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Best Practices for Regulation Best Interest

Despite the Covid-19 pandemic, firms are still required to comply with Regulation Best Interest

Best Practices for Regulation Best Interest

Despite the Covid-19 pandemic, firms are still required to comply with Regulation Best Interest, also known as Reg BI. The Securities and Exchange Commission began enforcing Reg BI on June 30, so it is important for brokerage firms and brokers to understand and comply with the new regulation.

Regulation Best Interest is the broker-dealer standard of conduct, which was passed one year ago in June 2019. The  SEC approved a package  of rules requiring brokerage firms to disclose potential conflicts based on the fees investors pay and the commissions brokers earn when giving financial advice.

The rules also require brokers to raise the standard to meet a client’s best interest and avoid potential conflicts when recommending stocks, mutual funds, and other financial products. In addition, it imposes four related obligations on brokers, including:

  • Disclosure Obligation:Brokers must provide certain required disclosures – before or at the time of a recommendation – about the recommendation and the relationship between brokers and their retail customers.
  • Care Obligation:Brokers should exercise reasonable diligence, care, and skill in making the recommendation.
  • Conflict of Interest Obligation: Brokers shall establish, maintain, and enforce written policies and procedures reasonably designed to address conflicts of interest.
  • Compliance Obligation:Brokers will establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest.

Form CRS and Amended Recordkeeping Requirements for Reg BI

Regulation Best Interest requires both RIAs and brokers to provide their clients with a new document that discloses key facts about a firm – a client relationship summary known as  Form CRS. This form outlines the services offered by a firm including all fees, costs, conflicts of interest, required standards of conduct associated with its services, and a review of the firm’s legal or disciplinary history.

The SEC also made the following amendments to Exchange Act Rules 17a-3 and 17a-4 to require firms to create and preserve records for obligations imposed by Regulation BI.

  • 17a-3(a) (35): For each retail customer to whom a recommendation of any securities transaction or investment strategy involving securities is or will be provided, a record of all information collected from and provided to the retail customer pursuant to Regulation Best Interest, as well as the identity of each person who is an associate of a broker or dealer, if any, responsible for the account.
  • 17a-4(e)(5): Broker-dealers are required to retain all records of the information collected from or provided to each retail customer pursuant to Regulation Best Interest for at least six years after the earlier of the date the account was closed, or the date on which the information was replaced or updated.

What to Expect During Examinations

The Office of Compliance Inspections and Examinations (OCIE) will begin examinations to assess implementation of Reg BI. These initial examinations will likely occur “during the first year after the compliance date” and be designed primarily to evaluate whether firms have established policies and procedures reasonably designed to achieve compliance. OCIE will also evaluate whether firms have made reasonable progress in implementing those policies and procedures, according to the  OCIE Risk Alert.

In a recent  press release, officials of the Financial Industry Regulatory Authority (FINRA) said they will take the same approach as the SEC when reviewing broker-dealers and their members for compliance with Reg BI and Form CRS.

Bottom Line: How to Comply with Reg BI

In summary, here are the steps that firms and broker-dealers should take to ensure compliance with Reg BI and Form CRS:

  • Modified Policies and Procedures: Firms should have updated their policies and procedures to reflect Reg BI changes. Brokers are expected to create their own additional policies to fulfill compliance with Regulation Best Interest. One tip here is to review your current lexicon list versus Reg BI requirements and firm policies.
  • Regulatory Audit: Archiving all communications can assist with protecting firms as the records can show the client’s best interests were met. This approach is the best defense for lawsuits and regulatory investigations.
  • Recordkeeping Compliance: Firms need to ensure they have the capabilities to capture, archive and reproduce content across multiple communications and social channels to comply with the amended Exchange Act Rules 17a-3 and 17a-4. This includes emails, message boards, electronic faxes, text messages, social media communications, tape or digital records of voice conversations, collaboration platforms, etc. stored in compliance with SEC’s standard.

Under Regulation Best Interest, the SEC wants to hold brokers to a higher standard. The rules require brokers to stop referring to themselves as advisors if they are not working under a fiduciary standard. These new regulations should be taken seriously because failing to comply with the new Reg BI obligations can result in strict penalties for firms and their employees.

Marianna Shafir, Regulatory Advisor, Smarsh

Marianna Shafir is Regulatory Advisor at Smarsh, where she’s responsible for legal and regulatory affairs worldwide. She helps clients navigate compliance obligations, technology trends and industry regulations through her knowledge of best practices for electronics communications supervision. Prior to joining Smarsh, Marianna worked for BNY Mellon and Invesco in varying legal and compliance roles.

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