Article

SEC's new rule for broker dealers: Regulation Best Interest

April 24, 2020 · Authored by Kristen Hughes

On June 5, 2019, the Securities and Exchange Commission (SEC) adopted Regulation Best Interest (Reg BI) Rule 15I-1 under the Securities Exchange Act of 1934. Reg BI establishes a best interest standard of conduct for broker dealers when a recommendation is made to a retail customer of any securities transaction or investment strategy involving securities. The regulation became effective on Sept. 10, 2019, and requires compliance by June 30, 2020.

This regulation seeks to enhance the required standard of conduct to ensure broker dealers are acting in the best interest of the customer, ahead of their own interest. This overarching principle is referred to as the “general obligation.” In addition, there are provisions that require compliance with specific obligations, which set forth what it means to “act in the best interest.” The general obligation is satisfied only if the specific component obligations are satisfied.

The specific obligations are as follows:

1. Disclosure Obligation
   Broker dealers must provide written disclosure of all material facts about the scope and terms of its relationship with the customer. This includes disclosing that the firm is acting in a broker dealer capacity, as well as providing the associated fees, the scope of services and conflicts of interest. Such disclosures should be made at the time or prior to the recommendation and should be updated to reflect any material changes or inaccuracies as soon as practicable, but not later than 30 days after the change occurs.
2. Care Obligation
   Broker dealers must exercise reasonable diligence, care and skill. The broker dealer must believe that the recommendation is in the customer’s best interest having known all costs, risks and rewards. A broker dealer should consider reasonable alternatives, if any, offered by the broker dealer in determining whether there is a reasonable basis for making such a recommendation. The Care Obligation is evaluated at the time of the recommendation, and not in hindsight.
3. Conflict of Interest Obligation
   Broker dealers must establish, maintain and enforce policies and procedures, which identify conflicts of interest in making recommendations to customers and require, at a minimum, disclosure or mitigation of such conflicts. Broker dealers must eliminate certain conflicts, such as sales contests, quotas and bonuses that are based on the sale of specific securities in a certain period.
4. Compliance Obligation
   Broker dealers must establish, maintain and enforce policies and procedures to achieve compliance with Reg BI. This requires policies and procedures to address the remediation of any noncompliance and the implementation of controls, training and periodic reviews and testing.

Along with adopting Reg BI, the SEC concurrently adopted Form CRS. The Form CRS is essentially a relationship summary to provide information about the relationships and services the broker dealer offers, the associated fees and costs in addition to specified conflicts of interest and standards of conduct, including any disciplinary history. The form intends to summarize information in a standard format to allow for comparability across broker dealers. The relationship summary is identified as the initial level of disclosure while the Disclosure Obligation, as identified above, reflects additional layers of detail.

The SEC also amended Rules 17a-3 and 17a-4 of the Securities Exchange Act, which outline minimum requirements for record keeping and retention. Rule 17a-3 was amended to include new paragraph (a)(35) under the Securities Exchange Act, which requires broker dealers to record recommendations made to each retail customer, record all information collected from and provided to the customer pursuant to Reg BI, and to record the identity of each person responsible for the account. This new requirement provides a basis for broker dealers to evidence their compliance with Reg BI and for the SEC to examine such documentation. Rule 17a-4(e)(5) was also amended to require broker dealers to maintain and preserve records of the above noted items until at least six years after such record or relationship summary is created, and to record all dates that information was provided to retail customers.

To prepare for compliance with Reg BI, broker dealers should:

1. Identify where existing policies and procedures may not be sufficient to meet the requirements under Reg BI, and design, document and implement new policies and procedures to address said inefficiencies
2. Draft disclosures to be provided before or at the time of recommendations
3. Update written supervisory procedures to ensure inclusion of policies and procedures that seek to mitigate conflicts of interest

The Financial Industry Regulatory Authority (FINRA) has provided a Reg BI and Form CRS Checklist to assist members with their assessment of and impact to existing policies, procedures and compliance frameworks. For more information, refer to the SEC Release for Reg BI and SEC Release for Form CRS.

For more information on this topic or to learn how Baker Tilly specialists can help, contact our team.