Regulation Best Interest: SEC 2020 Examination Priorities—Examinations for Compliance With Reg BI and the Investment Adviser Interpretation

The SEC has issued its final Regulation Best Interest (Reg BI), Form CRS Rule, RIA Interpretation and Solely Incidental Interpretation. I am discussing the SEC’s guidance in a series of articles entitled “Best Interest Standard of Care for Advisors.”

My last post on Best Interest for Advisors #22 discussed the FINRA 2020 Examination Priorities (https://www.finra.org/sites/default/files/2020-01/2020-risk-monitoring-and-examination-priorities-letter.pdf) provisions on examinations for compliance with Reg BI and Form CRS. This article discusses the SEC’s 2020 Examination Priorities (https://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2020.pdf) provisions on compliance with Interpretation Regarding Standard of Conduct for Investment Advisers (“RIA Interpretation”) and Form CRS (as well as compliance by broker-dealers with Reg BI).

As background, the SEC starts their discussion on those topics by explaining:

The Commission’s June 2019 adoption of Regulation Best Interest, the Interpretation Regarding Standard of Conduct for Investment Advisers, and the Form CRS Relationship Summary will have a direct impact on the retail investor experience with broker-dealers and RIAs. Regulation Best Interest requires broker-dealers, or a natural person who is an associated person of a broker or dealer, among other things, to act in the best interest of their retail customers when making a recommendation of any securities transaction or investment strategy involving securities without placing their financial or other interests ahead of the interests of the retail customer. The standard of conduct draws from key fiduciary principles and cannot be satisfied through disclosure alone. The Interpretation Regarding Standard of Conduct for Investment Advisers reaffirms, and in some cases clarifies, aspects of an RIA’s fiduciary duty that comprises duties of care and loyalty to their clients.

Comment: While the SEC may view their guidance for investment advisers as “reaffirming” and “clarifying”, the RIA Interpretation imposes some requirements that, at the least, are inconsistent with common practices by investment advisers. As a result, and to prepare for these examinations, RIAs should compare the Interpretation to their current practices and, in particular, to their disclosures, including their ADV disclosures.

The SEC then goes on to explain that examinations in the first half of 2020 are designed to help broker-dealers understand and implement the new rules-until they are applicable on June 30. But after that date, the SEC will examine for compliance. However, the applicability date for the RIA Interpretation was July 12 of last year and, as a result, the SEC will be examining investment advisers for compliance immediately. Here it is in the SEC’s own words:

In order to assist firms with planning for compliance with the new rules, the SEC established an inter-Divisional Standards of Conduct Implementation Committee, of which OCIE representatives are members. To further assist broker-dealers before the June 30, 2020 compliance date for Regulation Best Interest and Form CRS, OCIE will engage with broker-dealers during examinations on their progress on implementing the new rules and questions they may have regarding the new rules. After the compliance dates, OCIE intends to assess implementation of the requirements of Regulation Best Interest, including policies and procedures regarding conflicts disclosures, and for both broker-dealers and RIAs, the content and delivery of Form CRS. Moreover, OCIE has already integrated the Interpretation Regarding Standard of Conduct for Investment Advisers into the IAIC examination program.

Comment: To summarize, the applicability date for Reg BI for broker-dealers is June 30, 2020. The compliance date for RIAs was July 12, 2019 (and as a result, investment advisers are already expected to be in compliance with the SEC Interpretation). While Reg BI will only apply to retail customers, the RIA Interpretation applies to all of an investment adviser’s clients. But Form CRS applies to both broker-dealers and investment advisers beginning on June 30, 2020 . . . with regard, in both cases, to “retail investors”.

FINRA’s 2020 Examination Priorities listed specific questions that it will ask broker-dealers. However, the SEC did not list specific issues in its examination priorities. However, in other discussions in the Priorities, the SEC gave an indication of its areas of interest. For example, the SEC said:

It is critically important that registered firms provide investors with the disclosures required by the federal securities laws, including those relating to fees and expenses, and conflicts of interest, which will help enable the investing public to make better informed choices. Registered firms must effectively implement controls and systems to ensure those disclosures are made as required and that a firm’s actions match those disclosures.

Comment: The SEC has materially changed its expectations of conflict of interest disclosures by investment advisers. One need look no further than the Share Class Selection Disclosures Initiative (SCSDI) for evidence of that. Any investment adviser who is not aware of the changed expectations should consult with his or her attorney to revise and expand the disclosures in the ADV (and possibly elsewhere).

The SEC continued:

Examinations will focus on recommendations and advice given to retail investors, with a particular focus on: (1) seniors, including recommendations and advice made by entities and individuals targeting retirement communities; and (2) teachers and military personnel.

Comment:  The SEC amplified the comment about seniors by saying:  OCIE will again emphasize the protection of retail investors, particularly seniors and those saving for retirement. While not explicit, that could easily be seen as advice to retirees about investing (e.g., advice to IRA owners) and recommendations about rollovers from retirement plans to IRAs.

Finally, at least for this article, the SEC said:

OCIE will also continue to examine RIAs to assess whether, as fiduciaries, they have fulfilled their duties of care and loyalty. This will include assessing, among other things, whether RIAs provide advice in the best interests of their clients and eliminate, or at least expose through full and fair disclosure, all conflicts of interest which might incline an RIA, consciously or unconsciously, to render advice which is not disinterested. That RIAs are acting in a manner consistent with their fiduciary duty and meeting their contractual obligations to their clients is paramount to maintaining investor confidence in the markets and investment professionals. OCIE, therefore, will continue to focus on risks associated with fees and expenses, and undisclosed, or inadequately disclosed, compensation arrangements.

Comment: For those that haven’t been paying close attention to recent SEC pronouncements and litigation, the SEC is taking the position that investment advisers have at least two broad duties:  the duty of care (stated above “advice in the best interests of their clients”) and the duty of loyalty (e.g., a duty to fully and fairly disclose material facts about conflicts of interest). The SEC’s focus, for the moment, seems to be primarily on duty of full and fair disclosure (which is more demanding than many investment advisers believe, both in breadth and detail). However, the duty of care is also an issue for investment advisers, for example, where clients are placed in more expensive investments and, as a result, the advisers receive payments from a custodian or, for an adviser with a dually registered broker-dealer recommending a more expensive share class that pays 12b-1 fees).

That’s it for now. But, for context, we are closer to the beginning on these matters than we are to the ending. In other words, there is more to come.

The material contained in this communication is informational, general in nature and does not constitute legal advice. The material contained in this communication should not be relied upon or used without consulting a lawyer to consider your specific circumstances. This communication was published on the date specified and may not include any changes in the topics, laws, rules or regulations covered. Receipt of this communication does not establish an attorney-client relationship. In some jurisdictions, this communication may be considered attorney advertising.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Faegre Drinker.