Brokers Must Prepare Defense for Decisions Amid Turbulent Market

President Donald Trump’s “Liberation Day” tariff announcements wiped out nearly $6 trillion in market value over two days. Since then, some tariffs have been paused, others have been escalated, and broker-dealers are in a precarious position addressing complaints that they aren’t acting in their clients’ best interests.

Such uncertainty and rapid swings in the market—particularly record-setting one-day declines—historically have presaged a deluge of claims against broker-dealers. Customers complained that their broker didn’t disclose risks, put them into strategies that suffered enormous losses, or were otherwise inappropriate under the circumstances.

Regulation Best Interest, or Reg BI, requires broker-dealers who recommend “any securities transaction or investment strategy” to a retail customer to “act in the best interest of the retail customer at the time the recommendation is made.” This requirement may be satisfied if the broker-dealer discharges four obligations: care, disclosure, conflicts of interest, and compliance.

The care obligation requires a broker to exercise “reasonable care” to understand potential risks and rewards when making a recommendation; have a reasonable basis to believe it’s best for the retail customer based on their investment profile and objectives; and not place the financial interest of the broker ahead of the interest of the retail customer.

A broker also must have a reasonable basis to believe that a series of recommended transactions collectively aren’t “excessive” based on the customer’s investment profile.

The scope of this care obligation has proved tricky for broker-dealers to understand. A broker-dealer generally should adopt a comprehensive approach that includes a review of the objective aspects of the investment strategy, consideration of the expected return of the security or investment strategy, and a review of the retail investor’s profile and personal objectives.

Typical features of a customer’s profile, such as their age, net worth, liquid net worth, tax status, financial situation, and specific needs are paramount considerations.

Current market volatility surrounding trade and tariff policies is a good reminder that brokers must consider more than just a customer’s investment profile to develop the “reasonable basis” required under the care obligation.

A Securities and Exchange Commission staff bulletin from April 2023 warned brokers must develop their understanding of an investment or investment strategy by considering its “likely performance in a variety of market and economic conditions.” The bulletin also advised broker-dealers to consider the effects of, and reasonable alternatives to, transactions or strategies designed to gain exposure to specific market sectors.

Broker-dealers need to mesh all the relevant factors with the information they have about a specific customer when analyzing whether they have a “reasonable basis” for their recommendations. Options strategies, for example, tend to fare better during volatile times because option pricing formulas factor in volatility metrics that often counteract time decay considerations.

Strategies that might look good now can involve higher risk, higher turnover rates, more transactions (meaning more commissions or fees to the broker), and high cost-to-equity ratios. Such a strategy, then, may be inconsistent with moderate or conservative investment profiles—a point the SEC made in a 2024 settlement.

Alternatively, broker-dealers might recommend sector-based investments or strategies. With tariff and trade policy in flux right now, industry sectors could be affected differently—some entirely unaffected while others benefit or struggle—and those effects may be different in the short term versus the long term.

Non-traditional exchange-traded products face similar uncertainty and potential volatility, which may be magnified if the ETP is designed to return a multiple on an underlying index.

Broker-dealers likely need to factor these types of issues into their analysis because the ability of trade policy changes to drive market movements is among the “variety of market and economic conditions” that could affect a specific investment or strategy.

Enforcement priorities at the SEC and the Financial Industry Regulatory Authority may be shifting, but enforcement isn’t stopping. While it’s reasonable to anticipate a slow-down by regulators in pursuing edge-type cases, that says little about how retail customers might try to enforce their rights in private actions or arbitration.

Broker-dealers need to protect themselves with good compliance practices, whether they face risk from regulators or private parties. They have had a few years to design, implement, and test their Reg BI programs, and to learn from the growing number of FINRA and SEC enforcement actions.

Comprehensive training of registered representatives, as well as robust recordkeeping, related to the reasonable-basis analysis should be essential ingredients even if the SEC has hinted that documenting the basis for specific recommendations isn’t technically required.

All of this should be part of a broader compliance program that is reasonably designed to achieve compliance and to weather the storm of fluctuating market conditions and the heightened risks of enforcement scrutiny and customer claims that so often follow.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Brian Lanciault is a partner in Thompson Hine’s business litigation, securities & shareholder litigation, and white collar defense & investigations groups.

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