Navigating Reg BI: Strategies for Smaller Firms to Stay Compliant
By Lisa Gok, chief legal officer, Cetera Financial Group
Implemented by the U.S. Securities and Exchange Commission in 2020, Regulation Best Interest, or Reg BI, is a standard of conduct designed to safeguard investors and standardize requirements for broker-dealers and financial advisers. Under these requirements, advisers must adhere to a “best interest” standard of conduct when recommending any securities transaction or investment strategy for retail customers.
With three decades in the compliance field, including 11 years as an assistant regional director with the SEC, I’ve observed that implementing Reg BI has proven to be challenging for many firms – and the requirements can be particularly daunting for smaller firms with limited resources dedicated to compliance. Yet Reg BI was among the SEC’s top enforcement priorities in 2023, signaling that firms will need to remain vigilant in their compliance measures.
In a previous article, we defined Reg BI and its requirements. In this article, we will delve into the challenges, especially for smaller firms, and provide strategies for navigating the SEC’s enhanced enforcement.
Top Challenges: Complex Disclosures and Overlapping Requirements
Reg BI adopts the concept of “layered disclosures” for conflicts of interest. All firms are now required to identify and disclose any conflicts, particularly those resulting from compensation practices, and use Form CRS to convey the information to customers.
This form captures basic information about any potential conflicts, but it is designed primarily to serve as an introduction to the issues for customers. Advisers have found that it is often necessary to provide more comprehensive conflict disclosure documents, with additional information about the firm’s products and services and any conflicts that may exist between the interests of the customer and the firm.
Advisers must compare a complex array of potential recommendations based on historical return, risk, and cost in order to satisfy the Reg BI requirement that they present equivalent alternatives. Firms may therefore need to integrate tech-driven solutions that enable advisers to track, document, and compare their investment recommendations.
Advisers are also expected to manage the overlap and differences between the requirements in Reg BI and the Department of Labor’s Retirement Security Rule. Although the provisions of these rules are similar, they are not identical. Firms must therefore keep abreast of existing and new requirements contained in the DOL rule.
Actionable Steps: Self-Disclosure and Written Procedures
Advisers can position their firms for compliance by staying on top of the latest news and actions of the SEC; our earlier discussion focused on best practices for doing so. Advisers should also keep in mind the SEC’s favorable response to firms that self-report securities violations.
As noted above, a primary feature of Reg BI is the requirement that advisers implement a comprehensive conflict management process. Firms should re-evaluate their business practices and revenue models on a regular and ongoing basis to assure that their conflict management process remains current. If, however, they discover prior conflicts of interest, they should consider self-reporting to the SEC to take advantage of possibly reduced penalties in doing so.
The SEC has demonstrated that self-reporting can provide firms with significant benefits. In a recent compliance sweep, several firms that were found non-compliant had to pay penalties ranging from $7 million to $11 million. One registered investment adviser that self-reported, however, paid only $2.5 million in penalties. The message is clear: you may receive a huge reduction in penalties if you self-report and fully cooperate with the SEC.
To avoid the risk of penalties, it is essential that firms establish written supervisory procedures. Reg BI specifically includes a compliance requirement that obligates firms to document their supervisory processes in writing. This should be done on a holistic basis, with the participation of both legal and compliance professionals and management across all areas of the firm. And to remain effective, supervisory processes should be reviewed over time as the business evolves.
Looking ahead, it is likely that advisers and firms of all sizes will continue to face tighter enforcement of Reg BI. Although challenging, the new requirements represent a step toward a higher standard of care for brokers – and an opportunity to build greater trust with investors.
Lisa Gok is the chief legal officer at Cetera Financial Group, where she serves as executive legal adviser to Cetera and its board of directors. In this role, Gok is responsible for ensuring a holistic legal view for Cetera, ensuring best practices while operating as a strong strategic partner for Cetera on a broad range of legal, operational, and corporate activities. Prior to joining Cetera in 2012, Gok held a variety of leadership positions both in and outside of financial services, including 15 years with the U.S. Securities and Exchange Commission.
The views and opinions expressed in the preceding article are those of the author and do not necessarily reflect the views of The DI Wire.
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