Identifying and dealing with conflicts of interests when meeting Regulation Best Interest obligations isn’t a “check-the-box” affair, according to a new staff bulletin from the Securities and Exchange Commission, but it is an ongoing process that must address each conflict.
The bulletin, released on Wednesday, was in a Q&A format to help firms and advisors understand how to deal with conflicts, and the commission stressed it should be considered in conjunction with Reg BI, which revised conduct standards for advisors and broker/dealers and went into effect more than two years ago. The bulletin purported to offer clarity on how firms could comply with conflict obligations in the rule, including how firms can identify and (if necessary) mitigate or eliminate conflicts.
“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,” the bulletin read.
Advisors may need to eliminate the conflict if an advisor would find it difficult to provide “full and fair disclosure,” meaning a client couldn’t give informed consent, or if a firm finds that it’s unable to mitigate the conflict in such a way that it could make a recommendation in a client’s best interest. For example, the SEC described a situation where a firm has an incentive program based on the advisor’s ability to meet certain benchmarks or metrics.
The staff bulletin also detailed a number of ways firms could mitigate conflicts, “depending on the nature and magnitude” of those in question, though staff stressed the list it supplied was nonexhaustive.
As examples, the commission urged registrants to avoid compensation thresholds that boosted their pay via increases in certain product or service sales, shun incentives to prefer one type of account or product over another, and eliminate them within similar product lines, suggesting firms cap the credit advisors might receive across mutual funds, annuities, REITs or other similar products.
When considering whether client disclosure was necessary, SEC staff reiterated that firms should not merely be checking a box but must tailor disclosures to the eccentricities of particular conflicts so investors can make an informed decision about the recommendation they’re asked to consider.
“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,” the bulletin read. “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.”
For the past two years, the SEC’s Examination Division has made it clear in its annual exam priorities that it would ask registrants about their compliance with Reg BI, having moved past the initial “good faith” review in the aftermath of the rule’s implementation. In June, the SEC charged a California-based brokerage firm and five of its reps with violating Reg BI obligations when recommending high-risk debt securities to retail investors. It was the first time the commission charged a defendant with Reg BI violations.
