Regulation Best Interest is a Restyling of FINRA
By Neal Shikes
Managing Partner, The Trusted Fiduciary
Neal J. Shikes is Managing Partner of The Trusted Fiduciary and has 30 years of experience in the Financial Services Industry and an expansive network. He is an Affiliate Expert Witness Professional of EWCS.
Much has been written about Regulation Best Interest and the updates associated with it. It seemed like a lot to digest so it didn’t seem like waiting for the “dust to settle” was a bad idea. However, the dust did not settle. Many states are now suing the SEC to kill Reg BI.
It doesn’t seem to be a secret that FINRA, the SEC, and broker dealers have been trying to avoid the application and legal liability of fiduciary duties for a long time. The SEC adopted Regulation Best Interest (Reg BI), in an attempt to establish and clarify standards of conduct for the broker dealer space and all “associated persons.”
When an industry professional reads Reg BI, it wouldn’t be surprising if they experience déjà vu. It, for the most part, seems eerily similar to FINRA regulation.
First, an industry professional may view Reg BI’s use of the term “Standard of Care” somewhat ironic since it is so often associated with prudence and fulfilling fiduciary duty. Also, it may be easy to conclude that the standards that are described in Reg BI, in general, do not differentiate itself much from what is described in FINRA’s suitability regulation:
“… a broker-dealer must exercise reasonable diligence, care, and skill when making a recommendation to a retail customer. The broker-dealer must understand potential risks, rewards, and costs associated with the recommendation. The broker-dealer must then consider those risks, rewards, and costs in light of the customer’s investment profile and have a reasonable basis to believe that the recommendation is in the customer’s best interest and does not place the broker-dealer’s interest ahead of the retail customer’s interest.”
FINRA Rule 2111 (Suitability):
“…A member or an associated person must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer’s investment profile. A customer’s investment profile includes, but is not limited to, the customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer may disclose to the member or associated person in connection with such recommendation.”
“… In interpreting FINRA’s suitability rule, numerous cases explicitly state that “a broker’s recommendations must be consistent with his customers’ best interests.”15 The suitability requirement that a broker make only those recommendations that are consistent with the customer’s best interests prohibits a broker from placing his or her interests ahead of the customer’s interests.”
“…a broker-dealer must also establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest as a whole.”
FINRA Rule 3120:
“…FINRA Rule 3120 requires a firm to have a system of supervisory control policies and procedures (SCPs) that tests and verifies a firm’s supervisory procedures. It is essential for a firm to recognize that FINRA Rule 3120’s requirement to have specific SCPs differs from the requirement for WSPs (written supervisory procedures) . A firm not only needs to maintain WSPs, but the firm also must have SCPs to test and verify, at least annually, that its WSPs are reasonably designed with respect to the firm’s and its associated persons’ activities to achieve compliance with applicable securities laws and regulations and FINRA rules.”
Disclosure & Conflict of Interest
“…First, under the Disclosure Obligation, before or at the time of the recommendation, a broker-dealer must disclose, in writing, all material facts about the scope and terms of its relationship with the customer. This includes a disclosure that the firm or representative is acting in a broker-dealer capacity; the material fees and costs the customer will incur; and the type and scope of the services to be provided, including any material limitations on the recommendations that could be made to the retail customer. Moreover, the broker-dealer must disclose all material
facts relating to conflicts of interest associated with the recommendation that might incline a broker-dealer to make a recommendation that is not disinterested.”
According to FINRA
. The Securities Exchange Act of 1934 broadly prohibits misstatements or misleading omissions of material facts, and fraudulent or manipulative acts and practices, in connection with the purchase or sale of securities.
. Section 15(c) of the Act prohibits a broker from effecting any transaction in or inducing or attempting to induce the purchase or sale of any security by means of any manipulative, deceptive, or other fraudulent device or contrivance.
. FINRA Rule 2010 (Standards of Commercial Honor and Principles of Trade) states that a firm “in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade.”
. FINRA Rule 2020 (Use of Manipulative, Deceptive or Other Fraudulent Devices) provides that no firm “shall effect any transaction in, or induce the purchase or sale of, any security by means of any manipulative, deceptive or other fraudulent device or contrivance.”
In addition to all of this, if one dares to read the SEC’s Regulation Best Interest one may be challenged to find where “Best Interest” is delineated and characterized though there is a whole lot of detail about the “CRS Relationship Summary” and disclosures.
In conclusion, one may be perplexed as to whether the relevant FINRA regulations, especially Rule 2111, applies anymore, or is the SEC just re-branding it? Then again, how much “wiggle room” did the SEC have to clarify standards of conduct without making it sound like fiduciary duty in the first place.
This article was originally published on the TrustedFiduciary.com
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