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The SEC recently issued a Risk Alert presenting findings from the Commission’s examinations of broker-dealers’ compliance with Regulation Best Interest. The Division issued this risk alert to highlight deficiencies noted during these examinations, as well as examples of weak practices that could result in deficiencies.
In the Alert, the SEC summarized the deficiencies of broker-dealer compliance in regards to Regulation Best Interest (Reg BI) across the four general obligations of Reg BI: Compliance Obligation, Care Obligation, Conflicts of Interest Obligation and Disclosure .
Compliance Obligation
Division staff stated that deficient broker-dealers did not have adequate written policies and procedures reasonably designed to achieve compliance with the Disclosure Obligation. In many instances, the firms had adopted boilerplate language that was not tailored to the firm’s specific practices, or merely restated a rule without adopting a corresponding policy.
Notable weaknesses included broker-dealer policies and procedures not:
- specifying when disclosures should be created or updated or how updated disclosures should be delivered to retail customers.
- having a process to demonstrate that disclosures had been provided to retail customers, making it difficult for the firm to have effective controls to review whether disclosures had been provided prior to, or at the time of, the recommendation.
Policies and procedures to comply with the Care Obligation
Some broker-dealers did not have written policies and procedures reasonably designed to achieve compliance by their financial professionals with the Care Obligation.
Examples included directing financial professionals to consider:
- reasonably available alternatives without providing any guidance as to how to do so.
- costs without providing any guidance around how to achieve this.
Training, periodic reviews and testing
When adopting Regulation Best Interest, the Commission noted that, depending on the size and complexity of the firm, a reasonably designed compliance program would generally include a training program, periodic reviews and testing.
Issues identified in compliance programs included broker-dealers:
- relying heavily on surveillance systems that existed before the effective date of Regulation Best Interest without considering whether those systems needed modification.
- depending on surveillance systems that captured only executed transactions to monitor for compliance with Regulation Best Interest. These systems did not capture hold recommendations or recommendations that are not accepted by the retail customer.
- offering employee training that included information on Regulation Best Interest but did not identify the firms’ processes for compliance with Regulation Best Interest.
Conflict of Interest Obligation
Many broker-dealers didn’t have written policies and procedures reasonably designed to specify how conflicts are to be identified or addressed.
Some broker-dealers limited the identified conflicts to those associated with prohibited activities. Others used high-level, generic language that didn’t accurately identify the conflict and didn’t reflect all conflicts of interest associated with the recommendations made by the firm or its financial professionals.
Some broker-dealers inappropriately relied on disclosure to “mitigate” conflicts that appeared to create an incentive for financial professionals to place their interests ahead of retail customers. Mitigation measures were not established.
It’s important to note that disclosure alone does not satisfy the Conflict-of-Interest Obligation for these kinds of conflicts. Rather, the Conflict-of-Interest Obligation explicitly requires the broker-dealer to establish, maintain and enforce written policies and procedures reasonably designed to identify and mitigate conflicts of interest.
To address the issues identified by Division staff in deficiency letters, many broker-dealers have modified their practices, policies and procedures. Despite this, there is still a lot to digest when it comes to examining Reg BI as it continues to be a focus of the SEC’s examinations of broker-dealers.
How we can help
If you have questions regarding Reg BI, or want to ensure that your policies, procedures and testing are up to par with the SEC’s standards, please reach out to our team.
