The North American Securities Administrators Association (NASAA) recently released a report prepared by its Broker-Dealer Section Committee (Committee) presenting the findings of Phase II (B) of its National Examination Initiative. The report is noteworthy, in part, because it represents a well-organized presentation of the Committee’s assessment of broker-dealers’ implementation of Regulation Best Interest (Reg BI) and identifies conduct categorized as “presumptive breaches” of Reg BI. Moreover, the report (Reg BI Report) was published on the same day NASAA released proposed revisions to its Broker-Dealer Conduct Model Rule intended to support the incorporation of key aspects of Reg BI into state laws. There is certainly room to debate the Committee’s assessments, but broker-dealers should not ignore the Reg BI Report – even if they disagree with some of the views expressed therein. Accordingly, this client alert summarizes the Reg BI Report and presents our initial observations.
The Coordinated National Examination Initiative
The information underlying the Reg BI Report was collected by state securities regulators in 25 jurisdictions via on-site and remote examinations of more than 200 broker-dealers. Although the information reviewed by the Committee did not identify the firms examined, it observed that the broker-dealers examined varied in “size, business model, and location.”
The examinations were aimed at assessing compliance in years “two and three of Reg BI.” Thus, presumably all of the findings discussed in the Reg BI Report are based on information associated with activity between June 2021 and June 2023.
It should be noted that the examinations underlying the Reg BI Report focused on transaction-level reviews of what NASAA refers to as “complex, costly, and risky product types,” which it described as:
- Leveraged and inverse ETFs;
- Non-traded real estate investment trusts (non-traded REITS);
- Private placements, and;
- Variable annuities.
The objective of the Reg BI Report was to present “qualitative findings” of how broker-dealer firms have been “meeting or exceeding state expectations . . . as well as identifying areas where FINRA firm compliance appeared weak (opportunities for improvement).”
Key Findings, Best Practices and Presumptive Breaches
Consistent with the stated objective, the Reg BI Report discusses the Committee’s assessments as to both strengths and weaknesses in practices observed. The identified best practices are likely welcome news for firms that have implemented the same. But they also present valuable insight into state regulators’ expectations, which is great information for firms as they consider ongoing compliance needs. On the other hand, the Reg BI Report’s discussion of weaknesses and “presumptive breaches” foreshadows future exam findings and enforcement actions, and thereby warrants consideration by broker-dealers across the country.
The following table presents a brief summary of findings, key observations, and concerns raised by the Committee during Phase II (B) with relation to firms’ Reg BI obligations, as well as best practices identified by the Committee. The below is not an exhaustive list of all observations discussed in the report, and we suggest firms take the time to read the report in its entirety.
The Reg BI Report includes multiple references to “presumptive breaches” of Reg BI. Notably, the “presumptive breach” language is only found in the SEC’s Reg BI Adopting Release in connection with the use of the “adviser/advisor” title for persons who are not supervised persons of an investment adviser. The states appear to be taking the position that certain provisions of Reg BI establish “clear requirements,” and that failures to comply with those requirements should be a presumptive breach. Yet, some of the requirements pointed to by the Committee are not exactly purely objective standards and involve sufficient room for judgement, which will likely complicate the view that non-compliance would be a presumptive breach of Regulation BI.
Regardless, the Committee has identified six specific forms of conduct that “States would generally view . . . as presumptive breaches of Reg BI,” including:
- Failure to timely file a proper Form CRS.
- Failure to supplement the Form CRS with detailed disclosure of fees, costs and conflicts associated with recommendation prior to or at the time of the recommendation.
- Improper use of adviser/advisor title.
- Continued use of time-sensitive, product-specific sales contests.
- Failure to adopt policies and procedures reasonably designed to identify, eliminate or mitigate conflicts of interest.
- Failure to adopt policies and procedures reasonably designed to achieve compliance with Reg BI as a whole.
Product Specific Observations
The below chart provides a brief summary of key observations and guidance raised by the Committee with relation to “complex, costly, and risky product types” it describes in the report. We suggest firms review this section of the report carefully when considering their practices and policies related to these specific product types.
In sum, the Reg BI Report has identified a number of key observations and concerns raised by the Committee related to firms’ Reg BI obligations and specific products and highlighted specific guidance or Best Practices suggested by the Committee to help firms better their compliance efforts. It is important to note that NASAA is a membership of sovereign states, and the findings and guidance suggested in its Phase II (B) of its National Examination Initiative may be more – or less – stringent than the standards applied by any particular sovereign. Nonetheless, the points noted – especially those that seem to be strong interpretations of the Reg BI obligations – are critical considerations in ongoing guidance to broker-dealers and their associated persons.