Some broker-dealers are failing when it comes to compliance with critical retail sales and advice regulations including Regulation Best Interest, Form CRS and best execution rules, according to the 2022 Report on Finra's Examination and Risk Monitoring released today.

The report, which broker-dealer chief compliance officers often use as a blueprint for spending to shore up compliance in the coming year, reveals that Finra examiners found a number of alarming Reg BI violations during 2022.

“As most firms have experienced, we spent a lot of time on Reg BI in many of our exams. And we focused a lot of the time on procedures and processes and Form CRS. I think we're going to be moving more towards delving in a little deeper on point-of-sale issues,” Michael Solomon, Finra’s senior vice president of exams, said in a new podcast on the exam findings.

Top Reg BI violations that Finra examiners found were the following:
• “Making recommendations of securities or investment strategies (including account type) without a reasonable basis to believe that they were in the best interest of a particular retail customer.”
• Recommending a series of transactions “that were excessive in light of retail customers’ investment profiles and factors such as high cost-to-equity ratios and high turnover ratios.”
• Limiting consideration of cost solely to sales charges instead of also considering other relevant costs and fees, such as product- or account-level fees, when recommending a product, Finra said.
• Not maintaining profile information for retail customers, which undermines the firm’s ability to demonstrate compliance with the Care obligation in Reg BI, Finra warned.
• Failing to conduct a reasonable investigation of offerings prior to recommending them to retail customers. Firms that were examined were “unable to reasonably evidence due diligence efforts regarding the issuer.”
• “Failure to comply with the conflict of interest obligation, including not identifying conflicts and disclosing or, if necessary, eliminating conflicts of interest associated with recommendations of securities.“

“I think you'll likely see more churning cases. As most people know, we no longer need customer cooperation under Regulation Best Interest. Finra recently had its first enforcement case under Reg BI for churning, so you'll likely see more of those,” Solomon warned.

“We'll look more into complex products and the intersection of Reg BI with complex products, which has been a perennial issue of focus for Finra,” he added.

Solomon said he has also asked his examination team “to focus more on the new product process and how Reg BI has been incorporated into that, particularly with respect to reasonable alternatives to a new product and whether those alternatives are provided to advisors as part of the roll out of new product.”

What types of accounts reps are recommending is also likely to figure large in exams this year. “Account type recommendations is an area that we're going to look more into to make sure there's rigor in terms of deciding whether a brokerage or a fee-based product or other account types are in the best interests of the client and documenting that decision,” Solomon said.

Examiners are also likely to probe what Solomon said was “the gaming of fee-based accounts versus brokerage accounts where we're seeing some issues. And I think we're going to look to explore further things like activity in brokerage accounts before converting the account to a fee-based account.”

Not tracking the products and costs attached to reps’ recommendations could also trip up firms this year during exams. Often firms should be looking at higher-cost products and which advisors seem to be selling more higher-cost products than would otherwise be normal for that type of advisor, Solomon warned.

From a firm perspective, "we're going to spend more time looking at [firms’] conflict inventories and how firms have maintained those, updated those, and addressed the conflicts that they put on those inventories,” he said.

“We've also seen some simply wrong interpretations on what is a recommendation. And so that's an area that we're going to try to bore into a little bit in terms of how firms decide on what is a recommendation, whether they're accurately doing that. So, that's just a couple of the areas that I think firms will likely see a change and pivot in what we've been looking at over the last year or two,” Solomon said.

Finra also found deficiencies in firms’ Form CRS, the centerpiece report broker-dealers are supposed to deliver to customers to adequately communicate the firm’s conflicts of interest.

Finra exams found some firms are “omitting material facts such as limitations of the firm’s investment services;” disclosing incomplete or inaccurate cost disclosures; inaccurately representing the firm’s or its financial professionals’ disciplinary histories; failing to describe types of compensation and compensation-related conflicts; and incorrectly stating that the firm does not provide recommendations.

Ornella Bergeron, Finra's senior vice president, member services, said firm’s lack of compliance with best execution rules are another trouble area. Best execution is a legal mandate that requires brokers to seek the most favorable price to execute their clients' orders within the prevailing market environment.

“First, firms are not conducting periodic regular and rigorous reviews of the quality of executions of its customer orders or customer orders from other broker dealers. Or in some cases, when conducting such reviews, not considering certain execution quality factors that are required by the rules. The other item I’ll mention is we saw issues with firms not publishing accurate quarterly reports. For example, [they’re] reporting only held orders instead of both held and not held,” Bergeron said.

Firms that are “incorrectly stating that the firm doesn't receive payment for order flow from execution venues,” is also an issue, she added.