Implications of Reg BI for Broker-Dealers and Advisors

Reg BI introduces four new obligations for brokers and broker-dealers that go above and beyond FINRA’s suitability standards. While previous regulations required broker-dealers to ensure investments were ‘suitable’ for clients, the new regulations go a step further by requiring them to act in the clients’ best interest.

In addition to the new regulations, the SEC introduced Form CRS, or Customer/Client Relationship Summary, requiring broker-dealers and registered investment advisors to disclose the nature of the relationship, fees and costs, standards of conduct, and conflicts of interest, including any revenue-sharing or behind-the-scenes payments.

Reg BI will have a significant impact on broker-dealers who must adhere to higher standards when dealing with clients, but Form CRS represents only a small change for registered investment advisors that can add the documentation to the Form ADV that they already provide to clients. As a result, we can see greater competition from broker-dealers.

It’s also important to note that dual registrants who are both broker-dealers and investment advisors only need to comply with Reg BI while engaging in broker services — not when acting in their capacity as an investment advisor.

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The SEC issued two risk alerts for Reg BI and Form CRS that outlined the specific actions that broker-dealers and registered investment advisors should take by June 30, 2020.

The Reg BI risk alert lists the documentation necessary to ensure that broker-dealers are meeting the four core obligations under the new rules. For example, a schedule of fees, broker compensation methods, and a full list of proprietary products must be disclosed to clients before investment recommendations are made.

The four key areas of documentation include:

• Disclosure – Broker-dealers must disclose all material facts relating to the scope and terms of the relationship, as well as all material facts relating to conflicts of interest associated with investment recommendations.

• Care – Broker-dealers must exercise reasonable diligence, care, and skill when making recommendations, which requires adequate due diligence of the customer’s investment profile and the underlying investment recommendation.

• Conflict of Interest – Broker-dealers must establish, maintain, and enforce written policies and procedures to address conflicts of interest, including the elimination of sales quotas and performance-based bonuses.

• Compliance – Broker-dealers must establish, maintain, and enforce written policies and procedures to achieve compliance with Reg BI as a whole, such as training, periodic reviews, and testing efforts designed to assess compliance.

The Form CRS risk alert requires that broker-dealers and registered investment advisors show that they will have sent the summary to clients within one month of the compliance date. While this might be straightforward for RIAs that can add disclosures to Form ADV, broker-dealers must create new disclosures and send them out before the deadline.

The delivery and filings requirements depend on the client:

• Existing Retail Investors – Initial delivery must occur by July 30, 2020 and before the opening of a new account, recommendations of a rollover, and recommendations of a new investment or investment service.

• New Retail Investors – The delivery must occur before or at the earliest of entering into a new contract, making a recommendation, placing an order, or opening a brokerage account for new retail investors.

There has been some speculation that the COVID-19 outbreak would result in a delay of Reg BI going into effect, but based on recent comments from the SEC, it appears that that is unlikely to be the case. Chairman Jay Clayton recently announced that the June 30, 2020 deadline would remain in place as preparations should have already been underway.

Despite the pending deadline, Morningstar surveyed 100 broker-dealers and found that one-third either didn’t start making preparations or were unsure if their firm had taken any ‘proactive steps’ to address their product line-up. These figures suggest that many companies could be behind the curve and at risk of potential enforcement actions.

If your firm is one of those that hasn’t made preparations, it’s time to start now because the deadline remains in place.

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Regulation Best Interest significantly expands upon the fiduciary requirements of broker-dealers when it comes to making investment recommendations to retail customers. While there’s little change for many investment advisors, broker-dealers will be brought up to advisor-like requirements, representing a big change for most companies in the space.

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