On July 31, 2024, the Securities and Exchange Commission (“SEC”) announced that it agreed to settle allegations that a California-based broker-dealer sold in excess of $13 million in “L bonds,” a speculative, unrated debt security, to retail customers with lower risk profiles. The settlement of this case is notable because it was the SEC’s first enforcement action claiming violations by a broker-dealer of Regulation Best Interest (“Reg BI”). In a motion for entry of final judgments by consent (the “Motion”), the SEC said that the broker-dealer and five of its registered representatives (collectively, “Defendants”) agreed to pay over $327,000 to settle the case, which is pending court approval to be finalized. The Motion can be accessed here.
The SEC first sued the Defendants in June 2022, alleging that over a period from July 2020 through April 2021, the Defendants recommended and sold an aggregate of $13.3 million in L bonds to retail customers with “moderate risk tolerances” despite the marketing material for the bonds stating that the securities were “high-risk” and suitable only for customers with substantial financial resources.
In its complaint, the SEC alleged that the Defendants failed to comply with Reg BI’s “care obligation,” which provides that broker-dealers and their associated persons must exercise reasonable diligence, care, and skill in recommending any securities transaction or investment strategy involving securities to retail customers. Additionally, the SEC alleged the Defendant broker-dealer failed to comply with Reg BI’s “compliance obligation” because it did not sufficiently establish, maintain and enforce written policies and procedures reasonably designed to achieve compliance with Reg BI. The full allegations set forth in the SEC’s complaint can be found here.
In a separate action brought by the Financial Industry Regulatory Authority, Inc. (“FINRA”), the Defendant broker-dealer agreed to pay over $1.5 million to settle allegations that it failed to adequately monitor potentially excessive trading in approximately 100 accounts. Details of the FINRA settlement can be accessed here.
Broker-dealers should continue to monitor carefully developments relating to Reg BI and ensure that they have policies and procedures reasonably designed to comply with Reg BI’s requirements. Compliance with Reg BI has been an enforcement priority of both the SEC and FINRA since the regulation became effective in June 2020, and both regulators will continue to bring enforcement actions in connection with violations of Reg BI.
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