Reg BI and Form CRS - New Rules Affect Relations with Broker-Dealers and Investment Advisers

Adopted in June of 2019, Regulation Best Interest (Reg BI) and Form CRS are part of a broader framework of Securities and Exchange Commission (SEC) rules intended to foster straightforward, quality communication between broker-dealers or investment advisers and their retail investor clients, while still preserving both investor choice and service costs. Although firms have been working on compliance for much longer, June 30, 2020 was the official compliance date for both Regulation Best Interest and Form CRS. Whereas FINRA and the SEC don’t necessarily expect full compliance yet, they will be carefully reviewing certain key documents and internal processes of investment advisers and broker-dealer firms. 

Now let’s discuss how these examinations might affect the way you transact with your customers and personnel management within an investment firm.

Initially, when assessing compliance with both Reg BI and Form CRS, the SEC's Office of Compliance Inspections and Examinations (OCIE) will expect broker-dealers to make a "good faith effort" to implement appropriately effective policies and procedures. Notably, the SEC will take the impact of coronavirus-related disruptions into account on a firm-by-firm basis. Additional detailed information about Regulation BI and Form CRS requirements is also available from the SEC.

Now, let’s take a closer, more detailed look at both Reg BI and Form CRS.

Regulation Best Interest

Regulation Best Interest, or Reg BI, tightens the standard of conduct for investment professionals under the Exchange Act. A broker-dealer or investment adviser may not put their own financial or other interests before their retail customer’s interests. Additionally, they must disclose or eliminate existing conflicts of interest, and they must be able to demonstrate the efforts they are making. Whenever an investment professional recommends a securities investment strategy or transaction to a retail customer, they must utilize information from the customer’s carefully developed investment profile, and professional knowledge, to act in the customer’s best interest. 

To fulfill these requirements, the investment firm must meet four-component obligations:

1. Disclosure Obligation:

There are many specific disclosures that broker-dealers and investment advisers must make. In general, they must disclose all material facts related to their relationship with the retail customer, including conflicts of interest.

1. Care Obligation:

The Care Obligation requires investment professionals to make recommendations using “reasonable diligence, care, and skill” considering their potential risks and benefits. Please remember that processes demonstrating the use of investment profiles will be an important method of meeting this obligation.

1. Conflict of Interest Obligation:

Satisfying this obligation requires enforcement of a firm’s written policies and procedures that handle conflicts of interest. These policies and procedures must address conflicts that incentivize placing one’s interest ahead of a customer. Such conflicts may include offering only proprietary products or other limited product menus, and products with third-party arrangements. Some conflicts must be eliminated, including certain sales quotas or contests, bonuses, and non-cash compensation based on specific securities, or specific types of securities sales, during a limited time period.

1. Compliance Obligation:

To meet this obligation, an investment professional must enforce written procedures and policies handling compliance with Reg BI. SEC staff may evaluate “any controls, remediation of noncompliance, training, and periodic review and testing included as part of those policies and procedures”.

SEC staff members need to understand how investment advisers decide on their investment recommendations. The intent is to foster open communication that protects investors from unscrupulous financial personnel, as well as advice that may be inappropriate for their specific circumstances. Therefore, investment firms must be prepared for documentation reviews, which may be extensive. Examples of reviewed documents may include compensation methods for registered personnel, product lists, information related to investment profiles, and other internal resources that may provide insight into the firm’s other processes. Please note that it is important to understand the reasons behind account recommendations, rollovers, and other advice regarding major investment decisions.

Form CRS

Specifically, Form CRS requires investment professionals and firms to develop and disseminate a relationship summary that discloses details about the services that retail investors will receive and how they'll be charged. Firms must file their relationship summary with the SEC, disseminate it to their investors, and post it on their public website if the website is available.

SEC staff may review the accuracy of a firm’s relationship summary and the firm's process for updating and disseminating it to both new and existing retail investors. According to a recent SEC risk alert, investment firms must distribute the relationship summary to their investors by July 30, 2020, and even sooner in certain circumstances.

The SEC’s risk alert on Form CRS also specifies some content that examiners may look for in a relationship summary, including:

1. Service and relationship descriptions, including specifics like investment authority and account monitoring

2. Disclosure of accurate and consistent fees and costs, especially common categories of fees that investors may incur

3. Disclosures of cash and non-cash compensation for financial professionals, and any associated conflicts of interest

4. Other conflict-of-interest disclosures, including incentives related to third-party payments, proprietary products, revenue sharing, and principal trading

5. Disclosure of any legal or disciplinary history at the firm or among its financial professionals

You may notice that there are some overlap requirements of Reg BI and Form CRS as they serve the same overarching purpose: promoting transparency and quality in the financial professions.

COVID-19 and the New Rules

According to a recent public statement by SEC Chairman Jay Clayton, through its extensive interactions with investment professionals and firms, the SEC has seen “considerable progress” toward compliance since adopting the new rules. Although the SEC has provided limited, temporary relief from some of its other deadlines during COVID-19, the June 30 compliance date for Reg BI and Form CRS will still hold, according to Clayton. Interestingly, Clayton also referenced the SEC’s ongoing commitment to operations during the pandemic, including its facilitation of the transition of the securities exchanges to “an all-electronic trading environment”. Furthermore, Clayton emphasized that as SEC staff work remotely, they continue to monitor and assist investment professionals and other issuers in complying with these important regulations.

State-Level Reg BI and Form CRS Compliance

Now that June 30th has passed, institutions will continue to monitor their compliance with these new standards. Some states have even added regulations to go even further than the SEC base Reg BI and Form CRS guidelines. For example, Rhode Island issued this bulletin, requiring state-level investment advisers to follow the same guidelines. State and Federal regulatory bodies have championed implementing these retail investor protections. As Reg BI and Form CRS regulations have just recently been implemented this is truly an evolving situation. 

Regulations in the Private Placement Market

Both Form CRS and Reg BI could potentially affect our clients at VerifyInvestor.com, many of whom conduct private placement offerings under Rule 506(c) of Regulation D of the Securities Act. It’s important to note that while issuers of Rule 506(c) offerings may publicly solicit or advertise, only accredited investors may participate. Therefore, after finding accredited investors for your Rule 506(c) offering, you will need to stay off the SEC’s radar by complying with all associated regulations, including utilizing an accredited investor verification service. As more institutions and regulatory bodies react and respond, stay informed of new developments by following VerifyInvestor.com’s Blog.