SEC: The compliance culture should include adherence to Reg BI

Investment advisers and broker-dealers were cautioned by Securities and Exchange Commission (SEC) staff to continuously identify, mitigate, and disclose all conflicts of interest with regard to advice given to retail investors in order to remain in compliance with Regulation Best Interest (Reg BI).

Compliance with the Investment Advisers Act and Regulation BI regarding conflicts of interest, according to SEC staff in a bulletin released on Tuesday, is not a "check-the-box" or "set it and forget it" exercise, but rather a "robust, ongoing process that is tailored to each conflict."


The staff stated in the bulletin that "all broker-dealers, investment advisers, and financial professionals have at least some conflicts of interest with their retail investors. Specifically, they have an economic incentive to recommend products, services, or account types that provide more revenue or other benefits for the firm or its financial professionals, even if such recommendations or advice are not in the best interest of the retail investor. This can create substantial conflicts of interest for both firms and financial professionals." 


The staff advised businesses to create a "culture of compliance." "As applied to conflicts of interest, creating an environment where conflicts are taken seriously and financial professionals feel empowered and encouraged to take an active role in identifying conflicts so that they may be adequately addressed may significantly decrease the likelihood of a violation."

When recommending any securities transaction or investment strategy involving securities to a retail customer, investment advisers and broker-dealers are required by Reg BI, which went into effect in June 2020, "to act in the best interest of a retail customer." It is intended to strengthen the suitability requirements for broker-dealers while also making it clear that when making recommendations, broker-dealers may not put their own financial interests ahead of those of a retail customer.


The SEC has already made it clear that it intends to hold companies accountable for how Reg BI is enforced; most recently, it sued a registered broker-dealer with offices in California and five of its representatives in federal court in June for alleged Reg BI violations.


Companies should have policies and procedures in place to monitor actual and potential conflicts of interest, as well as a plan to reduce or end the conflict if it would harm a retail investor. This plan should be reviewed and updated on a regular basis, especially whenever the company introduces new products, establishes new sales targets, or offers employees additional financial incentives.


Reg BI requires businesses to disclose any potential conflicts of interest that may arise from payments made to financial professionals in the form of fees or charges for services rendered, commissions, markups, order flow payments, cash sweep programs, sales promotions, quotas, sales contests, special awards, different or variable compensation based on the product sold, and more. The bulletin noted that incentives linked to performance reviews, revenue benchmarks, client transfers, and client retention can also lead to conflicts.


Sales goals and other forms of compensation that lead to conflicts of interest should not be implemented, according to SEC staff, who also added that compliance departments should actively monitor "recommendations or ongoing advice that result in additional compensation" for potential conflicts.


According to the nature and importance of conflicts within each firm, the bulletin stated that in some instances they must be reduced or eliminated.


The bulletin stated that after the conflicts have been found, they must be disclosed to investors in a way "designed to allow retail investors to make a more informed decision about a recommendation, and, in the case of investment advisers, provide informed consent to the conflict of interest."


As business conditions change, handling conflicts of interest should be revisited and revised frequently rather than just once a year.


To help ensure ongoing compliance with Reg BI and the (investment advisers) fiduciary standard, the bulletin advised firms to periodically evaluate the adequacy and effectiveness of their policies and procedures.

By fLEXI tEAM