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Best Interest Standard of Conduct

The Regulation Best Interest (Reg BI) compliance deadline is just around the corner – June 30, 2020, to be exact. One of the many challenges is obtaining a solid grasp of Reg BI and it’s numerous implications (it certainly doesn’t help that the entire rules and guidance package from the SEC is nearly 1,400 pages).

Reg BI implements a new standard of conduct for broker-dealers to act in the best interest of the retail customer without placing the financial or other interest ahead of the interests of the retail customer. This general obligation states broker-dealers must:

Act in the best interest of a retail customer when making a recommendation of any security transaction or investment strategy involving securities to a retail customer.”

Whether you’re still getting up-to-speed or simply need a quick refresher, we are here to help. We’ve assembled resources to help your firm prep for Reg BI, including a compliance readiness checklist, an abridged summary of the rule, and quick links.

FINRA Audit Guide

How Prepared is Your Firm?

Unsure where your firm is at with preparing for Reg BI compliance? In its annual priorities letter, FINRA outlined a list of nine questions it will use when reviewing whether a firm is adhering to Reg BI. We’ve summarized these questions below. Any “no” answers will have to be addressed by the June 30 deadline.

Compliance Readiness Checklist

 

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

1. Best Interest Regulation

Deadline: Implementation by 6/30/2020

The Best Interest Regulation establishes a standard of conduct for broker-dealers (BD) and Registered Investment Advisors (RIA) when making a recommendation of any account type, securities transaction, or investment strategy involving a retail client or prospect. The BD/RIA must act in the best interest of the retail client at the time a recommendation is made without placing their interests ahead of the retail client or prospect. A retail client is defined as a natural person, which the SEC recognized is different from FINRA’s definition of a retail client. There are four primary obligations that comprise “best interest:”
 

  1. Disclosure
  2. Care
  3. Conflicts of interest
  4. Compliance

2. Client Relationship Summary / Form CRS

Deadline: Implementation by 6/30/2020

The Client Relationship Summary, or form CRS, is designed to provide retail clients and prospects with a summary of the relationship types and services the firm offers. In some ways it is an expansion of a document already available through most investment firms that explains brokerage and investment advisory relationships. It requires disclosure of the following:

  • Standards of conduct
  • Fees and costs of services
  • Conflicts of interest
  • Any reportable legal or disciplinary events

The form CRS is limited to four pages for dual-registrants, and must be written in plain English that avoids the use of industry jargon. In practice, it must be delivered to each new or prospective retail client before or at the time of any recommendation including account or relationship type, security, or investment strategy. 

4. Solely Incidental Interpretation

Deadline: Immediately effective following posting in Federal Register

The Solely Incidental Interpretation delineates when a BD’s or RIA’s performance of advisory activities causes it to become an Investment Adviser (subject to registration and related regulations). In practical terms, this would occur when exercising discretion and/or entering into an agreement to provide ongoing monitoring on a periodic basis or at specific timeframes.

    Three Steps You Can Take To Prepare Your Firm

    Step #1:

    Documentation of best interest advice is central to Reg BI, and (unlike the DOL’s Fiduciary Rule) it applies to ALL account types. Ensure that CRM documentation of all recommendations is a systematic and a consistent part of your practice, including what type of account to recommend (e.g., commission-based or fee-based).

    Step #2:

    Review your account documents to ensure client profiles are both current and in alignment. Misaligned investment objectives and risk tolerance (e.g., aggressive growth/conservative) can be an opportunity to clarify/update client expectations and therefore position yourself and your team to deliver advice that is in the client’s best interest.

    Step #3:

    Give careful consideration to the account type and client profile when recommending mutual funds, UITs, Syndicate and other products that generally involve higher cost to the client and, of course, document the “WHY” in your CRM so that there is a clear paper trail.

    Resources:

    SEC’s Reg BI Overview and Resources
    https://www.sec.gov/regulation-best-interest

    SEC’s FAQ on Reg BI
    https://www.sec.gov/tm/faq-regulation-best-interest

    SEC’s FAQ on Form CRS
    https://www.sec.gov/investment/form-crs-faq#delivery

    FINRA’s Reg BI Guidance
    https://www.finra.org/rules-guidance/key-topics/regulation-best-interest

    FINRA’s definition of “recommendation”
    https://www.finra.org/rules-guidance/notices/11-02

    A Firm’s Guide to the Implementation of Reg BI and the Form CRS Relationship Summary
    https://www.sifma.org/resources/submissions/a-firms-guide-to-the-implementation-of-reg-bi-and-the-form-crs-relationship-summary/

    Advisor’s Guide To The SEC’s Final Regulation Best Interest And Form CRS
    https://www.kitces.com/blog/advisors-guide-to-the-secs-final-regulation-best-interest-and-form-crs/

    **The summary section above includes excerpts originally published by D.A. Davidson. It appears here in an updated form with permission from the author.**

    FINRA Audit Guide
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