Broker-Dealers Hope Good Faith Carries the Day as Reg BI is Implemented Amid Pandemic
A National Emergency declared, borders closed and businesses shuttered, but Regulation Best Interest (“Reg BI”) moves forward as scheduled – with a compliance date of June 30, 2020.
Reg BI is a package of rules, interpretative guidance and new reporting obligations that direct broker-dealers to act in the “best interest” of retail investor clients. It establishes a new standard of conduct for broker-dealers and associated persons of broker-dealers, requiring that, in recommending any securities transaction or any investment strategy involving securities to a retail customer, a broker-dealer must act in the best interest of the customer. Reg BI precludes a broker-dealer from placing its own financial or other interest ahead of the customer’s interests.
The SEC and FINRA have openly acknowledged that the COVID-19 pandemic creates practical and economic “challenges” for market participants, including broker-dealers, and have extended a variety of deadlines. However, they have determined not to extend the existing deadline for broker-dealer compliance with Reg BI.
Reg BI imposes real and sweeping obligations on broker-dealers. According to the SEC’s April 7, 2020 Risk Alert, examiners will focus on the four primary obligations that Reg BI imposes upon broker-dealers: Disclosure, Care, Conflict of Interest, and Compliance.
- Disclosure Obligation: a broker-dealer is obligated, prior to or at the time of the recommendation, to provide a retail customer, in writing, full and fair disclosure of material facts relating to the scope and terms of the relationship with the customer and material facts relating to any conflicts of interest that are associated with the recommendation.
- Care Obligation: a broker-dealer must exercise reasonable diligence, care, and skill when making a recommendation to a retail customer, and understand potential risks, rewards, and costs associated with the recommendation in light of the customer’s investment profile.
- Conflict of Interest Obligation: a broker-dealer must establish, maintain, and enforce written policies and procedures reasonably designed to address any conflicts of interest associated with its recommendations to retail customers.
- Compliance Obligation: a broker-dealer must establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest as a whole.
Reg BI poses two primary challenges for broker-dealers. Firms first need to identify gaps or potential conflicts in their practices, policies and procedures, and then they need to address those gaps and conflicts to ensure adequate supervision and compliance. To try and meet these challenges, broker-dealers have, among other things, considered reducing potential conflicts by cutting a number of available funds from their respective platforms, increasing and enhancing disclosures, eliminating commission-based brokerage accounts, providing additional training for associated persons, and creating compliance committees.
Meanwhile, with less than two months left until the compliance date, a global pandemic is interfering with ordinary practices and procedures – much less the implementation of new practices and procedures. For example, due to COVID-19, broker-dealers have been forced to abandon their planned training. Some will attempt video conferencing and other online efforts to achieve compliance while avoiding in-person training sessions or meetings which may violate state-imposed safety measures and stay-at-home orders. More generally, broker-dealers are already faced with a variety of logistical challenges in providing financial services and advice to clients. With offices understaffed, and with key personnel working from home, broker-dealers have been separated from their ordinary operations, from recordkeeping to on-site supervision. Indeed, it is challenging enough in this crisis to maintain and fulfill one’s normal duties and responsibilities. And yet, as of June 30, 2020, broker-dealers will be expected to adapt to and comply with new duties and responsibilities.
Accordingly, the hope and expectation is that regulators will understand that broker-dealers are under heightened pressure to ensure that they are prepared to meet the expected standards imposed by Reg BI, complicated by a pandemic-induced disruption. In an April 8, 2020 News Release, FINRA indicated that its initial approach will focus primarily on assessing whether firms have made “a good faith effort” to establish policies and procedures reasonably designed to comply with Reg BI. Likewise, the SEC has indicated that examinations will focus on a broker-dealer’s good faith effort to implement such policies and procedures, as well as the operational effectiveness of those policies and procedures.
While demonstrating good faith efforts to comply with Reg BI sounds vague and may prove to be a moving target, FINRA and the SEC have offered a glimmer of hope that strict standards will not be imposed upon broker-dealers in the midst of an unprecedented crisis. Indeed, the practical reality is that Reg BI, while applying to broker-dealers large and small, will be implemented on the ground by human beings who, like so many others, are juggling a new work-life balance and, in fact, coping with a new existence.