The SEC has released an FAQ on Regulation Best Interest, which has a compliance deadline of June 30, 2020.
The regulator has clarified that its definition of a “recommendation” includes securities transactions, account selection and rollovers, according to the FAQ.
The SEC also clarifies that when making recommendations, all dually registered financial professionals need to consider the “spectrum” of accounts they can offer, including both brokerage and advisory accounts as well as eligibility requirements, such as account minimums. But those registered as an associated person of a broker-dealer who aren’t themselves dually registered would only need to take into consideration the brokerage accounts available at their firm, according to the FAQ. Nonetheless, even if a broker’s firm only offers brokerage accounts, “you would still need to have a reasonable basis to believe that the recommended account is in the best interest of the retail customer,” the SEC says.
Furthermore, the regulator says that all communications with prospective and current clients are subject to Reg BI if they constitute a recommendation, such as opening an account, engaging in a securities transaction or moving an account to another firm, but not communications that simply suggest a meeting to discuss something later, for example. Educational communications, such as those involving sharing information about IRA contributions, for example, also don’t fall under the new regulation, the SEC says.
The FAQ also states that Reg BI requires financial professionals to provide clients, in writing, prior to or at the time of the recommendation, with a full disclosure of conflicts of interest, except in limited circumstance such as trade confirmation or prospectus delivery, in which case the disclosure can be made after the recommendation. In addition, the Customer Relationship Summary form, or Form CRS, will generally not satisfy the disclosure obligation and will require additional information, the SEC says.
The regulator also says financial professionals should not assume any incentives not specifically covered in Reg BI are automatically compliant with the rule. In addition, the FAQ provides a list of potential mitigation methods to comply with Reg BI, such as avoiding compensation thresholds and eliminating compensation incentives within comparable products.
Excerpts from the SEC’s FAQ:
Q: What account recommendations are covered by Regulation Best Interest?
A: Regulation Best Interest expressly applies to account recommendations including recommendations of securities account types generally (e.g., to open an IRA or other brokerage account, or an advisory account), as well as recommendations to roll over or transfer assets from one type of account to another (e.g., from a workplace retirement plan account to an IRA).
Q: Are there additional considerations if I am a dually registered financial professional making an account recommendation?
A: If you are a dually registered financial professional making an account recommendation, you would need to make this evaluation taking into consideration the spectrum of accounts that you can offer, and not just brokerage accounts.
Q: If I am only registered as an associated person of a broker-dealer, but my firm is a dual registrant, do I need to take into consideration both brokerage and advisory accounts?
A: No. If you are only registered as an associated person of a broker-dealer (regardless of whether you work for a dual-registrant or a broker-dealer affiliated with an investment adviser), you would need to take into consideration only the brokerage accounts available at your firm.
Q: I am an associated person of a broker-dealer. If I meet and talk with a prospective retail customer in an informal setting (e.g., on the golf course, at social gatherings, or while running errands), is my communication (sometimes referred to as a “hire me” communication) subject to Regulation Best Interest?
A: Whether your communication is subject to Regulation Best Interest depends on whether you make a “recommendation,” not on the location or setting of the communication.
A factor to consider is whether the communication “reasonably could be viewed as a ‘call to action.’” The more individually tailored the communication to a specific customer or a targeted group of customers, the greater the likelihood that the communication may be viewed as a “recommendation.”
If you engage in a communication with a retail customer that rises to the level of a “recommendation,” whether in the context of a “hire me” conversation or otherwise, the recommendation will be subject to Regulation Best Interest.
Q: I am an associated person of a broker-dealer. Are there circumstances where I can provide oral disclosures or provide written disclosures after a recommendation is made, without violating the obligation under Regulation Best Interest to provide written disclosures “prior to or at the time of the recommendation?"
A: Only in limited circumstances. Regulation Best Interest requires the broker, dealer, or natural person who is an associated person of a broker or dealer, prior to or at the time of the recommendation, to provide the retail customer, in writing, full and fair disclosure of all material facts relating to the scope and terms of the relationship with the retail customer and all material facts relating to conflicts of interest that are associated with the recommendation.
Q: I am a broker-dealer. Can I satisfy the Disclosure Obligation under Regulation Best Interest with my Relationship Summary (Form CRS)?
A: Generally, no. Whether the Relationship Summary or any existing disclosure, by itself, will satisfy the Disclosure Obligation in full would depend on the facts and circumstances. However, in most instances, you will need to provide additional information beyond the summary information contained in the Relationship Summary in order to satisfy the Disclosure Obligation.
Q: I am a broker-dealer. If my Relationship Summary includes a hyperlink to my Regulation Best Interest disclosures, can I satisfy my obligation to deliver the Regulation Best Interest disclosures by delivering Form CRS to new or prospective retail customers?
A: Regulation Best Interest and Form CRS have distinct disclosure delivery obligations. The staff notes that neither Regulation Best Interest nor Form CRS permits a “notice plus access” or “access equals delivery” method of electronic delivery. Rather, both Regulation Best Interest and Form CRS permit firms to provide electronic delivery of documents within the framework of the Commission’s existing guidance regarding electronic delivery.
Q: For purposes of the Care Obligation under Regulation Best Interest, what constitutes a “series of transactions” and whether a particular transaction is part of a “series of transactions?"
A: A “series” of recommended transactions is an established term under the federal securities laws and SRO rules that is evaluated in concert with existing guideposts, such as turnover rate, cost-to-equity ratio, and use of in-and-out trading, which have been developed over time and which serve as indicators of excessive trading. The staff notes that Regulation Best Interest does not change this well-established approach.
Conflict of Interest Obligation
Q: Are there any other specific conflicts that should be eliminated in addition to: sales contests, sales quotas, bonuses, and non-cash compensation, based on the sales of specific securities or types of security within a limited period of time?
A: The Commission emphasized that prohibiting certain incentives does not mean that all other incentives are presumptively compliant with Regulation Best Interest. Such other incentives and practices that are not explicitly prohibited are permitted provided that the broker-dealer establishes reasonably designed policies and procedures to disclose and mitigate the incentives created, and the broker-dealer and its associated persons comply with the Care Obligation and the Disclosure Obligation.
Q: Does the Commission mandate any particular mitigation methods? For example, do firms need to provide “level-fee” compensation or use neutral factors for differential compensation?
A: No. In lieu of mandating specific mitigation measures or a “one-size-fits-all” approach, broker-dealers have flexibility to develop and tailor reasonably designed policies and procedures that include conflict mitigation measures, based on each firm’s circumstances.
The Commission provided the following non-exhaustive list of practices that could be used as potential mitigation methods for firms to comply with Regulation Best Interest:
- avoiding compensation thresholds that disproportionately increase compensation through incremental increases in sales;
- minimizing compensation incentives for employees to favor one type of account over another; or to favor one type of product over another, proprietary or preferred provider products, or comparable products sold on a principal basis, for example, by establishing differential compensation based on neutral factors;
- eliminating compensation incentives within comparable product lines by, for example, capping the credit that an associated person may receive across mutual funds or other comparable products across providers;
- implementing supervisory procedures to monitor recommendations that are: near compensation thresholds; near thresholds for firm recognition; involve higher-compensating products, proprietary products or transactions in a principal capacity; or, involve the rollover or transfer of assets from one type of account to another (such as recommendations to rollover or transfer assets in an ERISA account to an IRA) or from one product class to another;
- adjusting compensation for associated persons who fail to adequately manage conflicts of interest; and
- limiting the types of retail customer to whom a product, transaction, or strategy may be recommended.
Click here for the full FAQ.