In an ongoing informational series, Taking Action–Reg. BI, Lowenstein Sandler LLP will provide updates and guidance to broker-dealers, investment advisers, and dual registrants to assist and enhance preparedness for the June 30, 2020 compliance date for Regulation Best Interest (“Reg. BI”) and Form Client Relationship Summary (“Form CRS”). In addition to this conference update, Taking Action–Reg. BI continues with the attached roadmap, which is intended to assist firms in planning and implementing Reg. BI.1
In late December, the Financial Industry Regulatory Authority, Inc. (“FINRA”)2 held a conference on Reg. BI and Form CRS. With the June 30, 2020 compliance date (the “Compliance Date”) approaching, the goal of the conference was to bring regulators and industry representatives together to discuss the implications of the regulatory shift and gauge the industry's preparedness. When prompted, fewer than half of the attendees raised their hands to indicate whether their firms had begun preparing for Reg. BI and Form CRS compliance, displaying the audience’s general unease with the impending change. Regulators from FINRA and the U.S. Securities and Exchange Commission (“SEC”) did little to allay fears by jokingly saying to the crowd, “Panic!” But after acknowledging the significant regulatory lift of implementation, they indicated there is still sufficient time to adequately prepare for compliance. Further, both regulators stated they are working closely together and are seeking to engage and be responsive to industry with any interpretative questions that may arise during implementation. The regulators will continue to provide guidance, and the SEC stated that it is currently drafting frequently asked questions (FAQs). All that being said, there is still uncertainty on the horizon with legal challenges to Reg. BI by states’ attorneys general and discussions of the Department of Labor (“DoL”) revising its erstwhile fiduciary rule, to which the SEC Director of the Division of Trading and Markets commented that the SEC would work with the DoL for “regulatory harmonization.”
Below are key takeaways from the conference:
I. Scope of the Regulation
a. Retail Customer– Reg. BI obligations are only applicable to “retail customers.” This term is broadly defined to include any natural person or legal representative of such natural person who receives a recommendation for their account. One panelist colloquially suggested to apply the “two-legged” test whereby if someone has two legs, they likely will be within the scope of Reg. BI. However, the interpretative limits and breadth of this definition are still being refined. For example, an SEC representative stated that the SEC staff is determining whether a family office would be considered a retail customer for purposes of Reg. BI and hopes to provide guidance on this question soon.
b. Recommendation– If no recommendation is provided, then Reg. BI obligations do not apply to a broker-dealer. An SEC representative commented that Reg. BI borrowed the concept of recommendation from the existing concept within the suitability framework and highlighted touchstone instances of whether a communication is a “call to action” or is “individually tailored” when determining if the communication is a recommendation. Similarly, a FINRA representative from its Office of General Counsel stated Reg. BI takes suitability and builds upon it, calling it “suitability on steroids.” He indicated that FINRA would keep existing FINRA Rule 2111 (Suitability) and update and adopt additional rules to conform to Reg. BI obligations. However, there is no timeline for when such changes will be effected. Under Reg. BI, firms will be required to consider the type of account suggested to a customer as a recommendation. Further, while account monitoring is not required by Reg. BI, if account monitoring is conducted, it will create an “implicit” recommendation to continue to hold existing positions. The SEC further commented that broker-dealers are still able to conduct an “account review” by applying the “solely incidental” concept outlined in the interpretative release that accompanied the Reg. BI adopting release.3
c. Form CRS– Each firm is required to draft this disclosure document that must describe all business lines and products the firm offers. Form CRS must be drafted and distributed by all registered broker-dealers, investment advisers, and dual registrants that conduct business with retail customers as broadly defined above, irrespective of whether they make recommendations to such customers. The document is limited to two pages (four pages for a dual registrant) and must be written in plain English.
II. Exam Areas of Focus
For upcoming exams, the SEC described four main “black and white” Reg. BI areas of focus, stating that it wants firms to have made “good faith efforts” to address each of these focus areas. The four areas of focus are: (1) identifying and eliminating conflicts of interest; (2) reviewing employee registrations and, if necessary, updating use of the term “adviser”; (3) updating policies and procedures and retaining documents to reflect the enhanced obligations of a broker-dealer; and (4) drafting and distributing Form CRS, including delivery and receipt tracking.
Conflicts of Interest – Identifying, disclosing, and eliminating conflicts of interest are at the core of Reg. BI. A wholesale review of the operations of the firm should be conducted with attention to the fees and compensation received by the firm. Conflicts of interest must be adequately disclosed to customers, which can include reliance on currently provided disclosures such as Rule 10b-10 confirms or prospectuses. However, certain conflicts must be eliminated, such as sales contests and quotas.
Use of “Adviser” or “Advisor” – Reg. BI prohibits the use of the term “adviser” or “advisor” by a broker-dealer not dually registered as, or supervised by, an investment adviser. It is important to review the registration and operations of the firm’s associated persons to determine the capacity in which they operate and how they hold themselves out to the public. Those individuals who are not dually registered but use the term “adviser” or “advisor” will either need to update all marketing materials (websites, business cards, etc.), or obtain proper registration prior to the Compliance Date.
Updating Policies and Procedures – Reg. BI creates four obligations (Disclosure, Care, Conflict of Interest, and Compliance). All four obligations must be addressed in order to be compliant with Reg. BI by the Compliance Date. To comply with these obligations, FINRA advised that it is essential for firms to develop procedures to address each obligation so that there is an “infrastructure to comply with Reg. BI.” It is also important to make and keep a record of these processes to provide sufficient evidence to examiners.
Form CRS – Form CRS is a “gateway” disclosure document limited to two pages (four pages for a dual registrant) that is a plain English description of the firm’s business, fee structure, and operations. This document should be used in a “layered” approach to disclosure, where additional information can be accessed by the recipient. Firms must submit Form CRS to the SEC by the Compliance Date in order to achieve compliance. Firms are also required to distribute Form CRS to all current and future customers within 30 days of submitting Form CRS and must track delivery and receipt of this, and every subsequent, distribution of Form CRS.
III. Continued Regulatory Dialogue
The SEC and FINRA were mindful of the significant challenge and burden of Reg. BI and Form CRS, including the need for firms to update their processes and procedures. Both regulators expressed a desire to engage with industry and encouraged conference attendees to email the SEC any interpretative questions or challenges at IABDQuestions@sec.gov.
The regulators also outlined a plan to gather information and to provide additional guidance leading up to the Compliance Date. In fact, the SEC stated that its Office of Compliance, Inspections and Examination (“OCIE”) has already conducted “targeted outreach” of firms and that starting in January 2020 OCIE will begin conducting “preparedness exams” that will consist of a series of questions and dialogue to understand and determine where firms stand with regard to Reg. BI compliance. The SEC reiterated that these exams will not be of the “gotcha” nature, but more fact finding and consultative in order to prepare firms for overall compliance with the new rules.
The SEC and FINRA are working together to provide firms with an information and document request list to assist in understanding the targeted areas and scope of the exam. The SEC also stated that FAQs should be published shortly and will be updated periodically, if necessary. The SEC commented that it will likely publish a Reg. BI best practices document based on the information gathered from its exams. This approach would mirror the SEC’s actions related to cybersecurity.4
For additional information regarding Reg. BI and Form CRS, you can reference the following resources. FINRA indicated the full conference should be available for web viewing in the coming weeks on the FINRA website.
- FINRA Reg. BI Website
- SEC Reg. BI: A Small Entity Compliance Guide
- SEC Form CRS: A Small Entity Compliance Guide
- SEC Form CRS: Instructions
- SEC Form CRS: FAQs
Please contact one of the listed authors of this Client Alert or your regular Lowenstein Sandler contact if you have any questions with respect to Reg. BI and Form CRS or would like assistance preparing for the Compliance Date, including reviewing and updating your compliance policies and procedures, training, and/or disclosures, as well as drafting a Form CRS.
Click here to access the roadmap.
1 The Firm’s Client Alert regarding FINRA’s Reg. BI and Form CRS Checklist is available at https://www.lowenstein.com/news-insights/publications/client-alerts/finra-provides-guidance-on-regulation-best-interest-and-form-crs-investment-management.
2 FINRA is a self-regulatory organization that regulates all U.S. registered broker-dealer firms, including those dually registered as investment advisers. Entities that are solely investment advisers are not regulated by FINRA, but are regulated by the U.S. Securities and Exchange Commission (“SEC”) or an appropriate state regulator.
3 “Commission Interpretation Regarding the Solely Incidental Prong of the Broker-Dealer Exclusion from the Definition of Investment Adviser,” available at https://www.sec.gov/rules/interp/2019/ia-5249.pdf.
4 “Cybersecurity Examination Sweep Summary,” available at https://www.sec.gov/about/offices/ocie/cybersecurity-examination-sweep-summary.pdf.