What the SEC Thinks of Reg BI Compliance So Far

Staff members of the Securities and Exchange Commission share some words of wisdom for advisers and broker/dealers newly subject to the Regulation Best Interest framework.

The U.S. Securities and Exchange Commission (SEC) held a public hearing Monday afternoon, called to present insights gleaned from the first round of Regulation Best Interest (Reg BI) compliance inspections.

Reg BI took effect June 30, despite the ongoing challenges presented by the coronavirus pandemic. Introducing the hearing and explaining the decision not to delay the implementation of Reg BI, SEC Chairman Jay Clayton emphasized the importance of addressing potential conflicts of interest during a period of major market stress.

“Though we understood the challenge presented to registered firms, we believed it was important for these new obligations to apply during the economic downturn associated with the pandemic,” Clayton said. “As we all know, Reg BI applies a best interest standard to account recommendations. This kind of decision often comes at a critical point, most often around the date of retirement. Investors making these decisions during the downturn deserve these enhanced protections.”

Before turning the spotlight over to a panel of SEC and Financial Industry Regulatory Authority (FINRA) staff members, Clayton commended firms for their efforts to comply with the complicated new set of requirements included within Reg BI. 

“I am pleased to say that firms are generally meeting their obligations, according to our initial reviews,” Clayton said. “The initial examinations have focused on assessing whether firms have made good faith efforts to comply, and, for the most part, they have. There are areas where improvements are needed. Often, the Customer Relationship Summary Form [Form CRS] could be clearer and otherwise improved. In too many cases, firms did not provide required information in the Form CRS about disciplinary history.”

Clayton encouraged listeners to review the FAQ documents and other guidance published in recent months by the SEC. He then turned the presentation over to Rina Hussain, assistant director in the SEC’s Office of Compliance Inspections and Examinations (OCIE); John Polise, an OCIE associate director; Lourdes Gonzalez, assistant chief counsel for sales practices in the SEC Division of Trading and Markets; and Bill St. Louis, FINRA senior vice president, member supervision.

Polise echoed Clayton’s comments that firms have generally made solid efforts to implement effective Reg BI compliance policies and procedures. One common shortcoming he has seen so far is that some firms’ compliance procedures merely restate Reg BI’s standards, rather than actually detail the steps and efforts that are required to achieve compliance, based on the firm’s unique business model and situation.

“In some cases, we have told firms there needs to be more context and usable information for staff,” Polise said. “Of course, there is a lot of room for firms to create processes and procedures that meet their unique situation, and we encourage that.”

Gonzalez said one apparent point of confusion she has identified has to do with the difference between disclosing and resolving conflicts of interest. These are not the same thing, she said.

“Though it is a broad, principles-based rule, there are certainly cases where you will be required to solve conflicts of interest under Reg BI, not merely to disclose them,” she warned. “The policies and procedures should specifically address areas of the business where disclosure is not sufficient.”

St. Louis said FINRA has a similar perspective to the SEC in these areas, and he encouraged firms to go back and review the SEC’s FAQs. He said FINRA examiners have been assessing how firms are complying with Reg BI.

“Some concerns that we’ve seen vis-à-vis the compliance obligation: procedures that have been developed, but have not been memorialized or not memorialized adequately and procedures that lack detail as to who, when and how,” St. Louis said. “For example, responsible individuals are not identified; procedures lack specificity, vis-à-vis steps or the cadence of certain steps and also a lack of controls around testing; no plans for testing of the procedures; and no plans around the testing of recordkeeping requirements. Reg BI has a number of recordkeeping requirements and that’s an area of concern for us that we see some firms have not, the procedures are not that good in that area and very little plans for testing.”

FINRA has also identified a lack of proactive testing of Reg BI’s recordkeeping processes and procedures. “Many firms are reviewing or already reviewed their product mix with a focus around associated costs and/or the reasonably available alternative analysis. So for example, we’ve seen firms make adjustments to what mutual fund or VA [variable annuity] fund share classes they’ll offer,” he said.

We’re seeing a failure to appropriately distinguish between suitability and Reg BI,” St. Louis added. “Many firms seem to have layered on Reg BI into their procedures leaving suitability there without really paying attention to harmonizing the two. Obviously, Reg BI has new requirements and FINRA Rule 2111 is still needed. It’s still on the books. It’s got a narrower focus that really speaks to recommendations to non-retail investors and we think it’s important for firms to highlight the difference and the applicability.

Polise said one final weakness that has been identified in the area of staff training relates the aforementioned issue of overly technical processes and procedures.

“As we saw with the written policies and procedures, there can be a tendency with training to focus too much on the technical details of the rules versus discussing how firms are actually going to comply with the rules,” he explained. “A word of warning: If you haven’t conducted any such training, please do so. If you have, please go back and confirm that you have given enough practical guidance on how to actually comply with Reg BI in the specific context of the practice. That’s key moving forward.”