Reg BI is almost here. Are you ready?
Because the new rule’s entire compliance process will require well-thought-out strategies and tactics to be executed flawlessly and on time by firms and their technology partners.
Barring a delay in implementation from either or both of two legal challenges, advisors and their firms will have to abide by the new standards set forth in the Securities and Exchange Commission’s (SEC) Regulation Best Interest as of June 30, 2020. It requires them to put their clients’ interests ahead of their own when investment recommendations are made and mitigate any potential conflicts of interest.
“This rulemaking package will bring the legal requirements and mandated disclosures for broker-dealers and investment advisers in line with reasonable investor expectations, while simultaneously preserving retail investors’ access to a range of products and services at a reasonable cost,” said SEC Chairman Jay Clayton in a statement announcing the passage of Reg BI back on June 5, 2019.
The package includes not only Reg BI itself, but also the new Form CRS Relationship Summary, and two separate interpretations under the Investment Advisers Act of 1940.
Collectively, the actions aim to enhance and clarify the standards of conduct applicable to broker-dealers and investment advisors, help retail investors better understand and compare the services offered and make an informed choice of the relationship best suited to their needs and circumstances. It also seeks to foster greater consistency in the level of consumer protections provided, particularly at the point in time that a recommendation is made.
Ever since the SEC voted to adopt the 1,300-plus-page package, the industry has scrambled to analyze and begin to adapt to the regulations to ensure they are in compliance and “audit-ready” by the June 30 deadline—efforts which have occasionally been hampered by a lack of clear guidance from the SEC.
Additional guidance in the form of published risk alerts on Reg BI and Form CRS were expected by the end of March, according to comments from Peter Driscoll, director of the SEC’s Office of Compliance Inspections and Examinations (OCIE), who spoke in early March at the Investment Adviser Association’s annual compliance conference.
The Reg BI risk alert was expected to include a sample of the documents the SEC is likely to request at the outset of an exam—which would look at how firms have set up compliance programs in light of the new rules.
Those exams could begin in July, while more data-driven exams looking at how advisors make product recommendations are scheduled to begin in early 2021.
“By that time there will be a healthy-enough population of trading at firms to start ingesting that into our analytics tools that we have for trading,” Driscoll told the compliance conference attendees.
Form CRS
A major component of the new Reg BI standards is Form CRS (Customer Relationship Summary), which is the requirement that RIAs and broker-dealers provide a brief relationship summary to retail investors at the start of the relationship.
The SEC says Form CRS will bring “transparency and comparability” to the process by which an investor chooses an RIA or broker-dealer, but it also brings some compliance headaches.
Per the SEC, the form can’t exceed two pages and must be written in a plain-English standardized “Q&A” format. It must describe the firm’s fees, any possible conflicts of interest, and disclose whether the firm or its employees have any legal or disciplinary history.
Form CRS can be delivered digitally or via paper, and will outline the types of client relationship offered by the RIA or broker-dealer, and the required standard of conduct for those relationships.
Form CRS must also include a link to a dedicated page on the SEC’s website, which offers information about broker-dealers and investment advisors, among other things. This is intended to allow the retail investor to clarify if they are dealing with an RIA or a broker-dealer, and what difference that might make to their experience.
Firms also have to provide the form (also filed with the SEC) whenever making a new account recommendation, at the time of a rollover recommendation for retirement accounts, or similar types of events.
Firms also need to send a new Form CRS whenever there are changes to the disclosure, such as pricing structure changes, or whenever the relationship summary must be updated.
Firms also have to keep a record of these communications for possible regulatory reviews.
Technology solutions will be critical to ensuring Form CRS compliance. CRM and/or back-office systems must be able to detect when the form is required to be delivered and automatically (electronically) sent.
What is “Best Interest”?
Despite weighing in at more than 1,000 pages, Reg BI mandates best-interest treatment of brokerage and advisory clients without actually providing a crystal-clear definition of what “best interest” means.
Firms will have to show they have a reasonable basis for believing their recommendations are in the client’s best interest under the rule’s new standard of care obligations. While most broker-dealers have long argued they already (and always) put customers’ best interest first anyway, Reg BI requires much more than simply believing this to be true.
Reg BI enhances a broker-dealer’s standard of conduct beyond the existing “reasonable basis” suitability obligation by requiring a broker-dealer to act in the best interest of its retail customer at the time of making a recommendation and proscribes placing the broker-dealer’s financial interests ahead of that of its customer.
Satisfying this enhanced obligation requires the broker-dealer to address conflicts of interest by establishing, maintaining, and enforcing policies and procedures reasonably designed to identify and fully and fairly disclose material facts about conflicts of interest.
The SEC made clear the best interest standard cannot be satisfied through disclosure alone. Thus, when mere disclosure of conflicts is insufficient, broker-dealers may need to mitigate or eliminate the conflict of interest altogether.
Industry self-regulator FINRA has made it a priority this year to help its member firms understand and comply with Reg BI with resources like checklists, podcasts and a compliance guide aimed specifically at smaller firms.
For its part, the SEC released guidance in the form of answers to “frequently asked questions” surrounding Reg BI.
Blaine Aiken, executive chairman at Fi360, a Broadridge company, summarized it all pretty well in a blog post earlier this year, saying, “Reg BI is nearly upon us; a new version of a DOL fiduciary rule is expected later this year; and states are introducing their own fiduciary rules. Change is the only regulatory certainty.”
The implementation of Reg BI represents another giant step on the road to providing clients with a better, more trusting experience with their wealth advisors, Aiken continued.
“Those firms that deliver a seamless Reg BI experience—and visibly put investor best interests first—will advance competitively in the eyes of their current clients and future prospects.”
COULD LEGAL CHALLENGE STILL STOP REG BI?
The SEC says Reg BI will enhance the broker-dealer standard of conduct beyond existing suitability obligations and make it clear that a broker-dealer may not put its financial interests ahead of the interests of a retail customer when making recommendations.
But, while Reg BI’s introduction of fiduciary-like obligations for broker-dealers does narrow the gap between the baseline standards for non-fiduciary and fiduciary advice, it still falls short of a full fiduciary standard.
This, Reg BI critics contend, is illegal due to 2010’s Dodd-Frank Wall Street Reform Act, and because of this, lawsuits to prevent its implementation have been filed and are about the only thing that could prevent Reg BI from taking effect on June 30.
Eight state attorneys general filed a lawsuit in the Southern District of New York last September seeking to block implementation of Reg BI, claiming it fails to meet basic investor protections established within Dodd-Frank.
Also in September, Michael Kitces and his XY Planning Network filed suit against the SEC over Reg BI’s double standard” for financial planning advice. The suit claims the “the SEC has exceeded its authority by impermissibly trying to re-write the registration requirements to become an investment adviser,” and that operating under a fiduciary standard of care is paramount.
Both cases were consolidated because they address overlapping issues. Then in early January, former Democratic legislators Barney Frank and Chris Dodd, the political duo behind Dodd-Frank, added their names to an amicus brief filed in support of the XY Planning Network lawsuit challenging Reg BI specifically on the grounds that it failed to adhere to provisions of DoddFrank.
The amicus brief claims the SEC needed to harmonize the standard of care for broker-dealers and investment advisors but did not, and the “Best Interest rule perpetuates the very inconsistency in standards of care that Congress passed the Dodd-Frank Act to fix.”
In short, it concludes, “the SEC’s rule fails to harmonize the standards for broker-dealers and investment advisers through a fiduciary rule, and is therefore at odds with the text and structure of [Dodd Frank] Section 913, as well as Congress’ plan in passing it. The rule cannot stand.”
The amicus brief, also signed by current high-profile members of Congress Rep. Maxine Waters (D-CA) and Rep. Jerrold Nadler (D-NY), urges the 2nd U.S. Circuit Court of Appeals to take up the case.
In one of his popular Nerd’s Eye View blog posts explaining his lawsuit, Kitces says the issue is simply that Congress has repeatedly prescribed that the delivery of financial advice must be delivered under a fiduciary standard of care, either by lifting the standards for brokers when providing such advice, or by requiring such advice to be delivered as a registered investment adviser in the first place.
“In other words, the point is not to challenge the broker-dealer model, but simply to separate brokerage sales from investment advice—as Congress mandated nearly 80 years ago—and instead let financial advisors be (fiduciary) advisors, and let brokers be brokers (who market and communicate their services as such to the public),” Kitces wrote.
Legal experts have widely suggested the 2nd Circuit is unlikely to halt Reg BI, and had not done so as of mid-March.
Legal observers have been mixed on their opinions, with some saying the 2nd Circuit is unlikely to halt Reg BI while others anticipate the rule will be vacated before June 30.
Alternatively, if faced with delayed implementation due to the Appeals Court, the SEC could choose to modify Reg BI to put it in compliance with Dodd-Frank.
— Brian Anderson
Veteran financial services industry journalist Brian Anderson joined 401(k) Specialist as Managing Editor in January 2019. He has led editorial content for a variety of well-known properties including Insurance Forums, Life Insurance Selling, National Underwriter Life & Health, and Senior Market Advisor. He has always maintained a focus on providing readers with timely, useful information intended to help them build their business.
