Whether Regulation Best Interest is working after 20 months depends in part on how readers interpret a report released last week by Finra.
The Financial Industry Regulatory Authority Inc. included a section about Reg BI compliance in its annual report on its examination program. The broker-dealer self-regulator outlined on pages 26-27 its findings from Reg BI exams, most of which involved shortcomings like brokerages not acting in their customers’ best interests and failing to mitigate conflicts of interest.
Finra followed the exam findings with a section on pages 28-29 titled “effective practices,” such as identifying and addressing conflicts related to compensation arrangements and limiting the sale of high-risk and complex investments to retail investors.
The language in the report didn't make clear whether the exam findings were separate from the effective practices. But Finra said the sections are related.
“Both ‘exam findings’ and ‘effective practices’ reflect things we’ve seen in exams,” Finra spokesperson Ray Pellecchia wrote in an email. ‘Exam findings’ identify areas where firms have not complied with the relevant rule(s). ‘Effective practices’ cite practices that go above and beyond rule requirements.”
Fiduciary advocates have zeroed in on the exam findings to argue Reg BI isn't living up to its investor protection promises. The standard of conduct, which went into force in June 2020, prohibits registered representatives from putting their financial interests ahead of their customers’ interests. Investment advisers continue to adhere to fiduciary duty when working with clients.
“The findings language … clearly cites material deficiencies that result in recommendations that fail to make the best interest standard,” Knut Rostad, president of the Institute for the Fiduciary Standard, said during a media briefing Tuesday. “There should be no mystery why B-Ds flunked. B-Ds were asked to craft and implement practices and policies without knowledge and guidance to describe what the [Reg BI] standard really means.”
But an industry representative said the Finra exams produced a different conclusion.
“The report is telling us Reg BI is working,” said Kevin Carroll, managing director and associate general counsel at the Securities Industry and Financial Markets Association. “There are things firms are doing well and there are things firms are not doing as well. Finra is not concluding there are widespread failures. That is not the case.”
Former Securities and Exchange Commission Chairman Jay Clayton argued that Reg BI introduced stronger investor protections than the suitability standard that previously governed brokers. A financial executive said that’s the way Reg BI is working out in practice.
“There is far more focus right now on making sure recommendations are the best possible recommendation for the client all things considered, including cost,” said John Taft, vice chairman of Robert W. Baird & Co. and former chief executive at RBC Wealth Management. “That’s a very different approach than mere suitability.”
It’s not just Finra that says some brokers are failing to meet the Reg BI standard. Last November, the North American Securities Administrators Association released a report finding that the regulation is failing to curb brokers’ conflicts of interest.
“Regulation Best Interest is not doing its job,” Benjamin Edwards, a professor at the University of Nevada-Las Vegas law school, said Tuesday during the Institute for the Fiduciary Standard’s media briefing. “We’ve had enough time to see the truth, and the truth is brokerage firms’ operations have largely gone unchanged. This is happening because oftentimes the business model smacks of betrayal. Brokers are getting more money for tilting their advice in favor of more expensive products.”
The brokerage industry disputed the NASAA report.
The Reg BI debate likely will intensify. SEC Chairman Gary Gensler said the agency will use examinations, enforcement and guidance to ensure that Reg BI protects investors.
Rostad said the SEC should improve Reg BI and a related disclosure document called Form CRS.
“They’re not complex,” Rostad said. “Fixing them is not like discovering a new cure for cancer. Fixing them is providing additional guidance and, if necessary, enforcement measures.”
Plus, a $400 million Commonwealth team departs to launch an independent family-run RIA in the East Bay area.
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