As of June 30, 2020, U.S.-registered broker-dealers must comply with the Securities and Exchange Commission's (the "Commission") Regulation BI, which establishes a standard of conduct for broker-dealers making recommendations to retail customers and prohibits broker-dealers from putting their financial interests ahead of their customers' interests. Under Regulation BI's Care Obligation, a broker-dealer making recommendations must consider several factors in its exercise of care, including the cost of the product, the existence of reasonable alternatives, and any material limitations (e.g., limited product offerings) the broker-dealer may have. Once a recommendation is objectively analyzed, it then must be vetted for consistency with a customer's investment profile, including any stated investment objective.
The rising popularity of ESG investing, however, raises numerous and unanticipated issues as it plays out across the regulatory landscape, in particular in the financial services sector. Because ESG investments sometimes carry a higher price tag and costs than non-ESG investments, some broker-dealers may be hesitant to recommend ESG investments in view of the newly imposed Care Obligation under Regulation BI.
Cost is, however, only one of many important factors that firms should consider under the Care Obligation―in fact, in the Regulation BI adopting release, the Commission cautioned against reflexively recommending the least expensive security, stating that a broker-dealer would not satisfy its requirements by simply recommending the least expensive security without analyzing the customer's investment profile. Furthermore, additional subjective factors, such as highly personalized non-economic considerations, have their place in the recommendation analysis. Firms should, of course, ensure that the policies and procedures for their recommendation analysis and related underlying documentation provide appropriate support for any of their recommendations on ESG investments.
Further complicating the regulatory landscape, however, is the U.S. Department of Labor's ("DOL") recently announced rule proposal regarding DOL's investment duties regulation for pension plan fiduciaries, which, if adopted, would preclude Employee Retirement Income Security Act plan fiduciaries from investing in ESG vehicles when an underlying investment strategy of the vehicle is to subordinate return or increase risk for the purpose of non-financial objectives. This proposal is opposed by, among others, the New York State Department of Financial Services, which argues that it will discourage fiduciaries from investing in ESG vehicles or considering ESG factors.
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