U.S. SEC Warns Brokers About Sales Contests That Violate Regulation Best Interest

The United States Securities Exchange Commission (SEC) recently issued a Staff Bulletin which discussed the use of sales contests or other sales incentives by FINRA Broker-Dealer firms in the context of SEC Regulation Best Interest (Reg BI).

Reg BI, 17 CFR 240-15l-1, specifically describes the “best interest” obligation as follows in section (a)(1):

“A broker, dealer, or a natural person who is an associated person of a broker or dealer, when making a recommendation of any securities transaction or investment strategy involving securities (including account recommendations) to a retail customer, shall act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker, dealer, or natural person who is an associated person of a broker or dealer making the recommendation ahead of the interest of the retail customer.”

Reg BI includes four best interest obligations – the disclosure obligation, the care obligation, the conflict-of-interest obligation, and the compliance obligation.

Although firms may address some conflicts of interest by disclosure to customers, the SEC discussed that certain conflicts cannot simply be disclosed, and must be eliminated. Specifically, the following activities by the Broker-Dealer would violate Reg BI – “sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sales of specific securities or specific types of securities within a limited period of time.”

Many cases of investor harm that end up in FINRA Arbitration are a result of financial incentives to the broker which encouraged the wrongful conduct or unsuitable recommendation. This can include churning, but also can involve high risk securities / investments that pay higher fees or compensation to the broker to generate more sales of the product. Issuers of high risk but low reward investments pay high commissions (sometimes at 8% or higher) because otherwise no reasonable broker would sell the investment. This can and does then lead to losses by public customers who were not explained the risk, and trusted their financial advisor. As the SEC makes clear, a Broker-Dealer cannot encourage the sale of certain kinds of high commission products through sales contests or quotas, and must have a compliance system in place to detect and prevent such violations of Reg BI.

If you believe you may have a potential claim against your financial advisor, please contact Scott Greco for a free attorney consultation about your case.