Broker-Dealers Struggle to Comply with Regulation Best Interest

Three years after the implementation of the Securities and Exchange Commission's Regulation Best Interest (Reg BI), broker-dealers are still facing challenges in meeting the advice standard, as highlighted by state securities regulators.

The North American Securities Administrators Association (NASAA) has recently released its third assessment of the compliance landscape in relation to Reg BI. This update follows earlier evaluations by state regulators, which focused on analyzing the disparities in advice standards between registered investment advisors and brokers prior to the SEC's adoption of the rule. NASAA also conducted its first review of broker compliance after Reg BI took effect in June 2020.

According to Andrew Hartnett, President of NASAA, the results of the latest review present a mixed picture. "This report indicates that firms have made some progress in implementing the rule since the previous NASAA report in 2021, but there is still room for improvement," he says. "Despite Reg BI being in effect for over three years, state securities regulators continue to conduct examinations for compliance."

The latest NASAA report draws on examinations of more than 200 broker-dealer firms, with a particular focus on their handling of costly, complex, and risky products like leveraged and inverse ETFs, private placements, and variable annuities.

Reg BI was introduced by the SEC with the goal of elevating the standards of conduct for brokers who provide advice to retail investors. However, it stopped short of imposing fiduciary obligations that apply to registered investment advisors.

The resulting rule-making package emphasizes upfront disclosures concerning fees and conflicts of interest. The expectation is that brokers would put forth a reasonable effort to evaluate alternative investments, ensuring that they align with clients' goals and risk tolerance while keeping fees and expenses at a minimum.

Nasaa Report Highlights Compliance Efforts

The latest findings from Nasaa reveal both positive and negative trends in compliance efforts among financial firms. On the bright side, more firms are implementing compliance policies and procedures specifically tailored to Reg BI (Regulation Best Interest). Additionally, these firms are developing more detailed investor-profile forms to gain a deeper understanding of clients' sophistication, goals, and risk tolerance.

However, Nasaa also notes that a significant number of firms are still neglecting to record clients' education level. Regulators emphasize that education level is crucial in determining investors' ability to comprehend the complex terminology often associated with risky products.

Focusing on the positive, Nasaa acknowledges the efforts made by firms to establish rules that limit access to complex or risky products based on factors such as a client's age, risk profile, and net income or worth.

Unfortunately, the report highlights some concerning findings. It states that "some firms are still ignoring common lower-cost and lower-risk products as part of the reasonably available alternative comparison." Furthermore, Nasaa identifies a lack of uniformity in effective conflict mitigation strategies across different firms.

To address these issues, Nasaa encourages the implementation of product-specific restrictions for certain clients, limiting their access to complex investments. Additionally, it recommends that firms adopt monitoring programs capable of generating exception reports. These reports would facilitate investigations into instances where firm personnel may have circumvented existing controls.

Moreover, Nasaa suggests that firms utilize cost-comparison tools to evaluate lower-cost alternative products more effectively. However, the report reveals that some firms have relied on "checkbox-style attestations" in their documentation of client discussions. These attestations merely indicate that other investment options were discussed without specifying any reasonably available alternatives.

Overall, Nasaa's report serves as a reminder to financial firms to prioritize compliance efforts and enhance their conflict mitigation strategies. By doing so, firms can better serve their clients' best interests while maintaining regulatory standards.