As promulgated by the Securities and Exchange Commission (the "SEC"), Regulation Best Interest ("Regulation BI")1 requires broker-dealers and natural persons associated with such broker-dealers to act in the "best interest" of their retail customers when making investment recommendations. The "general obligation" to act in the best interest of retail customers involves four component obligations – namely, the disclosure, care, conflict of interest and compliance obligations. Recent enforcement actions have brought compliance with these Regulation BI obligations into the spotlight, particularly when a broker-dealer or associated person recommends "complex" financial products to retail accounts. Violations of the "compliance obligation" have been deemed to occur in instances in which broker-dealers did not have sufficient policies in place to monitor whether investment recommendations of "complex products" sufficiently considered the retail investors' needs and investment profile. In addition, broker-dealers and their associated persons have been penalized for failing to ensure that their associated persons are sufficiently versed in these complex products before making investment recommendations.
REGULATORY CONCERNS REGARDING COMPLEX PRODUCTS
The SEC and the Financial Industry Regulatory Authority, Inc. ("FINRA") both provide guidance generally identifying complex products. The SEC, in its adopting release for Regulation BI, identified inverse or leveraged exchange-traded products as examples of complex products.2 FINRA construes the term "complex product" flexibly to avoid a static definition that may not address the evolution of financial products and technology. In general, FINRA has described a complex product as a product with features that may make it difficult for a retail investor to understand the essential characteristics of the product and its risks (including the payout structure and how the product may perform in different market and economic conditions). 3
Both Regulatory Notice 12-03 and Regulatory Notice 09-31 were cited when the SEC adopted Regulation BI, particularly in the adopting release's discussion of complex products.4 In the adopting release, the Staff identified that "broker-dealers recommending such products should understand that inverse and leveraged exchange-traded products that are reset daily may not be suitable for, and as a consequence also not in the best interest of, retail customers who plan to hold them for longer than one trading session, particularly in volatile markets."5
The SEC has also provided specific guidance on complex products in the context of compliance with Regulation BI, particularly in the SEC's Staff Bulletin on Care Obligations under Regulation BI.6 This Bulletin states that broker-dealers and their related persons should generally apply "heightened scrutiny" as to whether a risky or complex product is in the retail investor's best interest, and should consider whether lower risk or less complex products can achieve the same investment goals.7 The Bulletin also identifies recommendations of complex or risky products among the conditions firms should consider documenting in their reasoning for their recommendations.8
The "care obligation" under Regulation BI provides that broker-dealers and their associated persons must, when making securities recommendations to retail investors, exercise reasonable diligence, care, skill and prudence. This is to ensure they have a reasonable basis to: understand the potential risks and rewards associated with the transaction, believe that the transaction is in the customer's best interest based on their investment profile, and is not excessive.9 Firms can comply with the care obligation by incorporating more than general discussions of Regulation BI obligations in their written supervisory procedures ("WSPs")10 and implementing and maintaining procedures to collect information about patterns or overall trading to determine if there is excessive trading.11
The guidance provided by the SEC and FINRA demonstrates that if broker-dealers recommend complex products, then they have additional obligations, such as establishing and maintaining supervisory systems. They must also understand the terms, features and risks of such products in order to form a reasonable basis to recommend these to retail customers. They should also apply "heightened scrutiny" when determining if a product is in the best interest of the investor.
TRENDS IN RECENT ENFORCEMENT ACTIONS
Recent enforcement actions generally identify breaches of Regulation BI, as well as of FINRA Rules 3110 and 2010. FINRA Rule 3110(a) requires a member firm to establish and maintain a supervisory system and FINRA Rule 3110(b) provides that a member firm must establish, maintain and enforce written procedures to oversee the types of business it engages in. Both must be reasonably designed to comply with relevant securities laws and regulations as well as FINRA rules. A broker-dealer may fail to comply with these rules if it does not establish, maintain and enforce a reasonable supervisory system, which includes a broker-dealer's WSPs. A broker-dealer may also be in breach of its care obligations (as well as the general obligation to act in their customers' best interest) when it fails to sufficiently consider the risks and features of a complex product.
Characteristic of recent enforcement actions relating to Regulation BI are determinations that WSPs are insufficient and/or WSP supervisory failures occurred, as well as failures of broker-dealers to comply with the care obligation. Most recently, in May 2025, FINRA found that a FINRA member ("Dealer 1") failed to establish, maintain and enforce a supervisory system, and WSPs connected to recommendations of inverse/leveraged exchanged traded funds/notes ("NT-ETPs"). NT-ETPs with leverage features, inverse features or both are complex products that rebalance daily, and therefore are intended to be held for a short period. As mentioned, FINRA regulatory notices indicated that NT-ETPs are not suitable for retail investors who plan to hold them for more than one trading session. FINRA found that Dealer 1's supervisory system did not address Regulation BI as it related to NT-ETPs, by failing to confirm that its representatives understood the features and risks unique to NT-ETPs. Dealer 1 also did not establish a system that sufficiently ensured that representatives considered the intended holding period before recommending NT-ETPs and the system of principal review did not provide guidance of how the intended holding period should be considered in connection with NT-ETP recommendations. Additionally, supervisory review of NT-ETP recommendations was confined to confirming that the sales representative signed an attestation stating they were knowledgeable about NT-ETPs. FINRA also cites violations connected to discretionary trading, such as failure to detect red flags and failing to perform timely inspections of branch offices and an office of supervisor jurisdiction.12
In a March 2025 enforcement action, FINRA found that from June 2020 through December 2023, a FINRA member ("Dealer 2") failed to not only establish written policies and procedures and a supervisory system that complied with Regulation BI, but also identify or investigate an issue connected to purchasing an NT-ETP. The FINRA letter highlights that the broker-dealer's WSPs contained no provisions related to Regulation BI until May 2023, and even then it was only discussed generally. Additionally, the broker-dealer traded NT-ETPs, which are created to return a multiple of an underlying index or benchmark, the inverse or both in a trading session. The letter cites FINRA Regulatory Notice 09-31, which states that compounding can lead to significantly different performance than the index or benchmark, which may make NT-ETPs not suitable for buy and hold retail investors. The broker-dealer did not allow its representatives to solicit NT-ETP investments, but a representative still solicited a purchase of an NT-ETP, resulting in a significant loss to the holder.13
Likewise, in a December 2024 enforcement action, FINRA determined that a FINRA member ("Dealer 3") failed to establish and maintain a supervisory system, including WSPs that complied with the Care Obligation of Regulation BI, specifically to prevent excessive trading. While there is no singular test to define excessive trading, the letter identifies turnover rate and cost-to-equity ratio as relevant factors. FINRA identifies that the WSPs did not include guidance on calculating an account's turnover rate or cost-to-equity ratio, instead the firm principals manually reviewed the daily blotter to determine if there was excessive trading. Consequently, they did not collect information about patterns or overall trading. FINRA found that Dealer 3 had excessively traded two accounts. Moreover, FINRA found that Dealer 3's supervisory system violated FINRA Rule 2111 because it was not established and maintained to reasonably comply with suitability requirements for nontraditional and volatility-linked ETPs.14
In September 2024, the SEC entered into a cease-and-desist order with a FINRA member ("Dealer 4") for its failure to maintain and enforce written policies and procedures reasonably designed to achieve compliance with Regulation BI.15 Dealer 4 had policies to comply with Regulation BI for the sales of structured notes, but there was a compliance breakdown. The written policies required representatives to determine if the investor's profile met certain requirements for sales of structured notes and that sales remained below a concentration limit. Investors were also required to sign forms to demonstrate that they received the prospectus about the structured notes that contained fees, language that structured products are "buy and hold" investments and other risks. In addition, the policies included dealer review to ensure that the Regulation BI requirements were met and to flag noncompliant recommendations. In this instance, noncompliance was largely due to Dealer 4's acquisition of another dealer and the lack of coordination in their compliance systems.16
In November 2024, FINRA found that a FINRA member ("Dealer 5") had WSP failures related to its recommendation of non-traditional funds ("NTFs") that provide leveraged, inverse or both, performance of the underlying. Dealer 5 failed to include any specific policies or procedures to supervise NTFs. The policy did not state whether representatives were permitted to recommend NTFs or the circumstances under which NTFs should, or should not, be recommended.17
PRACTICAL CONSIDERATIONS
Given recent enforcement action trends, firms should review the relevant FINRA releases specific to complex products and ensure that their WSPs address the risks associated with these products.
Firms should also review their WSPs with the intent of determining whether such WSPs adequately address Regulation BI issues in relation to complex products. In particular, since NTPs are usually intended to be held only for a limited period of time, WSPs must accurately establish and ensure that the time period for holding NT-NTPs is tailored to a specific investor's investment profile.
Originally published in REVERSEinquiries: Volume 6, Issue
1.
Click here to read the articles in this latest edition.
Foonotes
1. Rule 15l-1 under the Securities Exchange Act of 1934.
2. See Regulation Best Interest: The Broker-Dealer Standard of Conduct, 17 C.F.R § 240.15l-1 (2019) (the "Adopting Release") at n. 594, available at: Regulation Best Interest: The Broker-Dealer Standard of Conduct. FINRA emphasized its concerns about sales of leveraged and inverse exchange-traded products in FINRA Regulatory Notice 09-31, Non-Traditional ETFs – FINRA Reminds Firms of Sales Practice Obligations Relating to Leveraged and Inverse Exchange-Traded Funds (June 2009) ("Regulatory Notice 09-31"), available at: Regulatory Notice 09-31.
3. See FINRA Regulatory Notice 12-03 (Heightened Supervision of Complex Products) (January 2012), available at: https://www.finra.org/rules-guidance/notices/12-03 ("Regulatory Notice 12-03"). In FINRA Regulatory Notice 22-08 (Complex Products and Options) (March 8, 2022), FINRA identified certain products that have emerged since Regulatory Notice 12-03, which may be considered "complex," including defined outcome exchange-traded funds ("ETFs") that offer structured retail product-type features, such as an underlying reference asset with downside protection and a cap; mutual funds and ETFs that offer strategies employing cryptocurrency futures, and track futures contracts rather than the underlying cryptocurrency (but also noting that such products' exposure to cryptocurrency could be considered complex); and interval funds or tender-offer funds, which provide limited liquidity. For more information on FINRA Regulatory Notice 22-08, see our Legal Update at: Legal Update -- FINRA Releases Notice on Complex Products and Options.
4. See the Adopting Release at nn. 594, 598.
5. See id. at 264.
6. Staff Bulletin: Standards of Conduct for Broker-Dealers and Investment Advisers Care Obligations (the "Care Bulletin"), available at: SEC.gov | Staff Bulletin: Standards of Conduct for Broker-Dealers and Investment Advisers Care Obligations.
7. See Care Bulletin at Question 17.
8. See Care Bulletin at Question 19.
9. See id at 245.
10. See FINRA Letter of Acceptance, Waiver, and Consent, NO. 2023077084701 (Mar. 18, 2025).
11. See FINRA Letter of Acceptance, Waiver, and Consent, NO. 2021072094101 (Dec. 17, 2024).
12. See FINRA Letter of Acceptance, Waiver, and Consent, NO. 2022073421202 (May 1, 2025).
13. See FINRA Letter of Acceptance, Waiver, and Consent, NO. 2023077084701 (Mar. 18, 2025).
14. See FINRA Letter of Acceptance, Waiver, and Consent, NO. 2021072094101 (Dec. 17, 2024).
15. See Securities and Exchange Commission, In the matter of First Horizon Advisors, Inc., Release No. 101071, Administrative Proceeding File No. 3-22142, (September 18, 2024); see also Bradley Berman & Anna T. Pinedo, Broker-Dealer's Failure to Comply with Regulation Best Interest's Compliance Obligation is a Willful Violation of the General Obligation, FREE WRITINGS AND PERSPECTIVES (September 25, 2024), https://www.freewritings.law/2024/09/broker-dealers-failure-to-comply-with-regulation-best-interestscompliance-obligation-is-a-willful-violation-of-the-general-obligation/.
16. See Berman & Pinedo, supra note
17. See FINRA Letter of Acceptance, Waiver, and Consent, NO. 202107000902 (December 4, 2024)
Visit us at mayerbrown.com
Mayer Brown is a global services provider comprising associated legal practices that are separate entities, including Mayer Brown LLP (Illinois, USA), Mayer Brown International LLP (England & Wales), Mayer Brown (a Hong Kong partnership) and Tauil & Chequer Advogados (a Brazilian law partnership) and non-legal service providers, which provide consultancy services (collectively, the "Mayer Brown Practices"). The Mayer Brown Practices are established in various jurisdictions and may be a legal person or a partnership. PK Wong & Nair LLC ("PKWN") is the constituent Singapore law practice of our licensed joint law venture in Singapore, Mayer Brown PK Wong & Nair Pte. Ltd. Details of the individual Mayer Brown Practices and PKWN can be found in the Legal Notices section of our website. "Mayer Brown" and the Mayer Brown logo are the trademarks of Mayer Brown.
© Copyright 2025. The Mayer Brown Practices. All rights reserved.
This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.
