SEC EXAMS Division Publishes Reg. BI Risk Alert

On January 30, 2023, the SEC Division of Examinations published a risk alert with observations from initial and subsequent broker-dealer Reg. BI exams.

Reg. BI compliance became mandatory on June 20, 2020.^[1] Since then, SEC and FINRA staff have provided answers to FAQs, published prior risk alerts, and highlighted Reg. BI compliance in their respective examination, enforcement, and risk monitoring priorities reports and letters. Over time, SEC and FINRA exams focused on Reg. BI compliance have evolved from merely considering administrative and housekeeping items (like compliance with the forms and instructions) to substantive reviews and closer consideration of potential violations. This was particularly true during 2022. The SEC also commenced its first Reg. BI litigation against a broker-dealer and its personnel in June 2022.

What Now?

Brokers serving retail customers can take simple steps to harden their compliance programs to avoid problematic outcomes during exams (and later). The risk alert sheds some helpful light in this regard, including these takeaways we distilled:

1. Do not adopt generic written policies and procedures. Reg. BI compliance programs should be tailored to the firm’s business model and types of recommendations provided to retail customers. As FINRA recently opined, there is “no one-size-fits all” approach to Reg. BI compliance.
2. Do not rely on surveillance systems that pre-date Reg. BI without considering whether they need to be modified.
3. Regularly assess potential and actual conflicts of interest and available mitigating strategies. Clearly assign responsibility to a specific position or unit.  
4. Prepare and provide full and fair disclosure of all material facts relating to the scope and terms of the relationship with the retail customer and all material facts relating to conflicts of interest associated with the recommendation. But do not solely rely on disclosures as a source of mitigation of conflicts. While layered disclosure is permissible, simply posting on a website will not suffice. Firms should review disclosures regularly to ensure that they are not materially outdated, incomplete, or inaccurate. 
5. If your registered representatives have both broker and investment adviser licenses, be sure to disclose the capacity in which the particular representative is acting, and any conflicts that arise from the representative acting in dual capacities.  
6. Train your staff and continually provide them with ongoing guidance. Most personnel understand the “why.” It is important not to forget about the “how” and “what” (e.g., how to evaluate reasonably available alternatives or costs when making a recommendation, what to consider during evaluations, and what tools and methods are available to use).
7. Document and enforce policies and procedures, maintain supporting documentation centrally, and ensure that surveillance systems effectively monitor for compliance with Reg. BI and its component obligations.

What Next?

As we approach the third anniversary of the compliance date, we suspect that SEC and FINRA enforcement staff will be advancing numerous settled actions stemming from 2022 exams. The SEC Division of Examinations will also be publishing its 2023 Exam Priorities Letter within the next one to two months. This convergence of exams and enforcement outcomes should paint a clearer picture of the nitty gritty Reg. BI details on which regulators are focusing. In the meantime, reviewing Reg. BI practices, policies, and procedures should be among the top new year’s resolutions for all retail-focused brokers.

 

 

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^[1] Reg. BI imposes a “best interest” standard of conduct on broker-dealers and their associated persons when making a recommendation to a retail customer of any securities transaction or investment strategy involving securities. A broker-dealer must act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker-dealer (or natural person who is an associated person of the broker-dealer making the recommendation) ahead of the interest of the retail customer. A firm satisfies Reg. BI by complying with its obligations with respect to: (1) disclosure, (2) care, (3) conflicts of interest, and (4) compliance.