Resources

Regulation Best Interest (BI) is a Securities and Exchange Commission (SEC) rule (effective July 1, 2020) that requires broker-dealers to only recommend financial products and services to their customers that are in their customer’s best interests, and to clearly identify any potential conflicts of interest and financial incentives the broker-dealer may have with those products. Previously, brokers were only held to the “suitability standard. This meant that when brokers advised their clients in the past, they only had to recommend investments that were suitable, but not necessarily in their client’s best interest. Regulation Best Interest aims to hold brokers to a higher standard. In addition, the new regulation also imposes four obligations on them:

Disclosure obligation: Broker-dealers are required to provide retail customers written disclosure regarding the scope and terms of the relationship and any conflicts of interest that are associated with the recommendations of the products and services they recommend. Clients must be told why a broker recommends any given investment product, specific strategy, or account change. The information must be presented prior to or at the time of the broker’s recommendation.

>u>Care obligation: Broker-dealers are required to exercise reasonable diligence, care and skill when making a recommendation to a retail customer. The broker-dealer must understand potential rewards and costs associated with each recommendation.

Conflict of interest obligation: Broker-dealers are required to establish, maintain, and enforce written policies and
procedures reasonably designed to address conflicts of interest associated with their recommendations. Policies and procedures must:

• 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 a limited product menu or offering only proprietary products which could result in the firm or its financial professionals placing 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.

Compliance obligation: Broker-dealers are required to establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Reg BI. Brokers must create policies that prevent conflicts of interest from interfering with them giving the best recommendations possible to customers. The SEC’s examinations of this regulation are designed primarily to evaluate whether firms have made “a good faith effort to implement policies and procedures reasonably designed to comply” with Reg BI.

In addition to having its documents reflect full and adequate disclosures to clients, broker-dealers must make sure that (i) they have sufficient policies and procedures in place to reasonably comply with Reg BI, (ii) their registered representatives receive adequate training on Reg BI, and (iii) such training is documented. Broker-dealers will also need to maintain evidence of supervision for compliance with Reg BI.

Form CRS

The new rules also require broker-dealers and RIAs to provide a brief relationship summary, Form CRS, to retail investors. The relationship summary contains important information about the firm, including disclosures about key information that can help the prospective client decide if a firm is right for him or her. It also provides a standardized way for investors to compare information about different firms.

Form CRS will provide customers with information about:

• the types of services the firm offers;
• the fees, costs, conflicts of interest, and required standard of conduct associated with those services;
• whether the firm and its investment professionals have reportable legal or disciplinary history; and,
• how to get more information about the firm.

Broker-dealers must provide the relationship summary before or at the earliest of:

• a recommendation of account type, security, or investment strategy;
• placing an order for the retail investor; or
• opening a brokerage account.

RIAs must provide the relationship summary to each new or prospective client who is a retail investor before or at the time of entering into an advisory agreement. Firms have an obligation to update the relationship summary within 30 days from when it becomes materially inaccurate. The Form can be provided in paper or in electronic form, depending on how one has chosen to receive disclosures.

FINRA is providing a Reg BI and Form CRS Checklist to help its members with their assessment and implementation of necessary changes to their policies, procedures and compliance programs in light of Reg BI and Form CRS. This checklist outlines the major requirements of the rules and notes key differences between FINRA rules and SEC’s Reg BI and Form CRS. The deadline for complying with Reg. B1 was June 30, 2020 and so, firms should be prepared for examinations on Reg BI as any time.