The Securities and Exchange Commission’s Enforcement Division has been quiet about Regulation Best Interest since the retail investment advice rule went into effect 18 months ago, but that silence is unlikely to continue, according to a new analysis from Quinn Emanuel’s SEC Enforcement Practice.

In fact, there are “strong indications” that SEC enforcement of the rule is coming, Kurt Wolfe of Quinn Emanuel’s SEC Enforcement Practice said in the new blog.

“SEC Chair Gary Gensler is under pressure from broad constituencies to show results in the space. For example, at a recent hearing of the Financial Services Committee of the House of Representatives, Rep. Carolyn Maloney (D-N.Y.) encouraged Chair Gensler to ‘take further action to strengthen this rulemaking,’” Wolfe said.

At the same time, “the SEC has signaled that regulated firms may not be getting Reg BI right, and senior SEC officials have made it clear that they intend to take an expansive, perhaps aggressive, approach to Reg BI,” which imposes a heightened best-interest standard on broker-dealers when they recommend securities transactions and investment strategies, Wolfe added.

That may include applying the rule to hold firms to a quasi-fiduciary standard, he said.

Last May, just one month after Gensler took over at the agency, examiners reportedly began issuing requests for information on Reg BI compliance.

Division of Examination’s “focus on Reg BI compliance is likely to result in increased referrals to the Division of Enforcement and in an uptick in settled and litigated Reg BI enforcement actions.  We expect that enforcement will come in two waves,” he said.

The first wave of Reg BI enforcement is likely to penalize firms that have failed to implement new or improved policies and procedures to comply with Reg BI, he said.

“This pattern of picking off low-hanging fruit—i.e., identifying and bringing enforcement actions for clear failures to comply—is typical for the SEC’s approach to enforcement of new regulations,” Wolfe continued.

The SEC already has resolved a number of enforcement actions against broker-dealers that failed to comply with the customer relationship summary (Form CRS), the disclosure regulation passed on the same day as Reg BI. More than 28 firms have settled actions with the agency, paying up to $97,500 for railing to file, deliver or post their CRS. 

“Firms could be in a similar position with respect to Reg BI without realizing it,” Wolfe said.

For instance, a November 2021 survey conducted by the North American Securities Administrators Association (NASAA) found that firms had not really changed their processes, procedures or compensation structures since Reg BI went into effect. Some firms even claim they have no conflicts of interest to manage.

NASAA also found examples of what it described as “presumptive breaches” of Reg BI, including firms using the “advisor” or “adviser” title while operating in a broker-dealer capacity, which the SEC has stated constitutes a breach of Reg BI’s disclosure obligation, Wolfe said. 

“For better or for worse, there is no precedent guiding enforcement of Reg BI. This blank slate gives the SEC wide latitude to interpret Reg BI, and the SEC’s Division of Enforcement significant discretion in enforcing the rule,” Wolfe said.

How do broker-dealers avoid becoming a test case for the SEC’s best interest standard?

“Firms that anticipate, or are facing SEC investigations or enforcement actions, should document steps that they have taken to enhance their compliance programs, policies, and procedures under Reg BI, so they are positioned to educate regulators (or courts, if necessary) about the affirmative steps that they have taken to comply with Reg BI,” Wolfe warned.

The second wave of SEC enforcement “will likely consist of more nuanced enforcement actions, challenging conduct where the application of Reg BI is less clear,” the attorney warned.

For instance, the SEC may challenge if broker-dealers have acted consistently with their duty of care and best interest, including with regard to consideration of alternative investment products, Wolfe said.

The agency may also question if self-directed online investment platforms make “recommendations” of investment products or strategies within the meaning of Reg BI, he added.

Of course, firms facing enforcement investigations and actions in any of these areas are not without defenses, Wolfe said.

The “SEC consciously considered and rejected imposing full fiduciary duties on broker-dealers in the enactment of Reg BI. Thus, to the extent the Division of Enforcement attempts to convert Reg BI into a quasi-fiduciary duty standard in the actions it brings, it may be helpful to point to the extensive consideration of precisely that question during the notice and comment period,” he said.

The lack of precedent interpreting Reg BI’s new best interest standard may also create a double-edged sword for the SEC, Wolfe warned.

“On one hand, the SEC and its Exams and Enforcement Divisions have significant discretion to expansively interpret the scope of Reg BI.  On the other hand, broker-dealers can also employ a broad range of arguments and strategies in defense of any overly broad or aggressive enforcement action,” he added.