The SEC’s Regulation Best Interest (Reg BI) applies to recommendations by a broker-dealer to “retail customers.” As the term suggests, a retail customer is a “natural person” (or the legal representative of a natural person) who uses the recommendation “primarily for personal, family, or household purposes.” This means that advice given to legal entities and advice related to investing the assets of a business are not covered by the regulation. But what about recommendations provided to retirement plans?
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On October 8, 2020, the U.S. Securities and Exchange Commission (SEC) released a joint statement by SEC Chairman Jay Clayton and the SEC’s directors of the Division of Investment Management and the Division of Trading and Markets “Regarding New FAQs for Form CRS” (CRS FAQ Joint Statement). The CRS FAQ Joint Statement offers guidance to both broker-dealers and registered investment advisers (collectively, firms). The focus of this guidance addressed Form CRS disclosures regarding firm or financial professional disciplinary histories. Along with the CRS FAQ Joint Statement, the SEC modified and released its “Frequently Asked Questions on Form CRS” (Form CRS FAQs).
Reg BI has passed its compliance date of June 30, 2020. The SEC and FINRA have commenced examinations to test brokerage firms’ good faith compliance with Reg BI and Form CRS disclosure satisfaction. Our article “Have No Fear, Reg BI Is Finally Here” provides a brief overview of Reg BI and deciphers its implications for brokers and broker-dealers. It also provides an overview of a recent Risk Alert drafted by the SEC’s Office of Compliance Inspections and Examinations (OCIE), and examines the SEC’s and FINRA’s review of Reg BI compliance.
The SEC’s standard of conduct for broker-dealers under Regulation Best Interest (Reg BI) became effective on June 30, 2020. While registered investment advisers (RIAs) always have been subject to a best interest standard of conduct (i.e., the overarching standard that encompasses both the duty of care and the duty of loyalty), the SEC’s clarification of that standard in its Interpretation Regarding Standard of Conduct for Investment Advisers (the RIA Interpretation) has been in effect since July 12, 2019. There are similarities in these two standards, but there are significant differences as well. Here is how the two standards compare:
On June 26, 2020, the U.S. Court of Appeals for the Second Circuit issued its ruling on the challenge to the legality of the Regulation Best Interest final rule (Reg BI), promulgated by the U.S. Securities and Exchange Commission (SEC) under the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. As reported on June 2, 2020, the Second Circuit entertained oral argument. It issued its ruling late in the day on June 26, just prior to Reg BI’s June 30, 2020, implementation date two business days later.
The Second Circuit’s ruling had three holdings: (1) the individual investment adviser petitioner had standing to bring the petition to review, but the state petitioners did not; (2) section 913(f) of the Dodd-Frank Act authorized the SEC to promulgate Reg BI; and (3) Reg BI is not arbitrary and capricious under the Administrative Procedure Act (APA). We focus the analysis herein on the latter two holdings.
A three-judge panel of the Second Circuit entertained arguments on June 2, 2020, in a lawsuit seeking to vacate and set aside the Securities and Exchange Commission’s (SEC’s) Regulation Best Interest (Reg BI). By way of background and in brief summary, Reg BI requires that broker-dealers make recommendations that are in the “best interest” of the retail customer, disclose conflicts of interest, and specify the services customers are receiving and the associated costs. As previously covered in this blog, the plaintiffs initially challenged Reg BI in September 2019. Despite this pending legal challenge and brokerage firms’ strained resources due to the pandemic and quarantining, SEC Chairman Jay Clayton said on April 2, 2020, in a public statement that the June 30, 2020, compliance deadline for Reg BI would remain.
The SEC has issued guidance addressing the Form CRS. The first is a Risk Alert from the Office of Compliance Inspections and Examinations (OCIE) indicating that OCIE will be looking for good faith compliance when it conducts examinations after the June 30, 2020 Form CRS compliance date. The second includes additional FAQs providing clarification on delivery and filing requirements along with several other topical areas. We discuss the examination guidance and the FAQs in more detail in an alert on our website for those looking for more in-depth analysis. Also, note that the CRS Risk Alert was issued concurrently with a similar Alert on Reg BI examinations in general, which is the subject of a separate post on this site.
As SEC Chairman Clayton previously indicated, the compliance date of Form CRS will not be extended, but the “initial” examinations will focus on whether firms made “a good faith effort to implement Form CRS.” While emphasizing that the Risk Alert is not intended to serve as an explanation of Form CRS requirements, OCIE explains that its initial examinations may include assessment of compliance with the following areas:
On April 7, 2020, the Securities and Exchange Commission (SEC) Office of Compliance Inspections and Examinations (OCIE) issued a Risk Alert providing guidance for the SEC’s post–June 30, 2020, examinations of firms’ compliance with Regulation Best Interest (Reg BI). This guidance is covered more fully in our Client Alert of April 13, 2020.
In an effort to present transparency in its prospective examination for Reg BI compliance, OCIE’s Risk Alert includes a three-page Appendix that provides an example of an OCIE Reg BI examination document and information request list. OCIE encourages firms to use the documents listed in the Appendix to assess their implementation plans for Reg BI. Firms should study this exemplar request list closely.
As the countdown to the June 30, 2020, date for compliance with Reg BI inches forward, FINRA and the SEC are providing a potpourri of support and information to help firms ensure compliance.
FINRA EFFORTS: FINRA’s northeast regional director announced in late October that FINRA will perform “preparedness reviews” of broker-dealers to determine firms’ readiness to comply with Reg BI. At its November Senior Investor Conference, FINRA President and CEO Robert Cook confirmed FINRA’s intention to perform these “stress tests.” . FINRA has emphasized that its intent is not to be punitive and fine firms for compliance violations. Rather, FINRA insists its primary goal is to assist firms in successfully implementing the nearly 1,000 pages of Reg BI’s regulations.
It appears that the SEC has initiated a “sweep” examination to inquire into the sales practices applicable to retirement plans for teachers and state and local government employees. We understand that multiple SEC regional offices have issued document requests seeking information from the third-party administrators, the broker-dealers, and the registered investment advisers that work with 403(b) and 457(b) plans. Further, the New York Department of Financial Services (NYDFS) recently launched an investigation into the sales tactics and costs involved with 403(b) plans, which appears to focus on the annuity practices of the insurance industry.