Training, conflict of interest early pain points of Reg BI compliance

Reg BI, which took effect June 30, is intended to enhance the quality and transparency of retail investors’ relationships with investment advisers and broker-dealers, bringing the legal requirements and mandated disclosures in line with reasonable investor expectations while preserving access (in terms of choice and cost) to a variety of investment services and products.

Under Reg BI, broker-dealers are required “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 that broker-dealers may not put their own financial interests ahead of the interests of a retail customer when making recommendations.

In order to comply with Reg BI, financial institutions and the financial advisers and broker-dealers who work for them must implement a series of policies and procedures; provide training on those policies and procedures for all affected staff; provide customers with cost risks and rewards of certain choices; and make certain disclosures regarding fees, conflicts of interest, and how the firm is being compensated.

The SEC, its Office of Compliance Inspections and Examinations (OCIE), and the Financial Industry Regulatory Authority (FINRA) have adopted a principles-based approach on enforcing Reg BI, which means firms have flexibility to design their compliance program based on their circumstances. The best approach is to establish policies and procedures that are reasonably designed to prevent placing the financial adviser’s interest over the customer’s interest, said Lourdes Gonzalez, assistant chief counsel for sales practices in the SEC’s Division of Trading and Markets, during Monday’s forum.

Some financial institutions are “focusing on the requirements rather than how to comply with the rule,” said John Polise, associate director of the OCIE’s Broker Dealer and Exchange Examination Program. Some firms are simply finding and replacing suitability—the previous standard for discussing options for different financial products—with Reg BI, he said.

Bill St. Louis, FINRA’s senior vice president for member supervision, said some financial institutions are going above and beyond to ensure their training is hitting home by posting the results of training tests or even fining registered representatives who do not complete the required training on time.

The key piece of training, St. Louis said, is that it teaches financial advisers and broker-dealers “how to comply, not just what the requirements are.”

A big area of concern for regulators is that firms are “failing to appropriately distinguish between suitability (of options) without really harmonizing with Reg BI and FINRA rules,” St. Louis said.

Another area of concern is cost and how the risks associated with particular financial products are being transmitted to customers.

Financial institutions “have to think of cost more broadly,” Gonzalez said. “Baked in” costs like markups, deferred sales, and liquidation costs should be explained and disclosed to consumers, she said.

“That doesn’t mean the lowest cost option is the best—other factors should be considered as well,” she said.

While some firms have simply decided to eliminate some of their high-risk or high-cost offerings in order to avoid running afoul of Reg BI, others are simply defaulting to the lowest cost options. Neither approach is necessarily the best one, the regulators said.

“A firm may not use a limited menu as an excuse to not comply with Reg BI,” Gonzalez said.

There has been confusion over whether some financial products can create a conflict of interest, the regulators said. Forgivable loans, for example, are considered conflicts of interest in most cases, and a firm needs to carefully consider how to mitigate or eliminate the conflict of interest.

Another less transparent form of conflict of interest is created when vendors pay reimbursements or gifts to customers, Polise said. Financial institutions need to make sure these payments are consistent with Reg BI.

Most firms are complying with the requirement in Reg BI that disclosures be written in plain English, but regulators took pains to remind institutions that even complex financial products need to be discussed in an understandable way.

For more information visit the SEC’s frequently asked questions on Reg BI, which are updated regularly.