On January 30, 2023, the U.S. Securities and Exchange Commission Division of Examinations released a Risk Alert regarding Regulation Best Interest (“Reg BI”). Focused on examinations of broker-dealers, the Risk Alert covered the range of Reg BI obligations: disclosure, conflicts, compliance, and care. It is a worthwhile reminder that Reg BI is a statutory effort to better align the obligations of brokers and their representatives with the fiduciary principles applicable to investment advisers.

Rather than broker-dealers fulfilling their obligations to deliver the appropriate disclosures in writing, the Division of Examinations noted a reliance on web-based disclosures or references to disclosure in other documents.  Additionally, Staff noted that firms provided insufficient guidance to their financial professionals regarding when additional disclosures were required and how to document that required disclosures were made, particularly when they were made orally.

With regard to identifying and addressing conflicts of interest, Division of Examinations noted shortcomings in terms of a lack of accountability for enforcement or testing. Another shortcoming noted was limited focus, such as limiting conflicts to those represented by prohibited practices. Staff also emphasized that the conflict of interest obligation includes not only identification and disclosure, but an explicit obligation to mitigate (i.e., to “modify practices to reasonably reduce”) conflicts of interest.

The discussion under the compliance obligation covers written supervisory procedures across the other obligations, as well as training, reviews, and testing. Under the care obligation, the Division of Examinations found fault in generalizations, such as procedures directing representatives to consider costs and available investment alternatives, yet offering no guidance on how to go about it or how to document it. In some cases, firms provided systems for these purposes, but did not mandate their use.

These all speak to the time-tested principles of compliance program design. The effectiveness of policies and procedures should be testable and assign responsibility to specific persons or groups. Disclosure must be accurate and provide the opportunity for informed consent. Training and testing should be customized to the implementation of the firm’s particular business activities. It is noteworthy that the conflicts of interest obligation under Reg BI included the expectations that firms would first seek to mitigate conflicts of interest. This is consistent with recent writing and goes back to the June 2019 Commission Interpretations on standards of conduct and is further reflected in certain provisions of the February 2022 proposed rule to enhance private fund investor protection.

Observations from Broker-Dealer Examinations Related to Regulation Best Interest