While the Securities and Exchange Commission has provided some regulatory relief over the past month or so in light of the coronavirus pandemic, the compliance date for what are arguably two of the most onerous rules — Regulation Best Interest and the Customer Relationship Summary form — remains intact.
SEC Chairman Jay Clayton announced on April 2 that there’s no need to push off the June 30 compliance date as firms’ compliance is well underway.
Firms with account relationships comprising “a substantial majority of retail investor assets have made considerable progress” in adjusting their business practices, supplementing and modifying their policies and procedures, and otherwise aligning their operations and preparing for compliance with Reg BI and Form CRS, Clayton said.
Based on the securities regulator’s engagement over the past 10 months with the industry “and because the continued implementation of these conduct and transparency initiatives, individually and collectively, will significantly benefit Main Street investors,” the SEC believes June 30 for Reg BI compliance and “other requirements, including the requirement to file and begin delivering Form CRS, remains appropriate,” Clayton said.
Advisors or broker-dealers are encouraged to “engage” with the SEC if they’re unable to make certain filings or meet other requirements because of disruptions caused by COVID-19, “including as a result of efforts to comply with national, state or local health and safety directives and guidance,” Clayton added.
Stefan Simpson, chief compliance officer at Garrett Wealth Advisory Group in Franklin, Texas, told me in a mid-April email message that the SEC is right to press ahead. While the coronavirus pandemic “might make the implementation of the new regulatory requirements a bit more cumbersome for firm compliance officers and leadership, the show must go on!”
As to Form CRS, also being dubbed Form ADV Part 3, “what better time than now to communicate with clients?” Simpson said. “Most good advisors are relationship-focused and consequently may have clients with an ‘I don’t need to read that; I trust you’ way of thinking towards the current Form ADV.”
Simpson maintains that the average client’s “attention span doesn’t lend itself well to the current regulatory document requirements, so providing a short and simple one or two page document [with Form CRS] that hits all of the high notes is a great solution.” A “larger percentage of clients may actually read it — and not only read it, but understand it!”
What Exams Will Look Like
Clayton stated that when it comes to exams and enforcement, the agency will consider “the firm-specific effects of such unforeseen circumstances (and related operational constraints and resource needs)” as they relate to the coronavirus pandemic.
Following the June 30 compliance date, SEC examiners will focus on whether firms have made “a good faith effort to implement policies and procedures necessary to comply with Reg BI, while also providing an opportunity to work with firms on compliance and other questions,” Clayton explained.
The Financial Industry Regulatory Authority said that it will take the same approach as the SEC when reviewing broker-dealers and their associated persons for compliance with Reg BI and Form CRS. FINRA, the enforcer of Reg BI, also emphasized that it will not ignore suitability violations.
Initial Reg BI exams will focus on assessing whether broker-dealers have made a good-faith effort to implement policies and procedures reasonably designed to comply and that are effective, the SEC stated in a Reg BI Risk Alert.
Form CRS exams will assess whether firms have made a good-faith effort to implement the form, “including reviewing the filing and posting of a firm’s relationship summary as well as its process for delivering the relationship summary to existing and new retail investors,” the agency’s Form CRS Risk Alert says.
After the June 30 compliance date, exams by the agency’s Office of Compliance Inspections and Examinations to assess implementation of Reg BI “will likely occur during the first year after the compliance date” and are designed primarily to evaluate whether firms have established policies and procedures reasonably designed to achieve compliance, the Reg BI alert explains.
OCIE also will evaluate whether firms have made reasonable progress in implementing those policies and procedures.
Initial Form CRS exams after June 30 may include an assessment of firms’ delivery and filing, content, formatting, updates and recordkeeping measures.
Pete Driscoll, director of OCIE, said in a statement that “based on conversations we have had with the industry, we know firms have made substantial progress in implementing these new rules.”
Implementation, Driscoll said, “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.”
John Polise, OCIE’s national director for the Broker-Dealer and Exchange program, added that “OCIE has been working closely with both FINRA and SEC staff to ensure that we harmonize our examination efforts” for Reg BI across the exam programs.
FINRA Tweaks Suitability Rule
While FINRA has stated that it will not eliminate its suitability rule in light of Reg BI, the regulator is making changes to it.
FINRA has filed a plan with the SEC to amend its suitability and noncash compensation rules to provide clarity on which standard applies and to address inconsistencies with Reg BI.
FINRA’s proposed rule change would: (1) amend the FINRA and capital acquisition broker, or CAB, suitability rules to state that the rules do not apply to recommendations subject to Reg BI, and to remove the element of control from the quantitative suitability obligation; and (2) conform the rules governing noncash compensation to Reg BI’s limitations on sales contests, sales quotas, bonuses and noncash compensation.
If approved by the SEC, the effective date will be June 30.
The changes would amend the FINRA suitability rule, Rule 2111, to state that it will not apply to recommendations subject to Reg BI, and to remove the element of control from the quantitative suitability obligation.
In addition, the proposed rule change would conform the CAB suitability rule, CAB Rule 211, to the proposed amendments to Rule 2111, and would conform FINRA’s rules governing noncash compensation to Reg BI’s limitations on sales contests, sales quotas, bonuses and noncash compensation.
“Reg BI addresses the same conduct that is addressed by Rule 2111, but employs a best-interest, rather than a suitability, standard,” FINRA explained.
“Absent action by FINRA, a broker-dealer would be required to comply with both Reg BI and Rule 2111 regarding recommendations to retail customers. In such circumstances, FINRA believes that compliance with Reg BI would result in compliance with Rule 2111 because a broker-dealer that meets the best interest standard would necessarily meet the suitability standard.”
To reduce the potential for confusion, FINRA stated that it is proposing limiting the application of Rule 2111 to circumstances in which Reg BI does not apply.
To do so, FINRA plans to add new paragraph to the FINRA Rule 2111 supplementary material and new paragraph to the CAB Rule 211 supplementary material that states that those rules shall not apply to recommendations subject to Reg BI.
Washington Bureau Chief Melanie Waddell can be reached at firstname.lastname@example.org.