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Source: Securities and Exchange Commission

Division of Examinations Staff

Dec. 21, 2020

[1]Regulation Best Interest established a new, substantially elevated standard of conduct under the Exchange Act for broker-dealers and associated persons of a broker-dealer (collectively “broker-dealers” or “firms”).[2]  After Regulation Best Interest’s June 30, 2020 compliance date, the Division of Examinations (“Division”) (formerly the “Office of Compliance Inspections and Examinations”) launched examinations to assess the Regulation Best Interest implementation efforts of broker-dealers.  Division staff has assessed the results of its initial Regulation Best Interest examinations and now that approximately six months have passed since the Regulation Best Interest compliance date, the Division intends to begin its next phase by conducting more focused examinations as outlined below beginning in January 2021.  As part of this effort, Division staff will examine whether broker-dealers have written policies and procedures and systems in place to achieve compliance with the Regulation.

Prior to the June 30, 2020 compliance date, the Division published a risk alert to identify to the industry its approach to initial examinations to evaluate compliance with Regulation Best Interest.[3]  In that risk alert, the Division described how it would focus on assessing whether firms have made a good faith effort to implement policies and procedures reasonably designed to comply with the procedural and substantive requirements of Regulation Best Interest.[4] 

On October 26, 2020, Commission staff hosted a Roundtable on Regulation Best Interest and Form CRS.[5]  The roundtable discussion provided an opportunity for the Division, along with staff from the Commission’s Division of Trading and Markets and staff from FINRA, to highlight to the industry preliminary observations on Regulation Best Interest from the examinations conducted to date.

Building on staff’s initial assessments, Division staff intends to expand the scope of examinations in 2021 that focus on specific requirements of the Regulation, including those that go beyond suitability standards and require broker-dealers to have a reasonable basis to believe that recommendations are in retail customers’ best interests.  The Division also intends to conduct enhanced transaction testing designed to examine whether broker-dealers have implemented effectively their written policies and procedures. 

Components of Regulation Best Interest that may be the subject of focus during an examination include:

  • Continued evaluation of firm policies and procedures, including evaluating specific firm processes for compliance with the Regulation, and alterations to firm product offerings, including the removal of higher cost products when lower cost products are available.
  • Evaluation of how firms have considered costs in making a recommendation, which may include:
    • what information is available to firm personnel to identify relevant costs;
    • how any such information has been used; and
    • any documentation of the consideration of costs.
  • Evaluation of the processes firm personnel have used to make recommendations to new customers – for example, if a firm recommended a rollover from an employee benefit plan, examiners will assess: what information was gathered from new customers; what disclosures were made at the time; how alternatives were considered; and what documentation was retained.
  • Evaluation of the processes firm personnel have used to recommend complex products, including what information was available and used to consider reasonably available alternatives.
  • Evaluation of the processes that firms have used to identify and address conflicts related to recommendations. 

The Division encourages firms to continue to evaluate their processes and, in particular, to consider whether the initial programs adopted by the June 30, 2020 compliance date are, in practice, reasonably designed to achieve compliance with Regulation Best Interest.[6]  Failure to have adequate written policies and procedures and failure to have adequate supervisory and compliance oversight may indicate recurring issues in complying with Regulation Best Interest.  The Division is providing transparency into its plans regarding Regulation Best Interest exams so that broker-dealers can set their expectations accordingly.

Finally, please send questions to the Commission’s Inter-Divisional Standards of Conduct Implementation Committee at IABDQuestions@sec.gov.  In addition, the Division is always interested in hearing more about new and emerging risk areas and products as well as how it can be more effective in its mission.  Division contact information can be found at: https://www.sec.gov/contact-information/sec-directory.  Please engage with our staff.  If you suspect or observe activity that may violate the federal securities laws or otherwise operates to harm investors, please notify SEC staff at https://www.sec.gov/tcr.   

 

[1] This Statement represents the views of the Division of Examinations staff.  It is not a rule, regulation, or statement of the Securities and Exchange Commission (“Commission”).  The Commission has neither approved nor disapproved its content.  This Statement, like all staff guidance, has no legal force or effect: it does not alter or amend applicable law, and it creates no new or additional obligations for any person.

[2] On June 5, 2019, the Commission adopted Rule 15l-1 (“Regulation Best Interest” or the “Regulation”) under the Securities Exchange Act of 1934 (“Exchange Act”), which had a compliance date of June 30, 2020.  Exchange Act Release No. 86031 (June 5, 2019).

[3] See The Division of Examinations, “Risk Alert – Examinations that Focus on Compliance with Regulation Best Interest” (Apr. 7, 2020), available here.

[6] Exchange Act Rule 15l-1(a)(2)(iv).

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