On October 2, 2024, the SEC announced the settlement of administrative proceedings brought against a dually registered broker-dealer and investment adviser for alleged violations of Rule 15l-1 under the Securities Exchange Act of 1934, known as Regulation Best Interest, related to its use of a mutual fund share class calculator in recommending investments to its retail brokerage customers. 

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 action involves 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 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 interest.  The compliance obligation requires broker-dealers to establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest.

According to the SEC order, the broker-dealer and its registered representatives utilized a share class calculator to identify and recommend an appropriate mutual fund share class for retail customers’ investment within college savings plans.  The Class A shares offered imposed upfront sales charges as well as annual fees, while Class C shares did not impose upfront sales charges but charged higher annual fees than Class A shares.  The order alleges that, while investing in Class A shares may have been in the best interest of many of its customers historically, the broker-dealer failed to update its share class calculator to account for changes to the expense structure of Class C shares made in March 2020 and December 2020 that significantly reduced the annual fees charged on Class C shares and made Class C shares less expensive than Class A shares for many of its customers.  As a result, between June 30, 2020 and July 2022, the broker-dealer continued to recommend Class A shares to its customers investing in the plans.

The order alleges that because the broker-dealer failed to understand the difference in costs of Class A and Class C shares during the relevant period, the broker-dealer and its registered representatives failed to exercise reasonable diligence, care, and skill when recommending investments within the plans to its retail customers and did not have a reasonable basis to believe that its recommendations were in the customers’ best interest.  The order also alleges that because the broker-dealer did not have procedures reasonably designed to ensure that it timely reviewed and updated the costs of share classes in its share class calculator, it violated its compliance obligation to establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest.  In addition, by failing to comply with Regulation Best Interest’s compliance obligations, the order alleges 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 $25,000.  In the order, the SEC noted its consideration of the broker-dealer’s prompt remedial acts and cooperation afforded to the SEC staff.

The SEC order is available here.