On Monday, the Securities and Exchange Commission (SEC) published a risk advisory outlining shortcomings in broker-dealers' adherence to Regulation Best Interest (Reg BI) that were discovered by its examiners.
Financial professionals are required to behave in the best interests of a customer when recommending investment strategies involving securities under Reg BI, which went into force in 2020.
According to the advisory, examiners at the SEC's Division of Examinations discovered that companies used generic rules and practices for Reg BI compliance that were not specific to their business models. Firms sometimes merely repeated the requirements of the rule without providing any guidance or guidelines.
For instance, several policies and procedures failed to specify when disclosures would need to be made and when they should be updated. Others lacked a procedure to prove disclosures had been provided to retail consumers, making it challenging for the firm to assess whether it complied with the rule's disclosure requirement.
The SEC noted that corporations did not adequately train personnel on how to weigh reasonably available alternatives or the costs of their suggestions when it came to complying with Reg BI's care responsibility.
The alert stated that while some businesses had technologies that their staff could use to calculate costs, they lacked a mechanism to verify their use when reviewing compliance. Examiners discovered that businesses did not give staff adequate direction in their rules regarding when to document the foundation for their recommendations or what specific data should be gathered.
According to the alert, a well-designed Reg BI compliance program should include periodic reviews and testing in addition to a training program. Examiners discovered that at some organizations, surveillance systems created prior to the implementation of Reg BI were not properly designed to prevent, detect, and remedy Reg BI violations including the recommendation of rollovers, account recommendations, and implicit hold recommendations.
The surveillance systems of companies frequently ignored hold suggestions and recommendations that were not accepted by the retail client, measuring only executed transactions for compliance with Reg BI. Because of this, businesses were unable to establish whether their proposals met Reg BI requirements.
Examiners found issues with Reg BI compliance training courses as well.
Firm policies and processes for Reg BI's conflict of interest requirement failed to outline how conflicts should be found and resolved. Additionally, the alert highlighted that they had not made clear whether certain sales incentive activities, such as "sales contests, sales quotas, bonuses, and noncash compensation that were based on the sales of specific securities or specific types of securities within a limited period of time," were prohibited by their policies and procedures.
Some companies' policies and procedures relied solely on disclosures to alleviate conflicts of interest, failing to outline how to change behaviors to fairly limit violations of conflict of interest.
The notice stated that broker-dealers that also act as investment advisers have a duty to disclose capacity and potential conflicts of interest to clients in order to prevent confusion about which capacity an employee was acting in when making a recommendation.
Firms have already received advice from the SEC and other authorities, such as the Financial Industry Regulatory Authority, regarding Reg BI compliance. The SEC launched a complaint in June against a broker-dealer with offices in California on the grounds that it had misled investors by offering them high-risk debt instruments.
By fLEXI tEAM