Preparing for Reg BI Exams: The Disclosure Obligation

Material fees and costs that the customer will be charged for the transactions, holdings and accounts. Reg BI does not require firms to disclose fees and costs at a granular level for each customer. Instead, it is sufficient to provide standardized numerical amounts (reasonable dollar or percentage ranges). Disclosures should clearly and accurately convey when and why a fee is being charged, and if the fee is being paid per transaction or on a quarterly basis.

Disclosures should also accurately describe commissions and markup fees and avoid vague terms like "handling fees" or "handling services." Fees should be periodically reviewed with customers.

The scope of the services that the firm's RRs can recommend, including any material limitations on securities or investment strategies. Material limitations to disclose include if an RR can only offer proprietary products, certain asset classes, only products from a select list of issues, and limitations on IPOs to certain customers.

Disclosures related to recommendations must also include (1) the bases for the recommendation, which should include the recommended investment approach, philosophy or strategy; (2) the associated risks of the recommendation in standardized items; and, (3) any other material facts given the facts and circumstances of the recommendation and the customer.

Whether the account will be monitored and frequency of monitoring, and the requirements to maintain an account. For existing customers, it is necessary to describe the type of account monitoring services that will be provided (if any). New and existing customers should also be aware of any barriers or requirements for opening accounts (account balance requirements, asset requirements). Fees associated with low balance requirements must also be identified.

Further disclosures are required under the Conflict of Interest Obligation, including: (1) any interest that "might incline" a RR to make a recommendation; (2) conflicts associated with proprietary products; (3) compensation for RRs; and (4) fees and costs borne by the customer.

Delivery of the Disclosures

Reg BI imposes certain delivery requirements. Mailing disclosures to a customer satisfies the Disclosure Obligation, but the time and expense makes physical delivery unrealistic. To satisfy the Disclosure Obligation via electronic delivery: (1) notice must be provided to the customer that the information is available electronically; (2) the access that is provided must be comparable to what would have been provided to the customer in paper format via physical mail or hand delivery; and (3) there must be evidence of delivery.

To satisfy the "evidence of delivery" prong, it is a best practice to obtain the informed consent of the customer to deliver the documents electronically. Instead of including generic language in an account opening document related to consent for electronic delivery, it is a best practice to have a separate Informed consent form that a customer must execute prior to the electronic delivery of documents.

Once the customer consents to electronic delivery, the information must be sent correctly. Firms must send disclosures either as an email attachment or as an embedded hyperlink that jumps directly to the disclosure.  Merely hyperlinking the disclosures on the firm's website or emailing the customer that the disclosures are available on the firm's website is insufficient to satisfy delivery requirement.

What to Expect From SEC and FINRA Exams

Initially, both the SEC and FINRA will be focused on whether or not firms and their RRs have engaged in "good faith" efforts to comply with Reg BI. As it relates to the Disclosure Obligation, examinations will focus on how firms meet the obligation to disclose material facts to the customer and will likely assess the content and timing of the disclosures.

Simply adopting policies and procedures will not demonstrate firm's "good faith" effort to comply. Firms should continually review and test internal policies and procedures for compliance by RRs and for effectiveness. If a policy or procedure is not working or RRs are failing to comply with the policies and procedures, address it before your SEC or FINRA exam begins — either further clarify the policies or procedures, provide further training to RRs, or implement corrective actions with RRs.

Meredith Jowers Lees is a commercial litigation attorney in the Birmingham office of RumbergerKirk. She focuses her practice on commercial litigation with extensive experience in securities and financial litigation. In addition, her diverse practice includes defense of insurance companies in bad faith/fraud claims and other coverage claims. Meredith can be reached at (205) 721-2815 or [email protected].