In a previous piece, we covered recent developments involving Regulation Best Interest (Reg BI) and Form CRS Relationship Summary (Form CRS) of the SEC’s standards package, and the confirmation of the rules’ compliance date of June 30. Now that we have entered into the compliance stage, it is time to focus on upcoming Securities and Exchange Commission and Financial Industry Regulatory Authority (FINRA) examinations of these rules, and walk through a sample self-assessment to help companies prepare.
If you are concerned that the SEC and FINRA are planning different approaches to examine compliance with Reg BI and Form CRS, there is no need to worry. Based on our ongoing monitoring of the SEC and FINRA, both regulators have indicated their commitment to follow a consistent exam model. Chairman Jay Clayton said as much in his April 2 statement, and SEC and FINRA examiners confirmed this in a recent FINRA virtual conference panel.
Initial exams are expected to start this month, so there may be some exams that are already underway. These exams will last for at least one year after the compliance date.
In May, at an industry panel discussion, Bari Havlik, the head of exams at FINRA, indicated that in the first six months after implementation, examiners would focus on the implementations of policies, procedures, and controls to comply with the rules. Following these initial exams, the SEC and FINRA will issue additional guidance based on what they found during these exams. In 2021, Havlik said, firms should expect FINRA to take a “harder line” in their examinations. (Let’s assume the SEC will do the same.)
In April, the SEC and FINRA telegraphed the scope and content of their initial examinations. The SEC’s Office of Compliance Inspections and Examinations (OCIE) issued two risk alerts, one on Reg BI and another on Form CRS. In the appendix of the Reg BI Risk Alert is an inventory of sample documents and information relevant to both Reg BI and Form CRS. Separately, FINRA released a report on firms’ common practices to comply with Reg BI and Form CRS.
On June 15, SEC Chairman Clayton offered additional areas of focus that firms should pay attention to since recommendations involving them were subject to Reg BI. These included 401(k) rollover and withdrawal recommendations that have become more common due to liquidity needs caused by the pandemic and relaxation of early withdrawal penalties and requirements. Clayton also cited recommendations involving complex and risky products, or those touting Covid-19 benefits.
Read together, the SEC and FINRA sources outline a checklist of areas that firms should expect regulators will cover in these upcoming examinations.
How well prepared your firm will be for an SEC or FINRA exam on Reg BI and Form CRS depends on what you have done to help demonstrate “good faith” implementation. There are a few sources that can help with the assessment, starting with what the standard is not.
In December 2019, during FINRA’s Regulation Best Interest conference, John Polise, the associate director at OCIE, discussed the SEC’s approach to exams in terms of what they would not be. He advised that examiners would not be playing “gotcha” with Reg BI and Form CRS exams. The more likely approach would be to evaluate a firm’s “good faith” efforts in trying to comply with the rules. While Polise did not define what “good faith” means, he did tell us what it wasn’t. According to Polise, total complacency or ignorance of these rules with no effort to make the necessary changes to comply would not satisfy the “good faith” standard.
A clearer indication of what the “good faith” standard entails is available in the OCIE risk alerts on Reg BI and Form CRS. The notices did not define this standard but gave some insights. The initial Reg BI exams will evaluate whether firms have, at a minimum, 1) developed policies and procedures to comply with Reg BI, and 2) made “reasonable progress” in implementing these policies and procedures. The initial Form CRS exams will evaluate whether firms have, at a minimum, 1) filed the Form CRS, 2) instituted an appropriate delivery process, and 3) adhered to the content and formatting requirements.
Based on what we have reviewed, certain documented measures may help make this determination, such as: 1) assignment of roles and responsibilities to keep your leadership/management informed; 2) assessment and updating of business practices; 3) implementation of new or updated policies and procedures; 4) delivery of training and educational materials, including plans for future efforts; and 5) changes to technical and operational controls to align with Reg BI and Form CRS.
We have prepared a sample assessment questionnaire to help make this determination. Note that this questionnaire is not inclusive of all possible considerations and does not replace a full audit or testing of your Reg BI and Form CRS controls—but it should help you gauge your efforts.
The questions are organized into the following areas.
Governance and implementation management. Consider whether you can readily speak to your firm’s Reg BI and Form CRS compliance efforts. These can include reliance on developed structures to lead and manage Reg BI and Form CRS compliance efforts, or on project management resources to manage deliverables and timelines.
Reg BI Compliance. Check the measures and steps taken to comply with Reg BI. For example, compile any new or updated policies and procedures. Document any gap assessment used to identify areas for improvement or to deploy technology tools or leverage the ones you have to monitor for Reg BI compliance. Pay particular attention to how you identified and dealt with conflicts of interest (e.g., inventories, committees, restrictions, and limitations on products, compensation, or surveillance). Make sure you have either updated or created account documentation and customer disclosure. Institute restrictions on “adviser"/"advisor” usage where appropriate after reviewing possible sources to apply these restrictions. Remember to flag any prohibitions on sales contests and related bonuses or non-compensation activities. Don’t forget to factor in the special areas of concerns cited by Clayton (see above) in your policies and procedures covering recommendations.
Form CRS Compliance. Check the measures and steps taken to comply with Form CRS. For example, make sure the form complies with the size limitations and content requirements and is easy to understand. Pay particular attention to procedures that will ensure the timely delivery of Form CRS, as well as help capture, supervise, and audit Form CRS delivery. Visit your firm websites to confirm the posting of Form CRS and maintain procedures for the form’s updates. Also, confirm your new or updated procedures to ensure they reflect these requirements.
Technical and Operational Controls. Check the measures and steps involving any updates made to your applications and systems to comply with Reg BI and Form CRS requirements. For example, the creation of—or updates to—client account processing (e.g., preparing new account forms, identifying customers subject to Reg BI/Form CRS, or tracking customer investment profile information). Consider any updates to operational controls or to marketing materials and client communications to comply with the rules. And don’t forget to review compensation plans and practices to identify potential conflicts that may require disclosure and/or elimination.
After completing the assessment, see if you can rate your state of readiness for an examination. Here’s a suggested report card.
We’re Ready! If you think your firm is ready, that’s great, and congratulations. Make sure you can back up your efforts with documentation such as: 1) policies and procedures, 2) assessments and descriptions of processes for remediation, 3) records of training delivered and planned, 4) periodic review and testing procedures on the new and updated controls, and 5) any material changes to your technical and operational controls.
Not Ready, But Working on It. If your firm is not ready but has documented what it has completed and what needs to be done, don’t despair, and continue. Make sure you focus on getting to any outstanding measures, and once they are completed, document these along with your other completed efforts. Hopefully, your efforts will culminate at the point that you can say you are at the “We’re Ready!” state noted above.
Pandemic Pause. If your firm could not meet all of the requirements because of the pandemic and related governmental orders, as we mentioned in our prior piece, consider whether it is appropriate to engage with either regulator, and make sure to document the outcome.
Have Not Started. If your firm has not started to prepare for compliance with Reg BI and Form CRS, for reasons having nothing to do with the pandemic, do not expect a sympathetic ear from the SEC or FINRA. Try to move on with what you can and document your efforts. The reality is that you may face a tough examination and have lots to do, considering the extensive requirements and potential changes required by Reg BI and Form CRS.
More Guidance Will Follow
Some final points: Both the SEC and FINRA are planning to use the initial exams to address compliance and implementation challenges and questions. So expect more guidance in the future. We are not sure how or when—or frankly, what—but we recommend that you continue to monitor this space. At a minimum, visit the SEC and FINRA Reg BI resource pages, and check the Reg BI and Form CRS FAQs periodically for more updates. (For example, the SEC just updated the Form CRS FAQs with additional guidance on delivery requirements.) And remember, as we noted in our prior piece, do not be surprised if things change—in particular, the exam timeline due to the pandemic.
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