Securities and Exchange Commission examiners have found that broker-dealers have failed to stem conflicts of interest in certain sales activity and are not properly disclosing their conflicts to retail investors as required by Regulation Best Interest, the agency said in a new risk alert issued this week.
Reg BI was supposed to establish a new, enhanced standard of conduct for broker-dealers and their representatives when it comes to recommending securities transactions, investment strategies or account types to retail customers. But SEC exams have continued to find deficiencies since the rule went into effect June 30, 2020, the SEC said.
The Division of Examinations “is issuing this risk alert to highlight deficiencies noted during examinations conducted, as well as examples of weak practices that could result in deficiencies,” said the SEC’s alert.
The regulation requires firms to establish, maintain and enforce written policies and procedures “reasonably designed to identify and mitigate conflicts of interest” at the rep level that might incline reps to make investment recommendations where they have some stake in the transactions.
The SEC said that mere disclosure of a conflict is not enough if the rep has an interest in a sale. A number of firms also failed to have written policies and procedures in place laying out how to identify or address the conflicts, and some firms are still not prohibiting sales contests, sales quotas, bonuses and the payment of non-cash compensation for the sale of specific securities in specific time periods, the SEC said.
Some firms limited their policies on prohibited activities to a single category, such as churning, or used “high-level, generic language” that did not identify the actual conflict and did not reflect all conflicts of interest associated with recommendations.
The firms also failed to make policies for those professionals who interact with retail customers in multiple capacities, such as dually registered representatives or those with insurance licenses.
“While some broker-dealers instructed financial professionals to disclose orally any differences from the firm’s standard disclosures, several of these firms provided insufficient guidance for the financial professionals to understand the circumstances under which they need to make additional disclosures,” the SEC said.
Disclosures should explain differences in fees and costs, type and scope of services provided and material facts relating to conflicts of interest associated with a recommendation, the regulator said. Some firms also failed to provide guidance for how to maintain a record that oral disclosures were made.
Under Reg BI’s “care obligation,” firms and their reps are required to exercise reasonable diligence, care and skill when making recommendations, such as any of the potential risks, rewards and costs associated with one. And they must have a reasonable basis to believe that the recommendation is in the best interest of a retail customer.
The SEC said that examiners found the following care obligation deficiencies at firms:
- Policies that direct advisors to consider reasonably available alternatives without providing any guidance for how to do so;
- Policies that direct advisors to consider costs without providing any guidance for how to do so;
- Systems that allow advisors to evaluate costs or reasonably available alternative products but whose use is not mandated;
- Policies that direct advisors to document the basis for their recommendations, but that don’t give instructions for when documentation is necessary or appropriate.
From a compliance perspective, some firms also relied heavily on surveillance systems that existed before the effective date of Reg BI, and the systems have not been updated to effectively monitor for compliance with the rule, the SEC said.