Time to Comply: No ‘Grace Period’ Likely for Reg BI

Morningstar recently surveyed nearly 100 broker/dealers (B/D) and found almost one-third either knew their firm had not or were unsure if their firm had taken “any proactive steps” to address their product lineup in light of Regulation Best Interest (Reg BI) compliance.

Reflecting on the survey results, Matt Radgowski, head of adviser solutions for Morningstar, tells PLANADVISER the U.S. Securities and Exchange Commission’s (SEC) Reg BI has been a dominant topic so far in 2020 in his numerous ongoing conversations with registered investment advisers (RIAs) and broker/dealers.

Radgowski says he is commonly called on to discuss the ways in which Reg BI goes further than the current suitability standard from the Financial Industry Regulatory Authority (FINRA). Advisers are warming to the fact that Reg BI imposes significant new care obligations that include evaluating cost as well as reasonable alternative investments for investors—and a need to carefully address more complex use cases, such as account rollovers into individual retirement accounts (IRAs). Ultimately, he expects, Reg BI “will require brokers to rethink the role of the adviser,” meaning the Reg BI framework may discourage commission-based business.

Compliance Deadline Looming

As the name suggests, Reg BI establishes a “best interest” standard of conduct for broker/dealers and associated personnel when they make a recommendation to a retail customer (i.e., an individual person) of any securities transaction or investment strategy involving securities, including recommendations of types of accounts. Tied into the broad rulemaking package is a related clarification and restatement of the SEC’s understanding of the fiduciary duty applying to investment advisers under the Investment Advisers Act.

As a general matter, the SEC will begin full enforcement of Reg BI on June 30, and the leadership at the market regulator has pretty clearly indicated there will be no “grace period” for compliance after that date.

“Advisers’ and brokers’ preparatory activity has really ramped up over the last month or two,” Radgowski says. “The compliance efforts are moving beyond the initial conversations into the realm of action. Based on the conversations I have been having, many firms have made progress preparing their customer relationship summary forms and other new disclosures. But they are still in the middle of doing the harder work of looking at their processes and procedures and evaluating what ‘best interest service’ will mean for their firm.”

As one might expect, there are some common practical areas emerging where firms are facing challenges with compliance assessments, Radgowski says.

“For example, it is a difficult balancing act to decide how much discretion and flexibility home offices will give to their outside advisers and representatives,” he explains. “How much control will the home office maintain in terms of product choices, client service models, fee structures, etc.? Who will define what best interest means for the firm? Creating the customer relationship summary form was just the first step. Actually changing workflows and systems is a lot harder.”

In Radgowski’s experience, some firms, particularly on the brokerage side of the business, are feeling pressure to evolve their service models in some potentially fundamental ways.

“I look at Regulation Best Interest as basically an amplifier of the forces that have been at play in the industry for a while, which have been leading to more advisory-based business models,” Radgowski says. “Fee and commission compression is hitting the advisory and brokerage world in a meaningful way. So we are seeing this whole industry shift towards scale and building more sustainable revenue. It’s all generating a highly competitive framework where planning-focused practices make a lot of sense.”

No Time to Wait

Firms should be well on their way toward Reg BI compliance at this stage, but for those that have been dragging their feet, FINRA suggests tackling the following questions. Any “no” answers will have to be addressed by June 30. 

• Does your firm have procedures and training in place to assess recommendations using a best-interest standard?
• Do your firm and your associated personnel apply a best-interest standard to recommendations of types of accounts?
• If your firm and your associated personnel agree to provide account monitoring, do you apply the best-interest standard to both explicit and implicit hold recommendations?
• Do your firm and your associated personnel consider the express new elements of care, skill and costs when making recommendations to retail customers?
• Do your firm and your associated personnel consider reasonably available alternatives to the recommendation?
• Do your firm and your registered representatives guard against excessive trading, irrespective of whether the broker/dealer or associated personnel “controls” the account?
• Does your firm have policies and procedures to provide the disclosures required by Reg BI?
• Does your firm have policies and procedures to identify and address conflicts of interest?
• Does your firm have policies and procedures in place regarding the filing, updating and delivery of Form CRS?