By Mark S. Nelson, J.D.
SEC Commissioner Allison Herren Lee, speaking to the ALI CLE 2021 Conference on Life Insurance Company Products earlier this month, said broker-dealers should be cognizant of whether certain practices, including at the account opening stage of a relationship with a retail customer, may constitute recommendations that would invoke the investor protections of Regulation Best Interest. Lee explained that such extra scrutiny by broker-dealers is needed because of the recent surge in new, largely inexperienced retail traders into securities markets.
Is it a recommendation? Regulation BI generally imposes specific duties on broker-dealers regarding disclosure, care, conflicts of interest, and compliance, but only if the broker-dealer is making a recommendation to a retail investor. Lee noted that the Commission’s supplemental materials accompanying Regulation BI speak of broker-dealer activities that reasonably may be viewed to function as a “call to action” or which may reasonably be viewed as “influenc[ing] an investor to trade a particular security or group of securities.”
While Regulation BI suggests a focus on particular securities or groups of securities, Lee suggested a possible gap in the regulation’s coverage due to a shift in how some broker-dealers may be promoting trading. Said Lee: “It is also evident that, in an increasingly commission free trading environment where broker-dealers generate substantial revenue from payment for order flow, incentives are shifting more and more from recommending particular securities to recommending day trading more broadly, irrespective of the securities traded.”
Lee also emphasized how portions of the broker-dealer industry have embraced new technologies. “Broker-dealers should be thinking critically and carefully about the extent to which nascent practices in the industry may, in fact, constitute recommendations, ” said Lee. These concerns echo the Commission’s request for information and comment on digital engagement practices (DEPs), some of which involve gamification of trading that have been the focus of much of the news coverage about online, no or low commissioner brokers.
Lee further observed that broker-dealers should not overlook the account opening process. According to Lee, a broker-dealer who offers default investments or a narrow class of investment options may be making a recommendation.
Conflicts. Lee summarized the instances where Regulation BI requires conflict mitigation, such as when an associated person might put their interest ahead of a customer’s interest, or a broker-dealer or associated person might put their interest ahead of a customer’s interest due to limits on a fund’s product menu, although she noted that the final rule does not require all conflicts to be mitigated.
Lee closed by noting that Regulation BI diverges from aspects of the NAIC model regulation for annuity sales, which emphasizes disclosure of a producer’s compensation. “As states continue to adopt and implement the NAIC model, I encourage those of you in the securities and insurance industries to evaluate your policies and procedures to ensure they are consistent with both standards.”