United States: The Countdown Is On! Building A Reg BI Compliance Program As Deadlines Loom

On June 5, 2019, the SEC adopted a package of rulemakings and interpretations designed to enhance the quality and transparency of investors’ relationships with broker-dealers and investment advisers. The focal point of this package is Regulation Best Interest (Reg BI), which establishes a “best interest” standard of conduct for broker-dealers and associated persons when making a recommendation to a retail customer of any securities transaction or investment strategy involving securities, including recommendations of types of accounts. As part of the rulemaking package, the SEC also adopted new rules and forms to require broker-dealers and investment advisers to provide a brief relationship summary, Form CRS, to retail investors.

The compliance date for Reg BI and Form CRS is June 30, 2020. However, given the significant amount of work that must be completed to implement the new regulations, this timetable is very aggressive. In addition, because the scoping, inventorying, gap analysis, and policies and procedures need to be in place before training may be conducted, this will push forward the deadlines for key implementation phases. To satisfy Reg BI’s requirement that a broker-dealer act in the best interest of the customer without placing its own financial or other interests ahead of the customer’s interest, broker-dealers must comply with four new component obligations when making such recommendations: (1) a disclosure obligation, (2) a care obligation, (3) a conflict of interest obligation, and (4) a compliance obligation.

This Alert highlights the gating issues and key implementation phases that firms should be considering, with a focus on Reg BI. We stand ready to assist with your firm’s Reg BI and CRS implementation needs. For a more detailed discussion of Reg BI and Form CRS, you may access our June 17, 2019, Client Alert “SEC’s Final Rules and Guidance on the Standards of Conduct for Broker-Dealers and Investment Advisers.”  

PHASE 1:  Timetable and Players – Identifying the Reg BI Implementation Team and Major Milestones.

The first step in developing a game plan for Reg BI implementation is identifying all key constituencies and major milestones. Working through these milestones and their timetables will highlight that many deliverables may need to be put in place over the next couple of months—well before the June 30, 2020, deadline. Some gating questions that firms should ask and areas they should focus on include the following. 

1. What areas need to be addressed well before June 30?

  • Technology. 
    • Identify and gather data for disclosures.
    • Develop infrastructure to record delivery of disclosures.
    • Address requirement to post Form CRS prominently on the firm’s website.
    • Identify and track customers subject to Reg BI and their investment profile information.
    • Develop new surveillance.
  • Client Onboarding and Maintenance.
    • Develop process for identifying customers subject to Reg BI/CRS.
    • Determine how customer investment profile information is obtained, tracked and updated. 
  • Product platform.
    • Inventory and analyze products and services available for retail customers to determine what information regarding such products and services (including fees and costs) is provided to registered reps (RRs) and whether there are any material limitations on securities or strategies that may be recommended. 
    • Develop process for informing RRs of changes to product fees and costs, material limitations, and new product and service offerings.
  • Operations. 
    • Develop process for initial Reg BI/CRS mailings and follow-up mailings.
    • Review client records for consent to electronic delivery.
  • Training, policies and procedures.
    • Train all RRs who interact with retail investors/customers, and RR supervisors. 
    • Draft and finalize policies and procedures.
    • Develop surveillance system to assist supervisors and Compliance.
    • Obtain and update retail customer investor profile by June 30 so RRs can make the client-suitability assessment.
  • Marketing material and business cards.
    • Assess changes necessitated by any changes in title (business cards, stationery, websites). 
    • Review broker-dealer marketing materials and customer communications. For example, these materials need to be reviewed to ensure they do not include statements that could be viewed as inappropriately “holding oneself out” as an investment adviser.
  • Compensation.
    • Review RR compensation and bonus structure and programs to determine conflicts that require disclosure and/or elimination.

2. Who needs to be involved in implementation discussions?

  • Front Office, including relevant committees (e.g., new products committee, reputational risk committee, commitment committee). 
  • Product Departments.
  • Client On-Boarding.
  • Information Technology.
  • Operations.
  • Human Resources (for RR compensation-related matters).
  • Finance (for product/service-specific revenue information).
  • Records Management (for retention of disclosure docs, and customer profiles).
  • Legal.
  • Compliance.
  • Conflicts Office/Business Selection Office.

PHASE 2:  Identifying In-Scope Lines of Business for Reg BI and CRS.

The second gating issue is scoping all the touchpoints with “retail customers” (for Reg BI) or “retail investors” (for Form CRS). These lines of business (LOBs) may include areas that historically have not been considered retail-facing business lines, given that the SEC’s definitions of “retail customer” and “retail investor” include persons who may be “institutional investors” under FINRA rules. Threshold questions firms should ask and issues they should consider include the following.

1. Which LOBs have “retail investor” or “retail customer” touchpoints?

  • Look at all your LOBs and determine whether they interact with retail investors (they will have to deliver a Form CRS) or retail customers (for Reg BI).
  • Keep in mind that retail investor/customer includes individuals who have well in excess of $50 million, trusts, LLCs, family offices, and other vehicles that are alter egos for an individual. This means that customers who may not have been considered “retail” could be in-scope for purposes of Reg BI and CRS. 
  • Consider which of these retail investors/customers have professional legal representatives. This will be relevant in assessing the Reg BI obligation.

2. Which LOBs make “recommendations” of securities transactions or investment strategy to “retail investors” or “retail customers”?

  • Are the recommendations “used” for personal, family or household purposes?
    • Note: “use” includes instances where the broker-dealer receives compensation indirectly from the recommendation even if the customer does not have/open an account, such as with check and application customers.
  • Did LOBs ever agree to monitor the account?

3. Are there any preset defaults for investment accounts, strategies or transactions that could implicate Reg BI? (e.g., certain account types—such as margin—that are opened by default)

  • Review all preset defaults for Reg BI compliance.

4. Are there LOBs with dual-registrants? 

  • Develop protocols for determining and disclosing the capacity in which a dual-registrant is acting.

5. Has the firm undertaken an obligation to monitor?

  • Review all brokerage account agreements/terms to identify any obligation to monitor account activity and any obligations regarding making of recommendations that go beyond the requirements of Reg BI. 
    • Note that Form CRS requires disclosure of the nature of any such monitoring. 

PHASE 3:  Putting It All Together.

After firms have identified all in-scope players, customers, accounts and business lines, the next step is to tackle the component obligations of Reg BI. To do this, firms may leverage existing frameworks (such as current disclosure processes and any enhancements that were made to comply with the DOL’s now-defunct fiduciary rule). These processes should be inventoried and mapped to the component obligations of Reg BI.  

Below are some of the areas firms should consider in conducting this gap analysis.      

1. Satisfying the Disclosure Obligation (Layered Disclosure Regime).

  • Inventory disclosures that are already made and the points in time when they are made. Determine which disclosures can be supplemented (e.g., account agreement, stuffers with confirms, prospectuses).
  • Conduct a gap analysis to identify additional disclosures that must be made (e.g., scope and terms, capacity, fees and costs, types and scope of services, material limitations, conflicts of interest).
  • Map out: (a) which of these additional disclosures may be standardized versus customer/transaction-specific; (b) timing—when and how they will be made; (c) which disclosures must be made at the point of sale/recommendation or orally (if any); and (d) how the firm will document disclosures that are made orally.
  • Determine how Form CRS will be delivered to retail investors and documented (i.e., before a recommendation is made, an order is placed, an account is opened).
  • Confirm that retail customers have complied with requirements for receiving electronic delivery of documents.
  • Determine protocols for “Hire me” discussions to avoid triggering Reg BI or CRS obligations.
  • Develop protocols for identifying and escalating outdated or inaccurate disclosures.
  • Determine protocols for identifying and disclosing all appropriate disclosures for new or evolving products and services.

2. Understanding Product Offerings and Implications for Reg BI.

  • Inventory all products that may be recommended to retail investors/customers, including the relevant payment/revenue to brokers and to the firm from each product.
  • Identify any material limitations on the universe of products available for recommendation (for disclosure, care and conflict obligations).
  • Identify any potential conflicts that exist and disclosures that are already made. To this end, firms should take a harder look at complex products and proprietary products, and any arrangements they may have with clearing brokers and service providers.
  • Identify what direction/training is provided to RRs regarding these products. To this end, firms should take a hard look at complex products and proprietary products.
  • Leverage existing committees and processes, such as the new business/products committee and commitment committee, for the care obligation (product suitability) and conflict obligation (mitigating conflicts).

3. Supplementing Existing Suitability Policies to Comply With the Care Obligation. 

  • Identify what RRs and the firm do for FINRA suitability, e.g., any documented due diligence process/checklist. Identify descriptions of the firm/LOB/RR’s general investment strategy.
  • Determine how cost will be incorporated into the analysis.
  • Determine what tools can help RRs meet the new quantitative suitability requirement.
  • Determine how RRs should identify, analyze and document their consideration of reasonably available alternatives.

4. Satisfying the Conflicts Obligation.

  • Identify existing policies/procedures regarding the identification and handling of conflicts and any conflicts inventory, such as may have been created for banking regulators and/or in connection with the Volcker Rule.  
    • Review conflicts inventories for material conflicts that should be disclosed to retail customers.
  • Leverage existing committees and processes to identify and mitigate conflicts, such as the new business/products committee, business selection/conflicts committee, commitment committees, complex transactions/structured products committees, and reputational risk committee.
  • Inventory existing conflicts disclosures (e.g., in trade confirms and research reports) and related mitigation measures. 
  • Determine how conflicts created by material limitations on recommendations are mitigated. 
  • Take a hard look at compensation/revenue-related conflicts, proprietary/affiliate product-related conflicts, and differential treatment of customers (e.g., for IPO allocation).
  • Address gaps in mitigation of material conflicts through, e.g., the development of additional supervision or surveillance.
  • Review any sales contests, sales quotas, bonuses and non-cash compensation related to sales of securities or types of securities to identify ones that must be eliminated.

PHASE 4:  Establishing Policies, Procedures and Controls.

Note that policies and procedures should be in place well before the Reg BI and CRS implementation date so that firm personnel can receive appropriate training. As a practical matter, this may push forward the timeframe for Steps 1–3 to well before the June 2020 implementation date. 
In preparation for implementation, firms will need to:

1. Draft policies and procedures. Compliance policies and procedures must describe what RRs need to do to discharge their care, disclosure and conflict of interest obligations. Written supervisory procedures need to be developed for relevant supervisors responsible for the firm’s compliance with Reg BI and CRS. Relevant committees whose mandates relate to Reg BI (such as the new products committee) should also have updated policies and procedures. 

2. Draft training materials and conduct training. Training should be provided to RRs, supervisors and all other persons responsible for implementation of various aspects of Reg BI and CRS.

3. Develop surveillance programs. Surveillance should cover RR conduct as well as operational aspects of the Reg BI program (e.g., ensuring that appropriate forms and disclosures are delivered).

4. Update broker-dealer marketing materials and customer communications and develop procedures to comply with Reg BI. For example, these materials need to be reviewed to ensure they do not include statements that could be viewed as inappropriately “holding oneself out” as an investment adviser.

PHASE 5:  Complying with New Books and Records Requirements. 

Finally, firms will need to update current record retention schedules and processes to comply with the new books and records requirements in Reg BI and Form CRS. Among other things, firms will need to (1) incorporate retail customer investment profile elements into the data-gathering process, and (2) develop processes for recording the delivery of disclosures. 

In order to facilitate compliance with both recordkeeping requirements and the underlying Reg BI obligations, firms may need to implement IT solutions such as adding a new flag in the static data to keep track of customers subject to Reg BI, or what disclosures were made to whom at what time.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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