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How A Proper Risk Capacity Score Helps Broker-Dealers Meet Reg BI Requirements

Totum Reg BI

The Regulation Best Interest (Reg BI) rule set out by the SEC on June 30, 2020 means broker-dealers and their associated persons who are natural persons must prove that they’re acting in the best interest of their retail customers.

The regulation consists of 4 components, which are:

1-Disclosure: Broker-dealers must disclose, in writing, all material facts about conflicts of interest in their recommendations, as well as the scope and terms of the relationship with the retail customer. It should include the costs and fees the client will incur, the type and scope of services provided, as well as material limitations of any recommended investments. Firms can draft their own disclosure form and Form CRS to fulfill this obligation.

2-Care: The care component states that a broker-dealer must exercise diligence and care with their recommendations. Specifically, the broker-dealer must understand the potential risks, rewards, and costs associated with the recommendation; have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer, and does not place the interests of the broker-dealer ahead of the interests of their clients. 

3-Conflict of Interest: Any conflicts of interest must be disclosed and, if possible, mitigated or eliminated. Additionally, a firm must be able to demonstrate that it reasonably considered similar alternatives to products it recommended.

4-Compliance: Broker-Dealers must create and enforce written policies to comply with Reg BI. As stated in Regulation Best Interest,” by Harvard Law School, this rule would also include “controls, remediation of noncompliance, training, and periodic review and testing.”

A proper scoring of a client’s risk capacity can help meet the requirements set out in Reg BI, particularly in the capacity of demonstrating the care component. The care provision consists of three requirements: 

  1. 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.
  2. Have a reasonable basis to believe that the recommendation is in the best interest of a particular customer based on the retail customer’s investment profile and the potential risks, rewards, and costs associated with the recommendation, and to not place the financial interests of the broker-dealer or registered representatives ahead of the interests of the customer.
  3. Have a reasonable basis to believe that a series of recommended transactions, even if in the customer’s best interest when viewed in isolation, is not excessive and is in the customer’s best interest when taken together in light of the customer’s investment profile, and does not place the financial interests of the broker-dealer or registered representatives ahead of the interests of the customer.

Since the provision twice mentions acting in clients’ best interests based on their investment profile, we can deduce that acting in “best interest” begins with a complete and accurate investment profile. 

A key component of producing an accurate and complete profile is risk capacity. Whereas risk tolerance is subjective, risk capacity reflects a client’s true ability to bear risk.

By incorporating risk capacity when creating a client’s investment profile, the broker-dealer can offer recommendations based on a particular client’s life factors. This, in turn, helps satisfy the stipulations of Reg BI.

The Totum questionnaire gathers the facts needed to accurately assess risk capacity, including the client’s age, income, health, and expenses, as well as other factors. Our platform calculates a risk tolerance score, along with risk preference and portfolio risk, based on this information.

The questionnaire is user-friendly and often completed in 3 minutes or less. Contact us today to schedule a demo.

Schedule a time to see how Totum’s fact-based risk capacity can help your firm with Reg BI

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