OCIE Publishes Reg BI, Form CRS Risk Alerts

SEC Office of Compliance Inspections and Examinations Publishes Risk Alerts Providing Advance Information Regarding Inspections for Compliance with Regulation Best Interest and Form CRS

On April 7, 2020, the Office of Compliance Inspections and Examinations (OCIE) of the Securities and Exchange Commission (SEC) issued two risk alerts:  Examinations that Focus on Compliance with Regulation Best Interest and Examinations that Focus on Compliance with Form CRS (collectively, Risk Alerts).  The Risk Alerts are intended to provide broker-dealers and investment advisers with advance information about the expected scope and content of the initial examinations for compliance with Regulation Best Interest (Reg BI) and Form CRS.  The Risk Alerts note that OCIE examination will focus on assessing whether investment advisers and broker-dealers have made a good faith effort to implement policies and procedures reasonably designed to comply with Reg BI and Form CRS.  On April 8, 2020, the Financial Industry Regulatory Authority (FINRA) issued a statement advising FINRA members that, like the SEC, FINRA’s examination approach would focus principally on assessing whether FINRA members have made a good faith effort to establish and implement policies and procedures reasonably designed to comply with Reg BI and Form CRS. 

TL;DR

• The SEC is not extending the compliance deadline for Reg BI or Form CRS.
• The SEC is grading, in part, on effort.
• The SEC acknowledged that implementation will be an iterative process.

Reg BI Risk Alert

Disclosure Obligation.  OCIE may review broker-dealer disclosures, and other firm records, to determine if the disclosures provide the required information to retail customers. OCIE may also review when disclosures are provided to retail customers. Staff may review documents such as:

1. 1. 1. Schedules of fees and charges retail customers must pay and disclosures regarding these fees and charges, including disclosures regarding the fees and costs related to services and investments that retail customers will pay or incur directly and indirectly (e.g., custodian fees, account maintenance fees, fees related to mutual funds and variable annuities, and other transactional fees and product-level fees);
      2. The broker-dealer’s compensation methods for registered personnel, including: (a) compensation associated with recommendations to retail customers; (b) sources and types of compensation (e.g., direct payments by an investor, payments by a product sponsor); and (c) related conflicts of interest (e.g., conflicts associated with recommending proprietary products or with receiving payments for inclusion on a product menu);
      3. Disclosures related to monitoring of retail customers’ accounts;
      4. Disclosures concerning material limitations on accounts or services recommended to retail customers; and
      5. Lists of proprietary products sold to retail customers.

Care Obligation. To assess compliance with this obligation, OCIE may review:

1. 1. 1. Information collected from retail customers to develop their investment profiles (including any new account forms, correspondence, and any agreements the customer has with the broker-dealer).
      2. The broker-dealer’s process for developing a reasonable basis to believe that its recommendations are in the best interest of the retail customer (which may include, e.g., any process for establishing, understanding, and implementing the scope of reasonably available alternatives when making a recommendation).
         • The factors the broker-dealer considers to assess the potential risks, rewards, and costs of the recommendations in light of the retail customer’s investment profile.
         • The broker-dealer’s process for having a reasonable basis to believe that it does not place the financial or other interest of the broker-dealer ahead of the interest of the retail customer.
      3. How the broker-dealer makes recommendations related to significant investment decisions, such as rollovers and account recommendations, and how the broker-dealer forms a reasonable basis to believe that such investment strategies are in a retail customer’s best interest.
      4. How the broker-dealer makes recommendations related to more complex, risky or expensive products and how the broker-dealer forms a reasonable basis to believe that such investments are in a retail customer’s best interest.

Conflict of Interest Obligation:  To assess compliance with this obligation, OCIE may review the broker-dealer’s policies and procedures to assess:

1. 1. 1. Whether and how the policies and procedures address the following, as required by Reg BI:
         • conflicts that create an incentive for an associated person to place its interest or the interest of a broker-dealer ahead of the interest of the retail customer;
         • conflicts associated with material limitations (e.g., a limited product menu, offering only proprietary products, or products with third-party arrangements) on the securities or investment strategies involving securities that may be recommended to a retail customer; and
         • the elimination of the following conflicts: sales contests, sales quotas, bonuses, and non-cash compensation based on the sale of specific securities or specific types of securities within a limited period of time.
      2. How the policies and procedures establish a structure for identifying the conflicts that the broker-dealer or its associated person may face. OCIE may request documentation identifying all conflicts associated with the broker-dealer’s recommendations.
      3. How the policies and procedures establish a structure to identify and assess conflicts in the broker-dealer’s business as the business evolves. OCIE may request to see all policies and procedures in place during the scope period of the examination.
      4. How the policies and procedures provide for disclosure of conflicts and what conflicts are disclosed.
      5. How the policies and procedures provide for mitigation or elimination of conflicts and what conflicts are mitigated or eliminated.

Compliance Obligation. To assess compliance with this obligation, OCIE may review the broker-dealer’s policies and procedures and evaluate any controls, remediation of noncompliance, training, and periodic review and testing included as part of those policies and procedures.

Follow-ups. Staff may select additional areas for review based on risks identified during the course of the examinations.

Form CRS Risk Alert

Delivery and Filing.   OCIE may: (1) review whether the firm has filed its relationship summary, including any amendments, with the Commission 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. OCIE may review records of the dates that each relationship summary was provided to retail investors to validate whether the firm has complied with the following delivery obligations:

1. 1. 1. Existing Retail Investors. The initial delivery of the relationship summary to existing retail investors by July 30, 2020, and before or at the time of:
         • The opening of a new account that is different from the retail investor’s existing account;
         • A recommendation of a rollover of assets from a retirement account into a new or existing account or investment; or
         • A recommendation of a new brokerage or investment advisory service or investment that does not necessarily involve the opening of a new account and would not be held in an existing account (e.g., a first-time purchase of a direct-sold mutual fund through a “check and application” process).
      2. New Retail Investors. The delivery of the relationship summary to new retail investors before or at the earliest of:
         • Entering into an investment advisory contract with the retail investor;
         • A recommendation to a retail investor of an account type, a securities transaction, or an investment strategy involving securities;
         • Placing an order for the retail investor; or
         • The opening of a brokerage account for the retail investor.

Content. Staff 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 in order to make the required disclosures, in light of the circumstances under which they were made, not misleading.  For example, the staff may review relationship summaries for information about:

1. 1. 1. How the firm describes the relationships and services it offers to retail investors, including statements regarding account monitoring and investment authority.
      2. How the firm describes its fees and costs, including disclosures about the principal fees and costs that retail investors will incur, other fees and costs related to services and investments that retail investors will pay directly or indirectly, and examples of the categories of the most common fees and costs applicable to the firm’s retail investors (e.g., custodian fees, account maintenance fees, fees related to mutual funds and variable annuities, and other transactional fees and product- level fees).
         • Staff may review fee schedules, advisory agreements, and brokerage agreements and compare the fees listed in those documents against the fees listed in the relationship summary.
      3. How the firm describes the manner in which its financial professionals are compensated, including cash and non-cash compensation, and the conflicts of interest those payments create.
      4. How the firm describes its conflicts of interest, including incentives related to proprietary products, third-party payments, revenue sharing, and principal trading.
      5. Whether the firm accurately discloses if the firm or its financial 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 (e.g., it includes required legends, it uses text features where required, and it is written in plain English).

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 within 60 days after the updates are required to be made; 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.

Conclusion  

While the SEC and FINRA are not extending the compliance deadline for Reg BI or Form CRS, we believe that the Risk Alerts are valuable compliance roadmaps for broker-dealers and investment advisers.  To the extent that compliance policies and procedures have already been implemented, the Risk Alerts should provide a frame of reference against which to check their adequacy and accuracy.  To the extent that compliance policies and procedures have not yet been implemented, the Risk Alerts should provide drafting and implementation guidelines.