Tennessee-based broker-dealer First Horizon Advisors, Inc. has agreed to pay a civil penalty of $325,000 in connection with its recommendations for certain products, the SEC said in its press release this week.
The SEC found First Horizon failed to maintain and enforce policies and procedures reasonably designed to achieve compliance with Regulation Best Interest (Reg BI). First Horizon did not comply with the rule in several ways, including by approving recommendations to customers without having all the accurate information it needed to review for some accounts, the SEC alleged.
All of the charges relate to First Horizon’s recommendations of a type of derivative security called a structured note.
In on example cited by the SEC in its order, First Horizon in 2021 migrated more than 5,000 customer brokerage accounts to its system from that of a broker dealer with whom First Horizon had merged.
“This action underscores that broker-dealers must ensure appropriate compliance around complex financial products and that it is not enough to simply have written policies; firms must also enforce them.”
Osman Nawaz, Chief of the SEC Enforcement Division’s Complex Financial Instruments Unit
The SEC said that because of incompatibilities in the two systems, First Horizon did not have accurate customer information necessary to review structured note recommendations for compliance with First Horizon’s Reg BI policies and procedures.
In addition, the registered representatives who joined First Horizon from the merging broker-dealer did not have access to its exception reporting site to review structured notes transactions flagged as non-compliant, as required by First Horizon’s Reg BI policies and procedures.
In addition, for at least three years after the firm implemented Reg BI in July2020, First Horizon also did not maintain or enforce certain Reg BI policies and procedures applicable to structured note recommendations made by either its new or legacy First Horizon registered representatives.
Reg BI
Reg BI is encapsulated in SEC Rule 15 I-1, which establishes a standard of conduct for broker-dealers and natural persons who are associated persons of a broker-dealer when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer.
Reg BI is a compliance process
First Horizon Corporation merged with IberiaBank Corporation in July 2020. Beginning in January 2021, Iberia Financial Services LLC terminated its preexisting networking arrangement and First Horizon integrated its operations.
This is where things got messy, from a technology perspective.
In October 2020, several months before its integration with the merging broker-dealer, First Horizon learned that certain customer investment profile information, such as risk tolerance and investment time horizon, would not map from the merging broker-dealer’s systems to the comparable fields in First Horizon’s systems, and that other information – such as investible assets – would not transfer at all.
And in February 2021, First Horizon learned that technology issues prevented the new First Horizon registered representatives from accessing its exception reporting site to review exception reports related to their recommendations, and to provide new information or documentation needed to comply with First Horizon’s Reg BI policies and procedures.
The new First Horizon registered representatives were not able to access the exception reporting site until April 2022 – over a year after the discovery of the issue – and were permitted an additional three months by First Horizon to clear their backlogged exceptions, the SEC said.
The SEC points out that steps were not taken (that could have been) during the operations integration by First Horizon to help ensure that the registered representatives cleared the exception reports within the required timeframe.
Reg BI compliance in action
“This action underscores that broker-dealers must ensure appropriate compliance around complex financial products and that it is not enough to simply have written policies; firms must also enforce them,” said Osman Nawaz, Chief of the SEC Enforcement Division’s Complex Financial Instruments Unit.
The firm’s policies were fine here, but First Horizon lacked the procedures it needed to ensure its newly integrated technology apparatus would be able to stay in compliance with the rule. And it lacked any procedures to ensure that when a tech glitch did occur, a viable workaround was available. Its system for monitoring and flagging any issues of noncompliance in this area was also lacking.
At only four pages long, Reg BI itself does not initially seem daunting, but once one digs into the nearly 800 pages of guidance on how the SEC interprets it, the layers of complexity become apparent to any firm trying to meet its several obligations.
The four component obligations are:
- a disclosure obligation;
- a care obligation;
- a conflict of interest obligation; and
- a compliance obligation.
Meeting these obligations involves doing due diligence on one’s client, monitoring customer accounts, making certain disclosures to customers, and acting on any red flags in a timely manner.
Accomplishing these obligations eats up a lot of time and means filling out a lot of forms. And technology can help. Until it can’t. So that needs to be anticipated.
