The Securities and Exchange Commission’s (SEC) division of examinations released a risk alert on Monday that highlighted deficiencies from its own examinations on how broker-dealers should review policies and procedures related to Regulation Best Interest (Reg BI).
SEC’s observations uncovered Reg BI deficiencies, finding that broker-dealers and investment advisors have not properly followed obligations when making recommendations to retail investors. The alert is intended to help broker-dealers review their compliance programs related to Reg BI, in an effort to enhance their practices.
Since the SEC set new standards in 2020, Reg BI addresses the requirements and obligations of broker-dealers and investment advisors when providing recommendations to retail customers on securities transactions or investment strategies concerning securities, and establishes a “best interest” standard of conduct for both groups. The purpose is to ensure broker-dealers and investment advisors are putting their clients’ financial interests first. Compliance obligations are separated into four parts: a Disclosure Obligation, Care Obligation, Conflict of Interest Obligation, and Compliance Obligation.
Compliance Obligation
The Compliance Obligation mandates broker-dealers to establish written policies and procedures reasonably designed to achieve compliance with Reg BI, the SEC writes. However, the alert notes several instances where broker-dealers did not have adequate written policies and procedures. Instead, multiple instances of generic written policies and procedures were reported, which were also unfitted to the firm’s business model or otherwise limiting.
The SEC points to poor written policies and procedures related to the Disclosure Obligation as an example. In these instances, broker-dealers or investment advisors did not specify when the disclosures should be created or updated, or how the disclosures would be delivered to people. Some policies and procedures created also contained outdated, incomplete, or inaccurate information, and did not identify parties responsible for creating or updated disclosures.
Additionally, some firms did not have a process that showed disclosures had been provided to retail customers, the SEC says.
The SEC points out how several broker-dealers did not have written policies and procedures in place that complied with the Care Obligation, or were related to training, periodic reviews, and testing.
Conflict of Interest Obligation
In its observations, the SEC notes how some broker-dealers did not have written policies and procedures designed to specify how conflicts are identified or addressed. For example, the SEC states that while the procedure would state that a broker-dealer will identify and address conflicts, it would not provide additional detail on a plan or structure to do so. Other written policies did not prohibit sales contests, sales quotas, bonuses, and non-cash compensation.
Some broker-dealers narrowed identified conflicts as those associated with prohibited activities enforced by the SEC, or never actually identified the actual conflict. Several relied on a disclosure to “mitigate” conflicts that seemed to “create an incentive for the financial professional to place its interest ahead of the interest of the retail customer and did not establish any mitigation measures.”
Disclosure Obligation
Additional observations made by the SEC included some broker-dealers who failed to provide disclosures in writing, and instead just posted it on their website or referenced the disclosure in other documents. The SEC makes it clear in its alert that this does not fulfill the obligation to deliver disclosures to retail customers.
Certain broker-dealers did not disclose the capacity that a financial professional would work with retail customers, while others failed to establish policies and procedures “reasonably designed to identify the disclosures that should be made with respect to conflicts that are specific to financial professionals that interact with retail customers in multiple capacities.”
The SEC notes that many of the broker-dealers observed in this alert ended up modifying their practices, policies, and procedures.
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