In an ongoing informational series, Taking Action–Reg. BI, Lowenstein Sandler LLP will provide updates and guidance to broker-dealers, investment advisors, and dual registrants to assist and enhance preparedness for the June 30 compliance date for Regulation Best Interest (Reg. BI) and Form Client Relationship Summary (Form CRS).
On January 10, the U.S. Securities and Exchange Commission (SEC) released answers to frequently asked questions (FAQs) on Reg. BI to provide additional guidance in anticipation of its June 30 compliance date. The FAQs are broken down into four categories, which are highlighted below.
a. Account recommendation: What is an account recommendation?
- Under Reg. BI, an “account recommendation” should be broadly construed to include different types of account features, products, and services offered to customers. This includes the type of account – e.g., brokerage account, individual retirement account (IRA), education account – or where to rollover assets, e.g., from an employee retirement fund to an IRA. Within brokerage accounts, the SEC would consider account features such as margin or cash an account recommendation. Differing financial products available and account services provided (e.g., access to trade options or high-touch service) may also be considered account recommendations.
- The SEC indicated the spectrum of account types that need to be considered when providing a recommendation for Reg. BI purposes is determined by the registration status of the individual who is providing the recommendation. Thus, a dually registered individual must consider both brokerage and advisory accounts when providing a recommendation.
b. Recommendation threshold: What triggers a recommendation?
- The analysis of whether a recommendation has occurred will depend on the facts and circumstances and whether the activity represents a “call to action” or is individually tailored or targeted to a group of customers. For example, a broker who communicates to existing customers that the broker will be changing firms presents a “significant possibility that [the] communication may be reasonably viewed as a ‘call to action’” and would trigger Reg. BI recommendation obligations.
- Conversely, a communication that is educational in nature (e.g., letting a customer know the contribution limits for IRAs) would not be considered a recommendation for Reg. BI purposes.
II. Disclosure Obligation
- Reg. BI requires brokers prior to or at the time of a recommendation to provide retail customers with written disclosure that fully and fairly states all material facts related to the scope of the relationship and conflicts of interest related to the recommendation.
- Form CRS generally will not satisfy the Reg. BI disclosure obligation.
a. Disclosure timing: When must disclosures be provided?
- Existing Disclosures: Existing disclosure obligations that are permitted to be provided after the fact (e.g., trade confirmations and prospectus delivery) may satisfy Reg. BI disclosure obligations.
- Oral Disclosures: After-the-fact oral updates to disclosures are limited to information that could not have been known at the time of the recommendation, such as whether an account type will be brokerage or advisory. Firms must make and keep records of disclosures that are orally updated.
b. Disclosure delivery: How can disclosures be delivered?
- Electronic delivery of Reg. BI disclosures is permitted as long as (1) notice is provided that the information is available electronically; (2) access to information is comparable to what is provided in paper form; and (3) there is evidence of delivery, which is usually satisfied by a customer’s informed consent.
- Reg. BI disclosures may be provided to an existing customer in the June 30 statement mailing. However, any recommendations provided after June 30 but prior to the receipt of the Reg. BI disclosures will not be compliant with Reg. BI. This delivery requirement is separate from the requirement of brokers to provide their customers a copy of Form CRS.
III. Care Obligation
Series of transactions: What constitutes a series of transactions?
- A broker must exercise reasonable care when making a recommendation and therefore must have a reasonable basis to believe a series of transactions would not be excessive. Consequently, even if each individual transaction would be in the customer’s best interest, a series of transactions must be viewed cumulatively in order to satisfy the care obligation. A series of transactions is a fact and circumstance determination, which is made using existing guideposts such as turnover rate, cost-to-equity ratio, and use of in-and-out trading.
IV. Conflict of Interest Obligation
a. Eliminating conflicts of interest: What conflicts of interest should be eliminated?
- Broker-dealer incentives are permitted as long as the broker-dealer establishes “reasonably designed policies and procedures to disclose and mitigate the incentives created.” In lieu of mitigation and disclosure, broker-dealers may choose to eliminate certain incentives.
b. Mitigating conflicts of interest: How should conflicts of interest be mitigated?
- The SEC has not mandated an approach for mitigating conflicts of interest, but rather, it stated that mitigation techniques will depend on the size and structure of the firm. The SEC provided, as an example, mitigation practices described in the Reg. BI Adopting Release, which describes supervisory and compensation control methods.
For additional information regarding Reg. BI and Form CRS, you can reference the following resources:
- FINRA Reg. BI Website
- FINRA Reg. BI Conference On-Demand Recording
- SEC Reg. BI: A Small Entity Compliance Guide
- SEC Reg. BI: Frequently Asked Questions
- 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.