It was only a matter of time before the Securities and Exchange Commission moved on from asking advisors to simply “make their best effort” to comply with Regulation Best Interest, its 10-month-old investment advice rule, to actually enforcing the regulation.

Now, broker-dealers have begun receiving requests from SEC examiners asking them to justify and explain their registered reps’ investment recommendations, a panel of attorneys and former regulators said today.

“What we are already seeing in these regulator requests is that they are typically focused on … sampling firms’ data and transactions,” said David Porteous, a former SEC enforcement attorney and now a partner with the law firm of Faegre Drinker.

Porteous and others spoke during a webinar hosted by InvestorCOM on Reg BI.

According to Porteous, regulators are asking broker-dealers about particular products and customers for which there would be a greater need for documentation on transactions.

Right now, SEC examiners are watching the way firms monitor problems and trends, attorneys said.

“I’d expect them to look for patterns of recommendations of high-cost products, patterns of exchanges, [and the selling of] complex or risky products and significant trading activity, especially if that trading activity doesn’t align with customers’ risk tolerance,” said Ed Wegener, managing director of Oyster Consulting LLC. Wegener is a former vice president at the Financial Industry Regulatory Authority and was a member of the team that developed Finra’s risk-based examination program.

Looking For Patterns
SEC examiners are also “looking at patterns of complaints and what that is telling firms about the quality of recommendations,” when doing data analysis behind the scenes. “They’ll be looking for patterns of concern and asking you to respond,” Wegener said.

While the focus on product will vary from firm to firm, examiners will want to see consistency in how reps make recommendations and how firms monitor and address rising issues, panelists said.

“Certainly from a data-driven standpoint, we are seeing SEC requests that say ‘We want all transactions from X date to Y date,’” Porteous noted. “Then examiners will give you refined search criteria and further winnow down data to be able to say ‘OK, we’d like to see the information for XYZ customers to try to understand the basis of the documentation for these recommendations.’”

That usually means regulators have identified a trend or pattern they want to ask questions about to be able to determine how well reps complied with Reg BI from the product recommendation stage through the supervisory approval stage, Porteous added.

“Firms should make sure that reps have access and are using consistent information and that you have the ability to demonstrate these efforts in an examination, which I think will be shifting from a primarily procedures-based review to much more qualitative,” Porteous said.

Gary Gensler, the SEC’s chairman, said during a recent congressional hearing that he believes investors have the right to work with brokers who have their best interests at heart, noted Wegener. Gensler also said that the agency will be doing exams, enforcement and creating guidance to ensure firms fully comply with Reg BI “as written.”

This means agency examiners won’t just be looking at a firm’s technical compliance, but at how the firm monitors, discloses and resolves conflict, Wegener said.

Firms, Wegener said, should “focus on ensuring that [they] have procedures, processes and training in place that effectively support reps in making BI recommendations. They also need to effectively assess if recommendations are aligning with investors’ goals and show reasonable alternatives, features, costs and risks.”

Reps often ask, “How many products do I need to compare?”—which is where firms need to provide technology, procedures and training that allow professionals to make decisions based on comparisons of approved products showing net expenses, performance and risk. Reg BI programs that help reps document variable annuities recommendations should detail comparisons of rider fees, policy fees and maximum surrender fees, said Dave Carr-Pries, vice president of product and marketing at InvestorCOM.

Reps should also be trained to add contemporaneous notes in their comparisons that detail why they are considering a recommendation. The client may be looking for growth or may be looking to guarantee income or maximize tax savings. But these are notes that the firm will need in an SEC exam, Carr-Pries said.

“While every recommendation is different,” Wegener said, “regulators will look to see if reps are consistent when they make recommendations. [The] outcome may be different, but they should be considering the same factors. Firms should be able to demonstrate that.”