March 4, 2024



When does listing investment options for a client become a recommendation?

This is one of the big questions facing regulators Day 2 of FINRA Annual Meeting in Washington, D.C., Said that brokerages should ask themselves. James Wrona, vice president and deputy general counsel at the broker-dealer industry’s self-regulatory body, said many firms are trying to run right to the edge of providing advice, but not beyond.

“Someone said, ‘We’re just being a finder. We’re just bringing the parties together,'” Wrona said. “But be careful … because we’ve found that even when companies don’t think they’re making recommendations, sometimes they do.”

Wrona and his other speakers warned at the morning panel that companies making proposals across borders risked violating the industry’s best interest rules. The nearly 3-year-old rule requires brokers to always look out for the best interests of their clients and avoid conflicts of interest as much as possible. Conflicts that cannot be resolved must be disclosed.

It is generally considered less stringent than fiduciary standards, which require financial advisors to always put the interests of their clients first, even if it results in less profit for the advisor or his firm.

Nicole McCafferty, director of testing at FINRA, said there is no strict definition of what constitutes a recommendation. The picture is made even murkier by investments in automation and the growing use of so-called artificial intelligence systems that can provide advice independent of humans.

Julie Glynn, managing director and assistant general counsel at JPMorgan, said many robo-advisors are trying to stop giving advice by putting investment decisions explicitly in the hands of the advisers.

“They don’t think they’re making recommendations because they’re operating in autonomous mode,” Green said. “But I’ll be careful.”

However, despite repeated warnings from regulators about Reg BI, enforcement so far has been slow.FINRA The new rules were first invoked on May 12 In deciding to start a company from the industry. and the Securities and Exchange Commission, which regulates FINRA, Only one case was filed alleging Reg BI violations.

Wednesday’s panel sounded more warnings that it’s time for brokerages to get their houses in order, Compliance with Reg BI is coming to an end soon. Reg BI cases tend to fall into three “buckets,” FINRA Acting Enforcement Director Chris Kelly said earlier in the day during a panel discussion on regulatory trends and developments.

The first has to do with failing to complete or correctly complete a disclosure document known as the CRS form (short for Customer Relationship Summary). The second concerns situations where companies have not amended their internal policies and procedures to comply with Reg BI.

The third – and the most serious from the regulator’s perspective – involves actual breaches of Reg BI’s standards of conduct.

“As the year progresses, you’ll see more and more cases in the third bucket, dealing with disclosure obligations, duty of care and conflict of interest obligations,” Kelly said.

Much of Wednesday’s discussion also centered on a staff bulletin that the SEC began distributing on April 21 to draw attention to Reg BI’s duty of care. This duty places the onus on the broker to look out for the client’s best interests through a sound understanding of the client’s investment objectives.

The announcement emphasizes that brokers cannot discharge their duty of care unless they explicitly weigh the pros and cons of any alternatives to investment advice they may make. This is especially the case when it comes to complex and obscure products such as private equity funds, cryptocurrencies and other digital assets, derivatives and assets purchased with borrowed money, according to the SEC.

Broker-dealers don’t have to bother to explain in writing the reasons behind every trade they make on behalf of their clients. But in some cases, regulators will almost certainly want documents to support the broker’s actions, McCafferty said.

McCafferty says it’s not a bad idea to take note of times when a client is particularly opposed to a broker’s advice. It’s also best for brokers to explain in writing any advice that doesn’t fit a client’s risk tolerance or investment goals—at least at first glance.

McCafferty said she often hears brokerage representatives say they don’t think it’s necessary to provide written reasons for advice given by longtime clients. Brokers often insist that these long-term relationships imply a high level of trust in their advice.

But, McCafferty asked, what happens if a client dies and the account is taken over by a child or other close relative?

“If the reps don’t have any documentation, it’s very difficult to get a foothold on why they’re making a proposal that’s in the client’s best interest,” she said.

The SEC staff announcement also made clear that the regulator does not view Reg BI as particularly different from the fiduciary rules governing the conduct of investment advisers, Glynn said. The rule requires advisors to always put their clients first and to eliminate all but the most unavoidable conflicts of interest.

Glynn said Reg BI’s specific requirements and fiduciary rules may differ in detail, “but regulators consider the criteria in very similar ways in terms of outcomes,” she said.

These are just a few of the pieces of advice McCafferty and her speaking partners offered to the audience at FINRA’s annual meeting. Throughout most of the week, representatives of regulators and brokerage firms will offer their views on the latest compliance trends and developments in the industry in a series of roughly hour-long sessions.

During a panel discussion on Enforcement Trends on Wednesday, Kelly said regulators will also pay particular attention to hybrid firms that have not only broker-dealers but also advisory firms registered with the SEC. Such companies need to be doubly cautious about charging customers, he said.

Kelly said he knows of at least one company whose brokers charge clients a commission to buy the annuity, then quickly transfer the annuity into an advisory account that charges an ongoing management fee.

“There do seem to be a handful of brokers who take advantage of different fee structures by moving accounts back and forth,” he said.

Gurbir Grewal, head of the SEC’s enforcement division, said companies that have already attracted the attention of regulators would do well to choose to fight and at least consider some cooperation.

“If you have a lawyer who’s going all out on every charge, I think you lose credibility,” Grewal said. “I think it’s very rare for staff to get every factual detail wrong because we’re not that bad. .”