SEC Adopts Reg BI

The SEC Adopts Regulation Best Interest (Reg BI) and Additional Rules and Interpretations that Address Relationships Between Retail Investors and Investment Professionals

new compliance rules written on blackboardRegulation Best Interest

On June 5, 2019, the SEC adopted a new rule, referred to as Regulation Best Interest (“Reg BI”), that establishes an express best interest obligation applicable to broker-dealers (“BDs”) when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer.  Reg BI, as adopted, contains certain enhancements to the rule provisions that were proposed in 2018.

The new obligation under Reg BI requires a BD and its Associated Persons, when making a recommendation, to act in the best interest of the retail customer at the time the recommendation is made without placing the financial or other interest of the BD or Associated Person ahead of the interest of the retail customer.  Reg BI applies to account recommendations, including recommendations to roll over or transfer assets in a workplace retirement plan account to an IRA, and recommendations to take a plan distribution.  It also applies to implicit “recommendations to hold” that result from agreed-upon account monitoring.

Reg BI includes the following components:

  • The Disclosure Obligation. The BD must disclose material facts about its relationship with its customers and its recommendations, including specific disclosures about the capacity in which its Associated Person is acting, fees, the type and scope of services provided, conflicts, limitations on services and products, and whether the BD provides ongoing monitoring services;
  • The Care Obligation. The BD, in making a recommendation to a retail customer, must exercise reasonable diligence, care and skill.  The BD must understand potential risks, rewards, and costs associated with the recommendation.  The BD must then consider these factors in light of the retail customer’s investment profile and make a recommendation that is in that customer’s best interest.  Reg BI explicitly requires the BD to consider the costs of the recommendation;
  • The Conflict of Interest Obligation. The BD must establish, maintain, and enforce written policies and procedures reasonably designed to identify and at a minimum disclose, or eliminate, conflicts of interest.  This obligation specifically requires policies and procedures to:
    • Mitigate conflicts that create an incentive for the firm’s financial professionals to place their interests or the firm’s interests ahead of the customer’s interest;
    • Prevent material limitations on offerings (such as a limited product menu or an offering of only proprietary products) from causing the firm or is financial professionals to place their interests ahead of the customer’s interest; and
    • Eliminate sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sale of specific securities within a limited period of time.
  • The Compliance Obligation. BDs must establish, maintain and enforce policies and procedures reasonably designed to achieve compliance with Reg BI as a whole.

The SEC also approved measures that would (1) clarify the fiduciary duty applicable to registered investment advisers (“RIAs”), (2) require the delivery of a relationship summary between retail clients, RIAs and BDs, and (3) provide an interpretation of the “solely incidental” prong of the broker-dealer exclusion under the Advisers Act.

Investment Adviser Fiduciary Duty

The Supreme Court has found that a fiduciary duty is owed to investment advisory clients under the Advisers Act.  However, this duty is not defined in the Advisers Act or any rule thereunder.  The duty is solely principles-based and applies to the entire relationship between an RIA and its client.  The SEC’s rule reaffirms, and in some cases, clarifies, certain aspects of the fiduciary duty that an RIA owes to its clients.

Form CRS Relationship Summary

RIAs and BDs will be required to provide retail investors with a relationship summary at the beginning of their relationship.  Firms will summarize information about services, fees and costs, conflicts of interest, the applicable legal standard of conduct, and address whether or not the firm and its financial professionals have disciplinary history.  The relationship summary will have a standardized question-and-answer format and will permit the use of layered disclosure so that investors can more easily access additional information from the firm.

Interpretation of “Solely Incidental”

The broker-dealer exclusion under the Advisers Act excludes from the definition of investment adviser – and thus the application of the Advisers Act – a broker-dealer whose performance of advisory services is solely incidental to the conduct of business as a broker-dealer and receives no special compensation for those services.  The SEC’s interpretation states that a broker-dealer’s advice as to the value and characteristics of securities or as to the advisability of transacting in securities falls within the “solely incidental” prong of this exclusion if the advice is provided in connection with and is reasonably related to the broker-dealer’s primary business of effecting securities transactions.

Effective Dates

Reg BI and Form CRS will become effective 60 days after they are published in the Federal Register and will be subject to a transition period until June 30, 2020 to give firms sufficient time to comply.  The SEC’s interpretations will become effective upon publication in the Federal Register.

Oyster Consulting has the knowledge and experience to support your efforts to comply with these rules.  To receive assistance with the preparation of policies and procedures or disclosure documents, or to receive training to ensure you understand the impact of these rules, please give us a call at (804) 965-5400 and we will put you in touch with our experts.

 

About the Author:

Bob Tuch has over 25 years of experience in the financial services industry. He has served as in-house counsel for Nationwide Financial Services, Inc., an affiliate of Nationwide Insurance Company, and BISYS Fund Services, a mutual fund administrator and product distributor. At Nationwide, he managed a practice group that supported Nationwide-affiliated broker-dealers and provided legal support for Nationwide insurance agents. At BISYS, he provided legal support for BISYS mutual fund clients, including the preparation and review of mutual fund registration statements, the review of advertising and sales literature and the preparation of board meeting agendas, resolutions and minutes. Prior to serving in these in-house counsel roles, Bob held the position of Attorney Adviser in the Investment Management Division of the SEC.

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