Reg BI | Law 360 | June 5, 2020
“Law360 (June 5, 2020, 7:17 PM EDT) — With the compliance deadline for the U.S. Securities and Exchange Commission’s Regulation Best Interest fast approaching on June 30, broker-dealers and those who advise them are gearing up for a slew of new requirements that attorneys acknowledge will be a “very big lift.”
The new SEC rule aims to tighten the rules of conduct for broker-dealers who make recommendations to retail customers, creating a “best interest” standard that brings them in line with those of traditional investment advisers.
While some aspects of Reg BI set a higher standard for existing procedures, it’s the regulation’s disclosure requirements that pose the biggest headache as day one approaches, attorneys said.
“The entire rule is a very, very big lift for the broker-dealers,” said David Soden, an associate with Vedder Price PC’s investment services and litigation practice. “But if you look at the disclosure obligation, a lot of that consists of new law and new rules.”
The SEC’s final 770-page rule outlines how firms and their sales reps will need to systematically disclose to clients all material fees and costs, the “type and scope” of services, any potential conflicts of interest and the fact that they are acting in a broker-dealer “capacity.”
Shops offering limited product offerings or proprietary products need to ensure that they are disclosing the nature of those investments to clients in order to avoid violations come exam time, but their duty will stretch beyond that, attorneys noted.
“If a firm is selling a proprietary product, the ‘care obligation’ indicates they need to have a discussion with the client and suggest — something that is anathema to anyone who’s a salesman — that they look at other kinds of securities so they have a more balanced portfolio,” said Peter LaVigne, a partner in Goodwin Procter LLP’s financial industry and fintech groups.
“The people who run these proprietary brokerage firms don’t really want to hear this, but it’s something that they’ll need to put in their policies and procedures for their registered reps to think about when selling their products,” LaVigne said.
While even small brokers have their work cut out for them, larger firms with vast offerings within so-called fund supermarkets will face even larger hurdles.
“Firms are affected in so many different ways,” said James Arpaia, a Vedder Price shareholder and member of its investment services group. “But for the large multifaceted firms, the disclosures required of reps are tremendous versus a smaller firm.”
However, reps need not memorize the details of each and every investment offering out there, said Nicholas Losurdo, a partner in Goodwin’s financial industry group, noting that the care obligation states only that recommendations be made with “reasonable diligence, care, and skill.”
“The rep doesn’t need to know the ins and outs of all of the products [out there] to comply with Reg BI,” Losurdo said. “We don’t think the SEC will be looking for any ‘gotchas’ but instead will be looking to ensure that reps are familiar with the products they are recommending, that they are understanding the particulars of the client and are otherwise complying with the care obligation.”
Consultants and in-house compliance experts agreed that the disclosures are currently the biggest obstacle during a Securities Industry and Financial Markets Association webcast on Wednesday.
“At the top of the list is really the disclosures,” said Joshua Uhl, a senior manager in Deloitte & Touche LLP’s financial services practice, adding that training is a crucial part of compliance.
Uhl said he is assisting some clients with “mock exams,” derived from SEC guidance, to ask the questions, “Can we produce this documentation if requested, and secondarily to that, is the documentation any good?”
“All of the [financial advisers] within the broker-dealer and the registered investment adviser [must] really understand their obligations … and what they have to do differently after June 30,” Uhl said.
Jean Reilly, managing director with the wealth management consulting practice at Broadridge, added during the SIFMA event that she is helping clients with disclosures that touch on everything from updated policies and procedures to fee models and product lists and is also advising on the training of personnel.
Clients are also inquiring about the interplay between Reg BI and the existing “suitability rule” under the Financial Industry Regulatory Authority, Goodwin’s Losurdo noted.
The suitability rule, considered less burdensome, requires only that firms have “a reasonable basis to believe a recommended transaction or investment strategy involving a security or securities is suitable for the customer.”
At the heart of the issue is whether the client falls into the definition of a “retail customer” in Reg BI, Losurdo said. “In most cases it will be pretty bright-lined, but in some cases it will not be, and firms and their reps will need to think about this carefully,” he said.
The SEC considers a retail customer as any individual, or the individual’s legal representative, who receives securities-related investment recommendations primarily for personal, family or household purposes.
LaVigne added that he is advising clients that there will be situations where an individual could be covered by the suitability rule in some transactions, and Reg BI in others. “That’s something reps will have to look at closely every time they make a recommendation,” he said.
In early April, SEC Chairman Jay Clayton confirmed that the June 30 compliance deadline for Reg BI and the accompanying Form CRS would remain in place despite the impact of COVID-19 on firms and amid considerable controversy.
On Tuesday, a Second Circuit panel heard arguments opposing its implementation, with counsel representing a number of U.S. states and a group of investment advisers pressing on with claims that the rule does not go far enough to put broker-dealers on a level playing field with investment advisers.
While June 30 is the filing deadline for Form CRS, July 30 is the delivery deadline for broker-dealers to provide the form to their retail customers. But delivery to the customers was allowed beginning on April 6.
“If you’re ready to go, consider filing now and delivering sooner than the deadline,” Losurdo recommended. “There’s a possibility that the SEC could extend the deadlines, but we’ve been telling clients not to expect that.”
While the two-page limit of Form CRS is less of an issue for small firms with only a handful of offerings, it can prove to be a challenge for larger companies with various offerings and multiple business lines.
LaVigne noted that the assessment should include disclosures of any conflicts and all fees, from transactional to custodial to margin fees, adding that firms should take advantage of the go-ahead from the SEC to insert hyperlinks into the form.
“Firms will want to disclose both the direct and indirect costs and fees of investments,” he said. “The broker is going to have to do a thorough due diligence of everything being charged.”
Lee Thoresen, associate general counsel at RBC Capital Markets, speaking at the SIFMA webcast, said Form CRS is not meant to go into minutia.
But the firm is using what the SEC has referred to as a “layered approach” on behalf of its clients, including links to documents and “hitting the fine points” within the form’s instructions.
“It is supposed to be high level, but it is also very prescriptive if you look through the Form CRS instructions,” she said. “If you haven’t done so lately, [it’s] a good idea to go back to that.””
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