The SEC’s First Reg BI Enforcement Action

Business professionals are likely already familiar with the U.S. Securities and Exchange Commission (SEC)’s new rules for recommending securities and investments involving securities to customers. Known as Regulation Best Interest (Reg BI), this compliance framework establishes a “best interest” standard of conduct for broker-dealers and other parties involved in recommending securities to retail buyers. 

This is a groundbreaking set of regulations intended to protect buyers by ensuring that all recommendations made are in the best interest of the customer. This holds brokers to a new level of accountability beyond the existing suitability standard, and as we’re seeing, the SEC is already taking action to enforce these regulations and ensure compliance.

The SEC’s Regulation Best Interest

Reg BI refers to a set of rules designed to enhance the quality and transparency of relationships between retail investors and their broker-dealers. The SEC set the compliance date for Reg BI at June 30, 2020.

The entire checklist of Reg BI considerations is extensive and can be found at FINRA.org, though note that resources like these are merely tools meant to guide compliance efforts. 

Certain rules may be open to interpretation, which is why agencies affected by Reg BI need a comprehensive way to ensure their processes remain compliant with the SEC’s wishes. At a minimum, brokerages will need an automated way to record and maintain vital communications in ways that stay compliant with the SEC and FINRA obligations.

Specifically, there are four main components of Reg BI that brokers will need to be aware of:

1. Disclosure

The disclosure obligation ensures that customers will receive written notice of all potential conflicts of interest surrounding a recommendation. Details must include the capacity in which the advisor’s recommendation is made, material fees and costs incurred by the customer, and any material limitations on the proposed securities or investment plan.

2. Care

Expanding on FINRA’s suitability rule, the care obligation requires that brokers and advisors consider the costs, reasonable alternatives, and factors in each customer’s investment profile before making a recommendation. 

3. Conflict of Interest

Particularly for brokers and dealers, the conflict of interest obligation requires parties to establish reasonably designed policies and procedures to identify, eliminate, and disclose potential conflicts of interest. 

4. Compliance

The compliance mandate requires brokers and dealers to establish, maintain, and enforce written policies for complying with Reg BI and its associated obligations. 

Broker-dealers that don’t meet the compliance requirements may face disciplinary action from the SEC. Potential violations could involve Reg BI disclosure obligation, failure to file form CRS Reg BI, or breach of the care obligation. However, for several years, SEC took no enforcement actions against any corporation for violating Reg BI regulations. That changed recently.

The Multi-Million Dollar SEC Reg BI Case

On June 16, 2022, the Securities and Exchange Commission announced that it had taken its first enforcement action against a broker-dealer for violating Regulation Best Interest SEC regulations. It levied charges against Western International Securities, Inc., a registered broker-dealer. Five of the company’s representatives also faced accusations. According to the SEC, the brokers sold $13.3 million in high-risk and unrated bonds to investors. These sales occurred between July 2020 and April 2021.

The SEC further alleges that the broker-dealer sold the bonds to everyday “retail customers” on fixed incomes. These investors naturally had moderate risks, and the company reportedly knew the bonds carried high stakes and low liquidity. Consequently, the original issuer of these L Bonds ― GWG Holdings, Inc. ― explicitly recommended the bonds for higher-income persons.

The SEC found that the broker’s initial dealings also violated the Reg BI Care Obligation. It determined that the company and its representatives did not do due diligence or take care in recommending the bonds to at least seven particular customers.

Can Your Record-Keeping Guarantee Full Reg BI Compliance?

The SEC is beginning to take action on brokers that don’t meet Reg BI compliance, and companies need to be prepared.

Our professionals at Leap Xpert have spent years building a solid reputation as compliance experts in recordkeeping and archiving solutions. The software we create automates the recording and retention of messages for compliance with SEC, FINRA, and other regulatory bodies. Over the years, we have witnessed companies face hefty fines for several other regulations covered by Reg BI and encourage all compliance and business professionals to reach out to us for support.

Would you like to see our compliance solution in action? Book your demo to get started.