When regulators assess a broker-dealer’s operations, they will scrutinize how the firm adheres to Regulation Best Interest (Reg BI), the advisory standard for retail clients that took effect in June 2020.
More than four years later, many brokers continue to grapple with full compliance with this regulatory framework.
The Securities and Exchange Commission (SEC) recently issued a risk alert highlighting key areas where brokers are failing to meet Reg BI standards, signaling that the Division of Examinations will intensify its focus on firms' Reg BI compliance during routine inspections.
"Moving forward, the division intends to integrate Regulation Best Interest compliance into retail-focused examinations of broker-dealers, especially those that encompass sales practices within the examination scope," the SEC stated.
One major area of non-compliance involves the "compliance obligation," which mandates that firms implement and maintain policies and procedures to comply with Reg BI.
For example, a key component of Reg BI requires firms to provide disclosures about fees and other practice areas. SEC examiners found that some brokers did not specify in their policy documents when these disclosures should be made or updated. Additionally, some firms lacked a mechanism to confirm that retail clients had received and reviewed these disclosures.
Another significant shortfall in Reg BI compliance is related to the requirement that brokers evaluate a range of investment options to ensure they act in the client’s best interest. Examiners noted that some firms did not offer sufficient guidance to their front-line advisors on how this vetting process should be conducted. In some cases, systems were developed for advisors to assess a basket of comparable products, but their use was not mandated.
Risk alerts, such as this week’s Reg BI bulletin, serve as a critical tool for the SEC to provide compliance guidance and share cautionary examples with the entities it regulates. While these alerts aim to be constructive, they also serve as a reference point for examiners when identifying compliance failures, indicating that a firm should have been aware of these risks.
"The division is issuing this risk alert to highlight deficiencies observed during examinations, as well as to provide examples of weak practices that could result in deficiencies," the SEC explained. This alert is intended "to assist broker-dealers in reviewing and enhancing their compliance programs related to Regulation Best Interest."
The risk alert also underscored additional potential deficiencies. Reg BI requires brokerage firms to test their systems and train personnel to ensure compliance. However, examiners found that some firms were relying on outdated systems that predated Reg BI and were not sufficiently updated to meet the new regulatory requirements.
Furthermore, some firms established surveillance systems to monitor and evaluate whether brokers’ recommendations complied with Reg BI, but these systems only tracked executed transactions. Recommendations to hold assets or those rejected by clients were not monitored.
Similarly, some brokers’ systems for detecting prohibited activities were limited to well-known misconduct, such as churning (excessive trading to generate commissions), or employed language that examiners deemed too generic. For instance, firms might flag conflicts of interest related to compensation but fail to specify how certain conflicts could lead to recommendations that generate additional fees or commissions.
