As more retail investors enter the market, regulators have moved to raise the independent broker/dealer standard of conduct beyond mere “suitability” obligations. Broker/dealers and their representatives are now expected to act in the “best interest” of the retail investor and be boldly transparent about any conflicts of interest that might arise from their sales activity.
The Securities and Exchange Commission first adopted its Regulation Best Interest rules in 2019 to improve the quality and transparency of retail investors’ relationships with broker/dealers, bringing its legal and disclosure requirements in line with “reasonable investor expectations.” The agency then gave firms time to up their compliance game.
Now comes the enforcement push. In a January 30 risk alert, the SEC put firms on notice that recent retail-focused examinations of broker/dealer compliance practices revealed numerous “deficiencies and weaknesses” that could erode investor trust in the financial system. Many of the faults that agency examiners found were common pitfalls related to the rules’ disclosure and care obligation requirements such as:
- Generic written policies and procedures not tailored to a firm’s business model
- No clearly written procedures for creating, reviewing, updating, and distributing disclosures
- No process to show that disclosures had been provided to customers prior to or at the time of the recommendation
- Vaguely worded policies and procedures that make it difficult for firm representatives to consider “reasonably available” investment alternatives, investment costs, and methods for documenting the basis for a recommendation
The SEC has indicated it intends to continue its examinations and both it and the Financial Industry Regulatory Authority, the self-regulatory organization that governs wealth managers, have already begun doling out sanctions against financial professionals for violating Reg BI. As early as September 2022, FINRA sanctioned one registered representative for “excessive” trading in a customer account.
As the crackdown ramps up, broker/dealers have begun sharing best practices amongst themselves, knowing that if one of its competitors gets sanctioned, so might their firm. Altigo, a technology platform for alternative investments, has gleaned some of these best practices after years of onboarding dozens of broker/dealer firms they partner with.
Many such best practices focus on how firms create, update and distribute the three key disclosure docs they must file and furnish to investors (whether they make recommendations or not), specifically Form CRS—which summarizes material information about the firm and aims to helps its representatives develop trust with customers—and both the individual firm and registered representative Reg BI disclosures. These three forms are typically delivered to the customer together and are generally considered living documents in that they are regularly updated to reflect new disclosures or other information.
Other best practices these broker-dealer firms recommend include:
- Adding additional suggested questions to existing disclosure documents. These questions encourage customers to ask firm reps about potential conflicts of interest as well as help reps gather more information about their customers.
- Reviewing and updating on a quarterly basis firm and firm representative conflict registers, which help broker/dealers identify, mitigate, and remove potential conflicts of interest.
- Distributing disclosure docs prior to or concurrent with a recommendation. This is standard practice, but some firms have fallen into the bad habit of providing customers with disclosures as part of subscription paperwork. It’s too late by then because distributing disclosures along with “sub docs” suggests a recommendation has already been made.
- Reviewing Reg BI policies and procedures on a frequent basis to ensure firms stay current with the rules they write to stay compliant. Annual reviews are standard practice but that’s probably not enough in light of the enforcement push.
- Redistributing disclosures after each update to ensure customers always have the most up-to-date versions.
- Training registered representatives and other staff on a firm’s compliance processes, including Reg BI.
Concurrent with FINRA’s August 3, 2022 regulatory notice warning about electronic signature forgery, broker/dealers are also strongly urged to get prior permission from customers to send disclosures and other notices electronically. Emailed disclosures aren’t compliant if the customer hasn’t consented to electronic delivery.
Many of these recommendations can be automated and broker/dealers that employ technology to help document disclosure activity, among other compliance processes, are at an advantage. Should the SEC or FINRA come calling, digital solutions can also help firms automate disclosure updates and distribution, set guardrails that restrict premature disclosure distribution, and instantly generate reports for auditors to review.
Bill Robbins is CEO of Altigo, a subscription technology company that enables secure transactions of alternative investment products between sponsors, advisors, and other participants.
