It is clear that securities regulators have stepped up their oversight of Regulation Best Interest (Reg BI). The number of enforcement actions and large fines against individuals and firms that violate sales practice rules has increased and are expected to continue to grow in 2024.
FINRA brought over 20 Reg BI actions 2023 after eight cases in the previous year and only two in 2021. Examiners are making compliance with the comprehensive sales practice rules a top priority. The actions signal the start of what securities regulators have warned would be a “more substantive” phase in enforcing Reg BI. Indeed, SEC Chair Gary Gensler has said Reg BI will be enforced “to the letter.”
FINRA’s Role in Reg BI Enforcement: A Shift Towards Individual Accountability
A significant development is the enforcement strategy of imposing fines on individuals for sales practice violations, suggesting a departure from past enforcement actions that typically required firms, not individual brokers, to compensate harmed investors. By targeting individuals, regulators are aiming to deter sales practice misconduct by representatives and their supervisors who undermine firms’ fiduciary standards.
In a recent account-churning case, FINRA charged a broker-dealer with violating recently revised Rule 2111 (concerning suitability and quantitative suitability) that makes firms liable for trades, even when clients give representatives “actual or de facto control” of their accounts. FINRA imposed a 20-month suspension on a broker and ordered him to pay $58,000 in restitution to harmed customers. The broker was found to have violated the Reg BI Care Obligation when he “recommended a series of trades in five customers’ accounts that were excessive, unsuitable, and not in the customers’ best interest,” over two years.
In another quantitative suitability case, the SEC charged a broker-dealer with violations of Reg BI’s Care Obligation. The firm allegedly failed to supervise excessive account trading by its brokers and settled charges by paying $800,000 in fines. The firm had a monitoring system to review for excessive trading, but allegedly no system for addressing red flags. The SEC settled excessive trading charges with two individuals at the firm: one was suspended for six months and another paid $93,000 in restitution and fines.
Expanding Scope of Reg BI Examinations: Beyond Excessive Trading
We expect to see excessive trading as just one area of focus in SEC and FINRA examinations. One such area is the delivery of Reg BI disclosures. The SEC recently charged a broker-dealer for making securities recommendations to retail customers without complying with the Disclosure Obligation. In its order, the SEC affirmed its long-standing guidance on electronic delivery of disclosures, which states that, generally, broker-dealers may not rely on implied consent to evidence delivery; nonetheless, the broker-dealer defaulted approximately 360,000 accounts belonging to their existing retail customers to electronic delivery of the required disclosures using implied consent.
Anticipated Regulatory Reviews: Navigating Grey Areas in Regulation Best Interest
Up-coming regulatory reviews will likely consist of more detailed enforcement actions, addressing conduct where the application of Reg BI is less clear. For example, investigations may evaluate:
- Whether broker-dealers have acted consistently with the duty of care, including with regard to consideration of alternative investment products;
- Whether, and to what extent, broker-dealers are required to enhance their existing compliance programs to ensure compliance with the new “best interest” standard and its component obligations;
- Whether self-directed online investment platforms make “recommendations” of investment products or strategies within the meaning of Reg BI.
Upcoming exams are likely to review Reg BI practices on recommendations of products that are:
- complex, such as derivatives and leveraged ETFs
- high cost, such as variable annuities
- illiquid, such as nontraded REITs and private placements
- microcap securities
Examinations may also focus on recommendations to certain types of investors, such as older investors and those saving for retirement or college.
Oyster Consulting: Your Partner in Achieving Reg BI Compliance
Under the Conflicts the Interest obligation requires broker-dealers to establish, maintain and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest. Firms should review their procedures for the updating and delivery of Reg BI disclosures. If not completed already, firms should also review their Reg BI disclosures for accuracy, timeliness, and all possible conflicts.
Oyster Consulting’s compliance experts have extensive experience in ensuring broker-dealers and investment advisers achieve compliance with Reg BI. Oyster Consulting can help your firm review disclosures, test your supervision and review your technology platforms to ensure you are achieving compliance.
Modernizing your compliance program may be the first step you need to successfully and efficiently manage new or complex rules. Oyster Solutions compliance management software is the tool you need to stay on top of complex regulatory requirements like Reg BI. Oyster Solutions provides automated workflows, integrated policies and procedures, risk assessments and alerts to look for possible conflicts and inappropriate trades.