My partner, Heidi VonderHeide, has busied herself these last few months learning everything she can about Reg BI.  Happily, here is her post on the subject, and it doesn’t predict gloom and doom in the new year as that regulation is implemented.  – Alan

Just before the Holidays, I attended FINRA’s one-day Reg BI seminar in Washington D.C., where member firms and regulators (but primarily the SEC) discussed the new rule and what they hoped it meant for the industry.

As you would expect, a lot of the time was devoted to an overview discussion about the rule – most of which you’re already familiar with heard either because you’ve read the 700+ page release that accompanied the Reg or because you’ve been scouring the internet looking for any guidance on how to go about putting it into practice.

There was relatively little guidance on the how, but the most interesting discussions, in my opinion, came from the panelists from member firms.  Not that they had all the answers – to the contrary – a lot of the discussion focused on the questions or problems that they’ve encountered in attempting to implement the Reg and its procedural requirements.  Their struggle highlights the complexity behind even the simplest requirements.

Take, for example, the requirement that Form CRS be delivered to firm clients.  This new requirement is incredibly straightforward compared to others, yet, in practice it has proved incredibly problematic, even for the biggest member firms.  What mechanism does the firm use to send the CRS? Mail or email? What about the customers’ communication preferences? A lot of firms are relying on their clearing firm to send the document, but some clearing firms cannot guarantee that the Form CRS will meet the regulation’s “prominence” requirement.  And, once the Form is sent, how will the firm create and maintain adequate records of that transmittal?  How will the firm ensure timing is right for this (and other) disclosure transmittals (which must be provided to the customer at the time of the recommendation or before)?

These are the questions that firms are struggling with – and the clock is ticking.

On the plus side, the SEC and FINRA have provided repetitive reassurances (at the conference and elsewhere) that the initial Reg BI examinations – both before and after the June 30, 2020 compliance deadline – will not be looking for “foot faults” and, instead, that the focus will be on working with firms to identify deficiencies and achieve compliance.

So, what should firms be doing as the deadline approaches?  The simple answer is: taking this very seriously and being prepared to show FINRA how seriously you are taking it.

The more complex answer is:

  • Know thyself: the first questions firms are likely to receive will be asking what the firm has been doing to prepare for implementation.  The easiest and most obvious first step is to review your structure, relationships, business lines, existing procedures, existing documents and existing representatives.  This will be time consuming but will provide a solid starting point for identifying where changes need to be made.
  • Focus on language: What do you already disclose and how?  Are existing disclosures compliant with the Reg?  What new disclosures are needed and where do they go (i.e., how many disclosure documents are needed)?  What about titles and marketing materials?  Do they meet the new requirements around the word “advisor” and properly disclose service/account limitations?  What about account agreements and policy documents?  Do they promise any services or “monitoring” that could be problematic under the new rule?
  • Focus on training: Nothing shows seriousness more than comprehensive training.  This is not only for your registered persons, but for the individuals that supervise them.  Everyone needs to understand the Reg’s new requirements.  While the compliance and disclosure functions will largely be handled on the firm level, brokers are responsible for implementing them and, of course, ensuring that the recommendations made satisfy the care obligation.
  • Talk to your vendors now: One common theme at the conference was the shattered belief that clearing forms or other third-party vendors will be able to assist with transmission of these documents.  Don’t assume that is going to be an option. Some of the big firms at the conference told us they were using (and creating) their own technology to handle delivery and delivery record keeping.
  • Learn from others: Once the June 30, 2020 deadline comes, other firms’ Forms CRS will be available publically.  That will be the first real opportunity to see what others are doing and learn from it.  Of course, changing your Form CRS will trigger re-distribution requirements, so you may want to review as many industry examples as possible, decide on revisions, and then decide if and when to implement them.
  • Learn from those who have gone before you: It’s my prediction that FINRA will abide by its new mantra that it does not intent to institute “gotcha exams.”  Firms that try, but fail, to meet the still-unarticulated standard which FINRA will be imposing will not find themselves facing formal action….initially.

Here, we can learn a lot from the recent ADV/disclosure actions against IAs.  I expect FINRA’s enforcement trends to follow that same path.  This means that there will be relatively few formal actions for firms in the first few years – other than firms that do nothing to comply, and their refusal to act will be taken very seriously.

The first real wave of actions will be firms that pay only lip service to the rule and fail to make meaningful disclosure or procedural changes.

The next wave will come 3-5 years after implementation.  This is the arc of the enforcement-pendulum that firms fear most.  Years after the rule is in place, an industry standard will emerge and FINRA will file enforcement actions against the divergents.  The charges will perhaps be retroactive, imposing a 2025 standard on the decisions you are making right now.  It is then where this grace period will end and the enforcement sweeps will resume (think of the ADV and share-class sweeps we have seen in recent years on the IA side).

  • Don’t stop at strict compliance. The main objective on everyone’s mind is complying with the technical requirements of the rule. Given the amount of work and expense that will go into compliance, however, you should also be thinking about areas where you may want to go beyond the Reg’s threshold requirements. For example, Reg BI does not require documentation of the best interest recommendation made to a particular customer.  But that doesn’t mean you shouldn’t push your representatives to memorialize these interactions.  It may be an open question as to whether you will ever see an enforcement action arise out of your Reg BI procedures, but a customer complaint with that allegation is almost inevitable.

Of course, these are only a few of the questions firms will be asking themselves as they prepare for the June 2020 compliance deadline. If you have any questions, you can reach out to us at any time.  We’ve prepared some handy overview materials which we are happy to send to you.