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In case you’re wondering what the regulators will be focusing on this year, they let you know when they publish their annual Exam Priorities Letters. This week’s episode of Oyster Stew is Part 1 in a series discussing the SEC and FINRA 2020 Exam Priorities Letters.  Oyster Consulting experts discuss what’s new, particularly around Reg BI and Form CRS requirements.

Future exam priorities podcast topics will include:

  • Market Integrity
  • Best Execution
  • Technology and Cybersecurity
  • Business Continuity Plans
  • Cash Management / Bank Sweeps


Transcript provided by Temi transcript service

Oyster:  Welcome to this week’s serving of Oyster Stew a mix of financial services, commentary and insights. Each week we’ll discuss what is happening in the industry based on what we see as we work with regulators and clients. We hope you come away with the knowledge and tools to help you make the best decisions for your firm’s future. Today’s episode is part one of a series of podcasts discussing the SEC’s 2020 Exam Priorities.  

Buddy Doyle:   Hi everybody. This is Buddy Doyle. I’m Chief Executive Officer of Oyster Consulting, and welcome to this latest version of Oyster Stew, our podcast that we use to talk about the financial services industry. I’m fortunate enough today to be joined by Evan Rosser and Joe Turner, both of whom are former regulators, have worked in the broker-dealer and investment advisor business for quite a while, and have transitioned to consulting as they go through their career. They have been with Oyster Consulting for some time. So thank you Evan, thank you, Joe, for joining us. What we’re talking about today is the examination priorities, from the SEC and FINRA. If you’re wondering what’s on their mind, it’s fortunate that they tell you every year. So Evan, I think what I’d like to do is maybe get some observations about the Letter and sort of some overarching thoughts about how FINRA is approaching this.  

Evan Rosser:  Thank you, Buddy. The Exam Priority letter starts with a cover letter, and I just wanted to mention a few items that appear in the cover letter. One, they talk about the new five categories of firms: retail capital markets, carrying and clearing, trading and execution, and diversified. And they talk a little bit about the efficiencies they hope to realize with this new categorization. But I think it’s still up in the air and they don’t go into much detail on how that’s going to affect the exam process. Another thing about this year’s letter, which I think is very helpful, it includes a list of practical considerations for firms that they can use an invalid evaluating their compliance programs, as well as links to additional resources. So I think that’s a very helpful tool that is in this year’s letter. Finally, I just wanted to make one observation that some of the initiatives in this letter are the result of new regulations and new rules, particularly Reg BI, which we’ll talk about in a minute, but many others are areas where FINRA has concerns with compliance and about compliance with existing longstanding rules. So not everything in the letter is a new area. In fact, there are many repeat areas, but it’s important to realize that this is not all new regulations, but it’s reviewing existing as well.  

Buddy Doyle:  And Joe, as I haven’t mentioned, there are certainly a lot of areas of focus for the regulators that are not new. Maybe you could give us a quick rundown of some of the things that we see consistently brought out by the regulators and examiners and maybe some thoughts on those topics.  

Joe Turner:  There are certainly some items on the list that we’ve seen before, and we want to emphasize the fact that just because they’ve been there before doesn’t mean they’re not just as important now as they were previously. Okay. We’ve got some items such as communications with the public, always an    

important topic. Always one that FINRA is concerned with and wants to be sure that you’ve got your policies and procedures in order, and that you are in fact doing surveillance and follow up to make sure that you’re in compliance with those. Sometimes the challenging part of the program, for a lot of firms, we want you to know that there are some alternatives out there for third parties to assist you in that, and we think that the communications with the public is something that you certainly are going to want to spend some time on. Trading authorization is another area.  

Certainly trading without written authorization is a problem. That’s always been a focus of theirs. We think that going forward that will continue to be an issue that they’re going to be focused on – any unauthorized trading. It is something they want you to have policies and procedures around. They want, “Do you look for any patterns that might suggest that that type of activity is ongoing and that you’ve got your policies and procedures in line to address that when it happens?” These again are items that have been around for a long time. I think they are certainly items worth spending more time on again this year.  

Buddy Doyle:  Okay. Well thank you for that. And yes, certainly the communication with the public continues to be a really important because it is how you describe generally what you do for your clients is through communication. And so, the regulators like to make sure that you’re fully describing your services in a fair and balanced way, and sometimes their judgment and your judgment might be a little bit different on that. Trading authorization again and having a focus on that. I don’t think you’ll be considering that a waste of time when you get your exit interview from an examiner. Evan, you mentioned Reg BI earlier. Maybe you can kind of roll into that topic and give us a little insight into the state of mind on Reg BI.  

Evan Rosser:   Yes. I think Reg BI is kind of one of the highlights of the letter. It’s also a highlight of the SEC’s exam priority letter back in June of 2019. The SEC adopted Regulation Best Interest, which establishes a best interest standard of conduct for broker-dealers and registered reps. When they make a  

recommendation to a retail customer, their recommendation can be a recommendation of a security. It can be a recommendation of an investment strategy involving securities or it can be the recommendation of a  

type of account in the 1300 pages of Reg BI. Best interest is not really defined; however it, can be met through meeting four obligations: a disclosure obligation, which means you disclose your conflict, your any relationship you have with the product or the issuer of that product; a care obligation, which is for the most part similar to the suitability standard in FINRA Rule, 2111.  

Conflict obligation is where you must disclose your conflicts, anything that might impair the firm’s or the registered reps’ objectivity in that recommendation, and a compliance obligation where you need to have procedures to make sure that these obligations are met. The is effective June 30, 2020. Up until that time, FINRA will be reviewing firms and their preparedness for Reg BI compliance. After that, after June 30, after the effective date, my hunch is, they will be reviewing your programs and while much is up in the air, I think though, and this is not in the letter, but they will be looking to see if you’ve made a good faith effort to comply with the rule. This year’s letter has a number of considerations for firms. When they start to develop and implement their Reg BI policies.  

FINRA will be looking to see if your firm has procedures and training in place to assess your  

recommendations to customers. Does your firm consider reasonably alternative or available alternatives to the recommendation? Do they guard against excessive trading irrespective of whether the broker-dealer or associated person controls the account? Does the firm have procedures to identify and address conflicts of interest? And in the work we’ve done around Reg BI, that’s really the starting point. Does your firm have a process to identify its conflicts and conflicts for the most part are compensation? And you need to look at where you get any revenue from a product you sell. What compensation you receive any trailing revenues from mutual funds, any additional compensation you have. And as I noted, are there reasonably available alternatives to your recommendation? And finally, it’s necessary to have a Form CRS customer relationship summary that explains your role and the transaction. And that’s something that’s required of both broker dealers and investment advisors.  

Buddy Doyle:  And I think Evan, as you mentioned, the bulk of the work that plays that we’ve been starting with organizations, it’s really been around that conflict list and whether they can manage those conflicts and mitigate those conflicts, or they have to eliminate those conflicts, or whether they have to disclose those conflicts and how are they going to disclose those conflicts. It’s been interesting going through Reg BI conversations with so many organizations, and it always seems like the focus has been on the Form CRS, the disclosure from the very beginning. And in reality, what goes into that Form CRS disclosure has to come from a thoughtful process and evaluation. Joe, you talked a little bit about communication with the public. To me disclosure is hand in glove with that. But can you give us a little bit of a sense of what firms need to do with respect to the Form? CRS?  

Joe Turner:  Well, as Evan mentioned, this is really a relationship summary, and it is in fact a disclosure as required for delivery to all the retail investors. It is a common part of Reg BI between broker-dealers and investment advisors. It is largely made up of the conflicts of interest that Evan was referencing. The good news is that the SEC has given us some very detailed and specific set of instructions, step by step instructions on how to put this document together. And two of the most important parts of it are critical parts of it. Number one, it should be in plain English. This is designed to give to your clients so they can understand exactly what your relationship is all about. It is not to be a bunch of legalese. Number two is, it’s limited in scope. In other words, you don’t want to bury your clients a 30-page document, so they say very specifically, two pages, nothing more. Now, that is slightly tweaked when you start talking about dual registrars. If your firms are in fact a broker-dealer and an RIA, then that two pages becomes four pages and you’ve got four pages to explain all of the items required for both the advisor and the broker-dealer. Now if you’ve got an affiliated investment advisor, separate entity, you go back to two pages for both of broker-dealer and two pages for the IA. The important thing in the end is that this has to make it to the clients. You need policies and procedures around the entire creation of the Form CRS. And, lastly, but not least, then those should include how you’re going to get the document in the hands of your clients and establish a possible process that is kind of foolproof so that everybody gets the Form CRS.  

Buddy Doyle:  And I think that to Joe’s point, it’s, it’s very important to have a documented process for doing that. It’s also very important to have a documented process to prove you did it. Many firms will go through the exercise of delivering this, drafting it, doing a really good job of having blunt disclosures, plain disclosures, which I’m a huge fan of. Okay. And then they give it to them, and we know they won’t read it because history shows that they probably won’t read it, which means write it bluntly, I think, and ask yourself how many times you’ve gotten a question about your Form ADV from a client. The second thing is to, again, make sure that you document that you sent it to them and in some reasonable fashion, so that when they come and examine, the evidence is there to prove that you fulfilled your obligation.  

Evan Rosser:    When we work with firms on Reg BI and Form CRS, we always start with what the firm did to get ready for the now vacated DOL Fiduciary Rule, because that rule required you to identify those conflicts, identify the compensation streams that might create conflicts, and not just the commission or the compensation from the product perhaps, but also how you incentivize your registered representatives. So firms that had done that work have already taken a huge leap in preparing for Reg BI and the Form CRS. If you look at some of the FAQs for the DOL rule, they’re very similar to the conflicts and issues that are raised by Reg BI and Form CRS.  

Buddy Doyle:  Well, with that I would like to thank you all for your time. Joe. Evan, thank you so much. If you are looking for any guidance or thought on your regulatory compliance program or the focus of the regulators, feel free to reach out to us and we will get back to you right away.  

Oyster:   Thanks again for listening to the Oyster Stew podcast. Don’t forget to subscribe so we can continue to bring you resources to help you make the best decisions for your firm. If you’re struggling with a topic and you’d like us to do a podcast on it, or you’d like a free consultation, feel free to reach out to us at (804) 965-5400 or by visiting our website at oysterllc.com.  

About The Podcast Speakers
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Buddy Doyle

As the CEO of Oyster Consulting, Buddy Doyle has led the charge to create a successful organization built on the belief that transforming experienced industry practitioners into consultants adds more value to our clients.

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Evan Rosser

Evan Rosser is an experienced and respected securities industry professional with over 25 years of experience managing complex securities investigations for NASD/FINRA and providing compliance expertise to both broker-dealers and investment advisors.  Evan has served as CCO for both investment advisors and broker-dealers, as well as providing compliance support to numerous broker-dealers and registered investment advisors.

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