The Financial Industry Regulatory Authority (FINRA) implemented a series of new regulations known as Regulation Best Interest (“Reg BI”), or client relationship summary, in June 2020. In partnership with the Securities and Exchange Commission (SEC), FINRA adopted new requirements designed to protect and “enhance the quality and transparency of retail investors’ relationships with investment advisers and broker-dealers, bringing the legal requirements and mandated disclosure in line with reasonable investor expectations, while preserving access (in terms of choice and cost) to a variety of investment services and products.” Since FINRA implemented regulation requirements, it has identified a few areas for improvement and highlighted some of the best practices that member firms can use to remain in compliance.
Understanding Reg BI and Form CRS
At the end of June 2022, three FINRA-affiliated individuals appeared on a podcast to discuss how the implementation of Reg BI and Form CRS has fared over the past two years. Scott Gilbert, vice president covering the large diversified firm group and alternative net capital group within FINRA’s Member Supervision division, clarified that “Reg BI establishes a standard of conduct for broker-dealers and their associated persons when they make recommendations to retail clients…Reg BI imposes four obligations on broker-dealers. That’s the disclosure obligation, the care obligation, the conflict-of-interest obligation, and the compliance obligation form.” Gilbert went on to define Form CRS as a companion to Reg BI that “discloses several points and features about the relationship between the firm and the customer, including the types of services that the firm offers, the fees, costs, conflicts of interest and standards of conduct associated with those services and those relationships, whether the firm and its employees have any disciplinary history and how to obtain additional information about the firm.” Additionally, FINRA stated that it intends to move forward with particular attention to the standard of care obligation.
What Examinations Look Like for Broker-Dealers
FINRA maintains that the SEC has implemented its own examination program and priorities, so it is working closely with the SEC to avoid “regulatory overlap” when examining a firm for Reg BI-related issues. Since the rule went into effect in 2020, FINRA has conducted more than 570 firm exams. According to Nicole McCafferty, senior director with the National Cause and Financial Crimes Detection Program, “We’ve seen more recently [are] issues with firms that historically had suitability issues, now having issues complying with care obligations…We’ve also identified instances where, from a customer-specific standpoint, there have been investments that are recommended that don’t appear to be in line with the client’s investment profile, and there are potential risks there.” McCafferty also mentioned that FINRA has identified several firms that have failed to mitigate or eliminate conflicts applicable to their business sufficiently. Finally, FINRA has found that firms are having procedural issues during these Reg BI reviews, where they are not specific enough in their detail as to how they intend to remain in compliance with the Reg BI obligations.
SEC Imposes First Reg BI Violation Charge
In mid-June 2022, the SEC filed the first complaint for a violation of Reg BI. The SEC alleges that Western International Securities, Inc. (“Western”) and five of its registered representatives violated Reg BI by recommending and selling high-risk, illiquid, and unrated debt securities (known as L Bonds). The complaint asserts that Western and the individual representatives “recommended these bonds without understanding the risks associated with these securities and without a reasonable basis to believe that these investments were in the best interests of the investors—many of whom were retirees or were on fixed incomes with moderate risk tolerances.” Additionally, losses related to investments in L Bonds have been involved in several FINRA arbitration proceedings.
FINRA Arbitration Cases Increasingly Related to Reg BI Claims
FINRA releases its dispute resolution statistics every quarter, including the top 15 controversy types at the center of customer arbitrations. According to the most recent report, claimants in FINRA arbitrations have filed 54 Reg BI claims against broker-dealers and registered representatives since January 2022. This marks the first time that Reg BI-related concerns have appeared among the top 15 FINRA arbitration claims. Clearly, the number of Reg BI claims is increasing just as the SEC and FINRA continue their efforts to regulate and enforce compliance.
Trusted Guidance When You Need It Most
With this renewed focus on Reg BI compliance, it’s natural to feel confused or frustrated by these ever-shifting rules and regulations. If you need help understanding your obligations or FINRA has notified you of an impending investigation, reach out to an experienced and knowledgeable securities law attorney as soon as possible to discuss your options. Together, you can assess the specifics of your situation and determine the most strategic path forward.
Call Judex Law LLC today at (303) 523-4022 to discuss your situation with a dedicated and friendly securities law attorney.
