Reviews of firms’ compliance with tougher conduct standards for U.S. retail brokers revealed shortcomings, the U.S. Securities and Exchange Commission (SEC) says.
The SEC’s division of examinations issued a risk alert detailing the results of compliance reviews that looked at firms’ adherence to the new conduct standard. Known as regulation best interest (Reg BI), adopted in mid-2020, the standard generally requires brokers and their reps to ensure they prioritize retail investors’ interests when making investment recommendations.
The rule also imposes certain disclosure and due diligence obligations on firms, and requires them to adopt policies and procedures to identify and address conflicts of interest.
However, the SEC found shortcomings in firms’ procedures for spotting and resolving conflicts of interest, including policies that didn’t explicitly ban sales contests, quotas or compensation systems that were designed to incentivize the sale of specific securities.
The regulator’s reviews also found inadequate policies and procedures at certain firms, including instances of generic, boilerplate policies that weren’t tailored to the firm’s business model or simply restated the requirements of the new standards.
Specific deficiencies included not specifying how or when required disclosures should be created or updated, and when they need to be provided to investors.
Deficient policies also failed to give reps guidance on fulfilling their obligations to consider alternative products, and on evaluating investment costs when making recommendations.
Some firms created systems that allowed reps to evaluate costs and alternatives, but didn’t require them to be used. That meant the firms couldn’t enforce policies and procedures that required financial professionals to consider costs and alternatives when making recommendations, the alert said.
Other firms directed reps to document their recommendations but didn’t provide guidance on when documentation is necessary or appropriate, the SEC reported.
“In general, staff observed instances where broker-dealers or financial professionals failed to understand the recommended product, failed to obtain or consider the customer’s investment profile, and failed to understand the potential risks and costs associated with the recommendation,” it said.
The notice also indicated that certain firms lacked the sort of training and oversight procedures needed when adopting a fundamental shift in conduct standards.
At the firms where deficiencies were uncovered, the dealers were required to modify their practices, policies and procedures to comply with the Reg BI standards.
The risk alert was issued to help other broker-dealers ensure compliance with the new rules by highlighting deficiencies and examples of weak practices, the SEC said.