Last month, the SEC’s Office of Compliance Inspections and Examinations (OCIE) issued a Risk Alert regarding examinations that will focus on broker-dealers’ compliance with Regulation Best Interest. The SEC wanted to make clear that the Regulation Best Interest compliance date of June 30, 2020 will not be extended. The OCIE will begin examinations with the program and will continue to add this element as part of exams for one year after the implementation date.
The purpose of the Risk Alert is to help prepare firms with information on potential focus areas of the Reg BI examinations and the types of information and documentation that it will be seeking. The SEC understands that COVID-19 has severely impacted many firms, and that includes the implementation of their Reg BI program. However, the OCIE wants to ensure that firms are making their best efforts to begin putting the pieces together considering our new reality.
What is Regulation Best Interest?
Regulation Best Interest enlarges a broker-dealer’s standard of conduct when the Firm is providing investment recommendations to retail clients. The components of the recommendations relate to the standard of conduct by acting in the best interest of the client at the time the recommendation was made. Additionally, Firms must establish the policies and procedures to ensure compliance with Regulation Best Interest.
Examination Focus Areas
The examinations will focus on the review of the policies and procedures, as well as the operational effectiveness related to 4 distinct areas:
- the duty to disclose;
- the duty of care;
- the duty to avoid or disclose conflict of interest; and
- the duty to adopt compliance procedures.
The SEC will focus on how the Firm is disclosing material facts related to the scope and terms of the relationship. The three areas covered include:
- the capacity in which the recommendation is being made;
- material fees and costs that apply to the retail customer’s transactions, holdings, and accounts; and
- material limitations on the securities or investment strategies involving securities that may be recommended to the retail customer.
The SEC may request the following documents as part of their review of the disclosure obligation element:
- Schedules of fees and charges assessed against retail customers and disclosures regarding such fees and charges
- The broker-dealer’s compensation methods for registered personnel
- Disclosures related to the monitoring of retail customers’ accounts
- Disclosures on material limitations on accounts or services recommended to retail customers
- Lists of proprietary products sold to retail customers
The SEC is focusing here on how the Firm “exercises reasonable diligence, care, and skill when making a recommendation to a retail customer.” disclosing material facts related to the scope and terms of the relationship. This includes understanding the potential risks, rewards, and costs associated with the recommendation. “The broker-dealer must then consider these factors in light of the retail customer’s investment profile and make a recommendation that is in the retail customer’s best interest.”
The SEC may request the following documents as part of their review of the care obligation element:
- Information collected from retail customers to develop their investment profiles
- The broker-dealer’s process for having a reasonable basis to believe that the recommendations are in the best interest of the retail customer, including
- the factors the broker-dealer considers to assess the potential risks, rewards, and costs of the recommendations in light of the retail customer’s investment profile;
- the broker-dealer’s process for having a reasonable basis to believe that it does not place the financial or other interest of the broker-dealer ahead of the interest of the retail customer
- How the broker-dealer makes recommendations related to significant investment decisions, such as rollovers and account recommendations
- How the broker-dealer makes recommendations related to riskier, more complex, or more expensive products
Conflict of Interest Obligation
The SEC is focusing here on how the Firm minimizes, eliminates or, at minimum, discloses conflicts of interest relating to recommendations to clients. To meet that obligation, the broker-dealer must establish and enforce written procedures designed to address such conflicts.
The SEC may review the Firm’s policies and procedures to assess the following as part of their review of the conflicts of interest obligation element:
- Policies and procedures related to:
- conflicts that create an incentive for an associated person to place its interest or the interest of a broker-dealer ahead of the interest of the retail customer,
- conflicts associated with material limitations on the securities or investment strategies involving securities that may be recommended to a retail customer, and
- the elimination of diverse types of conflicts;
- How the policies and procedures establish a structure for identifying the conflicts that the broker-dealer or its associated person may face;
- How the policies and procedures establish a structure to identify and assess conflicts in the broker-dealer’s business as it evolves;
- If and how the policies and procedures provide for disclosure of conflicts and what conflicts are disclosed; and
- How the policies and procedures provide for mitigation or elimination of conflicts and what conflicts are mitigated or eliminated.
The SEC may request certain documents as part of their review of the compliance element. OCIE may review the broker-dealer’s policies and procedures to evaluate any controls, remediation of noncompliance, training, and periodic review and testing.
Our firm has expert compliance professionals who can help you to design an effective Regulation BI compliance program for your business. Please contact us today. For more information related to this topic, check out our blog post on Form CRS.