On June 5, 2019 the Securities and Exchange Commission (SEC) voted 3-1 to adopt Regulation Best Interest (Reg. BI). Despite previous uncertainty and ongoing controversy, Reg. BI is now in final form and will require broker-dealers, and their associated persons, to act in the best interest of a retail customer when recommending any securities transaction or investment strategy involving securities to a retail customer. The rule, which has a compliance deadline of June 30, 2020, has four major components or “obligations” as the SEC described in its release:
- Disclosure Obligation: Broker-dealers must disclose material facts about the relationship and recommendations, including specific disclosures about the capacity in which the broker is acting, fees, the type and scope of services provided, conflicts, limitations on services and products, and whether the broker-dealer provides monitoring services.
- Care Obligation: A broker-dealer must exercise reasonable diligence, care, and skill when making a recommendation to a retail customer. The broker-dealer must understand potential risks, rewards, and costs associated with the recommendation. The broker-dealer must then consider these factors in light of the retail customer’s investment profile and make a recommendation that is in the retail customer’s best interest. The final regulation, which is an enhancement from the proposal, explicitly requires the broker-dealer to consider the costs of the recommendation.
- Conflict of Interest Obligation: The broker-dealer must establish, maintain, and enforce written policies and procedures reasonably designed to identify and at a minimum, disclose or eliminate conflicts of interest. This obligation, which is an enhancement from the proposal, specifically requires policies and procedures to:
- Mitigate conflicts that create an incentive for the firm’s financial professionals to place their interest or the interests of the firm ahead of the retail customer’s interest;
- Prevent material limitations on offerings, such as a limited product menu or offering only proprietary products, from causing the firm or its financial professional to place his or her interest or the interests of the firm ahead of the retail customer’s interest; 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: In an enhancement from the proposal, broker-dealers must establish, maintain, and enforce policies and procedures reasonably designed to achieve compliance with Regulation Best Interest as a whole.
To comply with Reg. BI, broker-dealers must be prepared to re-examine and transform their sales practice and supervisory business models and establish, implement, and begin enforcing new written policies and procedures that cover each component of the rule. These re-vamped written procedures will be expected to account for a new standard of care when making recommendations, new disclosure requirements, and a variety of potential and actual conflicts of interest, including those surrounding current compensation models. What’s more, as of now, all of these changes need to be completed by June 30, 2020. As Commissioner Hester Peirce acknowledged during the SEC’s June 5th open meeting, in order to meet this “ambitious” compliance period deadline, “Firms will need to start their implementation efforts immediately.” Importantly, these efforts will run across various broker-dealer business lines and will apply to all retail customer accounts. It will impact not only transaction recommendations, but also account recommendations, such as recommendations to take a retirement plan distribution or rollover a retirement plan to an IRA. It will also apply to implicit hold recommendations that result from agreed upon account monitoring.
Gino F. Ercolino is a Director in Treliant’s Securities Compliance & Investigations service area. He has over 20 years of experience as a financial regulator and attorney, serving in various leadership roles.
During his career as a securities regulator, Gino managed teams of attorneys, investigators, and examiners in hundreds of broker-dealer investigations. He supervised all phases of investigations, negotiations, settlements, and disciplinary hearings regarding potential violations of federal securities laws and self-regulatory organization (SRO) rules from the Financial Industry Regulatory Authority (FINRA), New York Stock Exchange (NYSE), and others. Throughout his career, Gino has also provided guidance on broker-dealer compliance requirements and rule interpretation.