Thought Leadership in Action

As we approach the second anniversary of Regulation Best Interest (Reg BI) going into effect, many are speculating news of the first major enforcement actions related to Reg BI violations will come soon. While it seems regulators have given firms a bit of grace as they transition to the new rules, top securities lawyers expect to see the Securities and Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA) pursue fines and penalties against financial advisory firms in 2022.

 Reg BI was adopted by the SEC in June 2019 as part of a rulemaking package and establishes a "best interest" standard of conduct for broker-dealers and associated persons making recommendations to retail customers regarding securities transactions or investment strategies involving securities.

 The New Standard for Broker-Dealers

Previously, broker-dealers have generally been expected to abide by the suitability standard, a FINRA rule requiring that investment recommendations are simply consistent with customers’ interests. Meanwhile, investment advisers, a category of financial professionals compensated by fixed fees or a percentage of total assets managed that usually offer investment counsel on an ongoing basis for things like retirement planning, have generally followed the fiduciary standard. This is a nonstatutory obligation that stems from court rulings and decisions resulting from SEC enforcement cases.

The fiduciary standard demands a more rigorous degree of professional care than the suitability standard, as there is an expectation that advisers will put their clients’ best interests above their own. Some might argue that Reg BI holds firms to a “quasi-fiduciary” standard, balancing an improved standard of care for broker-dealers with an ability to retain their core business model.

CRS Settlements as a Potential Indicator of More Enforcement

As part of the package that spawned Reg BI comes the requirement that broker-dealers provide clients with a customer relationship summary, known as Form CRS. Here, they must disclose details on the types of relationships they have, the services they offer (including information on costs and fees) and any conflicts of interest. So far, the SEC has charged a few dozen firms with compliance violations related to Form CRS.

 Common causes for SEC enforcement have been failure to distribute Form CRS to investors by the 2020 deadline and omissions of required information. An SEC committee in December 2021 noted, based on its initial review of observations related to Form CRS compliance, “areas where compliance improvements appear to be needed.” Aside from omissions and failure to adhere to finalized Form CRS instructions, the committee also called out the use of technical language and legal jargon. “Relationship summaries must be concise and direct, using plain English and taking into consideration retail investors’ level of financial experience,” the committee noted.

 Last year was the first year we could expect any enforcement activity, and while the SEC brought a number of matters concerning Form CRS, those cases were not based on complex fact patterns and did not require significant investigation,” said Susan Schroeder, former head of enforcement at FINRA. Schroeder is now vice chair of the securities department at the law firm WilmerHale and says that she expects to see more Reg BI enforcement in 2022, as regulators have had more time to look into firm practices.

Policies and Procedures That Avoid Enforcement Actions

Even in the absence of specific transactions that may be deemed inappropriate, the SEC can charge firms with violations if it finds policies and procedures to be insufficient. Consistent training across firms on Reg BI policies can also help keep them out of the hot seat with regulators. With larger firms having numerous branches and many employees and reps working from home, making sure everyone is on the same page is critical.

Stringent documentation is also needed to demonstrate compliance with Reg BI. Because firms need to be able to show that they’ve evaluated a product or investment strategy to determine if it’s in their client’s best interest, they’ll need to be able to show that they performed valid testing of investment decisions against other options. This process will need to be documented and retained should an examiner call into question a transaction.

FINRA has yet to bring forth executive action related to Reg BI, but it’s likely that their first efforts will follow the path the SEC has taken and target firms for missing their deadlines for Form CRS or filing them with incomplete information. Because more exhaustive investigations of firms accused of demonstrating a pattern of violations will take much longer to complete, it could be that pursuit of lesser violations persists in the coming months before we see the announcement of more substantial charges later this year or in coming years.