SEC Flexes Regulatory Muscle with RIAs, Brokers in Focus

The SEC is warning advisers and broker/dealers that it is time to tighten up policies around conflicts of interest and ensure compliance with its Regulation Best Interest.

Early this month, the Securities and Exchange Commission released an updated staff memo that provides additional guidance on conflicts of interest and the enforcement of the SEC’s Regulation Best Interest rules for broker/dealers and registered investment advisers.

The memo represents the latest update to a string of publications the market regulator has released since finalizing Reg BI in 2019. Sources say the update’s Q&A format provides helpful, concrete examples of what types of compliance procedures and strategies the SEC is looking for, based on current guidance and issues that have come up in recent examinations.

Compensation practices are a key focus of the new guidance. The SEC memo emphasizes that any compensation that arises from agreements with third parties could create incentives that aren’t in a client’s best interest. It also stresses that firms must have clear processes in place to avoid the creation of adverse incentives.

Alongside this, the SEC also highlights issues that may arise from limited product menus. Limited product menus are allowed under Reg BI and other conflict of interest standards, but organizations should make sure that their offerings are not limited in a way that could lead to a conflict of interest or adversely influence the advice being offered.

Understanding the SEC’s Focus

“What we noted in a recent client update and what we are seeing from the SEC memo is that the Commission is really treating broker/dealers and investment advisers the same, in terms of their duties to clients,” says W. Hardy Callcott, a Los Angeles-based partner at the law firm Sidley. “There was some debate as to whether Reg BI would put broker/dealers on equal footing with advisers, and we think they have been, at least as it relates to conflicts of interest.”

Callcott says firms should have a process in place to monitor for conflicts of interest throughout the year and make updates accordingly. He notes that the Reg BI memo points to the role of sales representatives as a main area where conflicts may arise, and that the activities of sales reps may require firms to update their Form ADV and Reg BI disclosures if prices, products, menus or compensation changes occur.

Callcott says many broker/dealers are still working through the new requirements of Reg BI, given that they used to operate under a lesser suitability standard. But registered investment advisers are also making changes in an effort to ensure their own compliance procedures are in line with the SEC’s expanded expectations.

Mary Giconi, chief compliance officer at Fort Pitt Capital Group in Pittsburgh, says many advisers are likely to see these updates as confirmation of what they were already doing. She adds that it can be worthwhile for firms to undertake a review based on new information.

“Compliance within the adviser space has really matured over the years, especially at the larger firms,” she says. “That said, the point in the memo about not relying purely on disclosures is an important one. What we have tried to do at Fort Pitt is create a culture of compliance. That includes documentation, but it also includes constantly reviewing our processes around compensation, client service, gifts and entertainment. We try to build a culture of compliance so that it is embedded within our work.”

Giconi adds that it can be beneficial to treat compliance like an ongoing conversation within the firm, so that advisers feel like they can ask questions.

“The role of the compliance officer has changed significantly,” she says. “Compliance has really shifted from being a reports-generating department to a more dynamic part of the organization. There is a greater focus on training and building dialogue with the advisers so that we are providing the best client service that we can.”

The Compliance Dialogue

Building more dialogue into the compliance process can be helpful with client service, Giconi says, because it helps clients make informed decisions. Disclosure documents are important to provide to clients, but flooding clients with paperwork doesn’t always mean that they will read or understand everything.

Michael Mann, a partner at law firm Crowell & Moring, agrees. He says ongoing review and dialogue can uncover conflicts that may not be immediately clear.

“As markets have gotten bigger and broader, the potential for conflicts of interest to arise has become greater,” he says. “When you are dealing with complex and overlapping relationships, the question of fee disclosure, calculation and attribution can be extraordinarily complex and differ on a relationship-by-relationship basis.”

If a firm serves a diverse group of investors, for example, they each may have different agreements or needs, and these understandings may create conflicts that may or may not have been clear from the outset of the relationship. In every case, the potential for conflicts must be understood and addressed, Mann warns.

Mann notes that the rise of environmental, social and governance investing has also put a renewed focus on governance, and the SEC’s new ESG rules should also be a growing focus for registered firms.

“If you look at where the work is being done, governance is probably the most understandable component of ESG and the most measurable,” he says. “I think this is part of that piece too – looking at how firms conduct themselves and how securities laws protect investors in this broader context.”