The Financial Industry Regulatory Authority is planning to complete at least 1,000 Regulation Best Interest exams of broker dealers by year's end, a Finra enforcement executive said at Sifma’s Compliance and Legal Conference yesterday.
That will mean that by year end just under one-third of Finra’s 3,300 member firms will be examined for compliance with Reg BI, the Securities and Exchange Commission’s retail advice rule, which went into effect on June 30, 2020, according to Bill St. Louis, executive vice president and head of Finra's National Cause and Financial Crimes Detection Program
While the regulator has been examining for Reg BI violations since the rule went live, officials have chosen almost exclusively to report violations in industry-wide notices such as the 2023 Finra Report on Exam and Risk Monitoring Program rather than seeking enforcement actions against firms or reps.
But a year and a half after Reg BI went live, the enforcement gloves are coming off, Finra officials said this past week.
While Finra examiners were “very understanding” in the beginning, they flagged violations for firms and expected to see course corrections,” Christopher Kelly, Finra’s acting head of enforcement, said at the Sifma conference.
A number of the firms that have been warned “still haven’t remedied the [violations] the examiners…warned them about, so those will often result in referrals to enforcement,” Kelly told industry executives and compliance staff at the conference.
St. Louis said that Finra is taking a hard look at variable annuities and has at least one Reg BI enforcement in the works dealing with conflicts surrounding the contracts.
Still, the investing public and investor advocate attorneys should refrain from expecting a significant sea change in types of enforcement, Kelly said, since some of the new enforcement cases “might have been brought under our old suitability rule.”
In February, Finra publicly announced its first Reg BI enforcement action, charging the Long Island Financial Group, a five-person broker-dealer based in Roslyn, N.Y., with failure to supervise and establish, maintain, and enforce written policies and procedures
The firm, which provides services to retail customers, focusing on sales of equities, mutual funds and variable annuities, according to Finra's order, also failed to prepare, file and deliver its Customer Relationship Summary form, known as Form CRS to clients since Reg BI went into effect on June 30, 2020.
Without admitting or denying guilt, Long Island Financial Group settled the charges for a $35,000 fine, a public censure and the requirement that it certify that it has remedied the compliance failures.
“This case may not be not be sexy like fraud or excessive trading, but it’s important because it will cause Finra registered- broker dealers to say ‘regulators are now doing these exams and we have to have these written procedures in place showing our intent to train our brokers and personnel on Reg BI compliance,’” said Joe Wojciechowski, a partner with Chicago-based Stoltmann Law Offices, which represents aggrieved investors.
“I think Finra will bring a lot of these cases. Big firms have the compliance part of Reg BI down, but smaller firms that don’t have the resources are more likely to struggle,” he added.
The veteran investor advocate attorney also said he hopes Finra will ramp up enforcement of Reg BI’s “reasonably available alternatives” requirements, which require brokers and dually registered representatives to consider individual investor’s customer investment profiles, the risks and rewards and specific limitations on the investments themselves (such as liquidity requirements), while presenting other alternative investments.
“Explain to me how a client who needs fixed income can be pitched a non-traded, illiquid REIT or similar product with no real end-date or exit plan, when there are liquid bond funds, including municipal bonds, which when taxes are taken into consideration, provide comparable yield without the insane risk and massive broker commission?” Wojciechowski asked.
“I think any time a broker, under Reg BI, sells an illiquid, high-commission alternative investment like a non-traded REIT or some private placement, there is almost always a
better alternative, if they are serious about doing the analysis, Wojciechowski said.
“Are brokers doing this? Are compliance departments and wholesalers telling their staff that they need to look at less lucrative, reasonably-available alternatives? We don't
know for sure yet. But, recent data indicates that sales of alternatives has hit all-time highs,” Wojciechowski said.
If broker-dealers can’t provide this analysis or proof it’s been shared with customers to Finra examiners, it should be a violation of Reg BI, he added.