INSIGHT: Broker-Dealer Reg BI in the Age of Coronavirus

The June 30 effective date of Regulation Best Interest coincides with a global pandemic, economic recession, and dramatic market volatility. Regulation Best Interest and Form CRS requirements (together for simplicity, Reg BI) are the most important regulations imposed on the broker-dealer industry in over 85 years.

Reg BI essentially states that when recommending a securities transaction or investment strategy, including an account recommendation, a broker-dealer must act in the retail customer’s best interest. The broker-dealer must comply with specific care, conflict of interest, compliance and disclosure obligations, and must prepare and deliver a relationship summary to customers.

When it adopted best interest standard, the SEC had no reason to anticipate the coronavirus pandemic. Yet never have broker-dealers so well demonstrated that they already act in their customers’ best interest. Those who carp that Reg BI is imperfect should stand in the shoes of our clients and other brokers-dealers and registered representatives.

The broker-dealers we know have communicated with their customers and ensured that they have access to their accounts. They have reorganized their business operations and arranged for employees to work remotely—under robust supervision. These broker-dealers have reviewed customer investment plans, offering reassurance and discouraging premature investment decisions.

The SEC has said that it will not delay the effective date of Reg BI and is unlikely to change its position. Nevertheless, broker-dealers need guidance on a host of issues.

The SEC staff has issued guidance on some aspects of Reg BI, but one cannot be sanguine about the prospects of more. The commission staff is busy with a myriad of pandemic issues affecting the capital markets, trading and reporting systems, and regulatory responsibilities. Providing more guidance about Reg BI might not be possible given other demands on the commission staff.

Two Strategies for Implementation, Testing Compliance

How then should firms with limited resources and beset by the pandemic complete their implementation of Reg BI? And having completed their policies and procedures under Reg BI, how should firms analyze and test those policies and procedures for compliance with the regulations?

We recommend two strategies:

1. Prioritize Customer Needs, Not Presumed Regulatory Expectations

A broker-dealer’s first instinct might be to anticipate what the SEC and FINRA will expect, to fill the content of their unspoken words. We suggest that as firms complete their implementation of Reg BI and review and test their compliance systems, their analysis should emphasize their customers’ needs more than the presumed expectations of the regulators.

The essential purpose of Reg BI is to ensure that broker-dealer recommendations are in their customers’ best interest. If broker-dealers frame their analysis to achieve this purpose, and maintain records that they have done so, they will be better prepared later to defend their interpretation of Reg BI and their policies and procedures.

For example, firms may be uncertain how to mitigate conflicts arising from differences in compensation arrangements among types of accounts. The SEC’s adopting release includes multiple descriptions of the mitigation requirement. The release implies that mitigation requires that a broker-dealer (1) “reduce” the conflict, (2) address the conflict enough that disclosure about it is useful, or (3) eliminate the conflict’s “taint.”

Firms might be left to guess how each description is intended to apply to an account recommendation. A better strategy would consider how the broker-dealer should manage the conflict to best ensure that account recommendations are in the customers’ best interests.

A broker-dealer might adjust the relative compensation schemes for each account, adopt new techniques to track the types of account that each registered representative recommends, communicate with customers about account choices, enhance its broker training to address these issues, and adopt other measures to reasonably ensure that its customers are protected.

The broker-dealer might reject other proposed measures because they would not protect customers, might confuse them, or could unduly interfere with the registered representative’s effort to help customers meet their investment goals.

The point is to emphasize what customers need not what regulators might expect, when guidance has not been provided.

The broker-dealer should record its consideration of these measures and the reasons why its policies, procedures and controls will best ensure that it has managed the conflict of interest to achieve the essential purpose of Reg BI, making each recommendation in the customer’s best interest.

2. Prioritize the Mandates

Most broker-dealers have limited resources to complete their implementation by June 30, analyze and test their supervisory systems under Reg BI, and confront the myriad of pandemic-related issues. Of course, broker-dealers must strive to develop policies, procedures and controls necessary to achieve compliance with all of Reg BI by the effective date.

In reviewing and testing the new policies, procedures and controls, broker-dealers who are pressed by the circumstances of the pandemic might give priority to those parts of Reg BI that best ensure its fulfillment of the care obligation, which is the core of the new regulation.

Above is an illustration of a prioritization of policies, procedures and controls during Reg BI implementation and testing. At the core of the chart, in red colors, is the requirement to mitigate a registered representative’s conflicts with respect to complex or risky products. Each successively outer ring represents a mandate that in our view, may take a sequentially lower priority.

This illustration only represents our views, and other systems of the prioritization of policies, procedures and controls might be acceptable.

Firms must meet all the requirements of Reg BI, of course. But with limited time and resources, and the distractions of a pandemic, prioritization of the sort that we have illustrated might help ensure that firms achieve Reg BI’s ultimate objective, ensuring that broker-dealers and their registered representatives make recommendations in their customers’ best interest.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Thomas M. Selman is the founder of Scopus Financial Group, providing regulatory guidance to broker-dealers. Until January 2020, Selman served as FINRA’s executive vice president for regulatory policy and its legal compliance officer.