What Reg BI Means for Financial Advisors

Starting on June 30, the Regulation Best Interest Rule (Reg BI) will set a new standard of conduct for broker/dealers. It requires that a broker/dealer and its associated persons must always act in the best interest of their retail customers when recommending securities or investment strategies involving securities. Let’s explore what Reg BI means for financial advisors, including the requirements for complying with this new rule

First, Some Background

Just about a year ago, the SEC released Reg BI as part of a rulemaking package with the Form CRS Relationship Summary rule. The general obligation of Reg BI states the following:

When making a recommendation of a securities transaction or investment strategy to a retail customer, a broker must act in the retail customer’s best interest without placing his or her own interests ahead of the customer’s.

So, what exactly does this mean? It might help to break it down by two critical terms:

• Recommendation: This is a call to action—or inaction in the case of a hold recommendation—regarding securities or investment strategies. The more you tailor a communication to a specific customer or target group, the greater the likelihood it will be viewed as a “recommendation.”

• Retail customer: A retail customer is “a natural person, or the legal representative of such natural person, who: (A) receives a recommendation of any securities transaction or investment strategy involving securities from a broker-dealer; and (B) uses the recommendation primarily for personal, family, or household purposes.” This definition does not include non-natural persons (e.g., corporations and institutions), but it does apply to high-net-worth clients who may be excluded from FINRA’s suitability rule.

Now that we’ve covered the general obligation, let’s dive deeper into the details to understand what Reg BI means for financial advisors.

The 4 Components of Reg BI

To satisfy the general obligation of the new best interest rule, a broker/dealer and its advisors need to comply with all four component obligations of Reg BI.

1) Disclosure. Under the Disclosure Obligation, customers must receive, in writing, full and fair disclosure of all material facts about conflicts of interest surrounding a recommendation. The disclosure should include the capacity in which the advisor is making the recommendation, material fees and costs the customer will incur, and the type and scope of services provided, including any material limitations on the recommended securities or investment strategies.

Fortunately, these disclosures can be layered, and firms may rely on existing disclosure documents to fulfill some of the obligation. Form CRS serves as the first layer (more on this below), with general information about the types of services, costs, and fees. The other disclosures provide information at a more granular level. Examples of existing documents include:

• Product-offering documents (prospectuses, private placement memorandums, offering circulars)

• Client agreements (account forms, applications)

• Point-of-sale disclosure forms (annuity processing forms, switch forms)

• Trade confirmations

Also needed is a document that connects the high-level disclosure of Form CRS to the particular disclosures found in existing materials. Commonwealth, for example, has put together the Investor Disclosure Brochure to provide more information about our services, as well as detailed information regarding fees, costs, and conflicts.

Under certain circumstances, a financial advisor may need to provide a supplemental disclosure regarding material limitations or potential conflicts of interest specific to him or her.

2) Care. Often described as “suitability plus,” this obligation requires that a broker/dealer and its advisors consider the costs, reasonably available alternatives, and factors in the customer’s investment profile as they prepare a recommendation. It also expands on FINRA’s suitability rule. Although both rules apply to recommendations of securities and investment strategies involving securities, the Reg BI Care Obligation also applies to account-type recommendations (e.g., brokerage versus advisory) and rollovers.

3) Conflict of Interest. This obligation is more applicable to broker/dealers than advisors. Broker/dealers are required to establish reasonably designed policies and procedures to identify, eliminate, mitigate, and disclose conflicts of interest. They must also address conflicts that exist between them and their advisors’ clients, as well as between advisors and their clients.

4) Compliance. This obligation requires broker/dealers to establish, maintain, and enforce written policies and procedures for complying with Reg BI’s various obligations.

What You Need to Know About Form CRS

The Form CRS Relationship Summary rule applies to broker/dealers and SEC-registered investment advisers. As mentioned, it serves as the first layer of disclosure to clients or prospects, providing them with the ability to easily compare products, services, costs, fees, and conflicts of interest. Unlike Reg BI, however, Form CRS doesn’t apply only when making a recommendation.

Full compliance expectations may differ based on your firm. But there are specific initial delivery requirements that all advisors should be aware of:

• Firms must deliver Form CRS to current and prospective retail investor clients within 30 days of the regulatory filing deadline.

• Investment advisers must send Form CRS to clients and prospective clients before or at the time they enter an investment advisory contract with the retail investor. (This requirement includes oral agreements.)

• Broker/dealers must send Form CRS to clients and prospective clients before recommending an account type, securities transaction, or investment strategy involving securities or before placing an order for a retail investor (whichever comes first).

• Form CRS must be amended or revised and filed with the SEC within 30 days of any information becoming materially inaccurate. Further, the amended or revised versions must be delivered within 60 days of change to each retail investor who is a client or considered a prospect of the firm.

Are You Ready?

As you can see, Reg BI and its companion pieces have many moving parts. Since its release a year ago, tremendous time and effort have been spent establishing and updating policies and procedures, as well as processes and controls. Now it’s time to put them into action.