What Investors Can Learn from the 2023 FINRA Examination
Regulation Best Interest (Reg BI) appears in the 2023 FINRA Examination Risk Monitoring Program, suggesting that FINRA will be scrutinizing firms more closely this year for their compliance with this new regulation. Reg BI is designed to enhance protections for investors against predatory brokerage firms. But with only two enforcement in 2022, regulators will need to ramp up enforcement if investors are to experience a widespread benefit.
What is Regulation Best Interest?
Regulation Best Interest expands on the requirements of FINRA Rule 2111, which requires that brokers exclusively recommend investments that are in line with the investor’s financial needs. Their financial needs should account for their tax status, financial goals, age, and risk tolerance.
In addition to these concerns, Reg BI has added a Duty of Care Obligation, a Conflict of Interest Obligation, and a Disclosure Obligation to the list of broker responsibilities.
Duty of Care Obligation
Under the “Duty of Care” obligation, brokers must understand how a product works before they recommend it to their clients. Brokerage firms and the associated brokers must exercise reasonable diligence, care, and skill to understand a product’s potential risks, rewards, and costs. This means that brokers who recommend complex products should be aware if there are any products on the market that offer similar rewards at a lower cost.
One of the questions mentioned in the Care Obligation section of the Risk Monitoring Report asks:
- Does your firm consider a sufficient array of reasonable alternatives, including lower cost or lower-risk alternatives your firm offers?
- Has your firm considered applying heightened scrutiny as to whether recommended investments that are high-risk, high-cost, complex, or represent a high conflict of interest are in a retail customer’s best interest?
Conflict of Interest Obligation
The FINRA exam asks:
Are your firm’s policies reasonably designed to identify, and, at a minimum, disclose or eliminate conflicts associated with recommendations?
What Are Conflicts of Interest?
A conflict of interest might involve a broker recommending shares of a company that he or she also owns shares of. Firms should also disclose if they intend to limit their recommendations to the firm’s own products.
What Steps Should Firms Take to Avoid Conflicts of Interest?
The exam also asks firms to take the following steps to avoid conflicts of interest:
- Minimize financial incentives for brokers to favor one type of account over another.
- Adjust compensation for financial professionals who fail to adequately manage conflicts of interest.
Brokerage firms should disclose all material facts relating to their relationships with their retail customers.
Material facts include:
- Fees and costs associated with transactions,
- Minimum account sizes, and
- The philosophy behind the firm’s overall investment strategy.