Evaluating Reg BI Compliance
Art by Tim Bower
Unless the Securities and Exchange Commission (SEC) has a significant change of heart, the June 30 compliance date of its Regulation Best Interest (Reg BI) is almost upon us. However, broker/dealers (B/Ds) should not rest easy. In a Risk Alert published by the Office of Compliance Inspections and Examinations (OCIE), that agency announced how it will be investigating firms to evaluate Reg BI compliance. The alert is a valuable resource that firms might utilize to check their preparedness. It also allows, and encourages, continued work on compliance after June 30, particularly if the COVID-19 pandemic has hampered full compliance. The following are my top five takeaways from
the alert.
1) Some firms should expect to be examined within one year of the compliance date. The alert makes clear that OCIE staff will be looking at firms’ policies and procedures to make sure they are reasonably designed to comply with the regulation; in so doing, the staff will evaluate “whether firms have made reasonable progress in implementing these policies and procedures.” The OCIE states it “stands ready to work with firms” on issues it identifies. The SEC’s language in the alert should be good news to firms whose compliance efforts were disrupted by the pandemic.
2) Firms should not assume that they can stop working on their compliance policies and procedures after June 30. The OCIE will look to see which firms “make such modifications as may be necessary and appropriate, in light of information gained from the implementation process and other facts and circumstances.” That is, firms should immediately start reviewing how effective their Reg BI processes and procedures are and work to improve them. This is true for all firms, but especially those where compliance was affected by COVID-19. Therefore, while OCIE staff will not expect immediate perfection in compliance, they will expect to see continuing efforts to improve.
3) The OCIE will carefully review firm disclosures to examine compliance with Reg BI’s disclosure obligation. The OCIE staff will evaluate disclosures that the firm and its representatives provide to retail customers about the scope of their client relationship, limits on recommendations, firm and registered representative compensation, and conflicts of interest. Then it will compare those disclosures with the actual conduct of the firm and its representatives based upon information acquired from the firm. Therefore, after the compliance date, firms should take a hard look at what they are disclosing and determine if they need to disclose more. Notably, Reg BI allows firms and representatives to provide both supplemental written and oral disclosures.
4) The OCIE will verify that the information collected from retail customers is sufficient to properly assess whether the firm meets the compliance obligation. The staff will look at how the firm obtains information about customers and then how it uses that information to ensure it can make a recommendation in accordance with Reg BI’s care obligation. Therefore, firms should evaluate whether they indeed collect adequate information from their customers. For example, if a firm chooses to use its pre-Reg BI customer profile and account application after June 30, it should determine whether those elicit sufficient information to understand, and make an appropriate recommendation to, that customer in light of the risks, rewards and costs associated with that recommendation. The alert gives helpful information on how the firm can make such a determination. It also suggests that firms particularly focus on rollover and account-opening recommendations.
5) The SEC will expect that the firm be able to produce, in writing, and fully explain all conflicts of interest, not just those disclosed to the retail customer. To adequately gauge compliance with the conflict of interest obligation, OCIE examiners will compare a firm’s processes and procedures for addressing such conflicts against how the firm has applied those procedures in any conflicts it has faced. To that end, the staff “may request documentation identifying all conflicts associated with the broker/dealers’ recommendations.” Firms should consider preparing a list of all material conflicts, as defined in Reg BI, just in case the SEC conducts an examination. Doing so will also allow firms to take a second look at the agency’s processes and procedures and determine whether enhancements to their own policies should be made.
In summary, the alert serves as a warning that the SEC may be knocking on your door in the coming weeks or months. It also suggests that the examiners will be reasonable in conducting their investigations, particularly due to the pandemic. Importantly, the SEC is much more apt to take this approach if a firm can demonstrate reasonable efforts to comply with Reg BI on and after the compliance date, with efforts to enhance policies and procedures after the date.
David Kaleda is a principal in the fiduciary responsibility practice group at Groom Law Group, Chartered, in Washington, D.C. He has an extensive background in the financial services sector. His range of experience includes handling fiduciary matters affecting investment managers, advisers, broker/dealers, insurers, banks and service providers.