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Firms still violating Regulation Best Interest obligations, FINRA report finds

On Behalf of | Jan 18, 2024 | FINRA Compliance

As part of its annual review of compliance concerns, the Financial Industry Regulatory Authority examined member firms’ implementation of Regulation Best Interest and Form Customer Relationship Summary obligations throughout 2021-2023, AdvisorHub reports.

FINRA’s 2024 Annual Regulatory Oversight Report found that broker-dealers are continuing to violate some of the basic requirements of Reg BI and Form CRS.

The Securities and Exchange Commission adopted Reg B1 in 2020 to establish a “best interest” standard of conduct under which broker-dealers may not put their financial interests ahead of the interests of a retail customer when making recommendations.  Separately, every broker or dealer registered with the SEC is required to file Form CRS, a new customer or client relationship summary.

In its report, FINRA found a number of areas where firms are failing to comply with their Reg BI obligations.  These include:

-Failing to conduct a reasonable investigation of offerings prior to recommending them to retail customers.

-Making recommendations of securities or investment strategies involving securities without a reasonable basis to believe that they were in the best interest of a particular retail customer.

-Recommending a series of transactions that were excessive in light of retail customers’ investment profiles and factors such as high cost-to-equity ratios and high turnover ratios.

-Recommending complex or illiquid products that are inconsistent with the retail customer’s
investment profile by, for example, exceeding concentration limits specified in a firm’s policies, or
comprising a sizable portion of a retail customer’s liquid net worth or securities holdings.

-Not identifying conflicts and disclosing, mitigating or eliminating conflicts of interest
associated with recommendations of securities transactions or investment strategies involving securities.

Deficiencies were also found in Form CRS filings, including exceeding prescribed page lengths, omitting material facts, inaccurately representing the firm’s or its associated persons’ disciplinary histories, including inappropriate qualifying language to explain disciplinary history, and incorrectly stating that the firm does not provide recommendations.

FINRA recommended additional policies firms should implement to comply with their Reg BI and CRS obligations.  The authority called for mitigating the risk of making recommendations that might not be in a customer’s best interest by establishing product review processes to identify and categorize risk and complexity levels for products.  The report said brokers should apply heightened supervision to recommendations of products, or investment strategies involving securities, that are high risk, high cost, complex or represent a significant conflict of interest, or limiting such recommendations to specific customer types.  FINRA said firms should document with clear disclosure why recommendations are in the best interest of clients.

With regards to conflict of interest, the report said there should be conflicts committees to address conflicts along business lines and how to mitigate or disclose them.  FINRA also called for revising commission schedules for recommendations within product types to flatten the percentage
payout rate to employees, and broadly prohibiting all sales contests, regardless of whether they are required to be eliminated under Reg BI.

The attorneys at Lewitas Hyman understand the complexities that come with being the subject of a regulatory inquiry by the SEC, FINRA, and other self-regulatory organizations, and we have the experience to guide and advise you through any type of regulatory investigation. If you are the subject of a regulatory proceeding, contact us at (888) 655-6002 or through our online contact form for a free consultation.