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Here’s rough justice: FINRA’s February 9 disgraceful report on broker-dealer breaches of Reg BI came out just as the Winter Olympics was tarnished by the politics of the IOC.
It was management failure, where fair play and enforcing the rules lost out to political interests. It’s not the outstanding athletic achievements (i.e., Norway’s leading medal count 😊).
Casualties matter. Unabated conflicts eat away at investor returns and the Olympic spirit is beaten.
The Wall Street Journal called these Olympics “grim” and editorialized for reforms.
The same should be said for Reg BI.
The FINRA report appeared to be serious. FINRA called its findings “noteworthy.”
The findings described 19 deficiencies in 453 words. Four tenets underpin those deficiencies:
- Policies and procedures were not “designed to achieve compliance” with Reg BI.
- Training failed to prepare staff to comply with Reg BI.
- Conflicts were not identified or, if identified, not adequately addressed.
- There was a failure to provide full and fair disclosure of all material facts.
How did FINRA describe the upshot of those deficiencies?
“Failure to comply with the care obligation – Making recommendations that were not in the best interest of a particular retail customer.” (Emphasis added.)
That “best interest” note was tucked in the middle of the 19 deficiencies – in 22 words. Likewise, misusing the term “advisor” was discussed in 32 words.
This is obfuscation. The entire point of Reg BI is to transform suitable recommendations and conduct into a best interest standard. In this first report on Reg BI, which is FINRA’s core purpose and raison d’etre and the rallying cry of the SEC since April 2018, best interests were all but omitted.
In an Investment News story, a FINRA spokesperson, Ray Pellecchia wrote in an email, “Both ‘exam findings’ and ‘effective practices’ reflect things we’ve seen in exams… ‘Exam findings’ identify areas where firms have not complied with the relevant rule(s). ‘Effective practices’ cite practices that go above and beyond rule requirements.”
The chief lobby group for broker-dealers, SIFMA, explained. Kevin Carroll noted in the Investment News article that Reg BI is “working.” He then said, “FINRA is not concluding there are widespread failures. That is not the case.”
Those remarks ignore actual deficiencies. They mislead.
Pellecchia suggested practices deemed “effective” – or model practices – somehow make up for the actual findings. He did not say how.
Here is one way to explain it. Imagine you are pulled over for exceeding the speed limit by 15 MPH. There is no question as to the facts that you failed the standard. You suggest to the officer you should be let off because of all the times you said you obeyed the speed limit and do meet the standard.
That is FINRA’s and SIFMA’s logic.
Pellecchia then asserted that effective practices “go above and beyond” what the rule requires. This statement contradicts the language in the report, which says these practices, “may help member firms”.
The serious deficiencies enumerated in the FINRA report are also cited in the North American Securities Administrators Association’s (NASAA) November report on Reg BI. NASAA provided rich detail on BD deficiencies. It looked into policies, procedure and practices “in the areas of due diligence and care, disclosure, and conflict management” with respect to Reg BI.
NASAA concluded that most Reg BI firms sampled were “not providing fair and balanced point-of-sale disclosure regarding fees, costs and risk,” and that, “These Reg BI firms have steadily increased their participation in complex, costly and risk products... (They) continue to reply on financial incentives that Reg BI was intended to curb.”
Pellecchia and Carroll used language to appear to be fair and balanced. But it raises a red flag because it was contrived. Their balanced framing of the report belies the facts. Firm deficiencies are serious, prevalent and harmful.
The FINRA and NASAA Reg BI reports reveal important truths, while the brokerage industry muddles their findings with obfuscating language. This is hardly new. What is new is the opportunity for the SEC to fix serious deficiencies in landmark rulemaking through guidance and enforcement.
The International Olympic Committee (IOC) has a history of bad management and even corruption. The unfortunate fate of Kamila Valieva, the teen Russian figure skater, was just one case.
The Olympic spirit and Reg BI can be repaired. Reinstituting fair play and enforcing the rules would be a good start. Fixing Reg BI would be easy. Until then, as the Wall Street Journal said, “Good riddance to the Beijing Olympics”.
Knut A. Rostad, MBA, is the co-founder and president of the Institute for the Fiduciary Standard, a nonprofit formed in 2011 to advance the fiduciary standard through research, education and advocacy.
Read more articles by Knut A Rostad