These are certainly interesting days. So much is taking the attention of compliance professionals. By now everyone has implemented their business continuity plans (BCP) and likely made modifications to them here and there as the true test of these plans has been realized. BCP has now become yet another compliance ball to juggle for the foreseeable future. BCP recordkeeping will be important so be sure to track as you go. Regulators are certain to ask about this in upcoming exams.
Now that everyone is settled into their temporary work environments and any BCP gaps have been shored up, the looming June 30, 2020 compliance date for Regulation Best Interest (Reg BI) and Form CRS (client/customer relationship summary) is once again the primary focus for most broker-dealers (BDs) and investment advisers (IAs). SEC Chairman Jay Clayton has recently signaled there will be no regulatory relief around the June 30th compliance date.
On April 7th, the Office of Compliance Inspections & Examinations (OCIE) released two Risk Alerts providing BDs and IAs with insight around initial regulatory examinations to assess implementation of Reg BI and Form CRS. OCIE’s implementation assessment exams will likely occur within one-year of the June 30th compliance date. FINRA also released a statement that they will take the same approach as OCIE on their initial examinations of firms’ compliance with Reg BI and Form CRS.
OCIE Risk Alert: Examinations that Focus on Compliance with Regulation Best Interest
OCIE (and FINRA) will assess whether firms made good faith efforts to implement policies and procedures that are reasonably designed to achieve compliance with the general obligation of Reg BI to make recommendations that are in the best interest of the retail investor before or at the time the recommendation is made. You demonstrate compliance with the general Reg BI obligation by complying we each of the four (4) component obligations of Reg BI. The Disclosure Obligation, the Care Obligation, the Conflict of Interest Obligation and the Compliance Obligation.
The Disclosure Obligation requires BDs, prior to or at the time of a recommendation to a retail customer, to provide written, full and fair disclosure of all material facts relating to the scope and terms of the relationship with the retail customer; and all material facts relating to conflicts of interest that are associated with the recommendation being made to the retail customer. BDs can expect regulators to review the content of their disclosures as well as ‘other firm records’ to make a compliance assessment.
- Do your disclosures define the capacity in which the recommendation is being made?
- Do your disclosures provide applicable material fees and costs?
- Are any material limitations on the securities or investment strategies involving securities that may be recommended to the retail customer included in your disclosures?
- Are you making your disclosures ‘timely’ (prior to or at the time of recommendation)?
The Care Obligation requires BDs to exercise reasonable diligence, care, and skill when making a recommendation to a retail customer.
- Does the BD understand potential risks, rewards, and costs associated with the recommendation?
- Were these factors considered in light of the retail customer’s investment profile?
- Was the recommendation made in the retail customer’s best interest?
BDs can expect regulators to review the information collected from retail customers to develop their investment profiles (i.e. new account forms, correspondence, agreements between customer and BD). Regulators will want to understand:
- The process taken by the BD to determine a reasonable basis exists to believe that the recommendations are in the best interest of the retail customer.
- Factors considered by the BD to assess potential risks, rewards, and costs of the recommendations in light of the retail customer’s investment profile.
- BD’s process for having a reasonable basis to believe that it does not place its financial or other interests ahead of the interest of its retail customers.
- How the BD makes recommendations related to significant investment decisions, such as rollovers and account recommendations, and how the BD has a reasonable basis to believe that such investment strategies are in a retail customer’s best interest.
- How the BD makes recommendations related to more complex, risky or expensive products and how the BD has a reasonable basis to believe that such investments are in a retail customer’s best interest.
The Conflict of Interest Obligation requires BDs to establish, maintain, and enforce written policies and procedures reasonably designed to address conflicts of interest associated with its recommendations to retail customers. Of course regulators will review the BD’s policies and procedures to determine compliance.
- Do your policies and procedures address conflicts that create an incentive for an associated person to place its interest or the interest of the BD ahead of the interest of the retail customer?
- Do they include material limitations such as only limited product menu, only offering proprietary products, or products with third-party arrangements?
- Has the BD eliminated sales contests/quotas/bonuses/non-cash compensation based on the sale of specific securities or specific types of securities within a limited period of time?
- Do the policies and procedures establish a structure for identifying the conflicts that the BD or its associated person may face?
- Do they provide for disclosing, mitigating or eliminating conflicts?
The Compliance Obligation requires BDs to establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Reg BI as a whole. Regulators will assess compliance with this obligation by reviewing policies and procedures and evaluating controls, remediation for noncompliance, training, and periodic review and testing of the BD’s policies and procedures.
Included in this Risk Alert is an Appendix that should be reviewed as it provides a sample list of information the regulators may request in order to determine compliance with Reg BI.
OCIE Risk Alert: Examinations that Focus on Compliance with Form CRS
Unlike with Reg BI, the Form CRS obligation applies to IAs as well as BDs. BDs and IAs are required to deliver to retail investors a brief relationship summary (Form CRS) providing information about the firm. By June 30, 2020, the Form CRS must be filed with the SEC through Web CRD for BDs, or IARD for IAs (both Web CRD & IARD for dual registrants using one Form CRS for both brokerage and advisory services). In addition, if the firm has a public website, the Form CRS must be posted there. After the June 30th compliance date, regulators will assess for a good faith effort to comply with the Form CRS obligation.
- Has the firm filed its Form CRS including any amendments?
- Does the firm have a public website and if so, has the Form CRS been posted there?
- What is the process for delivering Form CRS to existing and new retail investors?
- Does the firm’s policies and procedures address the delivery process and dates?
- Does the Form CRS include all required information; does it contain true and accurate information; does it omit material facts?
- How does the firm describe the relationship and services it offers, including statements regarding account monitoring and investment authority?
- How does the firm describe fees and costs?
- How does the firm describe its conflicts of interest, including incentives related to proprietary products, third-party payments, revenue sharing, and principal trading?
- Does the firm accurately disclose if the firm or its financial professionals have legal or disciplinary history?
- Is the Form CRS formatted in accordance with Form CRS instructions?
- Do policies and procedures provide for Form CRS updating?
- Has the firm retained applicable records related to its delivery of the Form CRS?
Firms should expect regulators to review records of the dates that each relationship summary was provided to retail investors to validate whether the firm has complied with the delivery obligations.
existing retail investors, firms must deliver the summary by July 30, 2020 and
before or at the time of:
- Opening a new account that is different from existing accounts held by the retail investor;
- Recommending a rollover of assets from retirement accounts into a new or existing accounts; or
- Recommending a new brokerage or investment advisory service or investment that does not necessarily involve the opening of a new account and would not be held in an existing account.
new retail investors, Form CRS must be delivered before or at the earliest of:
- Entering into an investment advisory contract with the retail investor;
- Recommending to a retail investor an account type, a securities transaction, or an investment strategy involving securities;
- Placing an order for the retail investor; or
- Opening a brokerage account for the retail investor.
A thorough review of these two (2) risk alerts should enable firms to be ready for the initial compliance assessments expected by OCIE and FINRA within one year of the June 30, 2020 compliance date.
Note: RegEd is not engaged in rendering legal, accounting or other professional services. If legal or other professional advice is warranted, the services of an appropriate professional should be sought.
About the Author
Margie Webber is the Director, Regulatory Compliance BD/IA at RegEd, Inc.