Recently, InvestorCOM had the pleasure of speaking with Tom Selman, Founder of Scopus Financial Group and former Executive Vice President of FINRA’s Regulatory Policy Division.  In this dialogue, Tom discusses the emergence of Reg BI, what we’ve learned to date, and what firms should focus on.

 

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Parham Nasseri (PN): Tom you’re a prolific thought leader on many financial industry regulatory topics. If we were to step back are there a series of events that led to your interest in this topic area?

Tom Selman (TS): Yes, although for anybody who is starting their career, I would suggest that a lot of what happens will be serendipitous. I took a job as a summer associate in a law firm intending to do labor law. But at the time, the labor law market was in steep decline. This was in the 80s and the firm was a very active financial regulation practice. I became involved in that as a summer associate. With the decline of labor law at practice, my interest grew in financial services regulation.  I obtained a CFA Charter rather late in my career because I’m interested in principles of financial investing and also financial services law.

PN: Tom, speaking of regulations Reg BI or Regulation Best Interest as it’s called is considered to be one of the most significant enhancements of conduct standards since the SEC Act of 1934.  What are your thoughts on Reg BI and how will it sort of shape or position the industry on a go-forward basis?

TS: Reg BI is an important regulation that finally establishes a best interest standard for broker-dealers who are already subject to the standard, for example in arbitrations, and already had a high standard even in the rules of the suitability standard. The best interest standard brings together all of their duties and responsibilities in a single regulation and they’ll outline some important new principles on how to apply those duties.

I think Reg BI is very important and it’s a laudable regulation. People have said it should be a fiduciary standard. I’m not sure exactly what the tremendous difference would be if it were technically a fiduciary standard other than the difficulties of applying it to a commission-based business. I think the fiduciary standard is not easily applied to a commission-based business. In terms of investor protection, I’m not sure what it would add. In certain key respects, Reg BI is more onerous than the investment advisor’s fiduciary standard.

PN: The SEC recently issued a notice on their 2021 Reg BI examination priorities. Are there any indications on how the SEC will be approaching these examinations and what broker-dealers and firms operating in this business can do to prepare?

TS: Both the SEC and FINRA have indicated that this year they’re going to broaden their scope a bit and go beyond good faith compliance. But non-compliance in ways that may indicate good faith, but still it exists as non-compliance. The SEC’s Priorities Report implies that they’re probably not going to refer non-compliance to enforcement unless it constitutes some type of customer harm. That’s just an implication. They may end up doing many more referrals. Even the SEC staff has indicated that they’re not looking for ‘gotcha type’ examinations, they still want to look for real non-compliance by firms.

PN:  After that good faith period the SEC on December 21 issued a notice where it stated that it will be looking into whether broker-dealers have looked at costs and reasonably available alternatives at the time of the recommendation. Can you elaborate a little bit around the why behind this particular focus area of the regulations?

TS:  The Commission and FINRA have both been interested in costs for some time. Since the 90’s and early 2000’s, they looked at costs, for example, in terms of churning activity and broker-dealers at the accounts. It’s not just a question of suitability but also the cost associated with the suitability analysis. When you incur those commissions, they’ve always been interested in multi-class mutual funds, variable annuities, and the cost issues that are raised with that.  The cost issue is part of the duty of care. To me, it’s a continuation or almost a formalization of how FINRA and the SEC have felt all along. If you recommend a more expensive investment, this alone is not going to constitute a violation of Reg BI. There has to be a bit more to it. But cost will certainly be a focus of these examinations.

PN: The notion of assessing reasonably available alternatives within that care obligation. Any insights on that particular piece of the requirement?

TS: That’s a particularly interesting element of the expectations by the SEC. There was certainly always an element of that consideration. For example, with multi-class shares to compare the classes available to the customer to see which one would be most consistent with the customer’s investment strategy. The interesting question for me is how much they’re going to look at reasonable alternatives in terms of accounts. For example, the rollover of pension money into an IRA, the choice of a brokerage or an advisory account, the choice of type of accounts, brokerage account that’s provided. I’m not sure exactly where the Commission might end up with those considerations. That might be interesting. As well, how the Commission will treat reasonable alternatives for products.

PN: Would documentation on how decisions are made around account types or rollover recommendations or product types be of an asset to brokers?

TS: I think there has to be a lot of documentation throughout Reg BI. You have to be able to demonstrate to the examiner that the elements of Reg BI were implemented. With “reasonable available alternatives”, training is going to be incredibly important to limit reps who are not qualified to recommend, for example, alternative investments. If they’re not qualified to recommend them, then they probably shouldn’t be recommending them. Those who are qualified to recommend are likely the vast majority of people who have a license.  There may need to be some type of special documentation of the types of consideration that these reps are expected to make. With some highly complex investments, I don’t think all Alts, but some highly complex investments there may need to be some type of justification by the rep when they’re making the recommendation. I don’t mean to pick on alternative investments those are just one example of the type of investment I think the Commission and center are going to be looking at. I think any investment that is complex or not widely sold to customers yet may be the type that they consider.

PN: As firms work towards aligning with the principles of Reg BI, what would you recommend to them in terms of how they set up their practice for success?

TS: I think they need to consider what an examiner is going to want and I think they ought to consider what type of technology they can use to make this process easier.  The technology offered by InvestorCOM would make compliance much easier for many broker-dealers. They need to consider technology like that to be able to manage this. It’s a very complicated regulation.

PN: Thank you, Tom, it’s been an absolute pleasure speaking with you, and hope to speak with you very soon.

 

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This discussion is also available in the following formats:

YouTube,  Spotify, and Google Podcasts

Tags: exams, reasonably available alternatives, Reg BI, Tom Selman