On April 6, 2020, Reminger Co., LPA reported (click here) on the Securities and Exchange Commission’s (“SEC”) announcement that, despite the worldwide COVID-19 pandemic, it would not extend the June 30th deadline for subject financial services firms to implement policies and procedures under Regulation Best Interest (“Reg BI”) and roll out Customer Relationship Summary Forms (“Form CRS”). In connection with that announcement, SEC Chairman stated that the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) would be releasing guidance on its expectations for first-round examinations following the implementation deadline. Those Risk Alerts (one addressing Reg BI, and the other addressing Form CRS) were released on April 7, 2020 and are the subject of this article.
In both Risk Alerts, OCIE reiterated that exams will commence in the second half of 2020 insofar as the June 30, 2020 compliance date has not changed, but acknowledged that COVID-19 may impact every firm’s timeline in a unique way:
OCIE stands ready to work with firms and our colleagues in the Division of Trading and Markets on issues that may arise in the course of examinations and understands that the coronavirus disease 2019 (COVID-19) has created challenges for firms.
Thus, although compliance with these new standards may seem daunting, OCIE expressly stated in both releases that it is prepared to help firms work through implementation issues as well as any issues that arise during the initial regulatory examinations. Even with the impending deadline, firms can find some solace of flexibility as reflected in the Risk Alerts as the population in general adjusts to confront and combat this unprecedented pandemic. Consistent with other industry guidance, implementation of compliance protocols for Reg BI will be judged on a firm’s “good faith” attempt to develop and implement “reasonable” policies and procedures. These reasonable, good faith efforts will take into account COVID-19 as well as any proactive steps taken by a firm (including involvement of OCIE) in anticipation of the compliance date.
1. Risk Alert Examinations that Focus on Compliance with Regulation Best Interest
OCIE anticipates that it will immediately begin conducting examinations assessing the implementation of Reg BI “during the first year after the compliance date.” The focus of these initial examinations will be “whether firms have established policies and procedures reasonably designed to achieve compliance with Regulation Best Interest.” More specifically, OCIE suggests that it will evaluate whether “reasonable progress” has been made in implementing appropriate policies and procedures. The language of this Risk Alert suggests that complete compliance will not be expected immediately, only reasonable, good faith efforts at compliance while the particulars of this new standard are ironed out. OCIE expects firms to make “such modifications as may be necessary or appropriate, in light of information gained from the implementation process and other facts and circumstances.” In this regard, OCIE expects that firms will be flexible and engage in an ongoing implementation and monitoring process rather than developing a singular plan, putting the plan in motion, and moving on to the next task. In this regard, and although not limited to these topic areas, the initial examinations will focus on the four pillars of Reg BI as follows:
a. Disclosure Obligation (exams will assess whether and to what extent firms have disclosed (i) the capacity in which recommendations are made, (ii) what fees and costs apply to the transactions, holdings and accounts, and (iii) material limitations on the recommendations being made)
b. Care Obligation (exams will assess the level of due diligence undertaken before recommending a particular security or investment strategy)
c. Conflict of Interest Obligation (exams will assess the creation, maintenance and enforcement of policies and procedures to address firm-level and representative-level conflicts of interest)
d. Compliance Obligation (exams will assess the creation, maintenance and enforcement of written policies and procedures targeted at overall Reg BI compliance)
The Risk Alert also provides a sample list of documents that OCIE would expect each broker-dealer to maintain and be able to readily produce as part of any investigation, including (without limitation) the following:
a. Schedules of fees and charges
b. Documentation of compensation methods
c. Description of available account types (brokerage and non-brokerage)
d. Disclosures of material limitations on accounts or services
e. List of proprietary products
f. List of third parties or affiliates
g. New account forms and suitability profiles
h. Marketing materials
i. Training materials
j. Surveillance and monitoring reports
k. Firm policies and procedures
2. Risk Alert Examinations that Focus on Compliance with Form CRS
A subset of the new regulatory requirements deals with Form CRS and a firm’s obligation to create a “brief customer or client relationship summary about the firm,” referred to as a “relationship summary.” As with Reg BI, “initial examinations will focus on assessing whether firms have made a good faith effort to implement Form CRS.” Like the Reg BI Alert, this Alert identifies several focus areas that OCIE will emphasize during initial examinations:
a. Delivery and Filing (ensuring that relationship summary is filed with SEC and posted on the firm website by June 30, 2020; evaluating process for delivering to new and existing clients; and whether policies and procedures address relationship summary delivery process and dates)
i. A particular emphasis will be placed on the “dates that each relationship summary was provided to retail investors” to ensure that a firm complies with its delivery obligations. These obligations depend on whether an individual is categorized as an existing retail investor (in which case delivery must be made by July 30, 2020 and again if such investor opens a new account), or a new retail investor (in which case delivery must be made before the earliest of entering an advisory contract, recommending a security, placing a trade order, or opening a brokerage account.
b. Content (whether the relationship summary contains true and accurate information as well as all required information)
c. Formatting (assessment of whether contents are displayed according to instructions, including whether it is written in “plain English”)
d. Updates (analysis of policies and procedures to ensure that relationship summary is updated within 30 days after information becomes inaccurate and distributed to clients within 60 days as well as whether updates are appropriately highlighted and earmarked for the reader)
e. Recordkeeping (assessment of how delivery of relationship summary is recorded and document procedures relating to this process)
In conclusion, while OCIE made clear in the Risk Alerts that it is fully staffed and prepared to commence with exams specific to Reg-BI and Form CRS immediately following the June 30th compliance deadline, the tone of the Risk Alerts reflects Chairman Clayton’s prior statements that the SEC recognizes the challenges imposed by the COVID-19 pandemic and that examiners will be focusing on whether firms have made good faith efforts to implement Reg BI and will provide firms with opportunities to work with OCIE to address compliance and other related matters.
The financial services lawyers at Reminger are fully operational during the pandemic and stand ready to continue to assist clients to prepare for Reg BI’s implementation and effective date. Do not hesitate to contact us with any questions.