SEC warns brokers, advisers to make ongoing efforts to identify, mitigate conflicts

All brokers and investment advisers have unique conflicts of interest, and reducing their potential harm to investors essentially should be a daily goal rather than a one-time compliance change, the SEC said Wednesday.

The Securities and Exchange Commission sent that message in a staff bulletin posted Wednesday about broker and adviser standards of conduct under an investment-advice regulatory package centering on Regulation Best Interest that has been in force for more than two years.

“The staff believes that identifying and addressing conflicts should not be merely a ‘check-the-box’ exercise, but a robust, ongoing process that is tailored to each conflict,” the bulletin states. “The staff believes that identifying and addressing conflicts is not a ‘set it and forget it’ exercise. Firms should monitor conflicts over time and assess periodically the adequacy and effectiveness of their policies and procedures to help ensure compliance with Reg BI and the [investment adviser] fiduciary standard.”

The 17-page bulletin outlines examples of conflicts and how to identify and disclose them, offers ways to mitigate conflicts based on broker and adviser compensation arrangements, and highlights conflicts that must be eliminated, among other guidance.   

“The staff believes that disclosures should be specific to each conflict, in ‘plain English,’ and tailored to, among other things, firms’ business models, compensation structures, and products offered at different firms,” the bulletin states. “Stating that the firm ‘may have a conflict when the conflict actually exists is not sufficiently specific to disclose the conflicts adequately to retail investors.”

Among the suggestions for mitigating conflicts are to avoid compensation incentives for selling certain products and to minimize incentives for favoring one type of product or account over another. Firms also should monitor recommendations or advice that result in additional compensation.

Conflicts often arise from compensation incentives, such as variable pay based on products sold, accounts recommended, accumulation of assets under management and services provided, and payments from third parties, according to the bulletin.

“In the staff’s view, the greater the reward to the financial professional for meeting particular thresholds (or conversely, the most severe the consequence for failing to meet them), the greater is the concern whether the incentive program complies with Reg BI and the IA fiduciary standard,” the bulletin states.

Wednesday’s bulletin is the second this year to guide financial professionals in complying with Reg BI, which prohibits brokers from putting their own financial interests ahead of the interests of their customers. The bulletins don't introduce new requirements but rather elevate and illuminate obligations included in the 770-page regulation.

A March bulletin focused on account recommendations, and more are on the way, SEC Chairman Gary Gensler said in an InvestmentNews interview in June. The next one is likely to tackle the obligation to consider reasonably available alternatives based on costs and risks when making recommendations under Reg BI, SEC staff told reporters on Tuesday.

Gensler has indicated the SEC will use the bulletins and enforcement actions to ensure that Reg BI delivers on its investor protection promises. The SEC filed its first Reg BI enforcement case in June.

Wednesday’s bulletin addresses a prominent industry worry — how to comply with a principles-based regulation that does not define "best interest" or offer explicit rules for mitigating conflicts.

The SEC wants to dispel two misguided assumptions, SEC staff told reporters. The first is that disclosure alone is enough to satisfy Reg BI’s requirements. The other is that all conflicts must be eliminated.

The middle ground will be a challenge to achieve. The bulletin sets the foundation for conflict management by saying there are no conflict-free business models. It also urges brokers and advisers to show their work on adhering to Reg BI and the Investment Advisers Act, respectively.

“In the staff’s view, it may be difficult for a firm to demonstrate compliance with the applicable standard of conduct without documenting the measures it takes to mitigate conflicts of interest and any such periodic assessment of its policies and procedures undertaken by the firm,” the bulletin states.