Understanding Regulation Best Interest

In June, the SEC voted to adopt a package of rules and interpretations designed to increase the quality and transparency of retail investors’ relationships with financial professionals. These directives included the Regulation Best Interest (Reg BI) rule, the Form CRS Relationship Summary, and two distinct interpretations under the Investment Advisers Act of 1940.

During a recent #WebinarWednesday, NICSA members had the opportunity to explore these rules, with an emphasis on Reg BI and its implications on broker-dealers, investment advisers, and asset managers. 

Thomas Grygiel, Principal Consultant at ACA Compliance Group, moderated the event, which also featured the expertise of leaders from DST SystemsFidelity Investments, and MFS Investment Management.

REG BI
Chad Fleck, Vice President Compliance at Fidelity Investments, kicked off the webinar with an overview of Reg BI, which requires broker-dealers to act in the best interest of a retail customer when making a recommendation of any securities transaction or investment strategy involving securities. Fleck likened the rule to a four-legged stool. 

“All four legs have to be firmly on the ground for this thing not to wobble,” he said. “You’ve got a disclosure obligation, a care obligation, a conflict of interest obligation, and lastly, a compliance obligation that ties it all together.”

Fleck provided a brief overview of each obligation:

• Disclosure. Under Reg BI, Fleck said the following must be disclosed: The fact that a firm or representative is acting in a broker-dealer capacity; the material fees and coststhe customer will incur, and the type and scope of the servicesto be provided; including any material limitations on the recommendations.

“A good thing about disclosure is we don’t necessarily have to go out and create one massive encyclopedia of disclosure to hand to a customer — we can satisfy this with existing documents as long as they all come together to meet our obligation,” he said.

• Care. Similar to FINRA’s Suitability Rule, the care obligation mandates that a broker-deal who is making recommendations to a retail customer must consider risks, rewards, and costs — and have a reasonable basis to believe they are acting in the customer’s best interest based on the customer’s profile.

“You’ve got to take reasonable diligence, care, and skill to perform a reasonable-basis assessment of that proposed recommendation,” Fleck said. “I often call that ‘Know Your Security.’” 

If recommending a series of transactions, the broker-dealer must have a reasonable basis to believe that the series is not excessive as a whole, even if each transaction is in the customer’s best interest when viewed in parts.

• Conflict of Interest.  “Essentially, you want to disclose all conflicts of interest that have not been eliminated,” Fleck said. “You want to mitigate any that created incentive to provide advice that’s not in the customer’s best interest, but there are certain ones that specifically do have to be eliminated.” 

These include sales contests, sales quotas, bonuses, and non-cash compensations that are tied to specific securities sales and recommendations.

• Compliance. Fleck said the broker-dealer must tie everything together with a program designed to holistically establish, maintain, and enforce written policies and procedures for compliance with Reg BI.

 “The good news is we can still use a risk-based compliance program,” Fleck said. “We don’t have to perform a detailed review of each recommendation. We can still tailor it to the business.”

FORM CRS

Jeff Cook, Director of Regulatory Compliance at DST Systems, provided an overview of the Form CRS Relationship Summary, which will mandate broker-dealers and RIAs to provide retail investors with easy-to-digest information about the relationship between an investor and financial professional.

“We will need to assess each of our businesses, print vendors, adviser policies and procedures, trainings, delivery processes, supervisions, and record retentions,” he said. “Each will be impacted by the customer relationship summary in one form or another.”

Cook said the relationship summary is required to be written in plain English, must be machine-readable in a standardized question and answer format, and is limited to two pages for a broker-dealer or investment adviser or four pages for a dual registrant. Care should be taken when preparing, filing, delivering, maintaining, and amending this document to ensure compliance.

FIDUCIARY DUTY UNDER THE ADVISERS ACT

Jay Herold, Vice President and Sr. Counsel, MFS Investment Management, focused an interpretation issued by the SEC to reaffirm and clarify the commission’s views of the fiduciary duty that investment advisers owe to their clients under the Advisers Act.

“One of the challenges of instituting a best-interest standard of conduct for commission-based brokerage is best summed up as a question posed by many people since Dodd-Frank required the SEC to engage in rulemaking in this space: If a broker and an adviser are both subject to a best-interest standard, what’s the difference in their duties?” Herold said. “This interpretation seeks to help answer that question through the issuance of several general statements that are organized into different themes.”

Herold said the commission states that the two tenants of the fiduciary duty are the duty of care (providing advice in the best interest of the client), the duty to seek best execution, and the duty to provide advice and monitoring over the course of the relationship.

He said summed up duty of loyalty as prohibiting an adviser from putting one’s own interests ahead of clients.

INTERPRETATION OF THE “SOLELY INCIDENTAL” PRONG

Fleck provided an overview of the SEC’s interpretation of the “solely incidental” prong of the broker-dealer exclusion under the Advisers Act.

“With this notice, the SEC is saying that advice is outside of that ‘solely incidental’ prong if it’s not related to your primary business of giving advice as to the value and characteristics of securities — and also if it’s not related to your business of effecting securities transactions,” Fleck said.The SEC provided detailed examples are discretion and account monitoring. “I think we’re actually going to want more guidance from the regulators over time as we flesh out these examples that they cited. Firms should step back and think, how does this apply to our businesses?”

May contain forward-looking statements subject to various uncertainties. Personal views and observations of individuals contained herein are as of the date of the live event and do not necessarily reflect the views of Nicsa or any of its member organizations. Matters addressed in this work may touch upon legal or regulatory matters, however nothing herein is intended to be or should be construed as legal advice. You should contact your own counsel in order to obtain legal advice regarding these or any other matters. The information contained herein is for informational purposes only and does not constitute a recommendation of best practices.  



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