Are brokers acting in the best interests of their clients? “Not Yet,” Says FINRA | rumberger | Church

Noting Gaps, FINRA Suggests Best Practices for Reg BI Compliance

In its first-ever Best Interests Regulation (Reg BI) compliance review, the Financial Industry Regulatory Authority (FINRA) found that a significant number of broker-dealers were failing to achieve full compliance. By pointing out the most common shortcomings, the agency presents a guide to help industry members focus their due diligence. RumbergerKirk partner Pete Tepley walks us through it.

The SEC’s adoption of Reg BI in 2019, which I wrote about in 2020, imposed a standard of conduct for financial advisers and other broker-dealers, as well as added transparency for clients. Under the Reg BI standard, brokers and their Associated Persons (APs) can never put their own financial interests or those of their business ahead of those of their retail clients.

Most recently, in February 2022, FINRA released its first detailed performance review against Reg BI and related regulatory compliance. As this report makes clear, too many people in the industry have not fully adopted or implemented the requirements of Reg BI.

Recalling the fundamental principles of Reg BI, when recommending a securities transaction or an investment strategy or when recommending an account, companies and APs must comply with four fundamental obligations relating to:

  • Disclosure: what should be shared with customers?
  • Care: What processes are in place to ensure strategies and products are tailored to a specific client?
  • Conflicts of Interest: These should be eliminated, mitigated or, if unavoidable, fully disclosed.
  • Compliance: Demonstrate governance to ensure these obligations are met

The Reg BI portion of FINRA’s 2022 report examines a series of shortcomings. Here are some important points.

Learn from the mistakes of others

With respect to compliance, FINRA divides deficiencies into two broad categories:

  • Written Supervisory Procedures (WSP) that are not Reg BI compliant
  • Inadequate endpoint training on how to comply with Reg BI requirements

Specifically, FINRA found that some firms’ WSPs:

  • Simply stated Reg BI requirements without detailing how the company would comply
  • Has not explained how its APs should consider costs and Registered Annuity Advisors (RAAs) when making recommendations
  • Failed to address conflicts of interest that cause access points to put their interests ahead of those of their customers

FINRA has also found that some companies either did not develop adequate controls or developed controls but did not document their controls. Companies also provided inadequate training, not preparing their endpoints for compliance with Reg BI. FINRA specifically found that the training was either unclear or did not provide APs with specific steps to follow.

Regarding the obligation of care, FINRA found that companies and APs were:

  • Make recommendations that were not in the best interest of the client based on their personal circumstances
  • Recommend an excessive series of trades given the client’s investment profile

Skip to conflicts of interest, FINRA has found situations where these issues were not identified or, if identified, were not adequately addressed. Regarding the disclosure obligations, FINRA found that clients were not receiving full and fair disclosure of material facts, including:

  • Material fees received from referrals, such as revenue sharing, payments from product providers or issuers, or fees related to renewal referrals
  • Potential conflicts of interest when the PA traded the same securities or had an outside job
  • Material limitations on the securities offered

FINRA Recommended Best Practices

To help address the shortcomings, FINRA has provided a list of effective practices it considers effective in meeting Reg BI obligations. Key steps include:

  • Provide resources to help PAs and RAAs assess annuities such as:
    1. Electronic or paper sheets to compare investment costs
    2. Guidance on relevant factors for PAs to consider when evaluating competing and often less risky or complex products
    3. Tools that automatically compare recommended products
  • Review of customer transaction samples to determine how the AP has accounted for investment costs
  • Revise commission schedules
  • Eliminate sales contests
  • Limit risky or complex products for customers by:
    1. Product reviews that categorize the level of risk and complexity of products offered to customers
    2. Limit high-risk or complex products to specific customer types
    3. Apply enhanced monitoring to risky or complex product recommendations
  • Implement monitoring processes that look for the sale of the same products to a high number of customers
  • Perform branch exams with Reg BI specific exams

FINRA also advises that if a company has not already done so, it should take steps to ensure:

  • Its WSPs detail how Reg BI obligations are met. It is not sufficient to simply mention the obligations of Reg BI or to remove the words “suitable” or “suitability” in the existing WSPs and replace them with a variation of “best interests”.
  • Its PAs are trained on Reg BI obligations and how to meet them and have the right resources and tools to do so
  • It verifies and tests compliance with Reg BI obligations
  • This means identifying and monitoring complex and high-risk products, limiting the customers to whom they can be offered and ensuring enhanced monitoring when they are offered.
  • It eliminates and mitigates conflicts of interest, including eliminating sales contests and disclosing conflicts when they cannot be eliminated.

While complying with any new regulations can be challenging, thoroughly implementing measures to address Reg BI can help protect customers from investments that are not in their best interests while helping to protect businesses and PAs against the risk of litigation.

This article was originally shared on Corporate Compliance Information April 13, 2022 and is republished here with permission from the publication.

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