SEC Considering Additional Reg BI Enforcement Actions
At a Congressional Hearing held on July 19, 2022 – and on the heels of a recently filed action – Gurbir S. Grewal of the U.S. Securities and Exchange Commission (SEC or Commission) informed lawmakers that the SEC may pursue additional enforcement actions related to Regulation Best Interest. Regulation Best Interest or “Reg BI” (Rule 15l-1(a) under the Securities Exchange Act of 1934) became effective in 2020 and established a “best interest” standard of conduct for broker-dealers and associated persons when making an investment recommendation (or recommending an investment strategy) to a retail customer.
The hearing, titled “Oversight of the SEC’s Division of Enforcement” and held by a subcommittee of the House Committee on Financial Services, largely focused on testimony from Mr. Grewal, Director of the SEC’s Division of Enforcement. During the hearing, Director Grewal engaged in an exchange with Financial Services Committee Chairwoman Maxine Waters (D-CA) about Reg BI’s efficacy. Representative Waters, referring to Reg BI as “flawed” at one point during the hearing, suggested that Reg BI may represent a less robust standard of conduct for brokers than the fiduciary standard applicable to other financial advisors. Representative Waters expressed concern about “how broker-dealers have changed their practices [and] how they are better managing conflicts of interest?”
Representative Waters also referred to a recent Complaint filed on June 15, 2022 in which the SEC named broker-dealer Western International Securities, Inc. and five of its registered representatives in a federal lawsuit alleging that they violated Reg BI. In this enforcement case, the firm and the named representatives are alleged to have recommended high-risk and illiquid “L Bonds” to certain retail investors who were living on fixed incomes and had only moderate risk tolerances – amounting to alleged violations of, among other things, Reg BI’s “Care Obligation.” (Reg BI is satisfied by compliance with its four component obligations: Disclosure Obligation, Care Obligation, Conflict of Interest Obligation, and Compliance Obligation.) Representative Waters stated that she “can’t imagine only one firm or a handful of brokers” is in violation of Reg BI.
In response, Director Grewal noted that the SEC’s Division of Examinations has made “other referrals” for investigation related to potential Reg BI violations. This statement is not surprising, as the SEC recently noted in its 2022 Examination Priorities report that the Commission continues to focus “on broker-dealers’ compliance with Regulation Best Interest, wrapping up its initial exams to look for good faith compliance and kicking off the second phase of examinations with additional review of effectiveness of policies and procedures and transaction testing.” This second level of review includes, among other things, “firms’ recommendations and sales practices related to SPACs, structured products, leveraged and inverse exchange traded products (ETPs), REITs, private placements, annuities, municipal and other fixed income securities, and microcap securities.”
The attorneys at Giarrusso Law Group LLC have considerable experience with issues unique to the financial services industry, including federal and state legislative and regulatory developments affecting both investors and financial advisors. If you have a question regarding this recent announcement or any other industry matter, you can contact us at (201) 771-1115 or info@gialawgroup.com for a free and confidential consultation.