Broker-dealers were two to eight times more likely than registered investment advisors to recommend risky investments in 2018, according to the findings of nationwide regulatory examinations designed to benchmark the practices of more than 2,000 firms and 360,000 practitioners working with 68 million retail investor accounts.

The examinations found eye-opening differences between the way broker-dealers and RIAs were operating earlier this year, prior to the implementation of Regulation Best Interest, which was implemented on June 30 to reduce aggressive, conflicted and cost investment advice that harms investors.

One finding that stands out from the examinations, performed in 34 states: When complex products were sold, broker-dealers were twice as likely as investment advisors to recommend the purchase of leveraged and inverse ETFs, seven times as likely to recommend private placements, eight times as likely to recommend variable annuities, and nine times as likely to recommend non-traded REITs, the North American Securities Administrators Association (NASAA) said in its exam report.

“The examinations identified compliance challenges for the industry,” Lisa Hopkins, NASAA President and West Virginia Senior Deputy Securities Commissioner, said in a statement. “We appreciate the strong industry cooperation in these examinations and we look forward to seeing how industry addresses these challenges.”

Hopkins said the exams will be repeated next year to assess the effectiveness of Reg BI, implemented June 30. The organization has been critical that the new regulation did not implement a fiduciary advice standard on all practitioners charging for advice.

Indeed, states found notable differences between broker-dealers operating under a suitability standard and investment advisors operating under fiduciary duties. For instance, RIAs generally took more conservative investment approaches overall, “avoiding higher cost, riskier, and complex products. Investment advisers also reported more robust due diligence, disclosure, and conflict management practices,” NASAA said.

“Both broker-dealers and investment advisers have a significant opportunity to improve under Regulation Best Interest in order to better serve the interests of their retail clients,” Andrea Seidt, Ohio Securities Commissioner and Chair of NASAA’s Regulation Best Interest Implementation Committee said. “We are closely watching the industry’s early implementation of the SEC’s Regulation Best Interest with an eye toward determining whether the rule benefits investors as intended.”

The exams went forward despite pressure from industry trade groups to suspend the sweep, Nasaa said.  The Financial Services Institute (FSI), Securities Industry and Financial Markets Association (SIFMA), the Insured Retirement Institute (IRI) and U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness were amongst a consortium of trade groups that sent a letter to state regulators on February 25, 2020, “objecting to various aspects of the examination tool as well as the timeline and requested states suspend the examination initiative.”

Seidt, the NASAA chairwoman spearheading the examinations project responded to the letter the following day, making clear that “the initiative would not be suspended. While a few states agreed to short extensions on a case-by-case basis, member firms by and large complied with the state exam initiative on time and within requested parameters,” NASAA said.

Other important Nasaa findings include:

  • Broker-dealers offered a more diverse set of product offerings than investment advisors.
  • One third of broker-dealer firms offered complex, risky products like private offerings, variable annuities, non-traded real estate investment trusts (REITs), and leveraged- or inverse- exchange-traded funds (ETFs) to their customers, while almost no RIAs did.

In total, state securities regulators examined 516 broker-dealers (approximately 15% of the registered FINRA population), 1,552 investment advisors (about 9% of the state-registered population); firms ranging in size from 1 person to more than 35,000 representatives, approximately 360,000 registered persons in total, firm revenue ranging between $0 to nearly $22 billion, more than $106 billion in total, retail customer bases ranging from 0 (new firms) to more than 10 million accounts and over 68 million retail accounts in total, NASAA said.

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