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FINLAW: Asking your customer to move their brokerage account MAY violate Regulation Best Interest (“Regulation BI”)

FINRA member Firms are required by June 30, 2020, to comply with Regulation BI. Regulation BI is a rulemaking package that one regulator described as a “once-every-several decades” rule.[1]  Regulation BI mandates four essential obligations which will transform the way retail broker-dealers (“BDs”) do business in the United States.  These include the Disclosure obligation, Care obligation, Conflict obligation, and the Compliance obligation.  You must comply with all four to meet the requirements of Regulation BI.

1) Disclosure obligation: a BD must disclose before or at time of recommendation the details and facts regarding, among other things, the BD’s relationship with the customer, material fees and costs (or the general magnitude of compensation), types of services provided to customers and limits on service, and conflicts of interests.

2) Care obligation: while this obligation looks similar to suitability, it is so much more.  Regulation BI builds on the trigger of a securities recommendation like the traditional suitability rule but includes many SEC enhancements, including that Regulation BI applies to recommendations to roll over assets, costs, and requires a consideration of reasonably available alternatives.  Each recommendation must now also be in the customer’s best interest, a new standard for BDs.

3) Conflicts obligation: this includes both Firm-level and registered representative level conflicts.  BDs must either disclose or eliminate conflicts, and in some instances disclosing conflicts alone is not enough, like sales contests and non-cash compensation to representatives.

4) Compliance obligation: BDs must have WSPs to achieve compliance with Reg BI, including testing for compliance and education and employee training.

While Regulation Best Interest applies to recommendations made to a retail customer, this is not your parent’s FINRA suitability rule.  Yes, Regulation BI builds on the trigger of a recommendation like the  suitability rule but applies more broadly to include recommendations to roll over or transfer assets from one account type to another.

An interesting question is raised in the context of a “hire me” communication.  A “hire me” communication occurs when, for example, an associated person speaks to a prospective retail customer.  Regulation BI applies where there is a recommendation of a securities transaction, an investment strategy, or an account recommendation to a retail customer.  As a result, Regulation BI may be applicable when a “hire me” communication can be interpreted as a “recommendation” consistent with precedent and FINRA’s traditional interpretation.  Specifically, Regulation BI is applicable in a “hire me” communication where there is a “call to action” to open an account.

A “hire me” communication may also occur when an associated person who is leaving her old Firm to join a new one.  This occurs, for example, when one calls an existing Firm A retail customer to tell them about a move to Firm B. Where this is interpreted as a “call to action,” meaning, to open an account, engage in a securities transaction or act on an investment strategy, Regulation BI is applicable.

The SEC  addresses this point directly in its Frequently Asked Questions[2], as follows:

“Q: Would the analysis be different if I am leaving Firm A to join Firm B, and I call my existing Firm A retail customers to tell them about my move to Firm B?

A: The analysis would be the same; Regulation Best Interest applies if you make a “recommendation” … . The staff understands that it is common industry practice for an associated person of a broker-dealer leaving Firm A to go to Firm B to call his or her Firm A customers prior to his departure to attempt to persuade the customers to move their accounts to Firm B. In such circumstances, the staff believes that there is a significant possibility that a communication may be reasonably likely to be viewed as a ‘call to action.’ However, whether a communication involves a ‘recommendation’ turns on the facts and circumstances of the particular communication.”

The SEC explained that while

“[n]ot all communications between a representative and an existing retail customer in this context will rise to the level of a recommendation. For example, consider a scenario where you are leaving Firm A to go to Firm B, and you call your existing retail customer and say: ‘I wanted to let you know that I am leaving Firm A after today. As of Monday, I will be joining Firm B. It has been really great working with you all of these years, and I would love to continue our relationship. I will give you a call next week to tell you more about Firm B and discuss what it has to offer.’ Absent other factors, in the staff’s view, this communication would not be a ‘recommendation’ subject to Regulation Best Interest, as the staff does not believe this communication in and of itself would reasonably be viewed as a ‘call to action’ to open an account, engage in a securities transaction or act on an investment strategy.”[3]

The application of Regulation BI to requests that a customer move their brokerage account raises new risks for associated persons.  Now, the associated person who seeks to move her business to a new Firm needs not only to concern herself with whether her action violates any contractual or legal restriction in effect with her member firm, or whether her taking of any client confidential information violates Reg S-P.  Now, will such communication also violate Regulation BI?  If Regulation BI is applicable, all four obligations (Disclosure, Care, Conflicts and Compliance) must be met for compliance, which appears impossible until the associated person has already joined the new Firm.  This raises a question whether this aspect of Regulation BI does indeed operate for the best interest of customers?  By delaying the transfer of a customer account to a new firm where the associated person who has the customer relationship is now working, will customers be disadvantaged by market movements or delays in identifying and speaking to newly assigned registered representative at the old Firm?   Much more will be written on this and other aspects of Regulation BI’s significant transformation of the retail broker-dealer business in the United States.

[1] 2019 FINRA Regulation Best Interest Conference, Washington DC, (December 18, 2019)(comment attributed to  FINRA VP and Associate General Counsel J. Wrona).

[2] https://www.sec.gov/tm/faq-regulation-best-interest

[3] Id.

 

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