Effective Expense Management is Crucial to Complying with Conflict-of-Interest Regulations

Integrating compliance and expense management systems reduces manual data entry and streamlines compliance processes

Broker-dealers, investment advisers, and the third-party product sponsors whose products they offer need efficient and effective ways to track non-cash compensation as regulators monitor for conflicts of interest.

Long an area of concern, regulators have intensified their scrutiny of non-cash compensation that broker-dealers or investment advisers receive from third-party vendors per Regulation Best Interest (Reg BI). Regulators worry that financial professionals could put their interests before those of their clients, particularly retail investors.

So, vendors that provide non-cash compensation, like hosting educational seminars or paying business entertainment expenses, must monitor their sales teams for compliance with the offeror’s policies and procedures to avoid running afoul of regulators. In turn, broker/dealers and investment advisers must monitor the receipt of this type of compensation.

But many firms still require their sales and compliance teams to enter business entertainment expenses into internal systems manually — and often more than once. A salesperson may enter an expense into an expense management system only to have to re-enter it into the compliance system, or a compliance professional may need to do the reentry — exposing a firm to the risk of non-compliance.

Dependence on such processes may expose firms to compliance breaches because expenses could be incomplete or inaccurate due to potential human error. Manually entering and duplicating data also keeps salespeople and compliance professionals from doing higher-value work, like wooing clients or creating a culture of compliance. Therefore, integrating expense management and compliance systems is essential to complying with conflict-of-interest regulations and avoiding any related issues with vigilant regulators.

Regulators watching for conflicts of interest

The SEC recently released a staff bulletin in which it reiterated the standards of conduct for broker-dealers and investment advisers in identifying and addressing conflicts of interest — and noted the importance of recording and reporting non-cash compensation in doing so. In part, the SEC reminded firms that Reg BI requires a broker-dealer to disclose “all material facts relating to conflicts of interest” when making a recommendation to a retail customer.

In citing common sources of conflicts of interest, the SEC included “gifts, entertainment, meals, travel, and related benefits, including in connection with the financial professional’s attendance at third-party sponsored trainings and conferences.”

FINRA similarly perceives that third-party relationships could cause conflicts of interest that prevent a financial professional from acting in a client’s best interest. Therefore, the regulator’s Non-Cash Compensation Rules prohibit a member firm or associated person from directly or indirectly accepting or making payments of any non-cash compensation, subject to specified exceptions.

FINRA’s Non-Cash Compensation Rules include:

Though FINRA does not prohibit offerors from paying for any training, events, or entertainment on behalf of firms at all, the regulator does impose limitations and conditions. Per FINRA, exceptions to its Non-Compensation Rules include:

“an occasional meal, a ticket to a sporting event or the theater or comparable entertainment which is neither so frequent nor so extensive as to raise any question of propriety and is not preconditioned on achievement of a sales target;” and
“payment or reimbursement by ‘offerors’ (product issuers, advisers, underwriters and their affiliates) in connection with training or education meetings, subject to certain conditions, including meeting location restrictions and not preconditioning attendance on achievement of a sales target.”

With strict rules governing permitted payments and requiring disclosures, managing business entertainment expenses effectively and efficiently is essential to firms and offerors maintaining — and demonstrating — compliance with regulations such as the SEC’s Reg BI and FINRA’s Non-Cash Compensation Rules.

However, many firms and offerors rely on systems and processes that are ineffective and inefficient — and regulators have frequently cited failures in managing entertainment expenses or other non-cash compensation in levying fines and penalties against financial services firms. In addition to monetary losses, such sanctions can also damage a firm’s reputation.

Firms struggling with systems and processes

Non-cash compensation is often unrecorded or reported inaccurately because firms estimate values or overlook events entirely. Similarly, at offerors, salespeople may not enter expenses for compliance purposes. So, the offeror’s non-cash compensation records and reports could be inaccurate or incomplete.

Firms also may struggle to maintain compliance with their internal policies and procedures or external regulations due to a lack of effective processes and supporting technology. For example:

Tracking multiple contributions for the same event often requires repetitive data entry and aggregation is subject to errors.
Determining and enforcing firm policy and threshold levels requires significant effort to ensure accuracy and efficiency.
Relying on manual spreadsheets is inefficient and can result in tracking errors and difficulty in reporting and analysis.
Identifying potential violations is difficult without a system of automated alerts and visual indicators.
Manually completing processes prevents sales and compliance teams from focusing on their core business functions.

If there is a potential compliance breach, a firm may not spot it right away because its non-cash compensation records and reports are inaccurate or incomplete.

Integrating expense management and compliance systems

To ensure compliance, firms should have policies and procedures and technology that enable the effective and efficient review, approval, management, and monitoring of non-cash compensation against firm-defined thresholds.

Eliminating duplicate submissions of business entertainment expenses — one in a firm’s expense management system and the other reported to the compliance department for review against policies and procedures — would be a good start.

“Duplicating data entry increases compliance risks by allowing more room for human error. A salesperson or compliance professional could easily enter expenses incorrectly, which could cause an individual to exceed their firm’s non-compensation limits,” said Adam Schaub, vice president of platform product management at RegEd.

“Duplicate entry also inherently slows the process of reporting, tracking, aggregation such that it raises the risk of non-compliance,” he said.

RegEd’s Gifts, Gratuities & Contributions solution eliminates duplicate entries by integrating with a firm’s expense management system through an application programming interface (API). Firms can capture post-event expenses or gifts from any expense system and automatically create a new submission using their predefined review process.

“Our expense management system [EMS] API eliminates the duplicate entry and makes the two systems talk to each other seamlessly. This reduces risk because data is automatically entered into the compliance system,” said Amber Bird, product manager at RegEd. “It also saves time and effort for salespeople and compliance professionals by simplifying expense management.”

RegEd’s EMS API also lets firms:

Automatically approve submissions within firm-defined thresholds.
Immediately alert the compliance team of any issues or violations in real-time.
Synchronize contacts with the firm’s EMS system, which reduces the risk of a threshold being exceeded due to a recorded amount being duplicated.

“Streamlining the end-to-end compliance process for persons who are subject to either regulatory or company policy can help avoid problems with regulators who are watching for conflicts of interest,” Schaub said.

Also, in automatically aggregating totals for individuals and companies, RegEd’s Gifts, Gratuities & Contributions:

Reduces review time and speeds decisions by enabling management by exception.
Relieves the regulated person of the burden of tracking their limits or what they have given and received.
Allows reviewers to define policies for a period of time and manage risk proactively with a unified enterprise solution that provides easy access to the information they require.
Enables compliance managers and other stakeholders to holistically monitor the exchange of gifts, gratuities, contributions, and other non-cash compensation; track the pre-clearance approval process; supervise in compliance with firm policy; and identify limit violations.

Conclusion

As regulators monitor non-cash compensation that broker-dealers or investment advisers receive from third-party vendors, managing expenses efficiently and effectively helps firms and vendors keep spending within limits permitted under their internal policies and procedures and within external regulations meant to prevent conflicts of interest. Automating data entry through the integration of expense management and compliance systems also eliminates the risks of human error while improving operational efficiency as well.

If you are a RegEd client that would like to learn more about integrating your expense management and compliance systems through the EMS API for our Gifts, Gratuities & Contributions solution, please reach out to your Customer Success Manager.

If you do not currently use RegEd’s Gifts, Gratuities & Contributions solution, please contact sales@reged.com to learn more.

About RegEd

RegEd is the market-leading provider of RegTech enterprise solutions with relationships with more than 200 enterprise clients, including 80% of the top 25 financial services firms.

Established in 2000 by former regulators, the company is recognized for continuous regulatory technology innovation with solutions hallmarked by workflow-directed processes, data integration, regulatory intelligence, automated validations, business process automation, and compliance dashboards. The aggregate drives the highest levels of operational efficiency and enables our clients to cost-effectively comply with regulations and continuously mitigate risk.

Trusted by the nation’s top financial services firms, RegEd’s proven, holistic approach to RegTech meets firms where they are on the compliance and risk management continuum, scaling as their needs evolve and amplifying the value proposition delivered to clients. For more information, please schedule a consultation.