Reg BI and Form CRS Aftermath Is Just Getting Started

Broker-dealers spent most of the spring and summer struggling to establish what is arguably one of the largest regulatory changes in the investment space in decades (in the midst of a global pandemic, no less) and it looks like they can finally come up for air. However, as the dust settles, broker-dealers are realizing their own approach may not align with some of their peers’ or with regulatory expectations.

Regulation Best Interest (Reg BI) and Form CRS were supposed to involve a tailored approach to each broker-dealer’s unique business. Nevertheless, after noticing some competitors with multiple lengthy disclosure documents, new and robust procedures, changes to their product menu, a sophisticated system for tracking Form CRS delivery, and new controls to “mitigate conflicts.” Some broker-dealers were left asking: should we be doing more?

‘A good-faith effort’

Leading up to the effective date, a reassuring buzz phrase quickly gained popularity among regulators: “make a good-faith effort.” Perhaps it was due to broker-dealers voicing their struggles to interpret often-ambiguous language and to get clarity on obligations from well over 1,200 pages in regulations, guidance, and FAQs.

Though most broker-dealers put forth a good-faith effort, the SEC has taken notice of a significant number of firms falling short. A spokeswoman for the SEC indicated staff members have “observed areas where disclosure may be inaccurate or incomplete.” She went on to say that the agency’s examiners are going to formally review the filings to ensure they are accurate and not misleading.

Enforcement actions aren’t the only risk of non-compliance

While we can only speculate on what it will take for FINRA or the SEC to recommend formal action in connection with violations of Reg BI or Form CRS obligations, it’s clear that enforcement actions are not the only risk to consider. For instance, if FINRA or the SEC forces a broker-dealer to make material changes or updates to the Form CRS, the broker-dealer may be obligated to provide a notice of that update to customers. The rule requires the broker-dealer to emphasize or bring attention to the change(s) within that update. As such, what might otherwise be considered a normal and frequent disclosure could create concern with investors.

Another risk to consider is the number of plaintiffs’ attorneys looking for discrepancies that could be exploited to suggest the broker-dealer failed to act in a customer’s “best interest.” If this wasn’t enough cause for concern, consider The Wall Street Journal’s article pointed out some broker-dealers for falsely claiming they did not have any legal or disciplinary history on the Form CRS when they do.

Those working in compliance understand that the vast majority of broker-dealers are not the Wolf of Wall Street and make far more than a “good faith effort” to follow the rules while also providing exemplary service and value. From a compliance standpoint, our advice is simple: broker-dealers should invest more time now to make sure they get this right before the consequences of getting it wrong get much worse.

The right compliance framework

If broker-dealers’ stakeholders are still wondering what their Reg BI and Form CRS framework should entail, they should consider the following:

• Form CRS: By now, this should be drafted, filed and delivered to established customers. That doesn’t mean it should be final, as it can continue to be updated and improved. However, it will be the very first document reviewed by regulators, attorneys, and customers, so be prepared to document your process and answer questions. Kaufman Rossin’s risk advisory team can review the Form CRS and provide some valuable feedback.
• Reg BI Disclosure Supplement: If a broker-dealer has not prepared a separate stand-alone Reg BI disclosure in addition to the Form CRS, the firm is probably not complying with the Disclosure Obligation under Reg BI. This is because the SEC encouraged a supplemental disclosure in order to completely satisfy the disclosure obligations under Reg BI, which cannot possibly be accomplished through the typical Form CRS alone. An experienced team of advisors can draft this document and provide the necessary disclosures, which include detailed descriptions of the material fees and costs, conflicts of interests, risks, and more.
• Conflict of Interest Inventory (COI) and Mapping: Regulators are asking broker-dealers to provide a description of how they identify conflicts of interest and the ways they mitigate these potential risks. Broker-dealers should be prepared to provide substantive assessments detailing this process to satisfy regulators. Our team works with broker-dealers to provide them with a specific document to illustrate both:
  • An inventory of the material conflicts of interests
  • A summary of all the ways the broker-dealer mitigates each material conflict. Mitigation may include any combination of special procedures, supervisory processes, disclosures, forms, or other controls that can help to mitigate a particular conflict of interest.
• Written Supervisory Procedures: To demonstrate compliance with Reg BI, broker-dealers are required to establish procedures reasonably designed to comply with the rules. This goes beyond adding a chapter on Reg BI and Form CRS, and our team can help tailor such procedures to the broker-dealer’s business model. Broker-dealers’ procedures likely contain product-specific sections, references to senior investors, training, lists of prohibited activities and more – all of which likely reference suitability. Adding a template chapter without addressing other sections means a broker-dealer’s procedures may be inadequate. This is why an advisor should take time to update all these sections to verify that the procedures provide for consideration of the best interest standard, in addition to suitability, when applicable.

• Training: A great supervisory system and controls can only go so far if a broker-dealer’s representatives and associates don’t understand their obligations. In addition to the deliverables above, our team can provide broker-dealers with appropriate training that can be incorporated into their annual training or delivered on an ad-hoc basis to registered representatives and associates, so they understand their obligations going forward.

Though some time has passed since their effective date, broker-dealers are still trying to establish or change their compliance programs to meet the requirements of Reg BI and Form CRS. They don’t have to do it alone. A strategic partner can be a valuable and helpful resource.

Kaufman Rossin’s risk advisory services team has a turn-key solution that can help broker-dealers comply with Reg BI and Form CRS. Contact me or another member of our Risk Advisory Services practice for assistance with these and other regulatory compliance matters.