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Thursday, June 6, 2019

Fiduciary Standards/Reg B-I/Form CRS coming June 30, 2020

Cory Roberson, Principal of FIN Compliance and FIN Lancer
David McNeal, Consultant and Contributor of My Compliance Blog

June 5, 2019 - The Securities and Exchange Commission (“SEC”) voted to adopt a revised fiduciary standard known as Regulation Best Interest (Reg BI) and a Client Relationship summary (“CRS”) disclosure form aimed to provide investors with information to determine:


the type of business they work with,
the services receivedand
how they pay for such services. 

The regulation BI framework is generally considered to be the commission’s answer to the Department of Labor’s efforts to institute a revised fiduciary standard.  The actions will require procedural updates for broker-dealers and investment advisors.

“The rules and interpretations we are adopting today address issues that the Commission has been actively considering for nearly two decades,” said SEC Chairman Jay Clayton.
 “Our staff, working collaboratively across all of our Divisions and many of our Offices, has leveraged its decades of experience and expertise in considering these issues.  I believe that the exceptional work of the SEC staff, including their careful evaluation of the feedback we received, will benefit retail investors and our markets for years to come.”

If a retail investor chooses a broker-dealer or investment adviser (or both of them), the retail investor shall be entitled to a recommendation (by a broker) or to a counsel (by an investment advisor) that is in the retail investor's best interest and does not put the company's incentives or those of the financial professionals ahead of the customer.

Regulation Best Interest to protect retail investors

Regulation Best Interest (Reg BI) sets a new behavioral standard, specifically for broker dealers, which is aimed to improve the requirements of conduct for broker dealers.  The standard of conduct is based on key trust principles and cannot be met by disclosure alone.  It contains specific requirements for dealing with certain aspects of relationships between broker dealers and retail clients, including some compensation conflicts. 

Under Reg BI, broker-dealers will be legally required to act in the best interest of the client and cannot place its own priorities ahead of a retail investor when giving advice or suggesting any securities transaction or investment strategy.  

Regulation Best Interest includes the following components: 

Disclosure Obligations: A look into services

The new rules are aimed to improve the behavior of broker dealers to their customers and bring the standards of conduct into line with the reasonable expectations of investors.  The regulations will also provide retail investors with additional transparency and clarity through improved disclosures in order for clients to make informed decisions.   
Broker dealers must disclose material facts about their relationship and recommendations, including specific disclosures on the broker's capacities, fees, services provided, disputes, service and product limitations and its supervisory services. 

The interpretations reaffirm that investment advisors must clarify the standard of conduct and their scope of services in accordance with the statutory definition of an investment adviser. 

Care Obligation:  A look into registered reps/agent activities

When making a recommendation to the retail customer, a registered representative (“agent”) must exercise due diligence, care and competence.  The broker-dealer and its reps must understand the risks, rewards and costs that the recommendation involves.  The rule requires that the agent must consider its clients investment profile and make a recommendation in their best interest.  As a result of the proposal, the final regulation requires explicit consideration by the broker-dealer of its costs. 

Conflict of Interest Obligation: How the firm addresses some of its risks

The broker-dealer shall establish, uphold and implement written policies and procedures designed so that conflicts of interest are reasonably identified and at least disclosed or eliminated. This requirement, an improvement on the proposal, requires policies and procedures specifically to: 

Eliminate conflicts that could create incentives for a firm’s financial professionals to place their interests ahead of those of the retail customer; 
Prevent material limitations on offerings, such as a minimal product menus and proprietary products, that could cause the firm or its financial professional to place its own interests ahead of the customer; and

Eliminate sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sale of specific securities or specific types of securities within a limited period of time.


Compliance Obligation:  Procedures Manual

By enhancing the proposal, broker dealers must establish, maintain and apply policies and procedures to ensure compliance with the best interest regulation. 

Form CRS Relationship Summary 

At the start of their client relationship, investment advisors and broker dealers shall provide a summary of relationships for retail investors.  This will include an overview of a firm’s services, fees, costs, interest disputes, legal standards of conduct and the disciplinary history of the practice and its financial professionals.   

The Client Relationship Summary form (Form CRS "ADV Part 3") requires registered investment advisors and broker-dealers to inform retail investors with an overview of their professional relationship in a simple and comprehensible manner.  This relationship summary allows investors to access additional information on these subjects using a layered disclosure.  In order to promote comparisons by retail investors, the relationship summary is standardized in a question-and-answer format that is unique from current disclosures.   

Form CRS will also include a connection to a dedicated page which provides education information about broker-dealers and investment advisors and other materials on the Investor Education website of the Commission. 

Investment Adviser Interpretations 

An investment adviser owes its clients a fiduciary obligation in accordance with the Advisers Act.   In its final interpretation, certain aspects of the federal trust obligation which an investment advisor owes to its clients are reaffirmed and in certain cases clarified. 

For example, when reporting recommendations, including a plan to move assets in a working retirement plan account to an IRA, and/or for a plan distribution apply to the enhancement of the proposal. Regulation Best Interest also applies to implicit "holding recommendations" arising from agreed account surveillance. (ref. (1) Duty of Care; and (2) Duty of Loyalty--act in client’s best interest).

Solely Incidental Interpretation 

The rule excludes a broker-dealer under the Advisers Act whose performance of advisory services is solely accessory to the conduct of his business as a broker or distributor, and who is not paid a special compensation for such services from the definition of investment advisor —and thus from applying the Advisers Act.   

With the adoption of Reg B-I, the Commission released an interpretation to confirm and clarify the "Soley Incidental" prong under the Advisers Act, which is meant to clearly define when the consultative operations by a broker-dealer leads it to become an investment advisor within the context of the Advisers Act.  This interpretation supports and clarifies the role of the Commission and highlights the application in connection with exercising investment discretion over client records and account monitoring.

Applicability date of Reg B-I and Form CRS.

In order to give firms enough time to be compliant, Regulations Best Interest and Form CRS are made effective 60 days after their publication in the Federal Register and include the transition period until 30 June 2020.  Once we are published in the federal register, our interpretations under the Advisers Act become effective.  Reference "SEC Reg BI proposal"

This is a good time to create a system for updating your firm’s procedures.


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