Firms must demonstrate a "good faith effort" to comply.

Last month, SEC Chairman Clayton issued a public statement communicating that firms should not expect a delay of the June 30, 2020 compliance date for Regulation Best Interest (Reg BI) and Form CRS.1  While the Chairman's statement acknowledged the challenges that firms are facing and the significant resources being allocated to respond to the COVID-19 outbreak, the SEC will not provide an extension. That said, the Chairman suggested that regulators may show some restraint in their examination of firms, at least in the initial post-June 30th period, stating that "examiners will be focusing on whether firms have made a good faith effort to implement policies and procedures necessary to comply with Reg BI."2  

Shortly after the Chairman's statement, the SEC's Office of Compliance Inspections and Examinations (OCIE) released Risk Alerts with information about the scope and content of initial examinations after the compliance date.3  Consistent with the Chairman's statement, OCIE stated that initial examinations will focus on assessing whether firms have made "a good faith effort" to implement policies and procedures reasonably designed to comply with Reg BI, including the operational effectiveness of policies and procedures. Where compliance programs are not fully implemented by June 30th, firms should be able to demonstrate "reasonable progress."4  

Separately, FINRA made its own announcement that FINRA examiners will take the same approach as set forth in the SEC Risk Alerts when FINRA examines broker-dealers and their associated persons for compliance with Reg BI and Form CRS. 

With the June 30th deadline fast approaching, we highlight a few key takeaways from the Chairman's statements, OCIE's Risk Alerts and practical considerations for firms. 

What will the SEC and FINRA expect on June 30, 2020? 

Although the regulators have articulated a "reasonable progress" and "good faith effort" standard, they still expect firms to have completed much of the heavy lifting by Day 1. The SEC's initial Reg BI examination program will evaluate whether firms have, among other things, (i) developed policies and procedures reasonably designed to achieve compliance with Reg BI, and (ii) made "reasonable progress" in implementing these policies and procedures. 

The SEC's initial Form CRS examination program will, among other things, (i) review whether the firm has filed the Form CRS with the SEC, (ii) evaluate the firm's process for delivering the CRS to existing and new retail investors, and (iii) assess whether the Form CRS includes all the required information and is formatted in accordance with the instructions.

OCIE's Risk Alerts identify specific categories of documents they will request to assess firms' compliance. Firms should anticipate requests from OCIE for these materials and prioritize them, to the extent relevant. These categories of documents include the following: (i) written policies and procedures for complying with the disclosure, compliance and care obligations of Reg BI and disclosure obligations for Form CRS; (ii) documentation relating to customers' investor profiles; (iii) relevant surveillance reports to identify recommendations that are inconsistent with the care obligation; (iv) descriptions of processes for remediation of noncompliance; (v) training materials; (vi) procedures for periodic review and testing; and (vii) the Reg BI and Form CRS disclosures themselves.

In addition to the above, firms should anticipate "sampling" requests from OCIE, which may include the following requests for information: (i) a list of new accounts established for individual customers that identifies the date the Form CRS and Reg BI disclosures were delivered for each such account and whether the account type was recommended, among other things; (ii) a blotter of all trades for individual customers; and (iii) a list of retail customers for which a customer investment profile was created or updated and the date this information was received.

How can my firm demonstrate that we made a "good faith" effort to comply by June 30, 2020?

Whether a firm has made a "good faith" effort will depend on the facts and circumstances applicable to the firm. Specifically, the SEC will take into account the impact of the COVID-19 outbreak and the impact on the firm's operations, the size and nature of the broker-dealer's business, and the firm's efforts before the COVID-19 outbreak. The Chairman stated that he expects that "the Commission and the staff will take the firm-specific effects of such unforeseen circumstances (and related operational constraints and resource needs) into account in our examination and enforcement efforts."6  

To evidence that the firm made good faith efforts to comply, firms may consider the following steps:

  • Documentation of compliance efforts and resources allocated to Reg BI and Form CRS implementation. First, firms should document compliance efforts and resources allocated to Reg BI and Form CRS leading up to national, state, and local health and safety directives as well as the firm's efforts and resources available after such orders. This information will be useful context for the overall state of the firm's Reg BI and Form CRS programs. If applicable, this information will also support the narrative that but for the outbreak, the firm would be on track. 
  • Documentation of disruptors relating to the pandemic. In connection with the above, firms should document systems and operational difficulties experienced arising from or exacerbated by the COVID-19 pandemic and the related government shelter-in-place orders. 
  • SEC outreach. To the extent a firm is unable to make certain filings or meet other requirements because of disruptions caused by COVID-19, including as a result of efforts to comply with health and safety directives, the firm should consider notifying the SEC in advance of the compliance date and documenting these issues. In his statement, the Chairman noted that "[t]o the extent that a firm is unable to make certain filings or meet other requirements because of disruptions caused by COVID-19, including as a result of efforts to comply with national, state or local health and safety directives and guidance, the firm should engage with us."7  

Our implementation plans for the last three months are no longer feasible—what do we do?

The COVID-19 outbreak took everyone by surprise, and the months leading up to a new rule are always the most important. No one anticipated that the final three months leading up to Reg BI's implementation would be so challenging. Many firms' plans to roll out new technology and compliance systems may no longer be feasible. Building on the "good faith efforts" standard, firms may consider the following in planning for the upcoming compliance date: 

  • Determine what the firm can do to reasonably comply with Reg BI on June 30. Firms need not (and likely cannot) devote the resources necessary to develop a perfect program. Many systems and planned overhauls may need to be put on hold until the current COVID-19 crisis abates. 
  • Leverage existing policies and procedures and frameworks to the greatest extent practicable (such as current suitability procedures and surveillance, disclosure processes, and conflict review processes), recognizing that additional or enhanced policies and procedures may be implemented after the compliance date. The SEC's Reg BI Adopting Release recognized that firms may build off existing systems and procedures, as opposed to creating new ones.8
  • Training. Firms may not be able to conduct planned training by the June 30th compliance deadline. To the extent possible, firms should move forward with remote training to registered representatives, supervisors and all other persons responsible for implementing various aspects of Reg BI and Form CRS. Firms may also send alerts and/or internal compliance bulletins to their financial advisers emphasizing the new requirements of the care obligation. These alerts should communicate the new requirements and the firm's expectations.
  • Do not over promise. Be thoughtful in drafting disclosures, policies and procedure, but do not over promise and impose obligations that the firm is not required to do. For example, the regulators have consistently said that there is no obligation to document every recommendation. If a firm, nevertheless, is planning to go beyond the regulatory requirement and document every recommendation, this should be a Day 2 objective, unless the firm is sure it can fully comply with this requirement on Day 1. 

Can we expect more guidance from the SEC? 

The staff of the SEC's Trading and Markets and Investment Management Divisions are currently considering a number of interpretive questions in addition to those they have already answered.9  In some instances, these outstanding questions have a significant impact regarding whether a firm or line of business is subject to Reg BI or Form CRS at all. Unfortunately, the SEC staff has provided little information regarding when firms and the industry can expect answers to these gating questions. While we expect the SEC and its staff will continue to provide guidance over the coming weeks, it is unclear when this guidance is to be expected and what it will concern. 

Footnotes

1. Investors Remain Front of Mind at the SEC: Approach to Allocation of Resources, Oversight and Rulemaking; Implementation of Regulation Best Interest and Form CRS, U.S. Securities Exchange Commission Chairman Clayton (April 2, 2020) ("Chairman's Statement").

2. Id.

3.Examinations that Focus on Compliance with Regulation Best Interest (April 7, 2020) ("Reg BI Risk Alert") and Examinations that Focus on Compliance with Form CRS (April 7, 2020) ("Form CRS Risk Alert"). 

4. Reg BI Risk Alert. 

5. FINRA Statement on SEC's OCIE Risk Alerts for Reg BI and Form CRS (April 8, 2020). 

6. Chairman's Statement, supra note 1. 

7. Id.

8. See Regulation Best Interest, Exchange Act Release No. 86031 (June 5, 2019) ("In order to comply, broker-dealers could adjust their current systems of supervision and compliance, as opposed to creating new systems" and "Broker-dealers would have the ability to update [their existing] policies and procedures to comply with the Compliance Obligation, rather than create new policies and procedures"). 

9. See Frequently Asked Questions on Regulation Best Interest, Division of Trading and Markets (last modified February 11, 2020); Frequently Asked Questions on Form CRS, Divisions of Trading and Markets and Investment Management (last updated February 11, 2020).  

Originally published May 13, 2020 .

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.