After much debate and controversy, the Securities and Exchange Commission’s “Best Interest” package of advice rules is not only final, but broker-dealers need to fully implement by June 30, 2020—a little over one year from now.
To avoid running afoul of the SEC’s Office of Compliance Inspections and Examinations (OCIE), which will enforce the rules, firms need to closely analyze Reg BI’s 1,400 pages and determine how they apply to their businesses and their policies, procedures and processes. The SEC “will begin examining for compliance soon after June 30,” said James Lundy, a partner with the securities practice of law firm Drinker Biddle.
“With the chairman’s and SEC’s continuing and aggressive focus on ‘Main Street’ issues, we can expect these efforts to be a priority for the foreseeable future. We also need to expect that when significant compliance failures are discovered, they will likely be referred to the SEC’s Division of Enforcement for investigation and possible charges,” Lundy said.
The looming deadline and threat of enforcement make it critical for broker-dealers to have a list of the most the pressing items they need to address. Nowhere will that be more important than in the area of brokers’ “conflict of interest” identification, mitigation and disclosure, which Lundy said was a “novel” area of compliance for most firms and brokers.
“There is clearly a new obligation to identify, mitigate and disclose conflicts of interest,” said Rob Klapprodt, corporate strategy officer at Vestmark, a provider of unified wealth management technology and operating platforms. “While there are areas of ambiguity and it is not as rigorous from a fiduciary standard, it is more rigorous than the existing suitability standard for brokers,” Klapprodt added.
According to the new Reg BI conflict-of-interest obligation, broker-dealers must establish, maintain and enforce written policies and procedures reasonably designed to identify and at a minimum disclose or eliminate conflicts of interest. This obligation, which is an enhancement from the proposal, specifically requires that firms adopt and implement policies and procedures to:
- Mitigate conflicts that create an incentive for the firm’s financial professionals to place their interest or the interests of the firm ahead of a retail customer’s interest;
- Prevent a limited product menu or offering of only proprietary products that could cause the firm or its financial professional to place his or her interest or the interests of the firm ahead of a retail customer’s interest; and
- Eliminate sales contests, sales quotas, bonuses and noncash compensation that are based on the sale of specific securities or specific types of securities within a limited period.
It is clear from the rule that firms should think twice about running sales contests or offering a menu of solely proprietary products, Klapprodt said.
“A lot the bigger broker-dealers we work with have already taken strides toward compliance as [a] result of the [now-defunct] DOL rule, so this won’t be a major change for a lot of these firms, but smaller firms or those who are behind, need to ramp up quickly,” Klapprodt said.
Despite firms’ best efforts, there is still plenty of room for interpretation when it comes to understanding and implementing the best interest regulations, he noted.
For instance, there are at least 17 places where the SEC used the term “reasonable” and “reasonably” to describe what regulators will be expecting from firms in terms of the heightened conflict and care obligations for brokers, Klapprodt said.