Locke Lord QuickStudy: OCIE Releases Guidance on Broker-Dealer Regulation Best Interest Examinations

FUNDamentals™ Series
Locke Lord LLP
April 10, 2020

On April 7, 2020, the ‎ U.S. Securities and Exchange Commission’s ‎Office of Compliance Inspections and Examinations (“OCIE”)‎ released a Risk Alert disclosing its anticipated examinations related to the compliance of broker dealers with Regulation Best Interest.This Risk Alert, entitled Examinations that Focus on Compliance with Regulation Best Interest, provides broker-dealers with information about the scope and the content of the initial examinations with respect to Regulation Best Interest.  We have previously discussed the requirements under Regulation Best Interest including the Disclosure Obligation, Care Obligation, Conflict of Interest Obligation, and Compliance Obligation which apply to broker-dealer dealing with retail customers, as well as the [requirements under the new Form CRS.

We note that while OCIE recognizes the challenges surrounding examinations that may arise due to the COVID-19 and has indicated a willingness to work with firms on challenges related to COVID-19, OCIE has not extended the compliance deadline of Regulation Best Interest, which remains June 30, 2020.

Following the compliance date, OCIE will begin examinations of firms to assess their compliance with and implementation of Regulation Best Interest. These examinations will likely occur during the first year after the compliance date. These examinations will focus on evaluating whether broker-dealers have made good faith efforts to establish policies and procedures designed to achieve compliance with Regulation Best Interest and whether firms have made reasonable progress in implementing such policies and programs.

Areas of focus in the examinations are likely to center on the core obligations of a broker-dealer to act in the best interests of the retail customer at the time the recommendation is made. OCIE has provided specific examples of disclosures which they may look for, including:

  • Disclosure Obligation – OCIE may assess how the broker-dealer has disclosed material facts relating to the scope and terms of the client relationship, such as the capacity in which the recommendations are being made, material fees and costs related to retail customers transactions, holdings, and accounts, and material limitations on securities or investment strategies which may not be recommended to the retail customer.To assess this obligation, OCIE may review fee schedules, disclosures made to retail clients regarding fees, disclosures related to material limitations on accounts or services recommended, lists of proprietary products, and the broker-dealer’s compensation methods.

  • Care Obligation – OCIE may asses how the broker-dealer has exercised reasonable diligence, care, and skill when making a recommendation to a retail customer, which includes an understanding of the potential risk, rewards and costs associated with a recommendation, in light of the retail customer’s investment profile. To assess this obligation, OCIE may review information collected from retail customers to develop their investment profiles (including new account forms and correspondence), information regarding the broker-dealer’s process for forming reasonable beliefs about recommendations meeting the best interest of the retail customer (such as the factors used by the broker-dealer in assessing potential risks, rewards, and costs associated with recommendations), and how the broker-dealer makes recommendations related to significant investment decisions as well as more complex or risky products, and the reasonable basis for such recommendations.

  • Conflict of Interest Obligation – OCIE may examine how a broker-dealer has established, maintained, and enforced written policies and procedures reasonably designed to address conflicts of interests associated with its recommendations to retail customers. To assess this obligation, OCIE may review the broker-dealer’s policies and procedures with respect to: conflicts that create incentives for associated persons to place its own interests or those of a broker-dealer over the interests of the retail customer, conflicts associated with material limitations on securities, elimination of conflicts regarding sales contests, sales quotas, bonuses, and non-cash compensation based on the sale of specific securities, how policies and procedures establish a structure for identifying conflicts, how and what conflicts are disclosed, and how mitigation or elimination of conflicts are addressed.

  • Compliance Obligation – OCIE may examine how the broker-dealer has established, maintained and enforced written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest. To assess this obligation, OCIE may review the broker-dealer’s policies and procedures, and evaluate any controls, remediation of non-compliance, training, and periodic review and testing included within those policies and procedures.

The full text of the Risk Alert may be found here.

As we have in the past, we will continue to monitor these issues and will provide future client updates. This QuickStudy is for guidance only and is not intended to be a substitute for specific legal advice. If you would like more information on the matters discussed here, please contact the authors.