The US Securities and Exchange Commission’s Regulation Best Interest—or Reg BI— officially came into effect on June 30, 2020. Brokerage firms now have to comply with a whole new standard of conduct when dealing with retail clients, in one of the biggest regulatory shake-ups for the US market in years… but there have been concerns both around a lack of clarity and uncertainty of enforcement for the new regulation.
“Many brokers are still nervous about complying with the rule as the whole industry is still waiting on more practical guidance,” said Nasdaq in a warning post on July 13. “Many firms feel reasonably comfortable following the principals of the rule, but certain items—rollovers being key among them—are still a little uncertain. The SEC has said it will take “good faith efforts” into account in this initial enforcement period, but that is not nearly as comforting as knowing you are following the letter of the law.”
The problem is that there is no history of regulatory enforcement for the new package – and little clarity around how the new rules will be administered. Back in April, the SEC’s Office of Compliance Inspections and Examinations (OCIE) issued a risk alert detailing the expected scope and content of the initial examinations for compliance with Reg BI, which noted that it would begin examinations after the compliance date, during the first year, which would seek to “evaluate whether firms have established policies and procedures reasonably designed to achieve compliance,” and whether firms have made “reasonable progress in implementing those policies and procedures as necessary or appropriate, including making such modifications as may be necessary or appropriate, in light of information gained from the implementation process and other facts and circumstances.”
Examinations are likely to focus on a number of specific areas: including policies and procedures around the disclosure obligation, the care obligation, the conflict of interest obligation, and the compliance obligation.
“OCIE encourages firms to assess their implementation plans for Regulation Best Interest. Not every document listed in this Risk Alert will be applicable to every firm, and OCIE will conduct examinations based on the profile of each broker-dealer,” noted the SEC.
Form CRS is a separate regulation that the SEC adopted at the same time they did Reg BI, which requires broker dealers and investment advisors who offer services to retail investors to file with the SEC and to deliver a relationship summary. The SEC also issued a risk alert in April on CRS, suggesting that it would focus on delivery and filing, accuracy of content, appropriate formatting, and policies and procedures around record-keeping and relationship updates.
It certainly seems, from the initial guidelines, as if the regulator will take a relatively lenient and responsive approach, which should offer some relief to the industry. Officials from the Financial Industry Regulatory Authority (FINRA)’s Office of General Counsel, in a podcast on July 7, seemed to confirm this latitude.
“Firms need to be in compliance with Reg BI to the extent that they make recommendations to retail customers. And what that means practically is they should have updated their policies and procedures to account for Reg BI,” said FINRA’s Meredith Cordisco. “They should have made system changes to the extent necessary to account for the new standard and all of those things that Jim just mentioned, and they should have trained their reps, even if training is in a virtual setting now that we’re all home because of the pandemic…
“So right now, at least in these initial days post compliance date, we’re not expecting perfection, but we, of course, would expect good faith efforts. For Form CRS it means that firms have to have filed it, they have or they should be in the process of delivering that Form CRS to their retail customers, and they should have policies and procedures and systems in place to deliver it going forward when the triggers are met and also to evidence that delivery.”
It should however, be noted that the new Reg BI does bring in some notable changes – most importantly, around the definition of “retail” customer. Last week, FINRA sent an email to firms with an institutional customer-focus informing them that the SEC’s definition of “retail customer” differs from FINRA’s and that any “natural person,” regardless of net worth, is considered a retail customer. This means that while under the current suitability rule some high net worth individuals could be treated as institutions if other conditions apply, this is no longer the case under Reg BI.
“The e-mail was sent because we had some growing concern that maybe some firms who would classify themselves as institutional firms may not be aware that Reg BI could apply to them if they actually make recommendations to some high net worth individuals,” said Cordisco. “So, they’d sort of been disregarding any communications about Reg BI or any information they see in the press about Reg BI because they mistakenly considered it as not applying to them at all.”
The new regulation is a major change, and while it will apply to firms differently depending on their obligations, everyone (whether institutional or retail) should be looking to ensure that they are in full compliance with the new requirements before initial examinations start.
“Given this is a whole new regulatory package and there is no historical precedent, anxiety is high. We expect new guidance will be issued soon,” said Nasdaq.