On June 5th 2019, SEC adopted the Best Interest Standard regulation Reg BI for Broker-dealer and Investment-advisory firms. The regulation requires broker-dealers to only recommend financial products that are in their customer’s best interests, and to disclose any potential conflicts of interest and financial incentives the broker-dealer may have with those products.
The rule falls under the Securities and Exchange Act of 1934, and is intended to establish a standard of conduct for broker-dealers who recommend any securities transaction or investment strategy.
The regulation has five principal areas, and can be broken down as follows:
- A “best interest” standard comprising four obligations for broker-dealers when providing recommendations to retail customers (Regulation Best Interest or Reg BI).A required client relationship summary disclosure (Form CRS) for both broker-dealers and investment advisers. An interpretation of the federal fiduciary standard for investment advisers that reaffirms their fiduciary obligations.
- An interpretation clarifying that broker-dealers who provide advisory services are not considered to be investment advisors when such services are “solely incidental” to the conduct of their business.
Reg BI and Form CRS have a compliance date of June 30, 2020, while the interpretations will become effective upon publication in the Federal Register.
Compliance Obligations Reg BI mandates four Compliance Obligations:
- Disclosure Obligation: required before, and at the time of recommendation acceptance, and if there are any changes in conditions due to new conflicts or changes.
- Duty of Care Obligation: the exercising reasonable due diligence, care and skill in making recommendations.
- Conflict of interest Obligation: establishing policies and procedures to identify and address conflict of interest.
- Compliance Obligation: establishing policies and procedure to monitor compliance with Reg BI.
Disclosure and Form CRS Under the Disclosure Obligation broker-dealers are required to provide the “Form CRS”, which is in a question and answer format, to clients. These disclosures must contain:
- Summary of fees, costs, conflicts, and standards of conduct.
- Link to SEC’s Investor.gov site
- These disclosures must be distributed to clients before a recommendation of an account type, a securities transaction, or an investment strategy involving securities, or placing an order for the retail investor is made. They must also be sent out prior to the opening of a brokerage account for the retail investor.
- Disclosures should be distributed prior to or at the time of entering into the advisory contract.
- Should use the earliest of the deadlines imposed under requirements for BDs and RIAs.
- Firms must provide additional disclosures when they: Open a new account that is different from the retail investor’s existing account(s);
- Recommend that the retail investor roll over assets from a retirement account into a new or existing account or investment; or recommend or provide a new brokerage or investment advisory service;
- or investment that does not necessarily involve the opening of a new account and would not be held in an existing account (e.g., securities sold through a “check and application” process).
Duty of Care Obligation
The Duty of Care obligation is intended to ensure that advisers are exercising reasonable due diligence, care and skill in making recommendations.
Full and Fair Disclosure: It is necessary to supply sufficiently specific information so that the client is able to understand and make informed decisions related to the choice of products chosen for the client, including all fees, risks and conflicts of interest.
- Importantly, it is inadequate to: Disclose to clients without describing how the advisor is managing the conflicts of interest.
- Include conflicts without providing detailed description.
Firms will have an obligation to provide:
- Reasonable “diligence, care, and skill” to satisfy three obligations: reasonable-basis, customer-specific and quantitative. Additionally, firms must evaluate reasonably available alternatives, however broker-dealers will not have to evidence review of all alternatives.
- Care obligation covers recommendations concerning rollovers and account choice (e.g. brokerage or advisory), as well as those to take a retirement plan distribution for purposes of opening a securities trading account. Provide Advice in the best interest of client.
- Seek best execution.
- Provide advice and monitoring that the obligations are continuously met.
This means that you must be:
- Keeping track of the risk profile of the client, client objectives, and funding needs to build portfolio that is suitable.
- Choosing products that clearly prove that product returns, fees, expenses are right for client as well as compare it against other possible products and explain how the defined portfolio is in the best interest.
- Disclosing material facts and conflicts of interest in the choices made.
- Generating the Form CRS and send it to the client with the specifics of the client’s portfolio.
- Explain the choices made to client and get their consent.
- Conduct Trade Monitoring to understand the trades being done on behalf of the clients match with the client’s investment objectives.
- Portfolio is reviewed periodically to ensure the current portfolio still is within the client’s defined objectives and is still performing per the expectations.
- That best execution is monitored for prices and conflicts.
Conflicts of Interest Obligation
The Conflicts of Interest Obligation mandates the establishment of policies and procedures to identify and address conflict of interest.
- Reg BI allows firms to sell proprietary products, including initial public offerings, and continue to receive payments from third parties for shelf space – as long as they disclose conflicts of interest.
- For example, in instances where a registered representative holds a limited license (e.g. only to sell mutual funds), but the firm offers a full suite of products, the representative may need to disclose this to their customers.
This means that:
- All fees received for third party activities are documented and understood.
- Monitoring of all Outside activities of the Organization and the Registered Reps and Advisers to ensure none of these are creating conflicts in the products and services being offered to the client.
- Monitoring rep registrations and U4.
- Conducting background verification of reps and advisers to ensure no criminal violations, debts/liens, adverse media, or court cases exist in their backgrounds.
The compliance obligation requires firms to maintain policies and procedures to ensure compliance with Reg BI. It is important to note, this obligation provides an opportunity for the SEC and FINRA to bring enforcement actions for compliance failures without the existence of underlying violations of Reg BI – therefore, firms should carefully develop Reg BI policies and procedures with a view towards how they will demonstrate that they have met the best interest standard, including:
- Have books and records that prove and document all written and oral disclosures to clients.
- Train their staff to work in the best interest of the client.
- Ensure that all client facing staff read and attest that they will work in the best interest of the client.
What can firms do, and how can La Meer help?
La Meer’s GRACE for Reg BI is a web based / tablet enabled / mobile system that has been specially built to address the Reg BI comprehensively thru integrated end-to-end client and compliance management.
GRACE Reg BI provides the functions for client facing staff ability to record all information they gather on the client’s risk profile, notes of client interactions, create the model portfolio, choose products that are in their best interest, record notes about their suitability Vs other choices, as well as share the information with compliance and client from the single source of truth. It helps portfolio creation using industry standard information feeds for pricing, risk, fees to make an appropriate choice for the client’s profile.
GRACE Reg BI provides the Clients with secure portal to receive disclosures securely and electronically and share information with advisors for all aspects of their finances including, portfolio, trade reports, fees and billing and provides analytics related to their portfolio.
GRACE for compliance management helps set up the tone at the top with Policies and Procedures, Conduct Risk Assessments, Get Online Attestation, Manage Training, and Reporting functions for Advisors, Registered Representatives and Outside staff and enables the Compliance staff establish compliance to Reg BI.
GRACE Reg BI allows the Compliance group to:
- Look at all the market offerings and alternatives along with their risk characteristics, fees etc, to understand and ensure suitability of choices for clients.
- Define product restrictions that define what can and cannot be sold to particular customer type and enable this data to be shared across the organization to prevent violations.
- Identify and record Conflicts of Interest in all relationships with brokers, registered reps and others and ensure these conflicts reflect in the various disclosures to clients.
- Help monitor conflicts through its various functions from staff reporting, broker contracts and and branch, rep examination to identify conflicts of interest and keep track of their inclusion into client reports for full disclosure.
- Manage Disclosures and Form CRS to include all the relevant information and have it reviewed and released and provide them during the account opening, new product inclusion and other life stages.
- Conduct Suitability reviews, account opening, disclosures review, client due diligence, transaction monitoring, trade monitoring patterns, funds transfers, AML, online portfolio review, best execution, fees and billing and ensure that the portfolio continues to be in the best interest of the client at all times.
Please reach out to firstname.lastname@example.org to discuss further, or to request a demo.