State regulators: Reg BI fails to curb conflicts of interest

Most brokerages continue to demonstrate conflicts of interest when recommending investments to retail customers, a NASAA study shows.

Despite having operated under a new standard of conduct for more than a year, most brokerages continue to demonstrate conflicts of interest when making investment recommendations to retail customers, according to a new study by state regulators.

The North American Securities Administrators Association study examined 443 firms from 35 jurisdictions regarding how they’re adjusting their operations to comply with Regulation Best Interest, which the Securities and Exchange Commission implemented in June 2020. Under the rule, brokers are prohibited from putting their financial interests ahead of their customers’ interests.

The state regulators found that brokerages increased their offerings of “complex, costly and risky products” by 11% after Reg BI took effect, according to a NASAA statement. Additionally, 65% of brokerage firms “are not discussing lower-cost or lower-risk products with their customers when they recommend these products.”

“NASAA’s member states did not see the tide-turning reforms they had expected to see in the broker-dealer industry after Regulation Best Interest took effect,” Melanie Senter Lubin, NASAA president and Maryland securities commissioner, said in the statement. “This examination reveals that while there were some improvements, most firms are operating in the same manner as they were under the suitability rule, especially when it comes to harmful compensation conflicts.”

But SIFMA, a trade organization for the securities industry, took issue with the NASAA study’s results. “The report misses the mark in terms of the numerous and substantial changes that firms have made to enhance investor protection and satisfy the best interests of their retail investors,” Kenneth E. Bentsen Jr., president and CEO of SIFMA, said in a statement.

The study is the second phase of NASAA’s review of Reg BI. The first phase, published in 2020, looked at the industry’s practices before Reg BI was implemented. There were 225 broker-dealers that were assessed in both the first and second phases, and the latest report focuses on the progress made by those firms, which serve more than 77.5 million retail accounts.

Reg BI replaced the previous suitability standard that governed brokers, as the SEC tried to make the brokerage standard similar to the fiduciary duty that investment advisers must provide to their clients.

Brokerages “remained fairly stagnant and continue to operate precisely the same under Reg BI as they had under the suitability rule,” the report states. “One full year after the compliance deadline, most of the Reg BI firms sampled are not providing fair and balanced point-of-sale disclosure regarding fees, costs, and risk to retail investors. Meanwhile, these Reg BI firms have steadily increased their participation in complex, costly, and risky products under the new conduct standard and continue to rely on financial incentives that Reg BI was intended to curb, incentives rarely seen with fiduciary advisers.

“In short, too many Reg BI firms are still placing their financial interests ahead of their retail customers in violation of the rule’s chief directive,” according to the report. “Clearer regulatory guidance is needed to allow a course correction that would help Reg BI earn the ‘best interest’ label that it bears.”