SEC Hits First Horizon for Reg. BI Violations
After Regulation Best Interest went into effect in 2020, the financial regulatory world has sort of been waiting for the enforcement shoe to drop. For a few years, it hasn’t seemed to be at the top of the SEC’s agenda. Some wondered if 2024 would be the year of the dragon and the year of Reg. BI. Maybe we’re starting to see a shift? We did see a Reg. BI matter in February, and then another one in May.
Last week, the SEC settled another one with First Horizon Advisors for violating Reg. BI’s compliance obligation, this one involving “structured notes that First Horizon’s registered representatives recommended to retail customers.” I don’t know. It’s easy to be a scold when writing compliance pieces. And we don’t want to do that, but if you’re recommending structured notes to retail investors you’re probably asking for it? And you should maybe be really careful if you do.
Here is what the SEC says happened (though maybe it didn’t, we don’t know):
Good Things
First, some good things. First Horizon did have Reg BI policies and procedures that required its registered representatives to take some actions when recommending structured notes to retail customers. For example, registered representatives had to:
determine that the customer’s investment profile met First Horizon’s requirements for structured notes
determine that the resulting holdings would not exceed First Horizon’s concentration limit for those notes in the customer’s account; and
upload a disclosure form indicating that the customer:
received the product prospectus;
understood that First Horizon received compensation for selling structured notes; and
understood that structured notes are buy-and-hold investments involving principal risk.
If the customer sold one structured note to buy another one, then the registered reps also had to upload a “switch letter” that included fee disclosures and information about why the recommendation was “appropriate” for the customer.
Also, First Horizon’s Reg BI policies and procedures required its Principal Review Desk (or, PRD) to review structured product recommendations to determine whether they complied with its Reg BI policies and procedures. PRD relied on the information in its systems to assess:
the customer’s investment profile,
concentration limits in the customer’s account, and
whether the completed disclosure form and “switch letter” (if applicable) had been uploaded.
Merger Problems
Some problem emerged when the corporate parents of First Horizon and Iberia Financial Services merged in July 2020. Several months before the merger was finalized, First Horizon learned that some customer investment profile information wouldn’t map correctly from Iberia’s systems to First Horizon’s systems, and that other information would not transfer at all. PRD relied on this system heavily, and in some cases, the new First Horizon Representatives failed to complete new customer profile update forms as they were required to do.
In January 2021, First Horizon migrated 5,442 customer brokerage accounts without ensuring that its systems had the necessary customer investment profile information. The next month, First Horizon learned that technology issues would prevent the new First Horizon registered representatives from reviewing exception reports and from providing new compliance information or documentation until the operations integration was complete. In the meantime, they would have to work with First Horizon staff to clear exceptions and mitigate the technology issues. Still, First Horizon dragged their feet in ensuring that the new First Horizon registered representatives cleared the exception reports within the required 60 days. They couldn’t access the exception reporting site until April 2022—over a year after the discovery of the issue—and were then given three more months to clear their backlogged exceptions.
Other Issues
Also, until February 2023, First Horizon’s policies and procedures required PRD to create exception reports for trades that were flagged as non-compliant. Registered reps then had 60 days to resolve the exceptions. First Horizon generated at least 2,500 exceptions on structured note recommendations, but PRD didn’t timely create exception reports, and registered representatives did not timely clear exceptions, for at least several hundred of these recommendations.
Starting in February 2023, First Horizon implemented a preapproval requirement for structured notes, requiring that any recommendation comply with First Horizon’s Reg BI policies and procedures before the transaction was executed. Still, PRD approved (we don’t know how many) structured note recommendations without a “switch letter” on file.
The SEC says all this means First Horizon failed to satisfy the General Obligation under Reg BI and willfully violated Rule 15l-1(a)(1) under the Exchange Act. First Horizon is paying a civil penalty of $325,000 to put the matter behind it.
Two Lessons
Don’t sleep on your post-merger compliance issues. They’re traps for the unwary. John Deere just emerged with FCPA problems from its acquisition of Wirtgen Thailand earlier this month. Getting unfamiliar databases to talk to each other can be hard, but if you can’t do it there might be a price to pay down the road.
If you’re encouraging retail investors to dump their holdings in one set of structured notes so they can buy new ones, what are you doing? Are retail investors in Tennessee that sophisticated? Maybe they are, but you should be super-duper careful if you’re doing that.
In re First Horizon Advisors, Inc., Admin. Proc. File No. 3-22142 (Sept. 18, 2024)
Reg BI Enforcement Poised to Take Next Step, Investment News (Jan. 18, 2024)