Brokerages need to update tech systems to show Reg BI work to SEC

An SEC risk alert this week warned firms that surveillance systems fell short in ensuring reps consider costs and reasonably available alternatives. Will enforcement be next?

Brokerages need to upgrade their technology to better show their work on meeting Regulation Best Interest obligations, but it remains unclear when the SEC will put teeth into the rule, compliance experts and investor advocates say.

Earlier this week, the Securities and Exchange Commission released a risk alert that outlined compliance failures related to Reg BI the agency has seen in recent examinations. One theme in the document was that brokerages lacked systems for ensuring their registered representatives met Reg BI requirements when making recommendations on rollovers, account selection and investment strategies.

The SEC also found a lack of systems to help reps consider costs and reasonably available alternatives and monitor whether they’re doing so.

Brokerages should consider bolstering their technology, said Parham Nasseri, vice president of product and regulatory strategy at InvestorCom, a compliance consulting firm. It’s difficult to prove Reg BI compliance with manual documentation and self-attestation., especially for a firm with many reps.

“I believe without purpose-built technology, firms will have a challenge illustrating how they have considered costs and reasonably available alternatives across their organizations,” Nasseri said.

Reg BI prohibits brokers from putting their revenue interests ahead of their customers’ interests in investment returns. Former SEC Chairman Jay Clayton, under whom the agency approved the final Reg BI rule in 2019, asserted that Reg BI is tougher than the previous suitability standard.

Financial firms must adjust their systems for monitoring reps’ recommendations to include “flags” that are unique to Reg BI, said Issa Hanna, a partner at Eversheds Sutherland.

Under suitability, a variable annuity sale to an 80-year-old customer might be noted by a monitoring system. One attuned to Reg BI would also have to alert firm compliance when a rep recommends an advisory account instead of brokerage account to a customer who does little trading.

The SEC “is putting the industry on notice that they should be thinking about adding new flags to their existing software, if they haven’t already,” Hanna said.

System upgrades to comply with Reg BI can be done by modifying a tech stack, Nasseri said.

“There’s no need to do an entire rip-and-replace,” he said. “This isn’t a heart transplant.”

BURDEN ON SMALL SHOPS

Other shortcomings the SEC cited were that some firms maintained Reg BI documentation in local offices rather than in a central location and that they only tracked Reg BI compliance for executed transactions rather than those that the customer declined or that resulted in no portfolio change.

Those requirements are a heavy lift for small brokerages, said Sander Ressler, co-owner and managing director of Essential Edge Outsourcing Services.

A one-person shop, for instance, might recommend several investment options to a customer. The rep has to record and send each of them to a main office — whether they were accepted or rejected — to facilitate Reg BI compliance.

“You can’t overestimate the time burden that will place on small independent brokers for transactions that were never executed for the client,” Ressler said. “They’re going to end up being an ops person rather than a salesperson. [The SEC] is trying to force firms to be wider in their recommended portfolio rather than narrow.”

WHAT ABOUT ENFORCEMENT?

The SEC said the risk alert was meant to help firms comply with Reg BI. But an investor advocate said the SEC must do more than cite shortcomings to ensure Reg BI curbs broker conflicts.

“The only thing that will promote compliance in a meaningful way is enforcement,” said Micah Hauptman, director of investor protection at the Consumer Federation of America. “Is [SEC] Exams [Division] handing these deficiency letters to enforcement and is enforcement following up? I hope the risk alert portends a raft of enforcement actions, but I have no sense whether that’s the case.”

So far, the SEC has conducted only one substantive Reg BI enforcement action.

Ressler praised the SEC for issuing the risk alert to help the industry understand Reg BI obligations and shore up their practices before cracking down. It helps the agency avoid so-called regulation, or rulemaking, by enforcement.

“It really gives firms a good road map going forward,” Ressler said. “In this case, they’re providing guidance upfront, which I’m sure my clients appreciate.”