Brokers Trail Investment Advisors in KYC, Sell More ‘Complex’ Products–Regulators
Broker-dealers subject to customer suitability standards generally offer more expensive, riskier and more complex investment choices to customers than do investment advisers operating under more rigorous fiduciary standards, state securities regulators said on Wednesday.
That compares with 15% of investment adviser firms that said they sell the products that are prone to causing investor confusion and harm, according to the state regulators.
Mutual funds, equities, debt/fixed-income products and standard ETFs remain by far the most common products offered by brokerages and IAs, the regulatory group said, and 64% of all firms answering NASAA’s questionnaire did not make the complex products available to customers in the 2018 survey year.
“When they were sold, however, broker-dealers were much more likely than investment advisers to place these products,” the report from NASAA’s Regulation Best Interest Committee said.
The group initiated the study to create a baseline of practices that can be used to judge the effectiveness of changes firms make to comply with Reg BI. The Securities and Exchange Commission’s new customer-care regulation became effective on June 30, but the SEC and Finra will initially examine broker-dealers only to determine that they are making good-faith efforts to implement policies and procedures.
Several state regulators have criticized the SEC for adopting what they say is an amorphous Reg BI standard, which does not define “best interest,” for the fiduciary standard that requires investment advisers to put their customers’ interests ahead of their own.
The NASAA committee, which distributed its exam questionnaires in mid-February 2020, plans a second exam in 2021 to gauge effectiveness of the regulation.
“We are closely watching the industry’s early implementation of the SEC’s Regulation Best Interest with an eye toward determining whether the rule benefits investors as intended,” Andrea Seidt, Ohio Securities Commissioner and chair of the Reg BI implementation committee, said in a press release accompanying the exam report.
Seven industry trade groups and the U.S. Chamber of Commerce objected to the questionnaires when NASAA announced the exams in February, but the Reg BI committee declined their requests to suspend the initiative.
In other findings, 22% of brokerage firms surveyed did not use investor profiles such as “Know-Your-Customer” questionnaires to help determine appropriate investment recommendations. That compares with 13% of investment advisors who fail to use such KYC tools.
Only 20% of all firms asked customers for their education levels and only 42% inquired about their debt obligations. Broker-dealers gathered more information than IAs about customers’ years of investment experience.
Reg BI will require firms to disclose conflicts of interest, such as incentives from product sponsors, and possibly to mitigate them. It remains unclear whether firms will have to go beyond delivering prospectuses to satisfy the SEC on disclosing fees at point of sale presentations, but Reg BI requires brokers to disclose whether lower-cost suitable options are available than the investment products they recommend.
Fifty-nine percent of all firms reported having specific policies and procedures regarding conflicts, but only 24% have to date designed conflict registers and only 30% have designated conflict committees or officers (30%) to enforce the policies, according to the exam report.
While 69% of all firms have some policies on fee disclosure at point of sale, only 30% require discussion of fees when recommending rollovers from retirement plan 401(k)s at employers to brokerage firm IRAs, according to the survey.
About one of three firms (35%) said they have policies to discuss at point of sale the availability of similar products that may be cheaper outside their platforms.
“Based on survey responses, firms on both the BD and IA side have a lot of work to do here,” the NASAA report said about fulfilling the disclosure requirements.
The report implicitly criticized the SEC for not going far enough in restricting titles registered reps use when marketing themselves.
Reg BI will generally require insurance agents or brokerage firm reps who use “adviser” or “advisor” titles to be registered and supervised as IAs, but does not restrict titles such as “wealth manager” and “financial consultant.” Nearly 40% of broker-dealers surveyed had no education requirements for reps who use advisor/adviser titles, compared to 26% of IAs. Thirty percent of brokers permit the wealth manager/consultant titles compared to 9% of IAs.
“The examinations identified compliance challenges for industry,” West Virginia Deputy Securities Commissioner Lisa Hopkins, who is president of NASAA, said in a prepared statement. “We look forward to seeing how industry addresses these challenges.”
