Compliance Newsflash for January 22, 2020 – A Halftime Look at the SEC Investment Advice Rules

Midway through 2020, investment professionals must comply with the SEC's much ballyhooed-and criticized-rulemaking package on conduct standards and disclosures. The package includes, among other requirements, Regulation Best Interest (Reg BI). With compliance due in about five months, now is a good time to take a look at the long and winding road that led us to this point, and to take a quick look ahead.

-Bloomberg Law

Midway through 2020, investment professionals must comply with the SEC’s much ballyhooed—and criticized—rulemaking package on conduct standards and disclosures. The package includes, among other requirements, Regulation Best Interest (Reg BI). With compliance due in about five months, now is a good time to take a look at the long and winding road that led us to this point, and to take a quick look ahead.

Where We Started

In June 2019, the SEC issued its new standards package for brokers and investment advisers. The initial package totaled more than 1,300 pages; in September 2019, the SEC posted individual releases to the Federal Register to cover the main components:

Regulation Best Interest (Reg BI): The centerpiece of the package imposes an enhanced standard of conduct for broker-dealers’ recommendations to their retail customers.

When making a recommendation to a retail customer, defined as an individual who uses the information “primarily for personal, family, or household purposes,” a broker-dealer may not place its financial or other interests ahead of the interests of the customer. The broker must also establish, maintain, and enforce written policies and procedures reasonably designed to identify and disclose material conflicts of interest.

While Reg BI calls for the identification and disclosure of such risks, it does not require the broker to mitigate or eliminate the risks.

Form CRS Relationship Summary: Form CRS requires broker-dealers and investment advisers to provide a client relationship summary to retail investors. The SEC intends for the form to better inform retail investors about the types of client and customer relationships and services the firm offers, along with fees, conflicts of interest, and required standards of conduct. The form also requires disclosure of whether the firm and its professionals currently have reportable legal or disciplinary histories.

Interpretation regarding the standard of conduct for investment advisers: This interpretation reaffirms and, in some cases, clarifies the SEC’s views of the fiduciary duty that investment advisers owe to their clients under the Investment Advisers Act of 1940 (Advisers Act).

It compiles various citations and established principles and, according to the SEC majority, does not break new ground. The release serves to express in one place the SEC’s long-held view that an adviser must, at all times, serve the best interest of its client and may not subordinate a client’s interest to its own, or place their interests ahead of the interests of their clients.

Interpretation regarding the “solely incidental” prong of the broker-dealer exclusion under the Advisers Act: Setting out the SEC’s views on when a broker-dealer’s performance of advisory activities excludes it from being an investment adviser subject to the Advisers Act, the interpretation provides that a broker-dealer will be operating within the “solely incidental” exemption from the Advisers Act “if the advice is provided in connection with and is reasonably related to the broker-dealer’s primary business of effecting securities transactions.” The determination is a facts-based analysis, but the interpretation provides guidance on the application of the exclusion when exercising investment discretion over customer accounts and account monitoring.

The initial reviews were mixed at best. After all, it took the Commission eight years from when it first released a study required under Section 913 of the Dodd–Frank Act to publish rules and guidance that was supposed to help retail investors understand the differences between investment advisers and broker-dealers. The Commission actions faced lawsuits and strong objections within the SEC and in Congress, and spurred questions of preemption in states opting for their fiduciary standard laws.

Separately, the package purported to be simpler to follow as a principles-based approach while leaving key issues unanswered. For example, the package failed to include a definition of the best-interest standard, or address the impact of Reg BI on existing suitability standards (see a suitability comparison table here).

Where We Are

Not ignoring the mixed reactions, the Commission has released various resources to guide firms and has engaged FINRA to help out as well. In addition, the SEC faces lawsuits challenging its adoption of the Reg BI rulemaking.

Here is a brief summary of these developments to date:

July 2019: In a speech at Babson College in Boston, SEC Chairman Jay Clayton addressed many of the criticisms of the rulemaking. He dismissed claims that the regulations lowered the standards of care and defended Reg BI by noting that it “substantially enhances” the standard of conduct for broker-dealers.

July 2019: The SEC published the rulemaking package in the Federal Register, resulting in a September 2019 effective date for the interpretative releases and compliance with Reg BI and Form CRS beginning June 30, 2020. The Commission also introduced its first supplemental guidance for small firms on Reg BI and Form CRS.

August 2019: Chairman Clayton continued his defense of the package, and the Commission released a series of short educational videos about choosing and working with financial professionals. The effort was laudable, but some enhancements might be in order. FINRA got in the game for the first time by reminding firms about the package and promoting its new Reg BI page to house future guidance (including a podcast).

September 2019: Arriving at the effective date, the package’s two interpretive releases required compliance by covered firms.

Separately, the U.S. District Court for the Southern District of New York dismissed a consolidated lawsuit against Reg BI on jurisdictional grounds. The plaintiffs, private fiduciary advisers and a group of state attorneys general, claimed in the consolidated lawsuit that Reg BI failed to meet the standards established by Congress in the Dodd–Frank Act. The district court deferred to the Second Circuit to decide the case (see below).

October 2019: FINRA released an 11-page checklist to help member firms comply with Reg BI and Form CRS in preparation for their June 30, 2020 compliance date. The checklist summarizes the main requirements of these rules but also notes key differences between them and FINRA’s requirements.

Contrary to expectations following the adoption of Reg BI, FINRA does not intend to quickly put longstanding Rule 2111 (the suitability rule) out to pasture. As Robert Colby, chief legal officer at FINRA, stated at the National Society of Compliance Professionals’ annual meeting in October 2019, “we’re not going to get rid” of Rule 2111. Rather, the rule will remain in full force and effect for the foreseeable future.

To some degree, FINRA’s approach should have been expected because Rule 2111 applies to a broader range of customers than does Reg BI. Unlike Reg BI, Rule 2111 is not limited to retail customers but instead applies to all of a broker-dealer’s customers, including institutional investors. A complete removal of Rule 2111 would create unintended gaps in FINRA’s regulation regime. Going forward, FINRA is more likely to curtail rather than repeal Rule 2111 as the uncertainties of Reg BI are resolved.

December 2019: The staff of the Division of Investment Management and the Division of Trading and Markets released frequently asked questions (FAQs) on four commonly asked questions involving Form CRS, providing useful insight into the staff’s thought processes.

January 2020: The Second Circuit is currently reviewing briefs filed in late December 2019 in the action cited above. The results of the action will turn on the lower court’s deference to the SEC and its interpretation of Dodd-Frank language, as discussed in previous Bloomberg Law Analysis coverage.

The staff of the Division of Trading and Markets also issued another round of answers to FAQs.

Where We Are Going

Just past the halfway mark toward required compliance with Reg BI and Form CRS, there is more room and more time for the SEC to provide useful guidance, and that may well happen.

No firm subject to these rules should think a “Hail Mary” approach to Reg BI compliance in June 2020 will be sufficient. Just ask the regulator behind New York’s best interest standard for annuities and life insurance, Maria Vullo, now the CEO of Vullo Advisory Services, who joined us recently for a webinar on the package in December 2020. Vullo wisely cautioned that, “If they haven’t done so already, firms must act now to comply with the new SEC rules and NYDFS 187. Compliance with these requirements takes careful planning and the development of internal processes that are designed to satisfy both the letter and the spirit of these rules. Firms that fail to employ strong measures to comply do so at their peril.”

Firms should also note that the SEC’s Office of Compliance Inspections and Examinations (OCIE) announced that its 2020 broker-dealer examinations “will focus on issues relating to the preparation for and implementation of recent rulemaking.” It is no secret to what new rulemaking OCIE is referencing. OCIE noted that the rulemaking package “will require various market participants to make changes to their operations, including to required disclosures, marketing materials and compliance programs.”

FINRA also stated in its 2020 Risk Monitoring and Examination Priorities Letter that it “will review firms’ preparedness for Reg BI to gain an understanding of implementation challenges they face and, after the compliance date, will examine firms’ compliance with Reg BI, Form CRS and related SEC guidance and interpretations.”

Next Steps

Firms facing the approaching compliance date may want to consider the following:

Assess current state: To know what you need to do, you need to know the requirements and know what your existing controls are. Firms should start by reviewing the rulemaking releases, the various resources cited above, and our toolkit to ensure they understand the package requirements and then realistically assess their current controls to identify the gaps and potential enhancements needed to comply. Once this assessment is complete and documented—to serve as a roadmap for future assessments—assign a team or working group to create a timeline and project plan for this and future efforts to navigate the completion of any identified remediation measures addressing gaps or areas for improvement.

Establish or update policies, procedures and disclosures: To create a roadmap, a firm must have documented standards. Firms should review existing policies and procedures, codes, customer marketing materials, and disclosures and relationship summary documents, and make any necessary updates. Do not forget to include supervisory and compliance systems in this review to ensure effective oversight of these new and updated controls.

Implement new requirements: A file of documented requirements is not enough; a firm must operationalize its efforts. After documenting the standards to comply with these new requirements, firms should implement the standards by integrating them into supervisory, compliance, operational, technical, recordkeeping, and reporting controls.

Assess sales practices: Sales practices are integral to compliance with the package. Firms should revisit, and update if necessary, their sales practices to increase the transparency of fees and incentives to investors, to incentivize appropriate sales practice conduct consistent with the rulemaking, and to mitigate any material conflict of interests. This review should include identifying and eliminating all sales contests, sales quotas, bonuses, and non-cash compensation based on the sale of specific securities or specific types of securities within a limited period of time.

Educate workforce readiness: The sales force needs to be informed. Firms should educate their sales personnel about these new requirements and the firm’s measures in response (e.g., policies, procedures, prohibitions, processes, and controls). A one-time training approach is not sufficient. Deliver training on a regular and ongoing basis to ensure a full understanding of these requirements and its obligations, including any changes or adjustments made along.

To aid firms in preparing for the challenges involved in compliance, Bloomberg Law has recently added a suite of practical guidance documents on Reg BI and related matters. The documents provide an overview of the requirements, and include guidance on compliance considerations and best practices. The documents, along with other primary and secondary sources, can be found on the Bloomberg Law SEC Regulation Best Interest In Focus page.


Firms have a tremendous amount of work ahead of them to prepare for these new regulatory requirements, and time is of the essence as the June 2020 compliance date approaches.

Yes, there are still questions to be answered and issues to be resolved. Supporters and critics of the rules will continue to argue far past the compliance date. Lawsuits challenging the rulemaking by various states and interest groups may move forward. States like Nevada, New Jersey, and Massachusetts will push ahead with their regulatory or legislative provisions imposing higher standards, and creating a patchwork of requirements. Should states enact legislation imposing different or higher standards than Reg BI, the courts will be faced with the daunting question of whether the federal measures preclude state action in these areas.

Regardless of these challenges and the many questions to be answered, the package is one of the most consequential rulemaking initiatives undertaken by the SEC in recent years. Despite ongoing litigation, broker-dealers should expect that the Reg BI rulemaking package will become effective as scheduled in June 2020.

While regulators will initially apply a light enforcement touch to firms making their first attempts to comply, they will be looking for real progress toward the compliance goals. Firms should move in that direction now without waiting for the courts to act.