As of June 30, 2020, broker-dealers are
required to be in compliance with the new Regulation Best Interest (“Reg BI”)
standard of conduct. Firms were given one year to mold their compliance
apparatus, train representatives, draft policies, and implement procedures to
fit the heightened standard. However, anyone working in corporate compliance or
project management understands that implementing change on a company wide scale
in such a short time is an enormous task.
Now that the new standard has been in effect for a month, we believe it
is important to highlight some aspects of the Reg BI standard which may have
been overlooked when overhauling a firm’s compliance systems.
Reg BI replaces the suitability standard and
sets out more robust investor protections than had been required under
suitability.
§240.15l-1 Regulation best
interest.
(a) Best interest
obligation. (1) A broker, dealer, or a natural person who is an associated
person of a broker or dealer, when making a recommendation of any securities transaction
or investment strategy involving securities (including account recommendations)
to a retail customer, shall act in the best interest of the retail customer at
the time the recommendation is made, without placing the financial or other
interest of the broker, dealer, or natural person who is an associated person
of a broker or dealer making the recommendation ahead of the interest of the
retail customer.
Reg BI goes on to enumerate four obligations
which must be satisfied when making any security or investment recommendation.
Broadly speaking, those obligations are: 1) Disclosure- written disclosure of
material facts relating to the scope of the relationship including fees,
limitations on securities investments[1];
2) Care- suitability on steroids[2]; 3)
Conflict- identification, disclosure, and/or mitigation of incentives,
limitations, and conflicts which may exist; and 4) Compliance- maintenance and
enforcement of written policies and procedures designed to achieve compliance
with Reg BI.
Over the past year, broker-dealers should have
received training on each of these obligations and firms’ compliance
departments should have implemented the use of new forms to document their
adherence. However, given the deluge of new forms broker-dealers are using to
evidence compliance, two of the most important differences between suitability
and Reg BI may have gone overlooked.
Reg BI requires that a broker-dealer act in
the customer’s best interest at the time the recommendation is made. Under the
new standard, “recommendation” will be interpreted broadly and even
includes instances where a recommendation is made but the customer does not
execute the order.[3]
Reg BI also defines “retail customer” more
broadly than it was defined under the suitability standard. Under the
suitability standard, certain high net worth individuals could be treated as
institutional investors rather than retail customers if certain other
circumstances applied. Thus changing the applicability of the suitability
analysis. However, that is not the case under Reg BI: any “natural person” regardless
of their wealth or accredited investor status is a “retail customer”.
It should also be noted that there is no de minimus exception. So, in any
instance that a broker-dealer makes a recommendation to a natural person for
their personal, household or family use, Reg BI applies.
Now that Reg BI is in effect, FINRA expects
all firms and broker-dealers to be in compliance. However, even firms giving
their best efforts may fall short of full Reg BI compliance. The attorneys at
Cosgrove Law Group, LLC have decades of experience interpreting securities
regulations, auditing firm compliance, and responding to regulatory
investigations. If there is any doubt as to whether your firm has met its Reg
BI obligations, it may be time to contact experienced securities counsel to
navigate the regulatory landscape.
Author: Max Simpson
[1] Reg BI also creates an obligation to make
supplemental oral disclosures for topics not covered in forms which would
create a conflict given the specific circumstance. Best practice is to follow
oral disclosure with written disclosure to memorialize that the disclosure did
in fact occur.
[2] Of course this is an oversimplification of
Reg BI’s care standard which deserves its own separate blog. Suffice it to say,
the obligation of care is robust.
[3] FINRA UNscripted, EP63, Regulation Best Interest: Implementing a New Standard of Conduct,
July 7, 2020.
