive). See also Dep't of
Enforcement v. Cody, No.<PHONE_NUMBER>901, 2010 FINRA Discip. LEXIS 8
(NAC May 10, 2010) (same), aff'd, Exchange Act Rel. No. 64565, 2011
SEC LEXIS 1862, at *48 (May 27, 2011) (finding turnover rate of
three provided support for excessive trading); Dep't of Enforcement
v. Stein, No. C07000003, 2001 NASD Discip. LEXIS 38, at *17 (NAC
Dec. 3, 2001) (``Turnover rates between three and five have
triggered liability for excessive trading''). The Commission has
stated that, ``[a]lthough no turnover rate is universally recognized
as determinative of churning, a rate in excess of 6 is generally
presumed to reflect excessive trading,'' especially if the
customer's objective is conservative. Al Rizek, 54 SEC. 261 (1999),
Exchange Act Release No. 41725 (Aug. 11, 1999), aff'd, Rizek v.
SEC., 215 F.3d 157 (1st Cir. 2000). See also Craighead v. E.F.
Hutton & Co., 899 F.2d 485, 490 (6th Cir. 1990); Arceneaux v.
Merrill Lynch, Pierce, Fenner & Smith, Inc., 767 F.2d 1498, 1502
(11th Cir. 1985).
    \262\ The cost-to-equity ratio represents ``the percentage of
return on the customer's average net equity needed to pay broker-
dealer commissions and other expenses.'' Rafael Pinchas, 54 SEC.
331, 340 (1999), 1999 SEC LEXIS 1754, at *18 (Commission review of
NASD disciplinary proceeding). Cost-to-equity ratios as low as 8.7
have been considered indicative of excessive trading, and ratios
above 12 generally are viewed as very strong evidence of excessive
trading. See Cody, 2011 SEC LEXIS 1862, at *49 & *55 (finding cost-
to-equity ratio of 8.7 percent excessive); Thomas F. Bandyk,
Exchange Act Rel. No. 35415, 1995 SEC LEXIS 481, at *2-3 (Feb. 24,
1995) (``His excessive trading yielded an annualized commission to
equity ratio ranging between 12.1% and 18.0%.'').
    \263\ In-and-out trading refers to the ``sale of all or part of
a customer's portfolio, with the money reinvested in other
securities, followed by the sale of the newly acquired securities.''
Costello v. Oppenheimer & Co., 711 F.2d 1361, 1369 n.9 (7th Cir.
1983). A broker's use of in-and-out trading ordinarily is a strong
indicator of excessive trading. Id.
    \264\ See also supra notes 256, 257, 259, 261, 262, 263. See,
e.g., FINRA Regulatory Notice 12-25 at 14, 28-29.
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    The proposed rule would enhance a broker-dealer's existing
obligations in two ways. First, the proposed rule would create a new,
explicit obligation under the Exchange Act that a broker-dealer have a
reasonable basis to believe that a series of recommended transactions
is not excessive and is in the retail customer's best interest when
taken together. As noted, the Commission has found unsuitable
recommendations of a series of transactions on the basis that the
``frequency of trading'' was not suitable.\265\ Similarly, FINRA's
quantitative suitability rule requires the broker-dealer to have a
reasonable basis for believing that a series of recommended
transactions is not excessive and unsuitable for the customer when
taken together in light of the customer's investment profile.\266\ The
proposed rule, instead, would require a broker-dealer to have a
reasonable basis to believe that a series of recommended transactions
is not excessive and is in the retail customer's best interest when
taken together in light of the retail customer's investment profile.
What would constitute a ``series'' of recommended transactions would
depend on the facts and circumstances. Notably, here this would mean a
reasonable basis to believe that the series of recommended transactions
is in the best interest of the retail customer based on factors other
than the broker-dealer's financial incentive to recommend a series of
transactions, as discussed above, and in light of the retail customer's
investment profile, consistent with (a)(1).\267\
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    \265\ See supra note 259.
    \266\ See supra note 260.
    \267\ See discussion supra Section II.D.
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    Second, the proposed rule would require a broker-dealer to have a
reasonable basis to believe that a series of recommended transactions
is not excessive and is in the retail customer's best interest,
regardless of whether the broker-dealer has actual or de facto control
over a retail customer account. Currently, to prove a churning claim
under the antifraud provisions of the Exchange Act, courts and the
Commission have interpreted the federal securities laws to require that
the broker-dealer exercise actual or de facto control over a customer's
account.\268\ Similarly, FINRA's quantitative suitability rule only
applies to a member or associated person who has actual or de facto
control over a customer account.\269\
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    \268\ See supra note 257.
    \269\ See supra note 260.
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    The Commission believes that a broker-dealer should have a
reasonable basis to believe that 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, consistent with subparagraph(a)(1). We believe that
imposing this requirement without a ``control'' element would provide
consistency in the investor protections provided to retail customers by
this proposed paragraph (a)(2)(ii)(C) by requiring a broker-dealer to
always form a reasonable basis as to the recommended frequency of
trading in a retail customer's account--irrespective of whether the
broker-dealer ``controls'' or exercises ``de facto control'' over the
retail customer's account. Moreover, it would also take a consistent
approach with the other aspects of the proposed Care Obligation, which
apply regardless of whether a broker-dealer ``controls'' or exercises
``de facto control'' over the retail customer's account. Finally, by
removing the control element, the Commission believes the enhanced
requirement generally should expand the scope of retail customers that
could benefit from the protections of this requirement: specifically,
protection from a broker-dealer recommending a level of trading that is
so excessive that the resulting cost-to-equity ratio or turnover rate
makes a positive return virtually impossible.\270\ Thus, the fact that
a customer may have some knowledge of financial markets or some
``control'' should not absolve the broker-dealer of its ultimate
responsibility to have a reasonable basis for any recommendations that
it makes.\271\ We believe that when a broker-dealer is recommending a
series of transactions to the retail customer the broker-dealer must,
consistent with paragraph (a)(1), evaluate whether the series of
recommendations is placing the broker-dealer's interests ahead of the
retail customer's. Thus, even in instances where a broker-dealer would
not be considered to ``control'' or exercise ``de facto control'' over
the retail customer's account, the broker-dealer should be required to
comply with proposed paragraph (a)(2)(ii)(C).
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    \270\ See, e.g., In re Michael Bresner, et al., 2013 WL 5960690,
at *112-115, ID-Rel. No. 517 (Nov. 8, 2013) (finding, inter alia,
that some registered representatives did not churn certain
customers' accounts because they did not exercise de facto control
where one customer had declined recommendations ``a handful of
times'' and another customer had picked stocks ``based on
information he may have heard on the radio'' and made shadow trades
of the same stocks that the representative had recommended).
    \271\ See id.
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d. Consistency With Other Approaches

(1) DOL Fiduciary Rulemaking

    By requiring a broker-dealer that is making a recommendation to a
retail customer to act in the retail customer's best interest without
placing the broker-dealer's interests ahead of the retail customer's
interest, which is satisfied (in part) by the broker-dealer exercising
``reasonable diligence, care, skill, and prudence,'' we believe the
proposed Care Obligation generally reflects similar underlying
principles as the ``objective standards of care'' that are incorporated
in the best interest Impartial Conduct Standard as set forth by the DOL
in the BIC Exemption.\272\
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    \272\ The BIC Exemption requires that advice be in a retirement
investor's best interest, and further defines advice to be in the
``best interest'' if the person providing the advice acts ``with the
care, skill, prudence, and diligence under the circumstances then
prevailing that a prudent person acting in a like capacity and
familiar with the such matters would use . . . without regard to the
financial or other interests'' of the person. BIC Exemption Section
II(c)(1); Section VIII (d). The DOL stated this standard is based on
longstanding concepts derived from ERISA and the law of trusts, and
to ``require[s] fiduciaries to put the interests of trust
beneficiaries first, without regard to the fiduciaries' own self-
interest.'' BIC Exemption Release, 81 FR 21007, 21027.
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    As noted above, the DOL stated that the best interest Impartial
Conduct Standard is intended to ``incorporate the objective standards
of care and undivided loyalty,'' that require adherence to a
professional standard of care in making investment recommendations that
are in the investor's best interest, and not basing recommendations on
the advice-giver's own financial interest in the transaction, nor
recommending an investment unless it meets the objective prudent person
standard of care.\273\ Proof of fraud or misrepresentation is not
required, and full disclosure is not a defense to making an imprudent
recommendation or favoring one's own interest at the investor's
expense.\274\
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    \273\ Id. at 21028.
    \274\ Id.
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    Focusing on the ``professional standard of care'' or ``duty of
prudence,'' the DOL explains that the ``prudence'' standard, as
incorporated in the ``best interest'' standard set forth in the BIC
Exemption, is ``an objective standard of care that requires investment
advice fiduciaries to investigate and evaluate

investments, make recommendations, and exercise sound judgment in the
same way that knowledgeable and impartial professionals would.'' \275\
The fiduciary must adhere to an objective professional standard and is
subject to a particularly stringent standard of prudence when they have
a conflict of interest.\276\
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    \275\ BIC Exemption Release, 81 FR at 21028.
    \276\ Id.
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    Our proposed Care Obligation establishes an objective, professional
standard of conduct for broker-dealers that requires broker-dealers to
``exercise reasonable diligence, care, skill and prudence to''
understand the potential risks and rewards associated with their
recommendation and have a reasonable basis to believe that it could be
in the best interest of at least some retail customers, have a
reasonable basis to believe that the recommendation is in a particular
retail customer's best interest based on that retail customer's
investment profile and the risks and rewards associated with the
recommendation, and have a reasonable basis to believe that 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. Moreover, as noted above, this
Care Obligation cannot be satisfied through full disclosure, and proof
of fraud or misrepresentation would also not be required.
    In addition, the Commission believes that the incorporation and
enhancement of existing broker-dealer suitability obligations as part
of the proposed care obligation would address many of the concerns that
were raised by the DOL as a rationale for not referring to the existing
FINRA suitability standard as the basis for the best interest
obligation under the Impartial Conduct Standards.\277\ The proposed
Care Obligation incorporates and builds upon existing broker-dealer
suitability obligations, as discussed above. Again, while not the only
factors or sole determinants, cost and the broker-dealer's financial
incentives would be important factors--of many, including the financial
and other benefits to the broker-dealer--in determining whether a
recommendation is in the best interest.\278\ We preliminarily believe
that, in order to meet its Care Obligation, when a broker-dealer
recommends a security or investment strategy over another reasonably
available alternative offered by the broker-dealer, the broker-dealer
would need to have a reasonable belief that the recommendation was in
the best interest of the retail customer based on such other factors,
in light of the retail customer's investment profile. Furthermore, as
discussed in the Conflict of Interest Obligations below, proposed
Regulation Best Interest requires broker-dealers to take steps to
eliminate or mitigate material conflicts of interest arising from
financial incentives.
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    \277\ Although DOL did not specifically incorporate the
suitability obligation as an element of the ``best interest''
standard, as suggested by FINRA, the DOL stated ``that many aspects
of suitability are also elements of the Best Interest Standard'' and
that a ``recommendation that is not suitable under the securities
laws would not'' meet the standard. But, the DOL identified the
following concerns with the current FINRA suitability standard: That
it does not ``reference a best interest standard, clearly require
brokers to put their client's interest ahead of their own, expressly
prohibit the selection of the least suitable (but most remunerative)
of available investments, or require them to take the kind of
measures to avoid or mitigate conflicts of interest that are
required as conditions of this exemption.'' BIC Exemption Release,
81 FR 21007, 21027-28.
    \278\ See discussion infra Section II.D.
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(2) 913 Study
    Further, we believe that the proposed Care Obligation is also
similar to the recommended duty of care in the 913 Study. As previously
noted, the 913 Study recommended that the Commission engage in
rulemaking and/or issue interpretive guidance on the components of the
recommended uniform fiduciary standard: the duties of loyalty and
care.\279\ With respect to the duty of care, the 913 Study recommended
that the Commission should consider specifying uniform standards for
the duty of care owed to retail investors, through rulemaking and/or
interpretive guidance. The 913 Study noted that minimum baseline
professionalism standards could include, for example, specifying what
basis a broker-dealer or investment adviser should have in making a
recommendation to an investor (i.e., suitability requirements).\280\
Further, the 913 Study suggested that the Commission could articulate
and harmonize any such professionalism standards for broker-dealers and
investment advisers, by referring to and expanding upon, as