SEC Fines Broker-Dealer for Violating Reg BI’s Care and Compliance Obligations
Broker-Dealers
Compliance Operations
July 31, 2024
The Case
The US Securities and Exchange Commission (SEC) recently took enforcement action against a dually registered investment advisor and broker-dealer for failing to comply with Regulation Best Interest (Reg BI) requirements.
The firm, along with several of its representatives, was found to have recommended and sold approximately $13.3 million of unrated and high-risk securities, known as "L Bonds," to retail customers with moderate risk tolerances. The SEC alleged that these recommendations had no reasonable basis to believe the investments aligned with the clients' best interests.
Additionally, the SEC identified shortcomings in the firm's enforcement of its internal policies and procedures related to Reg BI’s “Care Obligation” and “Compliance Obligation.” The resulting enforcement actions included a civil penalty and other financial sanctions.
Regulatory Implications
These actions highlight the SEC’s ongoing emphasis on Reg BI compliance.
Regulation Best Interest, introduced under the Securities Exchange Act of 1934, establishes a standard that broker-dealers must follow to act in the best interest of retail customers when recommending any securities transactions or strategies. The regulation includes obligations such as the "Care Obligation," requiring broker-dealers to base their recommendations on reasonable diligence, and the "Compliance Obligation," which involves developing and maintaining robust internal policies and procedures.
This case illustrates the SEC's determination to hold firms accountable for failing to meet these obligations. The Financial Industry Regulatory Authority (FINRA) has also brought numerous enforcement actions related to Reg BI since 2023, indicating a collaborative effort to protect retail investors.
Practical Guidance for Firms
Broker-dealers are advised to carefully review and update their Reg BI compliance frameworks to align with the “Care” and “Compliance” obligations. Key considerations include:
Conduct Thorough Due Diligence: Firms should have a documented process to evaluate and understand the suitability of the products they recommend for each client, considering the client's risk profile and investment goals.
Improve Internal Policies and Training: Developing comprehensive policies and procedures that specifically address Reg BI requirements is crucial.
Maintain Comprehensive Documentation: Proper documentation of the decision-making process, including the rationale behind investment recommendations, can be vital in demonstrating compliance with Reg BI.
Since its founding in 2013, InnReg has been a trusted compliance consulting and outsourcing provider, assisting broker-dealers in developing effective compliance frameworks aligned with Reg BI’s obligations.
With a focus on identifying risks, implementing controls, and enhancing internal documentation, InnReg helps firms navigate complex regulatory landscapes and mitigate compliance risks.
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