Reg BI debuts under cloud of uncertain enforcement

After years of discussions and preparations, the Securities and Exchange Commission's best-interest standard took effect June 30, ushering in a new regulatory regime for financial service professionals.

But in the coming weeks and months, it's anyone's guess as to how the SEC's rule package will be enforced, especially in the midst of a pandemic, sources said. Commonly known as Reg BI, the package and its centerpiece best-interest standard, which the SEC adopted in June 2019, aims to compel brokers to put clients' financial interests ahead of their own and requires them to mitigate financial conflicts.

"Because it's a new rule with no real regulatory enforcement history, everyone is doing what they think needs to be done but at the same time waiting for additional regulatory guidance to understand where their programs may need to even be scaled back, where they've gone above and beyond what regulators may be expecting," said Joshua Uhl, a New York-based senior manager in Deloitte LLP's financial services practice.

Examinations could start any time now.

In April, the SEC's office of compliance inspections and examinations issued two risk alerts providing broker-dealers and investment advisers with advance information about the expected scope and content of the initial examinations for compliance with Reg BI and Form CRS.

For Reg BI, initial examinations will assess whether broker-dealers have made a "good faith effort to implement policies and procedures reasonably designed to comply" with the regulation, the SEC said. And for those subject to Form CRS, which necessitates that firms disclose to retail investors the nature and scope of their services, the types of fees customers would incur, the conflicts of interest faced by the firm and the firm's disciplinary history, examinations will assess whether they have made "a good faith effort" to implement the regulation.

"I think they are going to give the industry an opportunity to comply in the way they feel we should," said Kevin Carroll, managing director and associate general counsel for the Securities Industry and Financial Markets Association in Washington. "That process will involve getting initial feedback where they think we need to do more and take further action."

Separately, on the eve of Reg BI's compliance date, the Department of Labor, in an effort to harmonize regulations with the SEC, unveiled a proposed prohibited transaction exemption that would permit investment advice fiduciaries to receive compensation for their advice.

In mid-June, SEC Chairman Jay Clayton confirmed the June 30 compliance date and called special attention to rollover and withdrawal recommendations. "Firms should be particularly attuned to their regulatory obligations in light of the additional flexibility Congress recently provided investors to take withdrawals from certain accounts," he said in a statement referring to the Coronavirus Aid, Relief and Economic Security Act, which made it easier for participants to withdraw funds from 401(k) plans.

Rollover and withdrawal advice is going to be an important area for the SEC to examine and review, which could lead to some firms scaling back their efforts in those areas, said Lawrence P. Stadulis, co-chairman of the fiduciary governance group at Stradley Ronon Stevens & Young LLP in Washington. "Some firms are going to be shying away completely from rollover-type advice, other firms are going to have policies and procedures that very strictly limit and clarify circumstances under which they can render the advice," he said. "There's no prohibition so I don't see it completely going away."

Many firms already had heightened documentation requirements around rollover recommendations following the now-defunct Obama-era Department of Labor fiduciary rule, Mr. Uhl said. "So for many firms it's not that large of a delta for them; however, I think Clayton's guidance … says the retirement assets remain a predatory priority for the regulators," he added.

Kurt Schacht, managing director of the standards and financial market integrity division at the CFA Institute in Washington, said Reg BI could lead to better outcomes for clients. "Hopefully there will be a more explicit discussion and an explicit statement on what it's going to cost and the purpose of actually doing a rollover," he said. "I think the investor will be in a better position to decide if this makes sense for (them) to do."

Given the complexity of Reg BI and Form CRS, firms are likely to get "greater latitude" in the next few months, said Daren R. Domina, a partner in the investment management and private equity practice groups and head of the broker-dealer regulatory practice group at law firm Haynes and Boone LLP in New York. "I would speculate that the early enforcement cases will be more along the lines of recklessness or a reckless disregard of a firm's responsibilities or a high bar of a lack of sufficient disclosures or sufficient policies or procedures," Mr. Domina said.

Karen Barr, president and CEO of the Investment Advisers Association in Washington, said her team has been holding weekly calls with its member firms to assist them in preparing their disclosure documents. Prior to Reg BI, registered investment advisers were already required to act in the best interest of their clients, but the Form CRS disclosures apply to both advisers and broker-dealers.

"We understand that (the SEC's) OCIE examiners will likely look at Form CRS as part of regular examinations, and we appreciate OCIE's public statement that examiners will be looking for reasonable good faith efforts to implement Form CRS," Ms. Barr said. "Firms want to get it right."

In light of the pandemic, the SEC will likely conduct initial exams remotely and focus its attention on reviewing submitted materials, Mr. Stadulis said. "It seems unlikely they're going to go in and do full-blown compliance exams to see mechanically how (firms) comply with the policy, but rather that they have them and they're reasonable," Mr. Stadulis said.

Officials at the Financial Industry Regulatory Authority, which will work with the SEC to enforce Reg BI, reiterated in a July 7 podcast on the regulator's website that initial examinations will focus on firms' policies and procedures and "good faith" efforts.

"And then as we and the SEC and firms gain experience with both Reg BI and Form CRS, then we'll start doing deeper dives to make sure that all of the different obligations are being met," said James S. Wrona, FINRA's vice president and associate general counsel. "And we'll probably have a better sense then of what works and what doesn't work, and firms are going to take the same approach."

Preparing for Reg BI compliance over the past few months has been challenging as the pandemic and racial justice protests gripped the nation, industry stakeholders said during a SIFMA webinar in June. "To get into the mindset to focus on Reg BI, I think is a challenge for home-office people, for the field people, for everybody," said Lee Thoresen, Minneapolis-based senior counsel, head of regulatory and transactional at RBC Wealth Management Inc., during the webinar. "Just the ability to prioritize when you're feeling like it may not be a global priority is a challenge, and I think that it's something that I can sense amongst my team. (However), we have no choice, we have to push through, but it is something to acknowledge and something to make sure that you're taking care of yourself on the other side of things so that you can get through and push to the deadline."

Hans Schemmel, director of retirement and insurance-based solutions at Bank of New York Mellon's Pershing unit, added during the webinar that employees working from home are balancing more responsibilities than normal on a typical weekday, which makes compliance training difficult. "For us as an industry to say 'we're going to shift and start training people on (Reg BI) in this new way, which is all via Zoom or WebEx or whatnot'… I think these are the challenges that we all face going forward."

Looking ahead, Jillian Enoch, vice president of advocacy at SIFMA in Washington, said firms will likely make changes "to refine the actual mechanics behind things like documentation and surveillance."

Mr. Uhl noted that there's only so much a firm can do in preparing to comply with a regulation such as Reg BI. "So on day two what we want to do is really take another look at everything that we've implemented and think about how we make that a better experience for our advisers, for our customers and enhance it in a way that makes it easier to be compliant with the rule," he said.

That work is just getting started.