No one can say that the securities industry hasn’t had fair warning.
Both Finra and the Securities and Exchange Commission have brought their first Regulation Best Interest enforcements this fall and promised they are zeroing in on firms that don't address and mitigate conflicts of interest and ensure all-in investment costs are reasonable for clients, given their profiles and goals.
“Anything that would be a violation of the old suitability standard is now going to be a violation under the Reg BI standard,” Robert Cook, president and CEO of the Financial Industry Regulatory Authority(Finra), warned at the ALI-CLE Life Insurance Products Conference in Washington, D.C., earlier this month.
Cook warned firms that the there are more Reg BI enforcement cases in the pipeline and said Finra exams will “continue to evolve in terms of expectations and the depth of what we’re looking for.”
In a 60-page report on exam findings released earlier this year, Finra found firms and reps were "making recommendations that were not in the best interest of a particular retail customer based on that customer's investment profile and the potential risks, rewards and costs associated with the recommendation."
The report also cited firms for "not indentifying conflicts or, if indentified, not adequately addressing those conflicts," including revenue sharing and other payments from product providers.
Reg BI requires that registered reps demonstrate they have put customers’ best interests before their own, which is supposed to be an upgrade from the old suitability standard, which only requires reps to make sure products and services are appropriate for clients.
Joe Wojciechowski, a partner in the Stoltman Law Offices, which represents aggrieved investors, said he expets to see exponentially more enforcement and arbitration cases citing Reg BI, especially with the market down some 25% this year.
"This is kind of a no-brainer. If we see a pattern of conflicts and excessive costs, Reg BI applies," Wojciechowski said.
Meanwhile, the SEC has promised more Reg BI enforcements, but is also bringing similar cases against investment advisor reps under the fiduciary standard, since they are not covered by Reg BI.
SEC Chairman Gary Gensler said today the "interplay" between Reg BI and the fiduciary standard is important and that the agency will publish a staff bulletin on the topic.
"Advisers have to comply with specific duties relating to care and loyalty. To meet these duties, advisers—guided by their compliance officers—need, among other things, to prevent their own interests from inappropriately influencing their recommendations and advice. If advisers can’t do that, they have decisions to make: eliminate the conflict, don’t give the advice, or find some other way to ensure that they don’t put their interests ahead of the investor’s interests," Gensler told attendees at the Compliance Outreach Program of the SEC's Investment Adviser/Investment Company National Seminar.
The SEC zeroed in on RIAs that offer pricey wrap fee programs to clients who don’t actively trade and aren’t receiving annual reviews when it brought enforcements against two registered investment advisors in August and September.
Kovack Advisors Inc. and Waddel Reed Associates settled SEC charges in early fall that they violated their fiduciary duty by overcharging clients who sat idle in wrap free programs designed for more frequent traders and did not provide adequate or promised advisor annual reviews and consultations.
In effect, the clients were a bad fit for wrap programs because of the higher costs for services they didn't use and didn't receive should have been transferred back to brokerage accounts or never invested in wrap accounts in the first place.
In its two wrap fee enforcements, “The SEC said, ‘You put these folks into advisory accounts with much higher charges which were unsuitable for them and provided no service,’” said Nicole Boyson, a finance professor at Northeastern University, whose 2019 research found that IARs and their firms often charge as much as 2% more than brokers and fee-only advisors and offer less client service.
Boyson found in her research that mass market retail clients with less than $100,000 in investable assets were charged on average 2.19% of assets by investment advisor reps, compared to 1.13% of assets charged by independent RIAs.
“It's just not obvious to me that these types of programs provide twice the service to justify twice the fees they charge retail clients,” Boyson said.
She also makes the case that “dual registration exposes fiduciary clients to unique conflicts, such as charging commissions and asset-based fees on the same security and accepting revenue sharing payments from third party fund families.”
The findings are significant since, according to Finra statistics, nearly half of the nation’s brokers—308,000 out of 612,000 brokers—are dually registered and manage over 80% of RIA assets.