Additional clarifying guidance has been released by the Securities Exchange Commission surrounding Reg BI, this time taking aim at conflicts of interest. In the 17-page report, SEC staff note that conflicts under Regulation Best Interest and the Advisers Act fiduciary standard “should not be merely a ‘check-the-box’ exercise, but a robust, ongoing process that is tailored to each conflict.”
Below are our top eight takeaways for the bulletin:
1.) The SEC recognizes that all BDs and IAs have conflicts of interest
As far as I’m aware, this is the first time the SEC has very publicly noted that all broker-dealers, investment advisers, and financial professionals have at least some conflicts of interest with their retail investors. The nature and extent of those conflicts, however, depend on various factors, including a firm’s business model.
2.) Conflicts of interest can take many different forms
For starters, the intent behind a conflict can be both conscious and unconscious, according to the SEC. Similarly, compensation, revenue or other benefits to the firm or financial professional can be both financial or otherwise. For example, compensation based on assets gathered and/or products sold or it can be tied to or other rewards associated with quotas, bonuses, sales contests, or special awards. This can also include gifts, entertainment, meals, travel, and/or related benefits in connection with the financial professional’s attendance at third-party sponsored trainings and conferences.
3.) Your firm is expected to perform periodic reviews
Broker-dealers are expected to identify conflicts of interest on an ongoing basis and periodically review their policies and procedures for compliance with Reg BI. Investment advisers also must review, no less frequently than annually, the adequacy of such policies and procedures and the effectiveness of their implementation. The staff believes that identifying and addressing conflicts is not a “set it and forget it” exercise. Firms should monitor conflicts over time and assess periodically the adequacy and effectiveness of their policies and procedures to help ensure continued compliance with Reg BI and the IA fiduciary standard.
4.) Disclosure of conflicts is not enough
Disclosure of conflicts alone does not satisfy the obligation to act in a retail investor’s best interest. Where such conflicts cannot be effectively addressed through mitigation, firms may need to determine whether to eliminate the conflict or refrain from providing advice or recommendations that are influenced by that conflict to avoid violating the obligation to act in a retail investor’s best interest in light of the investor’s objectives.
5.) There are several factors to consider when mitigating a conflict
Several factors a firm should consider related to the nature and significance of the incentive, includes: the source of the firm’s compensation, whether or not it receives them directly from the retail investor; the extent to which a firm’s revenues vary based on the type of account, products, services recommended; whether or not the firm or its affiliates recommend or provide advice about proprietary products; the extent to which the firm uses incentives to encourage financial professionals to recommend or provide advice about accounts or investment products that are more profitable for the firm; the extent to which the compensation varies based on the investment product recommended; the nature of the payment structure for financial professionals (e.g., whether retrospective, the steepness of the increases between levels); the size or structure of the firm or if the firm’s financial professionals are dually licensed or engage in activities outside of the firm; retail investor base; and the complexity of the security or investment strategy involving securities that are recommended.
6.) Limited product menus could inherently indicate a conflict
The Bulletin devotes a single question to address conflicts arising from advice limited to a certain menu of products and also identifies this as an example of a situation that may give rise to a conflict of interest in its general overview of conflicts. The Bulletin expands Reg BI’s requirement that broker-dealers disclose material limitations on product offerings.
7.) Disclosures should be more than “check-the-box exercises”
The staff cautions firms that disclosures should not be merely a “check-the-box” exercise. The staff believes that disclosures should be specific to each conflict, in “plain English,” and tailored to, among other things, firms’ business models, compensation structures, and products offered at different firms. Stating that a firm “may” have a conflict when the conflict actually exists is not sufficiently specific to disclose the conflict adequately to retail investors.
8.) Disclosures associated with compensation/benefits needs to cover five main facts
When the conflict concerns compensation or other benefits, facts disclosed should, at a minimum, include:
- the nature and extent of the conflict;
- the incentives created by the conflict and how the conflict affects or could affect the recommendation or advice provided to the retail investor;
- the source(s) and scale of compensation for the firm and/or financial professional;
- how the firm and/or financial professional is compensated for their recommendation;
- or the nature and extent of any costs or fees incurred, directly or indirectly, by the retail investor as a result of the conflict.
To read the complete SEC bulletin, click here.
