On April 7, 2020, the SEC's Office of Compliance Inspections and Examinations (OCIE) issued two Risk Alerts: one focused on examinations of compliance with Regulation Best Interest1 (Regulation BI); and one focused on examinations of compliance with Form CRS.2 Each Risk Alert offers guidance to firms regarding the scope and content of the examinations that will take place after the compliance date of June 30, 2020.3 The following note outlines the Risk Alerts as follows:
- Section 2 Regulation Best Interest
- Section 2.1 provides a brief overview of Regulation BI;
- Section 2.2 highlights important dates and areas of focus for examinations; and
- Section 2.3 summarizes documents, disclosures, and information staff may request during examinations.
- Section 3 Form CRS Examinations:
- Section 3.1 provides a brief overview of Form CRS;
- Section 3.2 highlights important dates and areas of focus for examinations; and
- Section 3.3 provides further detail on how staff may address Delivery and Filing and Content requirements during examinations.
- Section 4 provides an overview of the statement released by FINRA regarding the two Risk Alerts.
II. Regulation Best Interest Examinations
2.1 Overview of Regulation Best Interest
Regulation BI establishes a new standard of conduct for broker-dealers and associated persons, requiring that they act in the best interest of their retail customers when making recommendations about any securities transaction or investment strategy involving securities. The best interest standard can only be satisfied by complying with four component obligations: (i). Disclosure; (ii). Care; (iii). Conflict of Interest; and (iv). Compliance.
2.2 Examination Dates and Areas of Focus
The Risk Alert emphasizes that examinations will likely begin during the first year after the compliance date of June 30, 2020 and will be designed to evaluate: (i). whether firms have made a good-faith effort to establish policies reasonably designed to achieve compliance with Regulation BI and (ii). whether firms have made reasonable progress in implementing those policies and procedures as necessary or appropriate (determined in light of facts and circumstances as well as information learned during the implementation process).
2.3 Examples of Document, Disclosure and Information Requests
The Risk Alert provides examples of documents, disclosures and information that staff may request during initial examinations to determine whether a firm has met the four component obligations of the best interest standard. The Risk Alert also contains an appendix with a sample of a request for information that staff may provide during an examination. Some of the examples from the appendix are as follows:
- General information, including, but not limited to, descriptions of brokerage and non-brokerage account types that retail customers can establish, fees and expenses schedules, compensation information, information regarding any proprietary products sold to retail customers, marketing materials and conflicts of interest documentation.
- Copies of all written policies, procedures, memoranda or other materials regarding compliance with respect to Regulation BI.
- A copy of the firm's relationship summary (or relationship summaries if multiple documents are used) provided to retail customers and all other documents provided to retail customers for the purpose of meeting the Disclosure obligation under Regulation BI.
- Copies of any training materials used to train personnel with respect to Regulation BI.
- Copies of any surveillance and monitoring reports designed to identify recommendations inconsistent with Regulation BI.
- Other documents and information, such as lists of new accounts that have been established, lists of retail investors for whom a customer investment profile was created or updated and blotters containing all trading conducted on behalf of customers.
The Risk Alert appendix is intended to serve only as an example of documents and information that may be requested by staff during an examination. Not every document listed in the appendix will be applicable to every firm, and examinations will be conducted in a manner that reflects the profile of each particular broker-dealer. Firms may wish to consider this appendix, however, while designing their Regulation BI implementation plans and preparing for upcoming Regulation BI examinations.
III. Form CRS Examinations
3.1 Overview of Form CRS
Form CRS requires SEC-registered broker-dealers and investment advisers to provide retail investors with a brief customer or client relationship summary containing information about the firm. Compliance with Form CRS requires that firms file these summaries on an annual basis with the SEC using the Central Registration Depository (Web CRD) or Investment Adviser Registration Depository (IARD) and post the current summary on the firm's website, provided that the firm has one. Example Form CRS mock-ups were included in the Form CRS rule proposal.4
3.2 Examination Dates and Areas of Focus
OCIE will begin examinations after the compliance date of June 30, 2020, and broker-dealers and investment advisers are required to deliver the summary to existing customers and clients by July 30, 2020. The examinations will assess whether firms have made a good-faith effort to implement Form CRS. The Risk Alert provides a summary of the areas that staff may focus on during these examinations, including (i). Delivery and Filing; (ii). Content; (iii). Formatting; (iv). Updates; and (v). Recordkeeping.
3.3 Additional Guidance on Delivery and Filing and Content Requirements
Staff evaluating the Delivery and Filing component may (i). review whether firms have filed and posted the required summary; (ii). evaluate the process for delivering the summaries to new and existing retail investors and iii. review whether policies and procedures address the required summary, delivery process and dates for new and existing investors. Staff evaluating the Content component of the relationship summary may look to ensure it contains (i). all required information and (ii). true and accurate information without omitting any material facts necessary to make disclosures not misleading in light of circumstances in which they are made.5
IV. FINRA Statement Regarding OCIE Risk Alerts
On April 8, 2020, FINRA released a statement regarding the two Risk Alerts.6 In this statement, FINRA noted that it would adopt an approach similar to that which is set forth in the Risk Alerts when examining member firms and their associated persons for compliance with Regulation BI and Form CRS. FINRA expressed its understanding that implementation will be an iterative process, and that examinations will initially focus on assessing whether firms have made a good-faith effort to establish and implement policies and procedures reasonably designed to comply with Regulation BI and Form CRS. Despite this approach, however, FINRA noted that it would still take action in the event that examination staff observes indications of customer harm or conduct that would have violated current FINRA standards, such as the suitability obligations set forth in FINRA Rule 2111.7
Both OCIE and FINRA guidance signal to firms that they should expect early examination of Regulation BI policies and procedures, with a view to ensuring good-faith compliance, and good-faith effort to comply with the spirit of Regulation BI and Form CRS. In this respect, unspoken is that the SEC and FINRA examiners will themselves be learning as they examine the practices of the various firms. As we have seen with past "roll out" examinations of important new regulations, lessons learned by examiners during initial post-effective-date examinations are sometimes later cited as best practices by FINRA and the SEC.7 As firms move toward the compliance date for Regulation BI and Form CRS, it is important to stay abreast of new guidance and to make necessary adjustments. The Shearman & Sterling team is paying close attention to these developments, and we are happy to respond to any questions or concerns you may have.
1. Office of Compliance Inspections and Examinations, "Examinations that Focus on Compliance with Regulation Best Interest" (April 7, 2020) available at: https://www.sec.gov/files/Risk%20Alert-%20Regulation%20Best%20Interest%20Exams.pdf. For more information regarding regulation BI and Form CRS, you may wish to refer to our client notes: "Raising the Bar? SEC Proposes Broker-Dealer Standard of Care and Guidance on Investment Advisers' Fiduciary Standard" (Apr. 24, 2018) available at: https://www.shearman.com/perspectives/2018/04/sec-proposes-broker-dealer-standard-of-care-and-guidance, "Raising The Bar: Sec Adopts Broker-Dealer Standard Of Care and Guidance on Investment Advisers' Fiduciary Standard" (June 27, 2019) available at: https://www.shearman.com/perspectives/2019/06/sec-adopts-broker-dealer-standard-of-care-and-guidance-on-investment-advisers-fiduciary-standard, and "SEC Publishes Frequently Asked Questions on Regulation Best Interest" (Feb. 19, 2020) available at: https://www.shearman.com/perspectives/2020/02/sec-publishes-frequently-asked-questions-on-regulation-best-interest.
2. Office of Compliance Inspections and Examinations, "Examinations that Focus on Compliance with Form CRS" (April 7, 2020) available at: https://www.sec.gov/files/Risk%20Alert%20-%20Form%20CRS%20Exams.pdf.
3. The Risk Alerts each note that while the SEC understands that COVID-19 has created challenges for firms, the SEC currently has not extended the compliance date for either Regulation BI or Form CRS.
4. Form CRS Relationship Summary; Amendments to Form ADV; Required Disclosures in Retail Communications and Restrictions on the use of Certain Names or Titles, Exchange Act Release No. 34-83063 (Apr. 18, 2018) at Appendices C-E https://www.sec.gov/rules/proposed/2018/34-83063.pdf. In addition, current Form CRS and corresponding instructions are available at https://www.sec.gov/rules/final/2019/34-86032-appendix-b.pdf.
5. FINRA Statement on SEC's OCIE Risk Alerts for Reg BI and Form CRS (April 8. 2020) available at https://www.finra.org/media-center/newsreleases/2020/finra-statement-secs-ocie-risk-alerts-reg-bi-and-form-crs.
6. FINRA has announced proposed amendments to Rule 2111 and certain other FINRA rules in light of Regulation BI. For additional information on these proposed amendments, you may wish to refer to our client publications: " FINRA Proposes Amendments to Suitability and Non-Cash Compensation Rules in Response to Regulation Best Interest".
7. See, e.g., Staff Summary Report on Examinations of Information Barriers: Broker-Dealer Practices under Section 15(g) of the Securities Exchange Act of 1934 (Sept. 27, 2012) available at https://www.sec.gov/about/offices/ocie/informationbarriers.pdf.
Originally Published 17 April, 2020
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.