The SEC says it will issue examinations to test compliance with Regulation Best Interest, with the initial tests likely starting within a year of the implementation of the new rules.
The rules, also called Reg-BI, were approved by the agency last year in what it said was an effort to compel broker-dealers to act in the best interests of their clients. Critics, including consumer groups, contended the rules did not go far enough to protect investors.
The rules are scheduled to go into effect on June 30.
"These initial examinations, which will likely occur during the first year after the compliance date, are designed primarily to evaluate whether firms have established policies and procedures reasonably designed to achieve compliance with Regulation Best Interest," the SEC said in an alert issued last week.
The SEC’s Office of Compliance, Inspections and Examinations (OCIE) is providing transparency into its plans regarding Regulation Best Interest examinations to allow broker-dealers to assess their level of preparedness as the compliance date nears, James Lundy, a partner in the securities law firm of Faegre Drinker, said in an exam prep bulletin released by the firm.
Lundy said the SEC will want to assess disclosures regarding "the capacity in which a securities recommendation is being made, including material fees and costs that apply to transactions, holdings and accounts; and material limitations on the securities or investment strategies,” such as the fact that there is no investment or account monitoring services being provided.
To ensure that firms are meeting their care obligation, Lundy said that examiners will want to see that B-Ds and their reps are collecting enough pertinent information on retail investors to “develop their investment profiles.” For the care obligation assessment, firms’ should ensure they have all the documents examiners will reques, including new account forms, correspondence and emails and agreements to make investment profile determinations, he said.
Broker-dealers will also need to be able to show they have a process in place “for having a reasonable basis to believe that the recommendations are in the best interest of the retail customer,” Lundy said.
Specifically, SEC examiners will want to know what factors a B-D used to assess the potential risks, rewards and costs of the recommendations in light of the retail customer’s investment profile, he said.
Each firm needs to be able to make the case persuasively that their process provides “a reasonable basis to believe that it does not place the financial or other interest of the broker-dealer ahead of the interest of the retail customer,” Lundy said.