Rejecting pleas from the securities industry to delay its effective date because of COVID 19, the Securities and Exchange Commission allowed Regulation Best Interest (Regulation BI) to become effective on June 30, 2020 as scheduled.
Regulation BI imposes a new and higher standard on securities brokerage firms and registered representatives (but not upon registered investment advisors, who are already subject to a fiduciary duty standard). The new requirement is that when making a recommendation to a “retail customer” concerning a security or an account, the recommendation must be in the best interest of the client. This standard is therefore below that of a fiduciary, but how much below is yet to be determined.
In summary, Regulation BI imposes four obligations on broker dealers, and an additional obligation on registered investment advisor. As to broker dealers, Reg. BI requires firms to
- Disclose information about their recommendations regarding investment products, strategies, or types of accounts the client should establish, which information must be presented before making the recommendation;
- Exercise due diligence, care and skill when making any such recommendations, and firms must have a reasonable belief that their recommendation is in the best interest of the client;
- Establish and maintain policies regarding conflicts of interest, including disclosing all conflicts of interest related to a recommendation to a client, and observing policies that preclude conflicts of interest from preventing the firm from providing the best possible recommendations to clients.
- Provide clients with Form CRS, which stands for Client Relationship Summary; the Form CRS cannot exceed two pages, and must disclose key facts about the firm, including the services it offers, costs, fees, conflicts of interest, standards of conduct associated with each of its services, and a review of the firm’s regulatory and litigation history. For brokerage firms, the CRS is a separate form.
A retail customer is defined as natural person who receives the recommendation “primarily for personal, family or household purposes.”
Reg. BI also requires that investment advisor firms provide clients with a Form CRS, which must be included with their disclosure brochure—which is Part 2 of the advisors Form ADV.
Interestingly, Reg. BI precludes firms form using the word “advisor” in their name unless they are under a fiduciary standard, resulting in some firms having to change their entity names.
Commentators expect that there will be an increase in enforcement actions by the SEC and FINRA as a result of Regulation BI, as the regulators target firms who fail to comply. Similarly, many defense attorneys expect that Reg. BI will result in a spate of new arbitration cases asserting violation of the Regulation and/or that the Regulation establishes a standard of care that the brokerage firm failed to meet.The Regulation may also lead to a further decline in the sale of commission-based products.
Some had argued that the SEC should have imposed a full fiduciary standard on broker/dealers (similar to that imposed by the Department of Labor, whose fiduciary rule was vacated by the courts), but the SEC declined to do so.