PANC 2022: Reg BI Compliance Tips From the SEC

The first day of the 2022 PLANADVISER National Conference, held this year in Scottsdale, Arizona, featured an in-depth discussion with three staffers at the Securities and Exchange Commission.

The speakers were Jacob Krawitz, senior special counsel in the Division of Investment Management; Kelly Shoop, branch chief in the Office of the Chief Counsel in the Division of Trading and Markets; and Roberta Ufford, senior special counsel at the Analytics Office’s Industry Specialist Unit of the Division of Investment Management.

The SEC speakers discussed the ongoing enforcement of the Regulation Best Interest package, which is now in full enforcement. They also covered other SEC regulatory efforts, including proposed regulations concerning money market funds, ESG investments and cybersecurity.

As the staffers emphasized, the enforcement of Reg BI is now in full effect, as is the SEC’s updated interpretation of the fiduciary duty as prescribed by the Investment Advisers Act. This means advisers and broker/dealers alike must be cognizant of the fact that “suitability” is not a sufficient standard when it comes to making product or account recommendations.

According to the panel, under Reg BI, when making a recommendation to a retail customer, a brokerage professional must act in the best interest of the retail customer at the time the recommendation is made—without placing their own financial or other interest ahead of the retail customer’s interests. This general obligation is satisfied only if a brokerage professional complies with four specified component obligations applying under Reg BI, as follows:

• The disclosure obligation requires that brokerage professionals provide certain required disclosures before or at the time of a recommendation, addressing the merits of the recommendation and the details of the relationship between the broker and the retail customer;
• The care obligation requires that brokerage professionals exercise reasonable diligence, care and skill in making the recommendation;
• The conflict of interest obligation demands that brokers establish, maintain and enforce written policies and procedures reasonably designed to address/mitigate conflicts of interest; and
• The compliance obligation orders brokers to establish, maintain and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest.

The panelists noted that Reg BI casts a wide net, and explained that the determination of whether a broker/dealer has made a recommendation that triggers the application of Reg BI turns on the facts and circumstances of a particular situation. Therefore, whether a recommendation has been made is not susceptible to a “bright line definition.”

The SEC staffers also noted that factors considered in determining whether a recommendation has taken place include whether the communication could be reasonably viewed as a call to action, or if it can be reasonably viewed as likely to influence an investor to trade a particular security or group of securities. As a rule of thumb, the more individually tailored the communication to a specific customer or group of customers about a security or group of securities, the greater the likelihood that the communication may be viewed as a “recommendation.”

Importantly, the speakers pointed out, Reg BI does not apply to investment advice provided to a retail customer by a dually registered professional when acting in the capacity of an investment adviser. This is true even if the retail customer has a brokerage relationship with the dual-registrant or the dual-registrant executes the transaction in a brokerage capacity. Furthermore, to trigger the best interest standard, a recommendation does not have to be positive in nature. That is, an explicit hold recommendation also triggers Reg BI, as do implicit hold recommendations that are the result of agreed-upon account monitoring between the broker/dealer and retail customer.

The panel pointed to the following practices that firms may consider putting in place to avoid Reg BI issues:

• Avoid compensation thresholds that disproportionately increase compensation through incremental increases in sales;
• Minimize compensation incentives for employees to favor one type of account over another, or to favor one type of product over another, such as proprietary or preferred provider products, or comparable products sold on a principal basis;
• Eliminate compensation incentives within comparable product lines by, for example, capping the credit that an associated person may receive across mutual funds or other comparable products across providers; and
• Implementing supervisory procedures to monitor recommendations.