SEC, Finra officials: Don’t just go through motions on Reg BI compliance

Financial firms that are failing to comply with the broker standard of conduct aren’t aligning their internal controls to meet its requirements, securities regulators said Wednesday.

Now that Regulation Best Interest has been in force for more than a year, examiners have had a chance to assess how brokerages are adhering to the measure, which prohibits brokers from putting their financial interests ahead of their retail customers’ interests when they're making recommendations about securities or investment strategies.

Under the rule, firms must establish policies and procedures to identify and disclose conflicts of interest and, in some cases, mitigate or eliminate them. The Securities and Exchange Commission said Reg BI, as it’s known, was designed to be a tougher bar for brokers to meet than the previous suitability standard.

But some firms have not modified their compliance processes to reflect the new rule’s mandates.

“We had some firms just take the word ‘suitability’ and replace it with ‘best interest’ in their written supervisory procedures — not really understanding the new requirements that have come into effect with the rule,” Nicole McCafferty, examinations director at the Financial Industry Regulatory Authority Inc., said during an online panel at the Insured Retirement Institute’s annual conference.

For the first few months after Reg BI was implemented on June 30, 2020, examiners from the SEC and Finra evaluated whether firms were acting in “good faith” to comply. Since the beginning of this year, the exams have become more detailed and comprehensive.

“We’ve really been able to take a broader approach as to what firms have actually done,” McCafferty said.

The SEC is looking at whether financial firms have established a Reg BI compliance program that reflects the characteristics of their practices.

“Firms need to take a considered and thoughtful approach that tailors their policies and procedures to meet the unique circumstances of the firm and its products,” said Corey Schuster, assistant director of Division of Enforcement’s asset management unit. “I think it’s important to give registered representatives guidance on not just what Reg BI says but specific examples of how to accomplish its requirements.”

Schuster also recommended that firms reflect on the products they sell and how they sell them.

“And firms may want to consider: Have you done a deep dive on conflicts?” he said. “Have you examined your disclosures regarding conflicts? And is there a need to mitigate certain conflicts of interest?”

One of the major differences between Reg BI and suitability is that under Reg BI, registered representatives must consider reasonably available alternatives and their costs compared to the recommendations they make to customers, said Mark Quinn, director of regulatory affairs at Cetera Financial Group.

“We think of it as a product knowledge requirement,” Quinn said.

Generally, McCafferty seemed pleased by the brokerage industry’s response to the relatively new standard of conduct.

“We have found that firms have really taken [Reg BI] seriously,” she said.

Best compliance practices include identifying and mitigating conflicts — either through a matrix or a conflicts committee; aligning sales of complex products with customers with appropriate risk tolerance; and obtaining sufficient information about customers to guide recommendations on account types, securities and investment strategies.