Is Your Firm Preparing for Regulation Best Interest?

Regulation Best Interest (Reg BI) Took Effect on September 10, 2019, with a Compliance Effective Date of June 30, 2020 – Is your Firm Preparing for Compliance?

Regulation Best Interest (Reg BI) took effect on September 10, 2019, with a compliance effective date of June 30, 2020. Given the breadth of the changes required under Reg BI, advisory and brokerage firms should begin their preparations for compliance now.

To assist regulated entities, both the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) recently published ‘guidance notices’. These notices provide a useful starting place for firms to begin their analysis of what new policies and procedures will need to be implemented or revise existing ones to comply with Reg BI and Form CRS.

Regulation BI and Form CRS

Reg BI establishes a new “best interest” (“BI”) standard of conduct under the Securities Exchange Act of 1934 (Exchange Act) for broker-dealers and their associated persons when making a recommendation of any securities transaction or investment strategy involving securities (including account recommendations) to a retail customer. Under this standard, a broker-dealer and its associated persons must act in the “BI” of the retail customer at the time the recommendation is made, without putting the financial or other interests of the firm ahead of the retail customer.

A broker-dealer discharges this BI duty by complying with four specific obligations:

• Disclosure Obligation: Broker-dealers must provide certain required disclosure before or at the time of the recommendation, about the recommendation and the relationship between you and your retail customer;
• Care Obligation: Broker-dealers must exercise reasonable diligence, care, and skill in making the recommendation;
• Conflict of Interest Obligation: Broker-dealers must establish, maintain, and enforce written policies and procedures reasonably designed to address conflicts of interest; and
• Compliance Obligation: Broker-dealers must establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest.

Both investment advisers and broker-dealers will be required to provide retail investors a form summarizing their relationship. This standardized, short-form, known as Form CRS (Customer/Client Relationship Summary), is intended to inform retail investors about: (i) the types of client and customer relationships and services the firm offers; (ii) the fees, costs, conflicts of interest, and required standard of conduct associated with those relationships and services; (iii) whether the firm and its financial professionals currently have reportable legal or disciplinary history; and (iv) how to obtain additional information about the firm.

SEC Regulation BI Guidance

On September 9, the SEC published a Small Entity Compliance Guide for Regulation Best Interest. The compliance guide is divided into 11 questions and answers about the new rule. Topics include what recommendations are covered; who is considered a retail customer; and what each of the new obligations requires.

The SEC also published a Small Entity Compliance Guide for the Form CRS Relationship Summary and Amendments to Form ADV. The guide is divided into 13 questions and answers. The guide addresses the compliance requirements for Form CRS and amended Form ADV, including formatting, updating, and filing the required relationship summary.

FINRA Regulation BI Guidance

FINRA has also issued its own guidance in the form of a Reg BI “checklist” to help broker-dealers comply with Reg BI. The Regulation Best Interest and Form CRS Checklist (Checklist) distills Reg BI and Form CRS into a more easily-digestible format. FINRA’s 20 Reg BI Checklist items are:

• Have procedures and training in place to assess recommendations using a best interest standard
• Apply a best interest standard to recommendations of types of accounts
• Apply the best interest standard to both explicit and implicit ‘hold’ recommendations if the firm agrees to provide account monitoring
• Consider the elements of care, skill, and costs when making recommendations to retail customers
• Guard against excessive trading, irrespective of whether the broker-dealer or associated person (AP) “controls” the account
• Consider reasonably available alternatives to a recommendation
• Consider how to ensure that high-risk or complex products are in a retail customer’s best interest (noted as a best practice, not a rule)
• Prior to or at the time of the recommendation, provide retail customers with full and fair written disclosure of all material facts relating to the scope and terms of the relationship with the retail customer (and noting as a best practice that APs are encouraged to discuss the basis for any particular recommendation with their retail customers and the associated risks, particularly when the recommendation is significant to the customer)
• At or prior to making a recommendation, make full and fair written disclosure of all material facts relating to conflicts of interest
• Use the term “advisor” or “adviser” only if the firm is a registered investment adviser, a registered municipal advisor, a registered commodity trading advisor, or an advisor to a special entity
• Have APs supplement written disclosures with subsequent oral disclosure (noting as a best practice following oral disclosures with timely, written disclosure summarizing the information conveyed orally)
• Have policies and procedures to identify and address the firm’s conflicts of interest
• Have policies and procedures to identify and mitigate the AP’s conflicts
• Have policies and procedures to identify and disclose material limitations on products recommended
• Have policies and procedures to prevent material limitations from causing the broker-dealer or AP to make recommendations that place their interest ahead of the retail customer’s interest
• Have policies and procedures to identify and eliminate sales contests, bonuses, non-cash compensation and quotas based on the sale of specific securities or specific types of securities within a limited time
• Update policies and procedures to ensure compliance with Reg BI
• Update policies and procedures and systems to ensure Reg BI’s recordkeeping obligations are satisfied
• Implement training to ensure that APs are aware of Reg BI’s requirements and
• Align policies and procedures to the new definitions in Reg BI.

Start Your Preparations

By June 30, 2020, registered broker-dealers must begin complying with Regulation Best Interest. In addition, broker-dealers and investment advisers registered with the SEC will be required to prepare, deliver, and file Form CRS.

If you have questions, please contact us

If you have any questions or if you would like to discuss the matter further, please contact me, Paul A. Lieberman, or the Scarinci Hollenbeck attorney with whom you work, at 201-806-3364.