SEC warns of tougher Reg BI exams next year

SEC warns of tougher Reg BI exams next year

The agency will ‘conduct enhanced transaction testing’ to see if firms are acting in customers’ best interests

The Securities and Exchange Commission warned brokerages Monday to expect tougher examinations for compliance with the new broker investment advice standard.

When Regulation Best Interest went into force on June 30, in the middle of disruptions caused by the coronavirus pandemic, the SEC said it was looking for ‘good-faith’ efforts to implement the measure. It gave a progress report on compliance based on early examinations at an October roundtable.  

In a statement released Monday by the SEC Division of Examinations, the agency indicated that it will broaden and deepen examinations.

“Building on staff’s initial assessments, Division staff intends to expand the scope of examinations in 2021 that focus on specific requirements of the regulation, including those that go beyond suitability standards and require broker-dealers to have a reasonable basis to believe that recommendations are in retail customers’ best interests,” the statement says. “The Division also intends to conduct enhanced transaction testing designed to examine whether broker-dealers have implemented effectively their written policies and procedures.”

The SEC is signaling that a new Reg BI sheriff will be coming to town next year.

“I do believe the expectations will be higher now than they were when the SEC started looking at Reg BI compliance after June 30,” said Fred Reish, a partner at Faegre Drinker Biddle & Reath. “The definition of ‘good faith,’ if that term is applicable at all now, will be more demanding.”

It’s been almost 18 months since the SEC released the final Reg BI measure and six months since firms have had to show they’re doing their best to comply. Now the SEC will be looking for concrete evidence that Reg BI is making a difference in a firm’s policies and procedures.

“It’s time to show where the rubber meets the road,” said Michael Watling, a partner at King & Spalding.

The SEC outlined areas where it is likely to focus in Reg BI examinations.

For instance, the reviews will evaluate firms’ policies and procedures, including alterations to product offerings like “the removal of higher cost products when lower cost products are available.”

The examinations also will probe the processes representatives use to make recommendations to new customers and about complex products and how firms identify and address conflicts of interest.

“That’s a signal to broker-dealers to put a major compliance effort into those specific areas,” Reish said. “If I were the chief compliance officer at a broker-dealer, this would be my road map.”

Reg BI is the signature achievement of SEC Chairman Jay Clayton’s tenure, which will conclude at the end of the month.

Clayton asserts that Reg BI is a stronger standard than the suitability rule that previously applied to brokers. Investor advocates say the measure is weaker in curbing conflicts than the fiduciary duty that will continue to govern investment advisers.

Clayton also stresses that Reg BI will apply to recommendations to move retirement assets from a 401(k) plan to an individual retirement account. The SEC on Monday indicated that examiners will be probing rollovers.

“Examiners will assess what information was gathered from new customers; what disclosures were made at the time; how alternatives were considered; and what documentation was retained,” the statement says.

The focus on rollovers aligns with the SEC’s enforcement emphasis on individual investors, Watling said.

“That is a place where the SEC is going to home in on because it presents risks to Main Street retail investors,” Watling said.

The Department of Labor recently released a final investment advice rule for retirement accounts that applies to rollovers, and the Financial Industry Regulatory Authority Inc., the broker-dealer self-regulator, also has made the a priority.

Brokerages should take note of the interest in rollovers from the major financial regulators, Reish said. “Anybody who isn’t paying attention to that is making a serious mistake.”

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