Thank you, Steve [Stephen Roth] for that kind introduction. Before I begin, a reminder: the views I express today are my own and do not necessarily represent the views of my fellow Commissioners or the staff.

It’s a pleasure to join you today to help kick off your 2021 Conference on Life Insurance Company Products. Your agenda over the next two days is comprehensive and touches on many of the important issues that matter to those who invest in these products. It’s great to see so many individuals from the Commission’s Divisions of Investment Management, Examinations, and Enforcement on the agenda. The variable insurance products offered and sold by those of you in this room are an important component in the retirement savings of many Americans. On-going dialogue between the Commission and the industry, particularly on issues such as disclosure, conflicts, and sales practices, helps us both to better serve investors.

In that spirit, I want to focus my remarks today on Regulation Best Interest.[1] As Chair Gensler has stated—and as I have expressed before—the Commission intends to work, both directly and together with FINRA and others, to ensure that Reg BI lives up to its name; that is, to ensure that investors receive not merely suitable recommendations, but recommendations that are truly in their best interest.[2] As you all know, the rule is largely principles-based, and its application should and will be flexible to account for evolution in the market and the needs of investors.[3] Why does this matter? Because, in addition to the many millions of Americans who have long invested their savings through retail brokerages, we are currently witnessing a substantial influx of new, less experienced investors relying on an increasingly high tech brokerage community to navigate the investment process.[4] A number of the largest brokerages are reporting substantial growth in account openings during 2020—by some measures exceeding 10 million new accounts in 2020 alone—and a decrease in the average customer age and account size.[5] Our focus on the needs of retail investors has never been more important.

As the Commission and its staff embark on a new fiscal year and examination cycle, I want to discuss two critical aspects of Reg BI that are relevant to today’s audience. First is the scope of what constitutes a “recommendation” and the approach that the Commission should take in interpreting that term under Reg BI. And second is the way in which both the Commission and firms should approach conflicts of interest.

Recommendation: An Evergreen Term for the Evolving Broker-Dealer Landscape

In adopting Reg BI, the Commission sought to ensure that financial intermediaries act in the best interest of retail investors regardless of whether they engage a broker-dealer or an investment adviser. While an adviser’s fiduciary obligation applies to the entirety of the advisory relationship, a broker-dealer’s obligation under Reg BI applies only at the time that the broker-dealer or its associated person makes a recommendation to a retail customer.

Thus, firms should bring enhanced focus to whether a recommendation has occurred because that is what triggers the enhanced standard of care under Reg BI—and, once triggered, firms must comply with each of the specific component obligations: disclosure, care, conflict of interest, and compliance.[6] The Commission declined to adopt a bright line rule in Reg BI for what constitutes a recommendation, explaining that doing so “could result in a definition that is over inclusive, under inclusive, or both.”[7] Instead, the Commission reiterated its belief that a principles-based approach, explicated by existing precedent and guidance, would provide the necessary clarity for determining whether a broker-dealer has made a recommendation.[8]

The Commission’s reliance on existing precedent, however, does not mean that the concept of a recommendation is static or that it applies exclusively to facts and circumstances described in past pronouncements. To the contrary, the use of a principles-based framework for determining whether a recommendation has occurred ensures that the application of Reg BI can and will evolve with the broker-dealer community. As the landscape shifts, the Commission can continue to interpret and apply Reg BI in a manner that is both consistent with precedent and designed to protect investors in increasingly modernized markets.

As stated in the Adopting Release for Reg BI, “[f]actors considered in determining whether a recommendation has taken place include whether the communication ‘reasonably could be viewed as a call to action’ and ‘reasonably would influence an investor to trade a particular security or group of securities.’”[9] Moreover, past Commission and FINRA guidance is clear that recommendations to engage in, for example, day trading would constitute a recommendation even if the communication did not mention particular securities.[10] And, as always, the Commission will evaluate the relevant facts and circumstances and the context in which a communication is made in determining whether a recommendation has occurred.[11] Consistent with the Commission’s and FINRA’s historical approach, those facts and circumstances may include the nature of the broker-dealer’s customer base and whether—by reason of age, inexperience, lack of sophistication, or other factors—it may be more likely for the firm’s communications to reasonably influence its customers’ trading decisions.[12]

Broker-dealers should be thinking critically and carefully about the extent to which nascent practices in the industry may in fact, constitute recommendations. Emerging uses of technology present a clear example of an area that warrants close scrutiny, especially when such technologies are used to engage and communicate with retail customers in a way that is reasonably likely or designed to influence investment or trading behavior, even if such influence is subtle. It is also evident that, in an increasingly commission-free trading environment where broker-dealers generate substantial revenue from payment for order flow, incentives are shifting more and more from recommending particular securities to recommending day trading more broadly, irrespective of the securities traded.

As the Commission stated in adopting Reg BI, the broad scope of what constitutes a recommendation “appropriately recognizes that customers may rely on firms’ and associated persons’ investment expertise and knowledge, and therefore the broker-dealer should be responsible for [] recommendations, regardless of whether [they] result in transactions or generate transaction-based compensation.”[13] And customers may especially rely on their broker’s knowledge or expertise when the broker is employing technology to streamline their investing experience. The use of algorithms, prompts, machine-learning, or other forms of technology to generate these communications does not relieve a broker-dealer of its responsibilities under Reg BI. The question is whether these practices may reasonably be viewed as a “call to action” or whether they “reasonably would influence an investor to trade.”[14]

Likewise, in light of the regulatory import of making a recommendation, broker-dealers should also reevaluate longstanding practices, such as those related to account opening, to determine whether Reg BI may apply. The Commission’s recent experience with the Share Class Selection Disclosure Initiative and other similar cases may be instructive in this respect.[15] In those cases, investment advisers were causing clients to purchase and/or hold mutual fund share classes that were more expensive (but usually more lucrative for the adviser or its affiliates) than otherwise available share classes, including in the context of money market funds used as cash sweep vehicles.[16]

What lessons might be learned from this in the broker-dealer context? Compliance personnel should closely evaluate account opening procedures, to consider whether practices for selecting default account options or presenting or otherwise highlighting a subset of investment options might implicate Reg BI. Depending on the facts and circumstances, the use of a default investment or the presentation of a small subset of investment options on an account opening form may well constitute a recommendation under existing interpretations of that term.

So, let me conclude this section of my remarks with a recommendation of my own: when evaluating the ways in which Reg BI applies to your business, think broadly about your communications with customers—no matter the form—to evaluate whether they might be recommendations.

Conflicts of Interest and Mitigation: An Ounce of Prevention

In addition to the Commission’s focus on broker-dealer communications and recommendations, we should continue to emphasize the importance of effective mitigation to address conflicts of interest under Reg BI, both at the firm level and for its associated persons.

By its terms, Reg BI does not expressly require the mitigation of all conflicts of interest. Instead, Reg BI’s conflict of interest obligation requires that a broker-dealer “identify and at a minimum disclose” all conflicts of interest associated with recommendations.[17] In addition to prohibiting certain sales practices, the rule broadly requires mitigation in two circumstances: (1) when a conflict might cause an associated person to place their own interest ahead of the customer’s; or (2) when limitations on the fund’s product menu might cause the broker-dealer or its associated persons to place their own interest ahead of the customer’s.^[18]

Notwithstanding the focus on disclosure for conflicts of interest at the firm level, it is important to reiterate that Reg BI’s overarching best interest obligation is not satisfied through disclosure alone.^[19] That is, a broker-dealer that is subject to Reg BI has an affirmative obligation to make recommendations in its customers’ best interest and cannot simply rely on disclosure to discharge that requirement.^[20] Thus, in circumstances where mitigation may not be strictly required by the rule text, the absence of mitigation may well heighten the risk of a tainted recommendation that will violate Reg BI’s care obligation.^[21] This is especially true when, in light of the communication and other technologies discussed above, it is increasingly common for recommendations to come from the firm itself rather than, or in addition to, its associated persons. Firms should expect close scrutiny of recommendations made in the face of an unmitigated conflict.

Where mitigation is specifically called for by the rule text, the requirement necessarily demands steps beyond mere disclosure. The Commission was clear that disclosure alone will not sufficiently reduce the potential effect that certain conflicts may have on recommendations.[22] Broker-dealers must take steps to affirmatively reduce the potential effect of conflicts so they do not taint recommendations.^[23] This means our Division of Examinations should focus on firms’ efforts at mitigation to ensure that measures are reasonably designed and effective in protecting retail customers. This is also an area where it would be helpful for Exam staff to publish its findings about those practices that are—and are not—effective at achieving this outcome.

In thinking about mitigation, it may be helpful to consider the various contexts in which conflicts arise for a firm’s representatives. Some are not affirmatively created by the firm, but rather are built into the products that a firm permits its representatives to recommend (e.g. some products pay higher commissions than others, or make revenue sharing payments when others do not). Some conflicts originate with the firms themselves (e.g. setting quotas, offering bonuses or other rewards, certain hiring incentives, payout grids, etc.). Firms must mitigate all of these conflicts, and have various options for doing so. However, a threshold question to ask about an incentive is whether it should be created or permitted at all. Sometimes the best mitigation is simply to avoid from the outset an inducement that might cause representatives to put their own interests ahead of their customers.

One final note worth mentioning here is something about which I know you are all well aware. The mitigation requirement in Reg BI represents a distinction from NAIC’s model regulation for annuity sales.^[24] That model, which was designed exclusively for the sale of insurance products, requires only disclosure of the producer’s compensation, and explicitly excludes that compensation from the conflicts of interest that require mitigation.^[25] Under Reg BI, which applies to the entire range of securities and includes variable insurance products, the Commission came to a different conclusion about the need for and benefits of mitigation. As states continue to adopt and implement the NAIC model, I encourage those of you in the securities and insurance industries to evaluate your policies and procedures to ensure they are consistent with both standards.

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In sum, the Commission remains committed to ensuring that Reg BI elevates the standard of care beyond suitability and that investors receive recommendations that are in their best interest. As the industry continues to change, and as technology increasingly plays a vital role in communicating with and servicing clients, I encourage you to think broadly about when the rule is triggered and how best to deal with all manner of conflicts that arise when Reg BI applies. In that regard, I will leave you with a favorite quote from novelist and social reformer Upton Sinclair: “It is difficult to get a man to understand something when his salary depends on his not understanding.”[26] The updated version of that quote, of course, would not be limited to just men. Nevertheless, its wisdom endures and bespeaks prudence and care in addressing conflicts of interest and ensuring that Reg BI lives up to its promise for America’s retail investors. Thank you for having me today.