Source: Securities and Exchange Commission
Office of Compliance Inspections and Examinations Staff
Nov. 16, 2020
It is critically important for registered investment advisers and broker-dealers to implement robust and effective policies and procedures reasonably designed to prevent violations of the federal securities laws, which includes ensuring that their financial professionals understand the risks and purposes of the products they advise on and/or recommend to firm clients and customers. Moreover, firms must ensure that their financial professionals, including independent contractors acting on their behalf, actually follow in practice those firm policies and procedures.
The recent settled charges by the Commission reflect examples of failures in design and/or implementation by firms of robust and effective policies and procedures, and highlight the importance of investment advisers and broker-dealers ensuring that the recommendations they make to their retail clients or customers comply with their legal obligations. These matters reflect instances where financial professionals recommended complex investment products to retail clients and customers that were intended for short-term use, but were not used as designed causing financial harm to their clients and customers. The VIX-related exchange-traded products (ETPs) recommended in these matters generally disclosed in their prospectuses and supplements that they were intended as short-term investments and that risks heightened when holding these products for longer periods.
Complex products and investment strategies are continually evolving in terms of their construction and risks. A compliance program that is not dynamic, but is instead based on product features, such as leverage or inverse correlation, is more susceptible (as is the case with these firms) to fail to maintain appropriate controls on the products available to their financial professionals. OCIE routinely observes firms that have dynamic compliance programs with policies and procedures and practices for onboarding new products, including complex products. These policies and procedures and related practices often include, at the firm level, an assessment as to whether and how the product should be used by clients and customers and the training and monitoring of financial professionals necessary for the firm to meet its legal obligations. OCIE has observed that this assessment, often done by a committee, typically calls for the active involvement of senior managers, and includes participation from compliance, legal, risk, marketing, portfolio management and/or operations.
Firms that offer their financial professionals access to a full scope of products on a platform made available by the firm’s clearing or executing broker should review the design and implementation of their policies and procedures so that product analysis is not solely left to each financial professional. Specifically, OCIE has observed firms that provide financial professionals with the training and tools such that the financial professional is familiar with the product to discharge the firm’s and his or her own legal obligations. For example, in the case of both existing products and new products, firms should consider which products are complex, suitable only for sophisticated investors, not suitable for investors who plan to hold them for longer than one trading session or not suitable for longer-term investment, so that the firm can take appropriate steps concerning financial professional access, training, and/or compliance monitoring and review.
As part of its examinations, OCIE often does, and will continue to, review for the inappropriate use of complex investment products and evaluate the robustness and effectiveness of related supervisory policies and procedures. OCIE will also evaluate compliance with Regulation Best Interest and an investment adviser’s federal fiduciary duty. Under these standards, a financial professional recommending a complex or risky product should apply heightened scrutiny to understand the terms, features and risks of the product and whether such product fits within the client or customer’s risk tolerance and specific-trading objective, and whether it would require daily monitoring by the investor or the financial professional. A recommendation by a firm’s financial professionals is a recommendation of the firm. Accordingly, in order to fulfill their legal obligations, it is critically important for firms to implement policies and procedures reasonably designed so that their financial professionals: (1) understand the risks and purpose of the products they recommend to firm clients and customers; (2) apply the necessary heightened scrutiny; (3) only recommend products in compliance with legal standards; and (4) monitor the investment daily, as applicable. In addition, the Chairman and the Directors of the Divisions of Investment Management, Corporation Finance and Trading and Markets recently addressed the application of Regulation Best Interest and the adviser’s federal fiduciary duty in the context of complex products.
For further information regarding OCIE priorities and its examination approach to Regulation Best Interest, please visit https://www.sec.gov/ocie. Firms are encouraged to familiarize themselves with the specific requirements of Regulation Best Interest by reviewing the Regulation Best Interest Adopting Release and the Small Entity Compliance Guide and other materials available on the SEC’s spotlight page. Questions regarding Regulation Best Interest may be directed to: IABDQuestions@sec.gov.
Finally, please know that OCIE is always interested in hearing more about new and emerging risk areas and products as well as how it can be more effective in its mission. OCIE’s contact information can be found at: https://www.sec.gov/contact-information/sec-directory. Please engage with our staff. If you suspect or observe activity that may violate the federal securities laws or otherwise operates to harm investors, please notify SEC staff at https://www.sec.gov/tcr.
 This Statement represents the views of OCIE staff. It is not a rule, regulation, or statement of the Securities and Exchange Commission (“Commission”). The Commission has neither approved nor disapproved its content. This Statement, like all staff guidance, has no legal force or effect: it does not alter or amend applicable law, and it creates no new or additional obligations for any person.
 On June 5, 2019, the Commission adopted Rule 15l-1 (“Regulation Best Interest”) under the Exchange Act, which had a compliance date of June 30, 2020. Exchange Act Release No. 86031 (June 5, 2019) at https://www.sec.gov/rules/final/2019/34-86031.pdf. See Regulation Best Interest Adopting Release, pages 263-264; see also Commission Interpretation Regarding Standard of Conduct for Investment Advisers, Investment Advisers Act Release No. 5248 (June 5, 2019) (“Fiduciary Interpretation”) at https://www.sec.gov/rules/interp/2019/ia-5248.pdf, p. 16.