The States Strike Back Against Reg BI

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“No thinking man can believe that an economy built upon a business foundation … can permanently endure without some loyalty to that (fiduciary) principle.”

Justice Harlan Fiske Stone, Harvard Law Review, 1934

Last week’s off-year elections in Virginia, New Jersey, Buffalo and Minneapolis bodes big trouble for the Biden administration. But overlooked last week was a report from state securities administrators stating, frankly, the opposite. The “states” supported administration efforts to strengthen the regulation of broker-dealers (BDs).

On November 4, the North American Securities State Administrators Association (NASAA) released its latest installment of a national survey of investment advisor (IA) and BD policies, procedures and practices pre-2018 and 2021 post-Reg BI.

The bottom line, according to the report: “Many broker-dealer firms still place their financial interests ahead of their customers.” They offer and sell “complex, costly, risky products” (CCR) and fail to disclose to investors the availability of lower cost and less risky products.

Four CCR products were identified because they have all three characteristics: private securities, variable annuities, non-traded REITs and leveraged or inverse ETFs. These products, “Routinely appear in investor complaints and state enforcement actions,” according to the NASAA.

How BDs (under Reg BI) and fiduciary IAs compare regarding these products is stark. Among BD firms (in 2021) 76% recommended at least one product, versus 14% of IA firms (in 2018). Specifically, 66% of BD firms and 5% of IA firms recommended variable annuities.

Other findings in the NASAA report included:

  • From 2018 to 2021, BD firms increased their commitment to CCR products. In 2018 (before Reg BI), 89% of BD firms offered CCR products, while in 2021 100% did so;
  • 65% of BDs did not discuss lower cost or less risky products when they discussed CCR products; and,
  • IA and BD practices for financial conflicts also differed dramatically. Compensation based on incremental sales growth was rewarded by 30% of BD firms and just 3% of IA firms; and differential comp was rewarded by 29% and .5%, respectively, of BD and IA firms.