SEC regulation to enhance broker-dealers’ standard of conduct when dealing with retail investors
Reg BI is intended to enhance the broker-dealer standard of conduct by requiring broker-dealers to both:
The SEC denoted practices of broker-dealers versus investment advisers and related activity in the issuance of the regulation. The SEC did not institute a fiduciary standard for broker-dealers under Reg BI. In addition, the SEC did not preempt state fiduciary regulations with the issuance of Reg BI.
The General Obligation is satisfied only if the broker-dealer complies with four key areas of obligation:
1. The Disclosure Obligation
The “Disclosure Obligation” requires the disclosure of all “material facts” related to the scope and terms of the broker-dealer’s relationship with the retail customer. The minimum material facts of the scope and terms of the relationship to be disclosed, in writing, prior to or at the time of recommendation include:
With the newly issued Form CRS Relationship Summary and Form ADV Amendments, the SEC is also requiring broker-dealers and investment advisers to deliver to retail investors a standard-formatted “Relationship Summary” that describes the relationships and services the firm offers to retail investors, fees and costs that retail investors will pay, specified conflicts of interest and standards of conduct, and disciplinary history.
2. The Care Obligation
To fulfill the “Care Obligation,” a broker-dealer must exercise reasonable “diligence, care and skill” in recommending a “transaction” or “series of transactions” to retail customers. The Care Obligation requires the broker-dealer to satisfy, at a minimum, all the elements of FINRA’S Suitability Rule (FINRA Rule 2111) in addition to the following:
3. The Conflict of Interest Obligation
The SEC views policies and procedures as critical to identifying and addressing conflicts of interest, either by disclosing or eliminating them. Reg BI defines a “conflict of interest” associated with a recommendation as an interest that might incline a person consciously or unconsciously to make a recommendation that is not disinterested. Although the Disclosure Obligation only requires the disclosure of material facts associated with conflicts of interest, ALL conflicts of interest remain in scope for purposes of Reg BI. As such, the “Conflict of Interest Obligation” requires broker-dealers to have written policies and procedures reasonably designed to:
4. The Compliance Obligation
The “Compliance Obligation” requires the establishment, maintenance, and enforcement of written policies and procedures reasonably designed to meet compliance with Reg BI, thus creating affirmative obligation under the Exchange Act. The SEC denotes that a firm’s compliance policies and procedures should be reasonably designed to the size and complexity of the firm and in keeping with reasonably designed compliance programs. A reasonably designed compliance program generally should include controls; remediation of non-compliance; training; and periodic review and testing controls.
In final form, Reg BI amends Rules 17a-3 and 17a-4 to require, for each retail customer to whom a recommendation of any securities transaction or investment strategy involving securities is or will be provided:
Coincident with the adoption of Reg BI, the SEC issued two interpretations:
Reg BI and Form CRS will become effective 60 days after they are published in the Federal Register, and will include a transition period until June 30, 2020. The Interpretations under the Advisers Act will become effective upon publication in the Federal Register.
The SEC notes that “whether a broker-dealer has acted in the retail customer’s best interest under the General Obligation will turn on an objective assessment of the facts and circumstances of how these specific components of Regulation Best Interest are satisfied at the time that the recommendation is made (and not in hindsight)”. As such, the SEC’s adoption of Reg BI demonstrates a continued focus on financial services conduct and sales practices, and is in keeping with the spirit of bank regulatory risk and governance focus on conduct, as well as consumer protection standards of UDAAP/UDAP.
Though the regulation directly impacts broker-dealers, all providers of retail financial service offerings should:
SEC Regulation Best Interest
SEC regulation to enhance broker-dealers’ standard of conduct when dealing with retail investorsDownload PDF