On July 29 and July 30, 2024, the SEC announced the settlement of administrative proceedings brought against two dually registered broker-dealers and investment advisers for alleged violations of Rule 15l-1 under the Securities Exchange Act of 1934, known as Regulation Best Interest. Regulation Best Interest establishes a four-part standard of conduct for broker-dealers and associated persons in making recommendations to retail customers regarding securities transactions and investment strategies involving securities.  The four parts consist of (1) the disclosure obligation, (2) the care obligation, (3) the conflict of interest obligation, and (4) the compliance obligation.  The settled actions involve alleged violations of the care obligation and the compliance obligation.  The care obligation requires broker-dealers and associated persons, in making recommendations to retail customers, to understand the potential risks, rewards, and costs 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.  With respect to specific customers, it also requires having a reasonable basis to believe that the recommendation or series of recommendations is in the customer’s best interest based on the customer’s investment profile, and does not place the broker-dealer’s or associated person’s interests ahead of the customer’s interests.  The compliance obligation requires broker-dealers to establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest.

July 29, 2024 Settlement Order

The July 29, 2024 order alleges that between July 2020 and January 2022 a broker-dealer acting through one of its registered representatives “unreasonably disregarded, dismissed, misunderstood, or failed to take reasonable steps to understand significant disclosures and information regarding” certain corporate bonds, known as L Bonds, that it recommended to retail customers.  The SEC further alleged that in December 2021 the broker-dealer, acting through the registered representative, recommended a $50,000 L Bond with a 5-year term to a 63-year-old semi-retired retail customer with a moderate risk tolerance and whose only documented investment objective was preservation of capital and who specifically explained to the registered representative that he did not want to lose his principal.  According to the SEC, the prospectus for the L Bonds disclosed that L Bonds involve a high degree of risk, including the risk of losing one’s entire investment, and that L Bonds are only suitable for persons with substantial financial resources and with no need for liquidity.  The SEC alleged that the broker-dealer and its registered representative failed to comply with the care obligation and willfully violated Regulation Best Interest.

Without admitting or denying the allegations, the broker-dealer and the registered representative agreed to cease and desist from future violations and to be censured, and the broker-dealer agreed to pay $5,115 in disgorgement and prejudgment interest and a civil monetary penalty of $85,000.  The registered representative also agreed to a six-month suspension from certain industry activities and associations, and to pay $28,421 in disgorgement and prejudgment interest and a civil monetary penalty of $15,000.

July 30, 2024 Settlement Order

The July 30, 2024 order alleges that from July 2020 through July 2021 a registered representative of a broker-dealer employed a risky day trading strategy involving the purchase and sale of options contracts in the accounts of several customers, several of whom had moderate to conservative risk profiles.  According to the order, this trading strategy resulted in the customers paying excessively large commissions to the registered representative and the broker-dealer.

The SEC alleged that the registered representative’s supervisor and the broker-dealer’s chief compliance officer were aware of the trading activities and failed to follow the broker-dealer’s policies and procedures to restrict the trading activity, and that the broker-dealer willfully violated Regulation Best Interest.

Without admitting or denying the allegations, the broker-dealer agreed to cease and desist from future violations, to be censured, and to pay a civil monetary penalty of $140,000.  The SEC noted the broker-dealer’s cooperation during the SEC’s investigation and the broker-dealer’s remedial actions, including senior management changes, payment of financial remediation to affected customers, and improvements to its policies and procedures.

The July 29, 2024 order is available here, and a related press release is available here.  The July 30, 2024 order is available here.