Subject: Regulation Best Interest

You Might Want to Write Down Why You Recommended that Rollover

Since Regulation Best Interest’s (Reg BI) June 30, 2020 compliance date, the Division of Examinations of the Securities and Exchange Commissions (the Division) has been busy implementing examinations of broker-dealers to assess compliance with the regulation. The Division is planning to include Reg BI compliance into future examinations of broker-dealers. Therefore, the Division issued a Risk Alert on January 30, 2023 calling attention to deficiencies found during broker-dealer compliance examinations, as well as certain inadequate practices that might lead to deficiencies. Broker-dealers should pay attention to the issues identified by the SEC so that they do not expose themselves to regulatory trouble later down the line.

Some of the exposed weaknesses and deficiencies regarding the Reg BI Care Obligation1 involved inadequate written policies that directed financial professionals to document the basis for their recommendations but failed to state when doing so is required or which information is needed. Under Reg BI, financial professionals are required to make account recommendations that are in the best interest of the retail investor. Doing so is especially important when a financial professional is recommending a significant financial transaction to a retail investor, like an account rollover recommendation.

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New Year’s Priorities: FINRA Releases its 2023 Report on its Examination and Risk Monitoring Program

Yes, (somehow) it is that time of year again. FINRA recently released its 2023 Report on its Examination and Risk Monitoring Program (the “Report”). As is typical (and this blog has well-covered), it contains a mix of old and new priorities.

Priorities Previously Included: Reg BI and Form CRS, Consolidated Audit Trail (CAT), Cybersecurity, Mobile Applications, Best Execution

New Priorities: An entire new category labeled Financial Crimes, Manipulative Trading, Fixed Income – Fair Pricing, Fractional Shares: Reporting and Order Handling, Regulation SHO

In general, FINRA breaks down the Report into five Categories: (1) Financial Crimes; (2) Firm Operations; (3) Communications and Sales; (4); Market Integrity; and (5) Financial Management. Within these categories, FINRA highlighted certain discrete topics. We discuss FINRA’s highlighted topics at greater length below.

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Rollover Recommendations – Do the SEC and DOL Requirements Align?

Key Takeaways

The SEC and the DOL have separately issued guidance on rollover recommendations – however, a close examination indicates that the guidance by both agencies is very similar. The SEC’s guidance for broker-dealers is in Regulation Best Interest and a recent Staff Bulletin on account recommendations. The DOL’s guidance about rollover recommendations came in the form of an expanded interpretation of fiduciary advice found in the Preamble to PTE 2020-02 and a set of Frequently Asked Questions. These pieces of guidance share the following three principles: (1) a best interest standard, (2) a process to support that best interest standard that requires consideration of relevant factors about the investor, the investor’s current retirement account and the recommended rollover account, and (3) documentation supporting the basis for the recommendation.

There are a few differences between the SEC and the DOL guidance that broker-dealers and their registered representatives should know about, including that the SEC rollover guidance is applicable to a much broader array of retirement plans and accounts, and also that the SEC guidance does not require a disclosure about the best interest reasons for the rollover recommendation as does the DOL under PTE 2020-02.

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And Now for the SEC’s First Substantive Reg BI Action

We have made it a point previously in this blog to track developments of the SEC’s Regulation Best Interest (Reg BI), even speculating more aggressive enforcement actions could be coming due to certain Reg BI deficiency letters sent to firms late last year. Since Reg BI went into effect in June 2020, however, many have waited with bated breath to see what enforcement of the regulation would look like in practice. While the SEC has pursued some cases regarding firms missing deadlines and omitting certain information in disclosure documents, it had taken no further action until June. On June 15, 2022 the SEC finally took its first substantive Reg BI action by filing a civil regulatory complaint in the U.S. District Court for the Central District of California against Western International Securities, Inc. and five of its brokers for allegedly selling a risky debt security, known as corporate L Bonds, to its retail customers. The Complaint invokes Section 15l-1(a) of the Securities and Exchange Act of 1934 — Regulation Best Interest — and seeks to enjoin the Defendants from the acts, practices and courses of business described in the Complaint.

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The Convergence Continues: SEC Staff Bulletin on Standards of Conduct for B-Ds and RIAs

On March 30, 2022, the SEC issued “Staff Bulletin: Standards of Conduct for Broker-Dealers and Investment Advisers Account Recommendations for Retail Investors” (SEC Retail Standards Bulletin). This guidance builds on prior SEC guidance regarding Regulation Best Interest (Reg BI) and the SEC’s “Main Street” initiatives impacting investment advisory firms since the SEC’s self-reporting “Share Class Selection Disclosure Initiative” announced just over four years ago. In the intervening years, the SEC issued a FAQ “Regarding Disclosure of Certain Financial Conflicts of Interest Related to Investment Adviser Compensation” and issued the Reg BI rulemaking package that included the “Commission Interpretation Regarding Standard of Conduct for Investment Advisers.” This blog has covered all of these developments and, regarding the once separate standards of conduct for brokerage and investment advisory firms, described the developing convergence of these standards as they apply to retail investors.

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Exam Time: FINRA Releases its 2022 Report on its Examination and Risk Monitoring Program

A common phrase to abide by in the New Year is “out with the old, in with the new.” FINRA’s 2022 Report on its Examination and Risk Monitoring Program (the “Report”), however, contains a combination of old and new priorities. We previously previewed the Report.

Old priorities, once again included, are: Anti-Money Laundering, Reg BI and Form CRS, and cybersecurity.

New risk areas include: firm short positions and fails-to-receive in municipal securities; trusted contact persons; funding portals and crowdfunding offerings, disclosure of routing information; and portfolio margin and intraday trading.

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Brace for Impact: It’s Going to be (Another) Busy Year for FINRA

F. Scott Fitzgerald said “There are only the pursued, the pursuing, the busy, and the tired.” FINRA may be all of these in 2022, as FINRA CEO Robert Cook announced FINRA’s laundry list of priorities during a SIFMA Q&A last week. Below are some of the highlights from his Q&A.

Exam Time: Annual Exam and Risk Monitoring Findings

While Mr. Cook advised the “ink isn’t dry” on the 2022 priorities, he suggested broker-dealers can expect more of the same, with some new additions. New topics for examination will include: trusted contact person, disclosure of order routing, and intra-day trading.

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Reg BI: What’s Going On and What May Happen Next?

SEC Chair Gary Gensler has not publicly stated much regarding Reg BI since Spring of this year. Generally, though, the messaging from SEC leadership regarding the Division of Examinations and the Division of Enforcement continues to be aggressive. In the retail investor area, for example, in late August Chair Gensler appointed Barbara Roper, the Director of Investor Protection for the Consumer Federation of America, as a Senior Advisor to the Chair. Turning back to Reg BI specifically, what we continue to hear out of the SEC is that Chair Gensler’s regime is going to play the Reg BI “hand that it has been dealt” aggressively.

On November 4, 2021, SEC Commissioner and former Acting Chair Allison Herren Lee gave a speech at ACLI’s CLE 2021 Conference on Life Insurance Products entitled “A Call to Action: Recommendations for Complying with Reg BI.” Commissioner Herren Lee covered several Reg BI topics, including what constitutes a recommendation and mitigation. Regarding recommendations, she noted that the Commission’s supplemental materials accompanying Reg BI speak of a “call to action” that may be viewed as influencing an investor to invest in or trade a particular security being enough to constitute a recommendation. On this topic, she emphasized the importance of the account opening process. Commissioner Herren Lee also addressed mitigation, in particular to manage the risk of an associated person putting their interests ahead of their customers, perhaps due to limitations in the firm’s products menu.

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Robinhood vs. Massachusetts’ Secretary of the Commonwealth: A Battle for the Ages over Massachusetts’ New Strict Fiduciary Duty Rule

Massachusetts’ Secretary of the Commonwealth, William Galvin, is taking on Robinhood for violating Massachusetts’ new fiduciary duty rule for broker-dealers. In December 2020, Galvin filed a 24-page regulatory complaint, seeking to ban the popular trading app for violating the State’s strict fiduciary duty rule that requires broker-dealers to act in the best interest of their clients. Galvin raised three different violations against Robinhood that allegedly fell short of the new strict fiduciary standard. This new rule, passed in February 2020, was created in response to the Securities and Exchange Commission’s Regulation Best Interest (Reg BI), which Massachusetts believed did not go far enough. Reg BI bars brokers from putting their own financial interest above those of their clients, but fails to define what it means to act “in the customers’ best interest” or mandate that brokers recommend a single best product. While Reg BI requires the disclosure and mitigation of conflicts of interest, Massachusetts felt this requirement was also lacking. Galvin stated that Reg BI is “basically a souped-up version of the suitability standard,” and felt a new State rule was necessary to protect the growing crowd of young investors in the State. During this past year, due to COVID-19 and other meme-based investment activities on the application, Robinhood accumulated over 3 million new users in the first four months of 2020. Galvin’s concerns revolve around the 500,000 customers in Massachusetts, with accounts totaling over $1.6 billion.

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