Update: Our May 11, 2020, alert provides new information on the June 30, 2020, compliance deadline for Regulation Best Interest (Reg BI) and Form CRS.
As McGuireWoods reported in an April 6, 2020, legal alert, the U.S. Securities and Exchange Commission (SEC) has indicated that it will not be delaying the June 30, 2020, compliance deadline for Regulation Best Interest (Reg BI) and Form CRS, despite granting extensive relief in other areas in response to COVID-19.
On April 7, 2020, the SEC Office of Compliance Inspections and Examinations (OCIE) issued two Risk Alerts intended as guidance for broker-dealers and investment advisers about the expected scope and content of the initial examinations for compliance with Regulation BI and Form CRS. Notably, the SEC continues to emphasize that it will be looking for good faith compliance efforts. In the press release announcing the issuance of the Risk Alerts, OCIE Director Peter Driscoll noted, “We understand that this implementation will be an iterative process, and our focus will be on firms continuing good faith and reasonable efforts, including taking into account firm-specific effects from disruptions caused by COVID-19.”
Some of the key points of each of the Risk Alerts are discussed below. McGuireWoods is prepared to discuss and advise on any questions with respect to the alerts or Reg BI and Form CRS compliance efforts.
Broker-Dealer Examinations Focusing on Compliance With Reg BI
With respect to Reg BI, not surprisingly, OCIE will focus on, among other things, whether a broker-dealer complies with the four main component obligations.
- Disclosure Obligation – A broker-dealer must provide a retail customer disclosure of material facts relating to the scope and terms of the relationship, and relating to conflicts of interest associated with the recommendation. In this regard, OCIE may request and review fee and expense disclosure, compensation methods, proprietary product sales practices, disclosures on material limitations on accounts/services recommended to retail customers and disclosures regarding retail customer account monitoring.
- Care Obligation – A broker-dealer must exercise reasonable diligence, care and skill when making a recommendation to a retail customer. In this regard, OCIE may request and review the information provided by retail customers, the process for establishing a reasonable belief that a recommendation is in the best interest of the retail customer (including the risk assessment process), and the process for making significant decisions or decisions with respect to complex products.
- Conflict-of-Interest Obligation – A broker-dealer must establish, maintain and enforce written policies and procedures reasonably designed to address conflicts of interest associated with its recommendation to retail customers. In this regard, OCIE may request and review any incentives for an associated person to place interests ahead of the interest of the retail customer; conflicts associated with material limitations; conflicts related to sales contests, sales quotas, bonuses and non-cash compensation; and how policies and procedures establish a structure for identifying and mitigating conflicts.
- Compliance Obligation – A broker-dealer must establish, maintain and enforce written policies and processes reasonably designed to achieve compliance with Regulation Best Interest as a whole. In this regard, OCIE may request and review policies and procedures and evaluate any controls, remediation of noncompliance, training and periodic review and testing including as part of those policies and procedures.
The Risk Alert also includes an appendix that contains a sample document request list. OCIE notes that:
This document provides a sample list of information that the [examination staff]… may request when conducting examinations of broker-dealers regarding Regulation Best Interest. OCIE has published this document as a resource for broker-dealers. This document should not be considered all-inclusive of the information that OCIE may request or the validation and testing OCIE may perform of firm policies and procedures. Accordingly, OCIE will alter its requests for information as it considers the specific circumstances presented by each firm’s business model. OCIE understands that not every document listed below will be applicable to every firm.
The sample document request is a helpful tool for broker-dealers to review in assessing the scope and comprehensiveness of their Reg BI policies and procedures.
Broker-Dealer and Investment Adviser Examinations Focusing on Compliance With Form CRS
With respect to Form CRS:
- Delivery and Filing – OCIE may (1) review whether the firm has filed its relationship summary, and whether the relationship summary is posted on the firm’s public website, if any; (2) evaluate the process for delivering the relationship summary to existing and new retail investors; and (3) review policies and procedures to assess whether they address the required relationship summary delivery processes and dates.
- Content – OCIE may review a firm’s relationship summary to assess whether it (1) includes all required information; and (2) contains true and accurate information and does not omit any material facts necessary to make the required disclosures. For example, relationship summaries may be reviewed for information about how the firm describes the relationship and services it offers to retail investors, how the firm describes its fees and costs, how the firm describes the manner in which its financial professionals are compensated, how the firm describes conflicts of interest, and whether the firm accurately discloses if it or its professionals have legal or disciplinary history.
- Formatting – OCIE may review a firm’s relationship summary to assess whether it is formatted in accordance with the instructions.
- Updates – OCIE may review a firm’s policies and procedures for updating the relationship summary to: (1) assess how and whether a firm updates and files its relationship summary within 30 days after any information becomes materially inaccurate; (2) assess how and whether a firm communicates these changes to retail investors; and (3) assess the firm’s process for highlighting to retail investors the most recent changes.
- Record-keeping – OCIE may review the firm’s records related to delivery of the relationship summary, and the policies and procedures regarding record-making and record-keeping, to assess how the firm complies with applicable delivery and record-keeping obligations.
FINRA Issues Statement on Risk Alerts
Also on April 7, 2020, the Financial Industry Regulatory Authority (FINRA) issued a statement confirming its examinations staff will take the same approach the SEC outlined in the Risk Alerts with respect to Reg BI and Form CRS compliance reviews during FINRA examinations. Like the SEC, FINRA stated that it will be looking for good faith compliance efforts. FINRA further emphasized that it stands “ready to work with firms and the SEC on issues that may arise in the course of examinations for compliance with Reg BI and Form CRS and understand(s) that the coronavirus disease (COVID-19) has created challenges for firms.”
Firms should consider these Risk Alerts as they continue to prepare their compliance programs and operations for compliance with the Reg BI and Form CRS requirements in advance of the June 30,2020, deadlines. McGuireWoods stands ready to help with these preparations and offer guidance on the requirements of Reg BI and Form CRS, as well as the implications of the Risk Alert.
McGuireWoods has published additional thought leadership analyzing how companies across industries can address crucial business and legal issues related to COVID-19.