The Securities and Exchange Commission adopted a new rule under the Securities Exchange Act of 1934 that established a standard of conduct for broker-dealers and the natural persons who are associated persons of a broker-dealer. It was established to enhance the broker-dealer’s standard of conduct to retail customers beyond the existing suitability obligation.

This standard of conduct takes critical principles from the underlying fiduciary obligations under the Investment Advisers Act of 1940. The SEC’s focus was regardless of whether a retail investor chooses a broker-dealer or an investment adviser, all retail investors should be entitled to a recommendation (by a broker-dealer) or advice (by an investment adviser) given in the best interest of the retail investor. It is essential to recognize that the term “retail investor” also includes Accredited Investors.

What does this mean?

Broker-dealers and their financial professionals are required to act in their client’s best interest when making a recommendation of securities or an investment strategy. To accomplish this, broker-dealer and financial professionals cannot place their financial or other interests ahead of the retail customer’s interest.

Broker-dealers must now address all existing and possible conflicts of interest that would place their interest ahead of the customer’s interest. All conflicts must be disclosed to the retail customer in the Regulation Best Interest Brochure and Customer Relationship Summary, know as the Form CRS. Note that conflicts of interest might not be mitigated enough through disclosure and should, therefore, be eliminated.

Regulatory Focus

One area of focus during the 2021 regulatory audits is Regulation Best Interest (Reg BI). Broker-dealers who have retail investors were required to have complied with all requirements by July 30, 2020. Below is a list of items to help you begin to prepare your firm for your next FINRA audit.

  1. Policies and procedures addressing Reg BI tailored to your firm
  2. All versions of your procedures implementing Reg BI
  3. Reg BI disclosure and Form CRS disclosure documents tailored to your firm
  4. The list of processes implemented or modified to address Reg BI
  5. Documentation of Form CRS preparation, filing, and delivery
  6. Training materials used to train associated persons and supervisory personnel on Reg BI (Training log, agenda, delivery method)
  7. Documentation of any monitoring or surveillance to verify Reg BI requirements are in place
  8. The firm’s process for escalating and addressing issues or potential issues of Reg BI
  9. The firm’s list of potential issues identified or escalated and how they were resolved
  10. Records of any testing that the firm has performed on Reg BI-related processes

Conclusion

The SEC is focused on providing transparency and full disclosure for retail investors. Broker-dealers need to be prepared when FINRA, SEC, or the state comes to audit your firm.

For more information on Regulation Best Interest and Form CRS:

MasterCompliance provides expert consulting, outsourcing, and implementation tools in planning and budgeting for your firm’s compliance responsibilities. If you need assistance with your Regulation Best Interest program, please contact us.