SEC examiners flag deficiencies in Reg BI compliance

Under Reg BI, which took effect in 2020, financial professionals are obligated to act in the best interests of a customer when offering investment strategies involving securities.

Examiners at the SEC’s Division of Examinations found firms implemented generic policies and procedures for Reg BI compliance that were not tailored to their business model, according to the alert. In some cases, firms simply restated the rule’s requirements without offering any guidance or guidelines.

For example, some policies and procedures did not explain when disclosures would be required and when those disclosures should be updated. Others did not have a process to demonstrate disclosures had been made to retail customers, making it difficult for the firm to determine whether it followed the disclosure obligation of the rule.

On compliance with Reg BI’s care obligation, the SEC found firms did not provide employees with adequate guidance on how to consider reasonably available alternatives or the costs of their recommendations.

Some firms created systems their employees could use to determine costs but in assessing compliance had no way to ensure the systems were being used, the alert said. Examiners also found firms did not provide enough guidance in their policies about when employees should document the basis for their recommendations or what specific information should be gathered.

A well-designed Reg BI compliance program should have both a training program and periodic review and testing, the alert said. Examiners found at some firms, surveillance systems designed before Reg BI took effect were not reasonably designed to prevent, detect, and correct violations of Reg BI regarding the recommendation of rollovers, account recommendations, and implicit hold recommendations.

Firms’ surveillance systems often measured only executed transactions for compliance with Reg BI, ignoring hold recommendations and recommendations that were not accepted by the retail customer. As a result, firms were unable to determine whether these recommendations complied with Reg BI.

Examiners also identified shortcomings in Reg BI compliance training programs.

For Reg BI’s conflict of interest obligation, firms’ policies and procedures failed to explain how conflicts should be identified and addressed. They also did not specifically prohibit in their policies and procedures certain sales incentive activities, including “sales contests, sales quotas, bonuses, and noncash compensation that were based on the sales of specific securities or specific types of securities within a limited period of time,” the alert flagged.

Policies and procedures at some firms did not specify how to modify practices to reasonably reduce conflict of interest violations, instead relying on disclosures alone to mitigate conflicts of interest.

Broker-dealers who also serve as investment advisers have an obligation to make capacity and conflict of interest disclosures to customers and avoid lack of clarity around which capacity the employee was making a recommendation, the alert said.

The SEC and other regulators, including the Financial Industry Regulatory Authority, have previously offered guidance to firms regarding compliance with Reg BI. The SEC filed a lawsuit in June against a California-based broker-dealer that allegedly sold high-risk debt securities to investors who weren’t fully aware of the risks.