FINRA Highlights Firm Practices from Regulation Best Interest Preparedness Reviews
On June 5, 2019, the U.S. Securities and Exchange Commission ("SEC") adopted Regulation Best Interest (Reg BI) under the Securities Exchange Act of 1934 ("Exchange Act").1 Reg BI establishes a “best interest” standard of conduct for broker-dealers and associated persons when they make a recommendation to a retail customer of any securities transaction or investment strategy involving securities, including recommendations of types of accounts. The SEC also adopted new rules and forms to require broker-dealers and investment advisers to provide a brief relationship summary, Form CRS, to retail investors.2 The compliance date for Reg BI and Form CRS is June 30, 2020.
Starting in late 2019, FINRA reviewed a set of small, mid-size and large firms to assess their preparedness for Reg BI and Form CRS. These assessments were not undertaken with the purpose of making findings of anticipated violations of Reg BI or Form CRS, but rather as a helpful dialogue with firms about their ongoing efforts and potential challenges. This report presents practices FINRA observed during those reviews and through ongoing conversations with firms about their preparedness initiatives. This report discusses information we obtained during our reviews (late 2019 to early 2020) and, as implementation is ongoing, firms likely have made further progress in preparing for Reg BI and Form CRS that may not be reflected by the particular elements described herein.
Firms may find additional information regarding their obligations by referring to:
- SEC’s Regulation Best Interest, Form CRS and Related Interpretations resources page;
- SEC’s Frequently Asked Questions on Regulation Best Interest;
- SEC’s Frequently Asked Questions on Form CRS;
- FINRA’s Reg BI Topic Page; and
- FINRA’s Reg BI and Form CRS Checklist.
Firm Practices Observed in Reg BI Preparedness Reviews
FINRA is sharing the following common practices we observed while conducting Reg BI preparedness reviews and other ongoing conversations with firms. We hope this helps firms assess their Reg BI initiatives and continue their work preparing for the compliance date.
1. Governance and Implementation Management – Firms developed governance structures to lead and manage Reg BI and Form CRS compliance requirements, including:
- Project Teams and Working Groups – Firms established project teams, workstreams or working groups either as part of a steering committee or as separate bodies reporting to the leadership team, including those that were:
- Composed of multi-member steering committees representing multiple functions (at larger firms) or one or two designated staff (at smaller firms);
- Structured around the four component obligations of Reg BI (i.e., disclosure, care, conflict of interest and compliance) and Form CRS; and
- Included representatives from multiple areas of a firm (e.g., business units, compliance, legal and communications) (at larger firms).
- Timelines – Firms developed timelines and project plans for making the necessary updates, including:
- Staggering deliverables by prioritizing either updates with longer implementation periods (such as changes that require technology or delivery methodology changes) or clear rule obligations and easier "quick win" items;
- Developing reverse timelines by setting deadlines for major goals and working backwards to set intermediate goals;
- Creating multistage review processes for all projects with an initial senior-level review of Reg BI impacts, development of detailed impact assessments and action plans, and executive review and sign-off on plans and execution near June 30;
- Designating one or more individuals to update and review the various project teams' calendars and hold periodic (e.g., weekly or monthly) meetings to keep the teams working towards and meeting target dates;
- Running pilots to confirm that updates were working and can be rolled out by the compliance deadline; and
- Developing contingency plans for the possibility that technology updates would not be ready by the compliance date.
- Training – Firms either started delivering training to staff and supervisors or were in the process of developing such training by, for example:
- Identifying vendors to provide training;
- Planning to train staff prior to the compliance date or later in the implementation process after completing all necessary policy, process and technology changes;
- Using a cross-functional approach to developing training plans, such as collaboration between training and corporate communications departments to determine relevant topics for overall firm communication and training plans; and
- Providing, or planning to provide, training through multiple channels, including newsletters or notices, "lunch and learn" events, dedicated in-person or on-line training, seminars or sessions at firm events (such as sales summits), as well as at regularly scheduled (e.g., monthly) meetings between compliance and business units.
2. Written Supervisory Procedures (WSPs) and Supervisory Systems – Firms were developing written policies and procedures and implementing technological tools to meet their obligations under Reg BI and Form CRS, including:
- Inventory of Changes – Firms identified gaps for which new or amended policies and procedures or supervisory systems need to be developed, including:
- Conducting the inventory by, for example, using “traceability” exercises to review their obligations under Reg BI and then trace those back to existing compliance policies to evaluate what, if any, changes needed to be made or whether new procedures must be created; and
- Categorizing all required changes into tiers, where changes in earlier tiers would be completed prior to the completion of the following tiers.
- WSPs – Firms were planning to or had already made changes to their policies and procedures, but there was significant variation in the scope of these changes and firms’ approaches to them, including:
- Developing substantially new policies and procedures (or planning to do so);
- Implementing modifications to existing policies and procedures (including but not limited to addressing 401(k) plan rollovers; documenting the risk, rewards and costs of recommendations of account types; and categorizing clients and products to determine if products are in clients’ best interest); and
- Relying primarily on either internal resources or outside consultants or counsel to revise existing or develop new policies and procedures.
- Providing clear criteria to determine whether a particular recommendation is in a customer’s best interest; and
- Updating policies covering recommendations of account types when made in a broker-dealer capacity.
- Technology Tools – Even prior to completing their work on policies and procedures, firms initiated efforts to identify and develop supervisory system modifications, including:
- Starting discussions with clearing firms and vendors about their systems’ capabilities;
- Leveraging existing technology tools to monitor compliance with Reg BI obligations by, for example, using existing trade monitoring systems to generate exception reports for excessive trading or unusual commissions or to block transactions; and
- Rolling out systems, tools and reporting on a pilot basis prior to June 30 to confirm they are functioning correctly.
3. Conflicts of Interest – Firms were addressing conflicts of interest requirements by, for example:
- Conflict Inventory – Firms created inventories or logs of conflicts (some of which may have been previously developed), implemented automated tools to track, report and document existing conflicts and initiated reviews of controls to mitigate or eliminate those conflicts.
- Conflicts Committees – Firms relied on existing or created new Conflicts Committees that, for example:
- Were composed of various functions, such as legal, risk, compliance, finance and business unit representatives, to identify existing or potentially new conflicts of interest, for example, if a firm introduced a new product, service or account;
- Worked with other firm committees or sub-committees, subject matter experts and relevant Reg BI workstream(s) to address all new conflicts and changes to existing conflicts; and
- Reviewed presentations by business lines about new products or services and related conflicts.
- Limitations on Products – Firms addressed conflicts of interest related to products, including:
- Creating automatic point-of-sale alerts or “product menus” to organize products by risk;
- Narrowing the selection of products available to registered representatives;
- Placing additional restrictions on less experienced registered representatives; and
- Prohibiting sales of specified products to all firm customers.
- Compensation – Firms planned to or had already started to address product sales that could result in the payment of differential compensation. For instance, sales of proprietary products or products within a particular product category (e.g., mutual funds or variable annuities) may offer higher compensation rates than other products. Firms addressed these conflicts, including:
- Adding compensation caps;
- Leveling the compensation across comparable products within a category;
- Making changes to compensation for certain product lines; and
- Addressing concerns about compensation directly with the product manufacturer or issuer.
- Leveling compensation across products (by, for example, creating a new product compensation model based on neutral factors, such as complexity, cost and time involved in selling each product); and
- Moving from trailing one-month to trailing twelve-month compensation grids.
- Surveillance – Firms updated existing account surveillance or created new surveillance tools to, for example:
- Review for excessive trading or unusual commissions; and
- Address conflicts of interest requirements, including compensation and other forms of recognition.
- Disclosure – Firms had either reviewed and updated existing, or created new, account documentation and customer disclosure forms by, for example:
- Working with their internal technology departments, as well as outside vendors, to confirm revised and new disclosures would be available to customers;
- Creating new schedules of commissions and fees for presentation to prospective customers;
- Developing new processes and, as appropriate, implementing technology solutions to deliver required disclosures at the earliest triggering event, which could be when there is a “call to action” versus at account opening for prospective customers; and
- Preparing summary fact sheets and templates for each product that educate registered representatives on the relevant conflicts of interest standards and other Reg BI implications for each product.
- Use of the Terms “Adviser” or “Advisor” – Firms implemented restrictions relating to the use of the terms “adviser” or “advisor,” depending on the registration status of the firm or its associated persons by, for example:
- Reviewing all of their marketing content to evaluate the use of “advisor” and “adviser;” and
- Developing branch inspection programs and surveillance tools to review email, social media and other sources to confirm that registered representatives who are not investment advisory representatives obtained the relevant state licenses or used new titles.
- Sales Contests – Prior to the adoption of Reg BI or in preparation for the compliance date, firms had prohibited sales contests, sales quotas, bonuses and non-cash compensation practices based on the sales of specific securities or specific types of securities within a limited time period.
4. Form CRS – Firms had started developing their Form CRS and developing related delivery timelines by, for example:
- Drafting – Firms prepared and revised drafts of Form CRS, focusing on conforming to the size limitations and making the form simple to understand for customers. Some firms intended to seek feedback on such drafts from industry forums and conferences.
- Timely Delivery – Firms developed procedures and timelines to provide Form CRS to retail investors within required timeframes, including:
- Working with internal technology departments, vendors, clearing firms and consultants;
- Addressing concerns about providing Form CRS to prospective customers by considering the use of their web portals in the situations where disclosures would need to be provided, but the meeting place is not conducive to traditional delivery methods;
- Evaluating customer needs, preferences and limitations when determining hard copy or electronic delivery methods; and
- Developing processes to capture, supervise and audit the delivery of Form CRS (some larger firms created integrated approaches into their customer relationship management (CRM) systems that reflect the date Form CRS was delivered or a copy of the email sent to the retail investor).
FINRA shares this report to provide firms with information on how some firms are preparing for Reg BI and Form CRS. However, this does not imply that FINRA requires firms to implement any of the practices described above, nor that implementing any of the practices would constitute compliance with Reg BI and Form CRS. FINRA will continue to provide resources to firms to assist them with their efforts to meet the new compliance obligations.
1 See Securities Exchange Act Release No. 86031 (June 5, 2019), 84 FR 33318 (July 12, 2019); see also U.S. Securities and Exchange Commission, SEC Adopts Rules and Interpretations to Enhance Protections and Preserve Choice for Retail Investors in Their Relationships With Financial Professionals (June 5, 2019) (providing overview of Reg BI and list of relevant SEC resources).
2 See Securities Exchange Act Release No. 86032 (June 5, 2019), 84 FR 33492 (July 12, 2019).