FINRA Wants to Help You With Reg BI Compliance

As the enforcement date approaches for the sweeping Regulation Best Interest rulemaking package, FINRA is working hand-in-hand with the SEC to ensure effective coordination—and to support advisers working on associated compliance challenges.

One of the biggest regulatory stories of 2019 was the finalization of the U.S. Securities and Exchange Commission’s (SEC) Regulation Best Interest (Reg BI) rulemaking package.

As the name suggests, Reg BI establishes a “best interest” standard of conduct for broker/dealers and associated personnel when they make a recommendation to a retail customer (i.e., an individual person) of any securities transaction or investment strategy involving securities, including recommendations of types of accounts. Tied into the broad rulemaking package is a related clarification and restatement of the SEC’s understanding of the fiduciary duty applying to investment advisers under the Investment Advisers Act.

Reg BI has both supporters and detractors, but all parties agree its implementation is of critical importance for advisers and broker/dealers in 2020. Indeed, firms on both the advisory and brokerage side of the aisle must be in compliance with the Reg BI package by June 30. Almost without exception, such compliance will require material changes in processes and procedures for firms operating under the SEC’s expansive jurisdiction—even those that believe they already only provide best-interest service.

Due to the complex nature of the 1,000-plus page rulemaking package, which mandates best-interest treatment of brokerage and advisory clients without actually defining what “best interest” definitively means, the Financial Industry Regulatory Authority (FINRA) has made it a priority this year to help its member firms understand and ultimately comply with Reg BI. To this end, FINRA has published Reg BI checklists, podcasts and other helpful materials, such as a compliance guide designed specifically for smaller firms.

From ‘Suitability’ to ‘Best Interest’

Addressing FINRA’s plans to collaborate with the SEC on Reg BI’s implementation, Robert Colby, FINRA chief legal officer, says his “self-regulatory organization” will be able to draw on its experience enforcing its own “suitability” standard, which he says was clearly part of the inspiration for the specific approach to conflicts of interest taken by Reg BI.

“The big question we are hearing is, how is Reg BI different from how brokers currently deal with customers?” Colby says. “This makes sense, because probably every broker would say that they already put their customers’ interest first and that their own incentives are, by design, aligned with how well their customers do.”

Colby says it is critically important to point out that Reg BI requires much more than a broker simply believing he is providing best-interest service to all clients. Reg BI is meant to be a heightened standard of conduct for brokers, going above and beyond any previous rulemaking.

“Under Reg BI, there can be no ambiguity about recommendations being in the customers’ best interest, and perhaps most importantly, firms must put in place specific and reasonable processes and procedures to ensure they are complying with Reg BI,” Colby observes.

Another major part of Reg BI is that firms on both the advisory side and on the brokerage side will have to provide a “Customer Relationship Summary Form,” or “Form CRS,” to all retail clients. Colby notes that there has been some confusion about how firms or representatives that are registered to operate in both an advisory and a brokerage capacity should structure their Form CRS—an issue that will require careful consideration among dual-registered firms.

Stepping back, Colby notes, Reg BI will in many ways supersede FINRA’s existing regulatory requirements, and thus FINRA itself also has some soul-searching to do in 2020 and beyond.

“The new standards being implemented by the SEC build on FINRA concepts that have been developed in the suitability effort,” Colby says. “We will be preserving our rules, but we don’t want to see conflict or confusion between SEC and FINRA expectations. One possible approach is to say that, with respect to retail investors, compliance with Reg BI will constitute compliance with our suitability rule. Something else to mention is the sales contest prohibition in Reg BI. At FINRA, we have a set of rules that limits sales contests but does not entirely ban them. My reading of Reg BI is that sales contests are deemed to be an inherent conflict of interest. So we are going to have to revisit our sales contest rules, for example.”

According to Colby, FINRA is emphasizing that staff training is going to be an important part of Reg BI compliance.

“Once your compliance policies and procedures are developed, everyone must understand them and know what is required,” he explains. “This training is very likely going to be firm-specific, because it’s meant to be training based on the firm’s specific policies and procedures. General education about Reg BI won’t be enough.”

No Time to Wait

Firms should be well on their way toward Reg BI compliance at this stage, but for those that have been dragging their feet, FINRA suggests tackling the following questions. Any “no” answers will have to be addressed by June 30—the compliance date for Reg BI. 

  • Does your firm have procedures and training in place to assess recommendations using a best-interest standard?
  • Do your firm and your associated personnel apply a best-interest standard to recommendations of types of accounts?
  • If your firm and your associated personnel agree to provide account monitoring, do you apply the best-interest standard to both explicit and implicit hold recommendations?
  • Do your firm and your associated personnel consider the express new elements of care, skill and costs when making recommendations to retail customers?
  • Do your firm and your associated personnel consider reasonably available alternatives to the recommendation?
  • Do your firm and your registered representatives guard against excessive trading, irrespective of whether the broker-dealer or associated personnel “controls” the account?
  • Does your firm have policies and procedures to provide the disclosures required by Reg BI?
  • Does your firm have policies and procedures to identify and address conflicts of interest?
  • Does your firm have policies and procedures in place regarding the filing, updating and delivery of Form CRS?