On June 30, the Securities and Exchange Commission finally implemented its long-awaited Regulation Best Interest, or Reg BI. This new regulation addresses the obligations of SEC-registered firms and their representatives to make recommendations that are in their retail customers' best interest and that do not place the firm or broker's interests above the customer's.
Specifically, Reg BI imposes four primary obligations when making recommendations: (1) disclosure obligations, (2) care obligations, (3) conflict of interest obligations, and (4) compliance obligations.
SEC and FINRA examinations will now evaluate compliance with Reg BI. Both the SEC and FINRA have stated that their examiners will determine whether there have been "good faith" efforts to comply with Reg BI. Perfection is not required, but firms must demonstrate that they are attempting to implement each of the new Reg BI obligations.
Of Reg BI's four obligations, the conflict of interest obligation is arguably the key component. Importantly, this obligation is applicable only to firms, not directly to its registered representatives. This is because firms are the entities responsible for implementing and enforcing plans that ensure compliance with this obligation.
Here are some critical elements of the conflict of interest obligation and ways firms can demonstrate "good faith" in attempting to comply with them.
Reg BI's conflict of interest obligation requires firms to establish and enforce policies and procedures identifying conflicts of interest, which are loosely defined as situations in which a firm or representative consciously or unconsciously puts their own or their firm's interests before the client's interest.
For example, when making a recommendation across products that are in a similar asset class, choosing to recommend a higher commission option would fall into the category of a conflict of interest that must be identified under Reg BI. Identifying actual or potential conflicts of interest in recommendations given to customers is critical to fulfilling the rest of this obligation.
Reg BI requires firms to put their new conflict-identifying policies and procedures in writing. In this first wave of examinations, regulators likely will not treat firms harshly if every new policy and procedure has not been complied with to the letter; however, not having written policies and procedures in place at all will likely result in an examiner finding a lack of good faith.
In addition, registered representatives and their staff need to have received, been trained on, and be familiarized with these conflict identification policies and procedures. FINRA will not require firms to demonstrate that their representatives know and comply with each of these new policies perfectly, but familiarity with the new polices and steps taken toward full compliance likely will be required.
Ideally, conflicts of interest — which place the firm's or broker's own interest ahead of the customer's — should be completely eliminated by firm policy and procedure changes, but if they cannot, then they must be disclosed to customers.
