Given the “rapidly approaching” implementation date for the SEC’s Regulation Best Interest and the “complexities of setting up the systems and processes” to comply with any new rule, broker-dealers firms should have already completed risk assessments by now, according to a New York-based consultant at Duff & Phelps.

Broker-dealer firms should also be “well underway” in setting up Reg BI-related systems, policies and procedures, in training retail investor-facing personnel, and in scrutinizing retail products for potential conflicts of interest, says Ken Joseph, managing director and head of disputes consulting at the consultancy firm.

The SEC has set June 30, 2020 as the compliance deadline for the implementation of Reg BI and believes that is “sufficient time” for firms to comply.

In a straw poll in late November, FA-IQ asked respondents about their preparedness for compliance with Reg BI.

Nearly a quarter, or 22%, said they are already fully prepared.

Most, or 67% of the respondents, said they are getting there and confident they will meet the deadline.

The rest, or 11%, said they haven’t done anything to prepare for compliance.

Joseph, who previously worked at the SEC for more than 21 years, shared with FA-IQ his assessment of the compliance preparations being made by broker-dealer firms and guidance to help them move forward.

While at the SEC, Joseph was a supervisor in the Division of Enforcement’s specialized asset management unit and a senior officer in the Office of Compliance Inspections and Examinations.

Ken Joseph

FA-IQ: In your conversations with broker-dealer firms, would you say that most, some or very few have made enough progress in their preparations to meet the compliance deadline?

Joseph: Because of the significant amount of publicity and outreach by the SEC and Finra, most B-Ds are well aware of Reg BI and the potential impact on their business. The more difficult question may relate to confusion between the suitability standard, the best interest standard and the fiduciary duty standard. Because best interest and fiduciary duty are principles-based, providing a prescriptive list of scenarios that could cause a risk of non-compliance is impossible.

FAIQ: What are the most critical tasks that broker-dealer firms need to accomplish to ensure compliance with Reg BI?

Joseph: Compliance with Reg BI requires attention to all parts of the rule. As [SEC] Chairman [Jay] Clayton has stated, disclosure, care, conflicts, and compliance are at the core of the rule. Given what may be a seismic change from the suitability standard for some, compliant B-Ds may be advised to pay particular attention to their disclosures and conflict identification and mitigation strategies. In addition, attention should be paid to the consistency and completeness of disclosures across investor/customer-facing documents and disclosures made in Form CRS [Customer Relationship Summary]. B-Ds should also invest heavily in training of firm personnel.

FA-IQ: John Polise — associate director of the broker-dealer and exchange program at the SEC’s Office of Compliance Inspections and Examinations — said in June that in the early days of the implementation of Reg BI, broker-dealer firms need not worry about ‘gotcha’-type examinations unless there are egregious circumstances that merit enforcement. What do you think would be considered egregious circumstances?

Joseph: Mr. Polise’s position is not stating new policy. The fact is that most instances of deficiencies identified in the examination process do not get referred to enforcement for investigation or ultimate prosecution. However, B-Ds who may be misrepresenting conflicts or misstating information about conflicts, fees and costs, and/or whose alleged misconduct causes financial harm to seniors, for example, could find themselves in the regulatory crosshairs. It is unlikely, especially in the early days of the application of the rule, that good faith and reasonable efforts to comply with the rule — absent other violations — would lead to enforcement actions.

FA-IQ: Finra is leaning toward keeping its Suitability Rule, even if Reg BI has been characterized by both Finra and the SEC as a step up from that rule. Do you expect broker-dealer firms to have any problems with having to comply with both Finra’s Suitability Rule and the SEC’s Reg BI?

Joseph: In my view, the suitability assessment is indeed part of the best interest determination. In practice, I don’t anticipate that informed and properly trained B-D personnel will have an issue applying the new rule. The more difficult question is whether dually-registered firms and personnel may be able to identify, when dealing with actual or potential retail customers/clients, whether they are wearing their investment advisor hat (where fiduciary duty applies) versus their registered representative hat (where best interest applies).

FA-IQ: A coalition of seven states — New York, California, Connecticut, Delaware, Maine, New Mexico and Oregon — and the District of Columbia filed a complaint for declaratory and injunctive relief against the SEC and Chairman Jay Clayton. The suit, filed in Manhattan federal court, argues that the SEC overstepped its authority by deviating from what was prescribed by the 2010 Dodd-Frank Act. Do you expect this lawsuit and any other legal challenge to delay the implementation of the Regulation Best Interest package?

Joseph: While the states have every right to pursue their claims in federal court, most pundits that I have spoken to do not believe there is much chance of success in light of the SEC’s federal mandate in crafting securities laws and regulations — unless, of course, a significant deficiency in the rule-making process employed by the SEC can be demonstrated. The goal of having a single standard is laudable but may not recognize the tangled set of relationships and services that B-Ds may provide to retail customers.

FA-IQ: What do you expect to be the greatest challenges broker-dealer firms will face when they come closer to the deadline for complying with Reg BI?

Joseph: There are two areas that could pose significant risks and challenges: first, in identifying, disclosing, and mitigating the myriad of conflicts that may exist (including fees, compensation, costs, etc.); second, in training or retraining firm personnel so that they are well-versed in the shift from suitability to best interest.

This Q&A has been edited for brevity and clarity.