SEC Best Interest Rule - Part 2

How do you know if your broker is making recommendations based on your investment profile, your current financial situation, and your best interests?

Since June 2020, FINRA-member broker-dealers and financial advisors have been subjected to Regulation Best Interest (also nicknamed “Regulation Best Interest.”) This SEC rule requires broker-dealers and their advisors to provide transparency in their recommendations to their retail customers. The intent is to ensure that all recommendations and suggestions are centered on the best interest of the customer.

But despite the new rule, not all brokers and broker-dealers have been in complete compliance. Following the implementation of Regulation Best Interest, the SEC’s Division of Examinations began a series of examinations to determine compliance by broker-dealers. In a recent report, the SEC indicated that their findings for compliance were mixed.

Regulation Best Interest established requirements with four components:

• Disclosure of any relationship between the broker-dealer and the customer prior to recommendation
• Exercising reasonable care, diligence and skill when making recommendations, including potential risks and the customer’s best interests
• Identify and address any potential conflicts of interest
• Compliance with Regulation Best Interest

Brokers and broker-dealers are required to follow these regulations anytime they recommend securities to their retail customers.

The SEC’s purpose for conducting examinations was to determine if broker-dealers had drafted and established their own written policies and procedures that would comply with Regulation Best Interest. Additionally, the SEC wanted to see if these firms reasonable progress with implementing their new policies and procedures.

In many cases, SEC staff found deficiencies in policies and procedures at several broker-dealers, including:

• Generic written policies and procedures that were not modified or customized to the firm’s business model, and only restated the Regulation Best Interest requirements.
• No policies and procedures that complied with the Disclosure component
• No identification of the individual responsible for drafting these policies and procedures
• No indication of when these disclosures should be updated, or delivered to retail customers, or identifying when any material changes would warrant in new or updated disclosures.
• No process indicating that a disclosure had been provided to a customer, nor a system for identifying if disclosures had been provided to a customer before or during the recommendation
• Directed brokers to consider costs, but providing no information on how to do that
• Directed brokers to document their reasoning for recommendations, but didn’t tell them how or when it’s required, making compliance with Regulation BI difficult to document
• Relied on surveillance systems that were implemented prior to Regulation BI without allowing for whether the systems needed updating to be in compliance
• Reliance on documentation that was kept locally, rather than relying on centrally located documentation
• Used surveillance systems that only examined executed transactions for compliance, not recommendations made prior to the transaction
• Some broker-dealers offered training on Regulation BI, but did not include the processes or tools they used for the firm’s compliance
• Many broker-dealers did not have written policies and procedures to address and identify conflicts of interest.
• Others did not adequately address conflicts of interest, limiting identification to known conflicts such as churning, or using generic language that failed to include conflicts of interest that are associated with recommendations made by the firm or its brokers.
• Some broker-dealers relied only on disclosure as the sole means of mitigating any conflicts that may have put the broker’s interests ahead of the customer’s without establishing any other mitigation measures
• Some broker-dealers simply put their disclosures on their website without written documentation and only notified the customers of the website; this does not satisfy the requirements for disclosure

These findings were not in all the examined broker-dealer’s practices.

Brokers who are also investment advisors will have to make multiple disclosures to their customers prior to or during recommendations. They may also be required to disclose multiple conflicts of interests. SEC staff found that some of the broker-dealers they examined did not have a process in place to make sure that the broker was also disclosing their status as an investment advisor to a customer prior to or during the recommendation.

Other broker-dealers did not establish policies that would identify necessary disclosures addressing conflicts of interest that are unique to registered representatives that have multiple roles at the firm and work with retail customers. Some firms also failed to provide instructions on maintaining records of the oral disclosures of these conflicts to customers.

Whenever a broker or financial advisor makes a recommendation to you, they are required to consider your best interests above all other considerations. If there are any conflicts of interest involved, they must also disclose that to you before making these recommendations. The idea is that you will have all the data you need to make an informed decision.

Should your broker omit important information from their recommendations, or suggest an investment that really doesn’t match your investment objectives, they may not have followed Regulation Best Interest. If you believe that your investment advisor or broker has not acted in your best interest, speak with an experienced securities lawyer to learn more about your options.

Silver Law Group represents investors in securities and investment fraud cases. Our lawyers are admitted to practice in New York and Florida and represent investors nationwide to help recover investment losses due to stockbroker misconduct. If you have any questions about how your account has been handled, call to speak with an experienced securities attorney. Most cases are handled on a contingent fee basis, meaning that you won’t owe us until we recover your money for you. Contact us today at (800) 975-4345 and let us know how we can help.