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SEC Charges BD, 5 Brokers with Reg BI Violations

Regulatory Compliance

Stepping up its enforcement of Regulation Best Interest (Reg BI), the Securities and Exchange Commission announced June 16 that it charged a registered broker-dealer and five of its representatives for failing to comply with certain obligations under the rule.  

According to the June 15 complaint, between July 2020 and April 2021, Western International Securities, Inc., along with brokers Nancy Cole, Patrick Egan, Andy Gitipityapon, Steven Graham and Thomas Swan, recommended and sold $13.3 million worth of unrated, high-risk debt security known as L Bonds to retirees and other retail investors.  

However, many of the retiree and retail customers to whom the L Bonds were sold were on fixed incomes and had moderate risk tolerances, despite the issuer, GWG Holdings, stating that the bonds were high risk, illiquid and only suitable for customers with substantial financial resources. As such, the SEC is seeking permanent injunctions, disgorgement and prejudgment interest, and civil penalties against Western and the five representatives. 

Failures to Comply  

According to the SEC’s complaint, the recommendations violated Reg BI in several ways under the regulation’s four component obligations: the Disclosure Obligation, the Care Obligation, Conflict of Interest Obligation and the Compliance Obligation. 

First, the defendants allegedly failed to comply with Reg BI’s Care Obligation because they did not exercise reasonable diligence, care and skill to understand the risks, rewards and costs associated with L Bonds. At the time they recommended L Bonds to retail customers, the registered representatives did not understand key risks associated with L Bonds and GWG, the SEC notes. 

The defendants also failed to comply with this component of the Care Obligation by recommending L Bonds to at least seven retail customers without a reasonable basis to believe L Bonds were in those customers’ best interests. Among other things, these customers had moderate-conservative or moderate risk tolerances—investment objectives that did not include speculation, limited investment experience, limited liquid net worth, and/or they were retired. “The Registered Representative Defendants nevertheless recommended L Bonds to these seven customers without reasonable bases for doing so,” the complaint states. 

The complaint also alleges Western failed to comply with Reg BI’s Compliance Obligation because it did not adequately establish, maintain and enforce written policies and procedures reasonably designed to achieve compliance with Reg BI. 

Instead, Western’s written policies and procedures merely recited the objectives of Reg BI, without offering registered representatives specific guidance tailored to Western’s operations, the complaint explains. Western also had inadequate procedures for enforcing what limited policies it had regarding compliance with the Care Obligation of Reg BI. 

Since Western’s policies and procedures were so vague, Western personnel had a limited ability to enforce them as required by Reg BI’s Compliance Obligation, the compliant explains. Western’s deficiencies in this regard include: 

  • Due to vague written policies, there was confusion as to whom at Western was responsible for reviewing transactions for suitability and compliance with Reg BI’s Care Obligation. 
  • Western had no written policies or procedures guiding its supervisors’ review as to whether a transaction was in a customer’s best interest for the purpose of complying with Reg BI. 
  • Western had no written policies or procedures guiding its compliance department’s review of transactions under Reg BI. 
  • Western had no written policies or procedures guiding its supervisors as to the purpose of the “rationale” in the Client Disclosure Forms, what it was supposed to communicate, or how they were to review the rationales to enforce compliance with Reg BI. 
  • Western had neither written policies nor procedures monitoring or enforcing its requirement that its registered representatives review reasonably available alternatives to a recommended security.

“Reg BI is clear: broker-dealers must act in the best interest of their customers,” stated Gurbir Grewal, Director of the SEC’s Division of Enforcement. “When they fail to do so, as we allege happened here, they put retail investors at risk and we’ll hold them accountable.”