SEC Adopts Regulation Best Interest

On June 5, the SEC adopted Regulation Best Interest.  Along with adopting Regulation Best Interest, the SEC also adopted three other elements pertaining to advice standards for retail investors including:  the Form CRS Relationship Summary, the Standard of Conduct for Investment Advisers, and a new Interpretation of “solely incidental.”

Links to Regulation Best Interest and the other adopted SEC documents can be found here

(Printer Alert:  The SEC Release announcing Regulation Best Interest is 771 pages long.  The text of Regulation Best Interest can be found beginning at page 765 and thereafter.)

Regulation Best Interest and Form CRS will become effective 60 days after publication in the Federal Register.  Firms will be given a transition period until June 30, 2020 to comply with these rules.

Regulation Best Interest will allow registered representatives to continue to transact business under a commission-based sales model and will rely upon disclosures as a means to mitigate potential conflicts of interest.

Regulation Best Interest outlines specific obligations for broker-dealers including:

Disclosure Obligation:  Broker-dealers and their registered representatives will have to provide retail customers with disclosure in writing of:

All material facts relating to the scope in terms of the relationship with the retail customer, including:

  • That the firm or its registered representative is acting as a broker or dealer with respect to the recommendation;
  • Material fees and costs of the transactions, holdings and accounts;
  • The type and scope of services provided to the retail customer, including any material limitations on the securities or investment strategies involving securities that may be recommended to the retail customers; and
  • All material facts relating to conflicts of interest that are associated with the recommendation.

Care Obligation:  in making a recommendation, broker-dealers and their registered representatives will have to exercise reasonable diligence, care and skill to

  • Understand the potential risks, rewards and costs associated with the recommendation and have a reasonable basis to believe that the recommendation could be in the best interest of at least some retail customers;
  • Have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer based on that retail customer’s investment profile and the potential risks, rewards and costs associated with the recommendation and does not place the financial or other interest of the broker-dealer or its registered representatives ahead of the interest of the retail customers; and
  • Have a reasonable basis to believe that a series of recommended transactions, even if in the retail customer’s best interest in isolation, is not excessive and is in the retail customer’s best interest when taken together in light of the retail customer’s investment profile and does not place the financial or other interest of the broker, dealer or such natural person making the series of recommendations ahead of the interest of the retail customer.

Conflict of Interest Obligation:  The broker-dealer must establish, maintain and enforce written policies and procedures reasonably designed to identify and disclose all conflicts of interest associated with recommendations

  • Identify and mitigate any conflicts of interest that create an incentive to place the interest of the firm and its registered representatives ahead of the interest of the retail customers;
  • Identify and disclose any material limitations placed on securities or investment strategies involving securities that may be recommended to a retail customer and any conflict of interest associated with such limitations;
  • Prevent limitations and conflicts of interest from causing the broker-dealer or its registered representatives to make recommendations ahead of the interest of the retail customers; and
  • Identify and eliminate any sales contests, sales quotas, bonuses and non-cash compensation that are based on the sales of specific securities or specific types of securities within a limited period of time.

Compliance Obligation:  In addition to the policies and procedures noted above, broker-dealers will be required to establish, maintain and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest.

CEFLI will continue to review Regulation Best Interest (as well as the other adoptions) and will provide further discussion of these issues at upcoming meetings of its Compliance & Ethics Committee as well as the 2019 CEFLI National Compliance & Ethics Forum.