SEC: Adherence to Reg BI should be embedded in compliance culture

SEC staff in a bulletin issued Tuesday said adhering to the Investment Advisers Act and Reg BI regarding conflicts of interest is neither a “check-the-box” or “set it and forget it” exercise but instead a “robust, ongoing process that is tailored to each conflict.”

“All broker-dealers, investment advisers, and financial professionals have at least some conflicts of interest with their retail investors,” the staff said in the bulletin. “Specifically, they have an economic incentive to recommend products, services, or account types that provide more revenue or other benefits for the firm or its financial professionals, even if such recommendations or advice are not in the best interest of the retail investor. This can create substantial conflicts of interest for both firms and financial professionals.”

Firms should establish a “culture of compliance,” the staff said. “As applied to conflicts of interest, creating an environment where conflicts are taken seriously and financial professionals feel empowered and encouraged to take an active role in identifying conflicts so that they may be adequately addressed may significantly decrease the likelihood of a violation.”

Reg BI took effect in June 2020 and requires investment advisers and broker-dealers “to act in the best interest of a retail customer” when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer. It is designed to enhance the broker-dealer standard of conduct beyond existing suitability obligations and make it clear broker-dealers may not put their financial interests ahead of the interests of a retail customer when making recommendations.

The SEC already indicated it intends to hold firms’ feet to the fire related to enforcement of Reg BI, most recently when it filed a federal lawsuit in June against a California-based registered broker-dealer and five of its representatives for alleged violations of the rule.

Firms should have policies and procedures in place to monitor existing and potential conflicts of interest, with a plan to mitigate or eliminate the conflict if the conflicted advice would harm a retail investor. That plan should be regularly evaluated and updated, particularly when the firm offers new products or creates new sales goals or other financial incentives for staff.

Under Reg BI, firms must identify all potential conflicts of interest created by compensation, revenue, and benefits paid to financial professionals in the form of fees or charges for services provided, commissions, markups, payment for order flow, cash sweep programs, sales promotions, quotas, sales contests, special awards, different or variable compensation based on the product sold, and more. Conflicts can also be created with incentives tied to appraisals or performance reviews, revenue benchmarks, client transfer, and client retention, the bulletin noted.

SEC staff recommended against implementing sales goals or other compensation that create conflicts of interest and added compliance departments should actively monitor “recommendations or ongoing advice that result in additional compensation” for potential conflicts.

In some cases, conflicts must be mitigated or eliminated, the bulletin said, depending on their nature and significance within each firm.

Once the conflicts are identified, they must be disclosed to investors in a manner “designed to allow retail investors to make a more informed decision about a recommendation, and, in the case of investment advisers, provide informed consent to the conflict of interest,” the bulletin said.

Handling conflicts of interest should not be a once-a-year endeavor but instead should be revisited and revised often as business conditions change.

“Firms should monitor conflicts over time and assess periodically the adequacy and effectiveness of their policies and procedures to help ensure continued compliance with Reg BI and the (investment advisers) fiduciary standard,” the bulletin said.