Bates Research  |  11-12-20

SEC and FINRA Offer Observations to Improve Compliance with Reg BI and Form CRS

SEC and FINRA Offer Observations to Improve Compliance with Reg BI and Form CRS

On October 26, 2020, the SEC and FINRA staff held a remote public roundtable to discuss the implementation of Regulation Best Interest (“Reg BI”) and the Customer Relationship Form (“Form CRS”) since mandatory compliance began on June 30, 2020. During the regulators’ roundtable, staff reviewed the core obligations required by Reg. BI and Form CRS and reported that firms generally were meeting those obligations. Staff also highlighted their observations on the areas that require improvement.

As Chair Jay Clayton remarked on the call, compliance with the Reg BI obligations and Form CRS requirements is necessary to improve the quality of the relationship between retail investors and their professionals. “That is what it is all about,” he said. Bates held its own webinar on Reg BI and Form CRS implementation and compliance (“120 Days On”) on Wednesday, October 28, 2020 to review client observations and the guidance provided at the roundtable. Here’s a recap on the key issues presented during the regulators' roundtable.

A Focus on the Practical

During the roundtable, SEC and FINRA staff methodically reviewed observations on current implementation of the obligations—disclosure, care, conflicts and compliance—under Reg BI. While acknowledging the “good faith efforts” by firms to comply, and the different approaches firms have taken to tailor their compliance to their firm’s products and business models, staff detailed many “necessary improvements.”

On disclosure, staff noted that firms are mostly relying on Form CRS, though some firms maintain targeted topic disclosure (e.g., on roll-overs). Based on their observations, staff recommended (i) that information be conveyed to retail investors in plain English (which is commonly determined to be at an eighth-grade level) to make it more accessible to retail investors; (ii) the use of charts rather than complicated text on fee disclosures; (iii) using technology solutions to accurately update; (iv) the use of electronic delivery with a focus on proper access to ensure, and evidence delivery; (v) detailed recordkeeping, which should be explicit in firms' written policies and procedures. Staff also acknowledged firms’ efforts to amend client onboarding processes to meet delivery requirements and that, in general, firms provided solid training to their representatives on delivery issues.

On the care obligation, staff described how firms are incorporating internal, proprietary and third-party systems in their review and documentation of decision making on roll-overs, mutual fund share classes, annuities, and other products. Staff observed that firms are incorporating various types of data gathering to bolster their compliance with the care obligation, including by providing for comments around each recommendation, distributing questionnaires, creating risk scores, capturing associated costs, and thorough other analysis. Staff said it wants to be able to review firm due diligence on product disclosures and to see, in particular, that firms are not just relying on the FINRA Rule 2111 suitability obligations, but are expanding and distinguishing between suitability and the broader obligations under Reg BI.

On Reg. BI’s conflicts of interest obligation, staff noted the “wide range of actions” firms have taken to “identify, mitigate and eliminate” conflicts, including the development of procedures and supervision around compensation, client relationships and products. Staff emphasized, however, that proper assessments must be done to identify potential for conflicts, saying that they expect firms to review such things as compensation to the firms, representatives and affiliates, and associated persons’ outside activities. They also want to see that firms reviewed their business models “to get the incentives right.” Staff reported that firms did a good job on mitigation (with some concerns about third-party reimbursements that could create a problem.) Though staff said that the SEC does not require a specific mitigation policy (in order to provide firms flexibility), the SEC offers FAQs and a non-exhaustive list on mitigation methods that firms should consider. 

On the compliance obligation, staff focused primarily on written policies and procedures, training and testing. Staff affirmed that compliance programs must adequately set out cleear policies on disclosure, care and conflicts. Staff, however, found that, while firms are demonstrating good effort in this regard, there was a gap between the written word and the actual practice of how to meet the requirements of the rule. While firms have made headway on training, staff focused on the need to evolve from what the rule says to how to comply with the rule, presenting higher expectations of what firms should memorialize in their books and records, and the need to develop testing plans to verifycompliance with the rule. As described in the Bates webinar, staff appears to want to see: “How are you vetting your investment products on your platform? How are the representatives choosing the products that are available on the platform? How are you reviewing the recommendations? And how are you memorializing what you are doing?”

Form CRS Observations

The CRS form is highly prescriptive in both formatting and content, in part to keep the disclosure document short (two to four pages). As described in a joint statement by SEC leadership, issued on October 8, 2020, the summary is intended to contain, in plain English, disclosures “on the same topics, under standardized headings and in a prescribed order,” on a form “that allows retail investors to compare different firms’ services, fees, and other important information.” 

Of the approximately ten thousand Form CRS submissions filed to date, staff observed a number of failings,  including: material disclosure omissions, vague descriptions of fee structures without direct (layered) hyperlinks, submissions that were too general on product offerings, failures to clearly identify affiliates, incorrect formatting (particularly for required “conversation starter” questions), headers in the wrong place, RIAs referring to themselves being fiduciaries where not permitted, and broken links that affect the adequacy of layered disclosure, among others. Further, staff raised concerns about those firms that were supposed to file Form CRS, but did not.

Form CRS and Disciplinary History

The broadest concern on CRS form filings raised at the roundtable was related to the sufficiency of submissions with respect to disclosure of disciplinary histories. Form CRS requires addressing the question “Do you or your financial professionals have legal or disciplinary history?” Staff warned that Form CRS is not the place for a qualifying answer to that question. It is intended to solicit only a yes or no answer, along with a link to where the investor can get more details. The failure of a significant number of firms to satisfactorily answer this question led SEC staff to add explicit new interpretations on reporting disciplinary history in its Frequently Asked Questions on Form CRS. The detailed response relates to criticisms leveled at both the Form CRS and the industry in a Wall Street Journal report.

The required disclosure on disciplinary history was intended to allow retail investors “for the first time” to be able to factor in disciplinary history information before entering into a relationship with the firm or professional. Staff reaffirmed that compliance requires that (i) the firm direct the investor to Investor.gov/CRS for additional research on firm financial professionals, (ii) the form must include the “conversation starters” to lead an investor to engage in discussion about any disciplinary history or events, (iii) a firm must report any disciplinary action that must be reported on other forms, and (iv) a firm is not allowed to add qualifying language “that might, intentionally or unintentionally, obfuscate or otherwise minimize the disciplinary history.”

Conclusion

Several takeaways were discussed during Bates Group’s follow up webinar. In addition to the analysis of the current state of implementation of Reg BI and Form CRS, the panelists agreed on several recommendations. They include the following:

  • Technology – Consider the use of technology to evidence Reg BI compliance. (Take an inventory—can it be used to demonstrate delivery or reveal conflicts, ensure repeatable and auditable results, and adequately capture useful data?)
  • Governance – FINRA expects appropriate memorialization in order to undertake an audit, and so that firms can standardize their processes. (What is the governance around conflicts, testing, training, and supervision?)
  • Guidance – Review current SEC Form CRS checklist, FAQs, and now, the expectations discussed in the roundtable. (Guidance = Expectations)
  • Training and Testing – Ensure that the practical application of the rule is being taught and tested, not simply what the rule says. (What is the follow up? How do you ensure policies are working and are effective?) Start testing, continue training, make necessary changes, and document the process.
  • Exam Preparation – Regulators want specific examples of why the recommendations are in the best interests of the client. Document the recommendations. Regulators want to see your regulatory change management program. (When did it start, who was involved, etc.) “Storyboard your process.”
  • Enforcement – Firms should review their reportable disciplinary history. Form CRS should be “accurate, complete and consistent with those other forms.”

Jennifer Sullivan, Bates Compliance consultant and a featured speaker at the webinar, noted that both the SEC and FINRA have been very vocal about communicating their expectations. She cautioned that there will likely be “very few excuses for non-compliance.” At the same time, she concurred with other panelists who asserted that “it’s not a gotcha exam. Shy of doing nothing, the Commission wants firms to get it right.” Bates will continue to keep you apprised of further Reg BI developments.


Bates Group’s Compliance team helps firms implement Reg BI, Form CRS, and navigate compliance concerning investor and consumer protection standards. To learn more about Reg BI and Form CRS compliance consulting support, including how your firm can improve its compliance please visit our Reg BI and Form CRS resource page or contact us directly:

Hank Sanchez, Managing Director, Bates Compliance - hsanchez@batesgroup.com or 504-450-9632

Rory O'Connor, Director, Bates Compliance - roconnor@batesgroup.com or 860-671-7270

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