Protecting Your Firm Under Regulation Best Interest
Remaining compliant with the SEC’s new rule.
After various attempts over the last several years to enhance the standard of care that brokerage firms owe to retail clients, the Regulation Best Interest (Reg BI) guidelines that the SEC adopted on June 15, 2019, will be effective on June 30, 2020.
What is Reg BI?
At its core, Reg BI is designed to create greater transparency to protect the retail investors who broker-dealers serve. The new standard of care mandates that broker-dealers put their clients’ best interest above their own personal gain and disclose certain information when making financial and investment recommendations. In the eyes of the SEC, a recommendation is anything that can be seen as a call to action, including recommendations for investment strategies, investment options, or types of accounts.
Similar to the way a medical practice is expected to document all patient data and only make informed medical recommendations that benefit patients’ health, the SEC’s newest regulation applies the same ideas to brokerage practices. Since Reg BI’s stricter rules could push more liability onto broker-dealers, it’s important for them to be familiar with the new rule’s four obligations to help protect their own practice.
The Four Obligations under Reg BI
The care and disclosure obligations will most impact broker-dealers’ day-to-day activities. However, it’s critical that broker-dealers meet all four obligations to ensure compliance with Reg BI and protect their clients and their own firm.
The Care Obligation
Under the care obligation, broker-dealers will be held to a new standard of care that requires them to make recommendations that align with retail clients’ best interests. While this may appear to be an obvious expectation, broker-dealers may have previously made recommendations that were suitable under FINRA’s suitability standard, but did not meet standards under Reg BI.
Now, broker-dealers are required to justify the cost of investments they recommend and present and evaluate all reasonably available investment alternatives. Additionally, firms with a limited menu of investment offerings cannot justify a recommendation if it’s the only one available and it doesn’t support their clients’ best interests.
The Disclosure Obligation
This obligation requires that broker-dealers disclose specific information when executing a securities transaction, opening a new account, or making a recommendation for an investment strategy or security. This generally includes the capacity and scope of their investment services; any associated fees, costs, or account minimums; whether they continually monitor brokerage accounts; and if they limit the security types they offer to proprietary products.
It’s important to note that broker-dealers must disclose all information required under Reg BI regardless of whether they’re serving a current or potential client — even if that client decides to utilize the recommendation at another firm.
Conflict of Interest Obligation
Unlike the care and disclosure obligations, the responsibility for the conflict of interest obligation falls primarily on the brokerage firm. To comply with Reg BI, firms must eliminate or mitigate any incentives that might encourage an employee to make a recommendation that elevates their own interest over their client’s interests, such as sales contests, quotas, or non-cash incentives.
Reg BI assigns responsibility for the compliance obligation to brokerage firms, rather than its individual employees. Firms are required to create, maintain, and enforce written policies and procedures that help prevent, detect, and correct violations under Reg BI.
While every firm is required to create their own policies and procedures that keep them compliant, Reg BI gives firms some flexibility to accommodate their individual business models. It’s important that broker-dealers are aware of and follow their pre-established policies and procedures to remain compliant with Reg BI.
Reg BI Outside the Office
Because broker-dealers are still bound to Reg BI’s obligations in any type of environment, they should cautiously approach casual interactions with retail clients to protect their practice.
Broker-dealers are not allowed to provide investment recommendations without following the new rule’s standard of care and disclosure requirements regardless of who they are speaking with and where they are holding that conversation.
For example, a broker-dealer would not be able to propose to a visiting neighbor that she should establish a 529 account to save for her children’s education. However, a broker-dealer may say that their firm can provide a selection of accounts that can help save for her children’s future.
Remaining Compliant Under Reg BI
Implementing and following the four obligations of Reg BI may be more difficult under the unusual circumstances of the coronavirus pandemic. Please contact our Clearing Services division by calling (214) 859-9100 or emailing email@example.com if we can be of help.
Hilltop Securities, Inc. (HTS) is a registered broker-dealer, registered investment adviser and municipal advisor firm that does not provide tax or legal advice. This information is intended for educational and informational purposes only and does not constitute legal or investment advice, nor is it an offer or a solicitation of an offer to buy or sell any investment or other specific product or service. HTS is a wholly owned subsidiary of Hilltop Holdings, Inc. (NYSE: HTH) located at 1201 Elm Street, Suite 3500, Dallas, Texas 75270, (214) 85