As the regulatory landscape is constantly evolving, Compliance Risk Concepts (“CRC”) is issuing its monthly review and summary of FINRA, SEC, and NFA notices and bulletins to assist our clients in keeping abreast of notable regulatory developments and deadlines in an effort to strengthen their compliance and regulatory initiatives.

FINRA

Regulatory Notices

There were no Regulatory Notices in April.

Special Notices

There were no Special Notices in April.

SEC

Final Rules

There were no final rules in April.

Proposed Rules

Per Release No. 34-97309, the SEC is reopening the comment period for its proposal (“Proposed Rules”) to amend the rule under the Securities Exchange Act of 1934 (“Exchange Act”) that defines certain terms used in the statutory definition of “exchange.” The reopening provides supplemental information and economic analysis regarding trading systems that trade crypto asset securities that would be newly included in the definition of “exchange” under the Proposed Rules. The SEC is requesting further information and public comment on certain aspects of the Proposed Rules as applicable to all securities and the compliance dates and other alternatives for the Proposed Rules. The Proposed Rules were set forth in Release No. 34-94062 (“Proposing Release”), and the related comment period, which was reopened in Release No. 34-94868 on May 9, 2022, ended on June 13, 2022. The reopening of this comment period is intended to allow interested persons further opportunity to analyze and comment on the Proposed Rules in light of the supplemental information provided herein (“Reopening Release”).

Per Release No. 33-11180, the SEC is reopening the comment period for its proposal, Modernization of Beneficial Ownership Reporting, Release No. 33-11030, (Feb. 10, 2022) (“Proposing Release”). In the Proposing Release, the SEC proposed to amend certain rules that govern beneficial ownership reporting (“Proposed Amendments”). The Proposed Amendments would modernize the filing deadlines for initial and amended beneficial ownership reports filed on Schedules 13D and 13G. The Proposed Amendments also would deem holders of certain cash-settled derivative securities as beneficial owners of the reference equity securities and clarify the disclosure requirements of Schedule 13D with respect to derivative securities. In addition, the Proposed Amendments would clarify and affirm the operation of the beneficial ownership reporting rules as applied to two or more persons that form a group under the Securities Exchange Act of 1934, and provide new exemptions to permit such persons to communicate and consult with each other, jointly engage issuers, and execute certain transactions without being subject to regulation as a group. Finally, the Proposed Amendments would require that Schedules 13D and 13G be filed using a structured, machine-readable data language. The SEC is reopening the comment period to allow interested persons an opportunity to comment on the additional analysis and data contained in a staff memorandum that was added to the public comment file on April 28, 2023.

Interim Final Rules

There were no interim final rules in April.

Interpretive Releases

There were no interpretive releases in April.

Policy Statements

There were no policy statements in April.

NFA

There were no Notices to Members in April.

News Releases

There were no NFA news releases in April.

Hot Issue

Although the initial compliance date for the amended Rule 17a-4 (broker-dealer records rule) came and went on May 3, 2023, the new requirements and options with respect to books and records maintained on electronic recordkeeping systems should be an ongoing consideration for broker-dealers. If you need help evaluating your systems and program for compliance with the new requirements, please contact CRC.

Our Perspective

Regulators continue to demonstrate their commitment to protecting investors by aggressively pursuing bad actors and reviewing and updating regulations to guard investors against constantly evolving threats.

The best approach to regulatory compliance is a proactive one. Staying ahead of the curve by taking note of statements and guidance released by regulators and using them as a barometer to assess the current regulatory climate can help ensure that a firm is prepared for a regulatory exam. Rather than scrambling to rectify issues or meet deadlines, a thorough, active compliance program that considers and incorporates regulatory developments is in a better position to satisfy regulators and preserve operations so they can best serve their clients.

For more information, please contact:

Mitch Avnet

p. (646) 346-2468  

mavnet@compliance-risk.com

David Amster

p. (917) 568-6470

damster@compliance-risk.com

Sources:

• SEC Regulatory Actions

The post Monthly Regulatory Summary (April 2023) appeared first on Compliance Risk Concepts.

In November 2022, FINRA published a podcast that discussed available guidance concerning several paths through which broker-dealers can be approved by FINRA for digital asset securities activity: 1) as a placement agent in private placement digital asset securities offerings, 2) as an ATS facilitating secondary transaction of digital asset securities, and 3) as a special purpose broker-dealer (SPBD) with custody of digital asset securities.

1) Placement agent in private placement digital asset securities offerings

Overview

The broker-dealer sends the trade-matching details (e.g., identity of the parties, price, and quantity) to the buyer and issuer of a digital asset security—like a traditional private placement—and the issuer settles the transaction bilaterally between the buyer and issuer, away from the broker-dealer. In this case, the broker-dealer instructs the customer to pay the issuer directly and instructs the issuer to issue the digital asset security to the customer directly (e.g., the customer’s “digital wallet”).

Everything happens away from the broker-dealer so it does not custody the digital asset. The broker-dealer does not handle, control, or receive customer funds or securities. Issuers and investors directly transact with each other through an escrow account established by issuer.

Key Considerations in a Placement Agent Application

1. Demonstrate an understanding of the risks of the digital asset security.
2. Communicate how the risks will be disclosed and how the offering documents will be reviewed.
3. Evidence an understanding of the obligations under FINRA’s advertising rules (including if first-year firm conditions apply).
4. Detail the role and function of the broker-dealer with specificity.
5. Be able to show that that there are procedures that are specific to digital asset securities and the distributed ledger.

2) ATS facilitating secondary transaction of digital asset securities (two types)

ATS #1: Bilateral settlement without ATS involvement

Overview

The ATS matches the orders of buyers and sellers of digital asset securities, and the trades are either settled directly between the buyer and seller or the buyer and seller give instructions to their respective custodians to settle the transactions. In either case, a broker-dealer operator does not guarantee or otherwise have responsibility for settling the trades and does not at any time exercise any level of control over the digital asset securities being sold or the cash being used to make the purchase (e.g., the ATS does not place a temporary hold on the seller’s wallet or on the buyer’s cash to ensure the transaction is completed).

• Step 1 - the buyer and seller send their respective orders to the ATS;
• Step 2 - the ATS matches the orders;
• Step 3 - the ATS notifies the buyer and seller of the matched trade; and
• Step 4 - the buyer and seller settle the transaction bilaterally, either directly with each other or by instructing their respective custodians to settle the transaction on their behalf.

ATS #2: Custodians carry out conditional instructions using information from ATS

Overview

In this case, there is a higher degree of control exercised by the broker-dealer operator because it tells the buyer’s custodian where to send the funds and the seller’s custodian where to deliver the securities. As with the four-step process, the broker-dealer operator does not guarantee or otherwise have responsibility for settling the trades and does not at any time exercise any level of control over the digital asset securities being sold or the cash being used to make the purchase (e.g., the ATS does not place a temporary hold on the seller’s wallet or on the buyer’s cash to ensure the transaction is completed) but it notifies the custodians for the buyer and seller, and the buyer and seller, of the match.

• Step 1 - the buyer and seller send their respective orders to the ATS, notify their respective custodians of their respective orders submitted to the ATS, and instruct their respective custodians to settle transactions in accordance with the terms of their orders when the ATS notifies the custodians of a match on the ATS;
  • Step 2 - the ATS matches the orders; and
  • Step 3 - the ATS notifies the buyer and seller and their respective custodians of the matched trade and the custodians carry out the conditional instructions.

Key Considerations in ATS Applications

1. Explain in detail how the transaction flows and business model involving digital asset securities and the ATS comply with either the three-step or the four-step process.
2. Ensure other documents are consistent with that process, such as:
   1. User disclosure
   1. Draft Form ATS
   1. Contracts
   1. Custodian disclosure
   1. Disclosures with other third-parties

3) Special Purpose Broker-Dealer (SPBD) with Custody of Digital Asset Securities

Overview

The business activities of a special purpose broker-dealer are limited to digital assets that are also securities (this can include operation of an ATS that trades only in digital assets securities or otherwise engages in other business involving digital assets securities). It cannot engage in business activities involving non-security digital assets or securities that are not digital assets (e.g., traditional securities).

Key Considerations in SPBD Applications

1. Demonstrate an understanding how the business model is impacted by the nine conditions detailed in the SEC Statement (dated April 27, 2021).
2. Explain how each of the nine conditions are met.
3. Make it clear where staff can find information responsive to each of the nine conditions.

Lastly, the FINRA podcast also identified several common issues with membership applications involving digital asset securities.

• Show that the applicant is capable of complying with FINRA rules and the U.S. federal securities laws and regulations.
• Missing details. For example:
  • What is the business plan?
  • What is the relationship between different parts of the broker-dealer’s business?
  • How does the transaction flow and business model involving digital asset securities fit with the available guidance?
  • How will the broker-dealer ensure that it functions in a way comporting with the applicable guidance?
  • How do the transaction flows address compliance and legal requirements?
  • Is there documentation to support that each step in the transaction flow meets those requirements?
• Being inconsistent in describing the proposed business activities involving digital assets, cryptocurrencies, distributed ledger or related products.

CRC has extensive experience with helping firms successfully navigate the New Member and Continuing Member Application process with FINRA. We are specifically familiar with the fintech space and offer clients the ability to quickly scale and support their application with experienced C-Suite level personnel. Contact us today to discuss how we can provide right-sized support as you consider forming a broker-dealer.

For more information, please contact:

Mitch Avnet

p. (646) 346-2468  

mavnet@compliance-risk.com

David Amster

p. (917) 568-6470

damster@compliance-risk.com

The post <strong>Considerations for FINRA Membership involving Digital Asset Securities</strong> appeared first on Compliance Risk Concepts.

March 2022

Overview & Summary

President Biden signed an executive order on Wednesday, March 9 that will direct the federal government to produce a plan to regulate cryptocurrencies. This Executive Order will outline the first approach to addressing the risks and potential benefits of digital assets and their underlying technology. The order lays out a national policy for digital assets across six key priorities: consumer and investor protection; financial stability; illicit finance; U.S. leadership in the global financial system and economic competitiveness; financial inclusion; and responsible innovation.

Notably, the order directs the Federal Reserve to research and potentially develop its own digital dollar, which would be similar to cryptocurrencies. The order also directs the Treasury Department to develop guidelines for Americans trading and using cryptocurrency to facilitate the mitigation and reduction of fraud or market volatility. The Treasury will conduct further research on the potential role of digital assets and blockchain in future payment systems. In addition, other agencies will examine cryptocurrency's role as a speculative asset and its role in illicit finance.

The current administration has been under pressure to play more of a coordinating role in Washington’s approach regarding this asset class, as industry executives continue to lament what they believe is a lack of clarity on rules; this executive order takes a step in that direction.

Our Take

The cryptocurrency market is now worth more than $3 trillion. Surveys suggest that around 16 percent of adult Americans – approximately 40 million people – have invested in, traded, or used cryptocurrencies.

Whether you are an adviser looking to expand your investment strategy to include digital assets, or you are looking to participate in ICOs or build out a platform for trading cryptocurrency as a broker-dealer, it is wise to consider partnering with an established compliance team who can help you navigate this imminent regulation and provide assistance from initial registration to regulatory examination.

CRC recommends that firms prepare to ensure that appropriate controls and procedures are developed to allow sufficient oversight into this area.

As with any compliance initiative or change to regulation, CRC recommends that all personnel are well trained, and that such training is both highly specific to firm policies and procedures and appropriately documented.

Opportunities for CRC to Assist Your Firm

• CRC is available for outsourced support with respect to cryptocurrency.
• CRC can proactively conduct a review of your existing compliance program to identify opportunities to potentially implement enhancements in preparation for regulatory examinations.
• CRC is available to assist with examination responses.
• CRC can prepare written electronic communications and record retention policies and procedures designed to comply with relevant industry rules, regulations, and laws.
• CRC offers best practices guidance to firms that seek to improve current protocols or to further strengthen existing program compliance.

Please contact Mitch Avnet for more information.

Mitch Avnet at mavnet@compliance-risk.com  or (646) 346.2468

The post News Update: Biden Takes Step to Regulate Cryptocurrencies appeared first on Compliance Risk Concepts.

The Securities and Exchange Commission announced on July 26^th that 21 investment advisers and 6 broker-dealers have agreed to settle charges that they failed to timely file and deliver their client or customer relationship summaries to their retail investors. In the release the SEC’s Director of Enforcement, Gurbir Grewal, notes:

“Today’s cases reinforce the importance of meeting those obligations and providing retail investors with information that is intended to help them understand their relationships with their securities industry professionals.”

The penalties ranged from $10,000 to $97,523. 

The Cost of Non-Compliance

Appropriate implementation, maintenance, and distribution of a two-page document could have saved these firms the hassle and embarrassment of fines and reputational damage. At CRC, we firmly believe that the best compliance program is a proactive one; the fines above demonstrate that regulators agree. 

Our Take

Regulators have continued to display heightened focus on transparent communication and disclosure when interacting with retail investors. Recent examinations of both SEC-registered investment advisers and broker-dealers have shown a sharp emphasis on Regulation Best Interest (Reg BI) related policies and procedures, particularly regarding the content and distribution (and subsequent evidence of delivery) of Form CRS. As such, firms should ensure that the Form CRS includes all mandated language and meets formatting requirements as specified by Reg BI. A firm’s compliance policies and procedures should also accurately reflect the processes implicated by Reg BI, including the delivery of Form CRS; firms should consider testing such procedures to ensure efficacy. If you have concerns regarding your firm’s Reg BI policies and procedures, please contact your Compliance Professional at CRC, or contact CRC using the method’s listed below so that we can connect you with a member of our team. 

For more information:

 Mitch Avnet at mavnet@compliance-risk.com  or (646) 346.2468 

Kate Gibbs at kgibbs@compliance-risk.com or (781) 742.4688 

The post News Update: SEC Fines 27 Firms for Form CRS Failures appeared first on Compliance Risk Concepts.

Background & Summary

On July 8, 2019, the US Securities and Exchange Commission (SEC) issued a joint statement in conjunction with FINRA’s general counsel addressing various elements of digital currency amid request for clarity on whether broker-dealers can hold digital assets under federal securities laws. The regulator reiterated its growing concerns relative to investor protection and clarified the fact that entities seeking to participate in digital currency markets must comply with relevant securities laws. The release placed specific emphasis on compliance with the customer protection rule. While recounting the success and importance of the customer protection rule, the SEC added, "[t]his record of protecting customer assets held in custody by broker-dealers stands in contrast to recent reports of cyber theft, and underscores the need to ensure broker-dealers robust protection of customer assets, including digital asset securities."

With respect to custody and digital securities, the SEC’s statement would seem to indicate that the regulator seeks to regulate such assets as uncertificated securities (i.e. ownership is confirmed via electronic certificate rather than a physical one). As such, broker-dealers would likely need to establish custody through the use of an SEC registered transfer agent, who would also maintain applicable records relating to security ownership. The statement also seems to allude to the fact that custodying digital assets through the use of digital wallets and maintaining private keys that would be controlled by the broker dealer are unlikely to be looked upon favorably, or ultimately approved by regulators. While the tone of the statement seems to be geared towards preparing digital securities for more mainstream access (i.e., gearing it towards retail investors), the bottom line for regulators, as evidenced by this release, is customer protection. As the industry navigates the nuances of digital securities markets, it should do so through the lens of protecting against fraud, theft, or misappropriation of client funds and/or information. 

Our Take

As always, it is our position at CRC that cooperation with regulators is key for the successful operation of financial services organizations. Regulators have continued to display heightened focus on the protection of retail and senior investors. As such, digital currency in particular is a developing area where cooperative, responsible players will hold the ace. Prompt, efficient, and honest communication and responses will satisfy regulators and clients alike, while also and bringing a sense of legitimacy and scrupulousness to digital currency operations. If you would like to speak with one of our Compliance Specialists about custody implications or have any other questions regarding digital currency, please do not hesitate to contact us. 

Contact Mitch Avnet at mavnet@compliance-risk.com or (646)346-2468 for more information. 

The post News Update: SEC Issues Statement Regarding Digital Assets appeared first on Compliance Risk Concepts.

On June 5, 2019 the Securities and Exchange Commission (“SEC”) voted to enhance the regulatory framework standard of conduct for broker-dealers (or “firms”) and provide an interpretation of the fiduciary duty for investment advisers by issuing Regulation Best Interest (“Reg BI”). Hearsay recently reached out to Mitch Avnet of Compliance Risk Concepts (“CRC”) to discuss the impacts of the new regulation.

Transition period, comparison to DOL Fiduciary Rule and overview of Reg BI

Chris Fernandes: What does the transition period look like for compliance with Reg BI?

Mitch Avnet: The SEC is allowing firms a transition period until the June 30, 2020 compliance date.

Chris: How does this new regulation compare to the long-anticipated Department of Labor (“DOL”) Fiduciary Rule?

Mitch: The Reg BI framework is more expansive than the vacated DOL Fiduciary Rule, as it covers all securities investment recommendations to retail customers rather than just those for retirement accounts.  By setting out specific obligations of broker-dealers and investment advisers, the SEC is seeking to tailor requirements to the different types of products and services each provide in order to preserve customer choice in the industry.

Chris: So, it is more complex. Does it place an increased burden on firms?

Mitch: Reg BI sets out new rules which will increase compliance efforts for firms but provides a more uniform standard and does not include many of the onerous aspects of the DOL rule such as a private right of action.

Chris: Could you give a high-level overview of the framework of the rule?

Mitch: Absolutely. The regulation has five principal areas, and can be broken down as follows:

• A “best interest” standard comprising four obligations for broker-dealers when providing recommendations to retail customers (Regulation Best Interest or Reg BI);
• A required client relationship summary disclosure (Form CRS) for both broker-dealers and investment advisers;
• An interpretation of the federal fiduciary standard for investment advisers that would reaffirm their fiduciary obligations; and
• An interpretation clarifying that broker-dealers that provide advisory services are not considered to be investment advisors when such services are “solely incidental” to the conduct of their business.
• Reg BI and Form CRS have a compliance date of June 30, 2020 while the interpretations will become effective upon publication in the Federal Register.

Requirements, disclosures and compliance for broker-dealers, under Reg BI

Chris: Let’s dig a bit deeper into what is required of broker-dealers under the rule.

Mitch: Reg BI consist of four obligations for broker-dealers when providing recommendations to retail customers. However, Reg BI does not expressly define “best interest.” Instead, it states that broker-dealers must act “without placing the financial or other interest of the broker ahead of the interest of the retail customer.” The SEC has made clear that the term does not create a fiduciary obligation and explains that it will determine whether a broker-dealer has acted in their customers’ best interest based on the four obligations: (1) disclosure, (2) care, (3) conflict of interest and (4) compliance.

Chris: Reg BI imposes an obligation to provide a 2-page relationship summary to clients. Can you provide additional details on what firms can expect this to entail?

Mitch: Broker-dealers are required to provide Form CRS, which is in a question and answer format, to clients. Disclosures must contain a summary of fees, costs, conflicts, and standards of conduct along with a link to the SEC’s Investor.gov site.

Chris: When are these disclosures supposed to go out?

Mitch: The timing of the disclosure varies. For broker dealers, firms should be distributing these to clients before a recommendation of an account type, a securities transaction, or an investment strategy involving securities or placing an order for the retail investor. These disclosures should also go out prior to the opening of a brokerage account for the retail investor. For investment advisers, the disclosures should be distributed prior to or at the time of entering into the advisory contract. Dual registrants should use the earliest of the deadlines imposed under requirements for BDs and RIAs.

Chris: Are there any other times throughout the client relationship when firms need to provide additional disclosures under the rule?

Mitch: Yes; firms must provide additional disclosures when they: open a new account that is different from the retail investor’s existing account(s); recommend that the retail investor roll over assets from a retirement account into a new or existing account or investment; or recommend or provide a new brokerage or investment advisory service or investment that does not necessarily involve the opening of a new account and would not be held in an existing account (e.g., securities sold through a “check and application” process).

Chris: What should firms be doing to comply with this part of the rule?

Mitch: CRC recommends firms review their current customer agreements and disclosures to determine what changes will need to be made and involve technology teams to consider potential digital solutions. We also recommend a cross-functional team of business, compliance and operational employees work together to confirm disclosure of all material facts pertinent to a conflict of interest associated with the recommendation that are “full and fair.”

Chris: Let’s talk about the duty of care.

Mitch: Firms will have an obligation to provide reasonable “diligence, care, and skill” to satisfy three obligations: reasonable-basis, customer-specific and quantitative. Additionally, firms must evaluate reasonably available alternatives, however broker-dealers will not have to evidence review of all alternatives. Similar to the DOL fiduciary rule, Reg BI’s care obligation covers recommendations concerning rollovers and account choice (e.g., brokerage or advisory), as well as those to take a retirement plan distribution for purposes of opening a securities trading account.

Chris: What should firms be doing to start on the path to compliance relative to this aspect of the rule?

Mitch: Our team recommends that firms dust off work done during their DOL Fiduciary Rule prep. Because the rule is not prescriptive, there is no “one size fits all” model for compliance.  The compliance obligation requires firms to maintain policies and procedures to ensure compliance with Reg BI. It’s important to note, this obligation provides an opportunity for the SEC and FINRA to bring enforcement actions for compliance failures without the existence of underlying violations of Reg BI. Therefore, firms should carefully develop Reg BI policies and procedures with a view towards how they will demonstrate that they have met the best interest standard – including documenting all written and oral disclosures to clients.

Conflicts of Interest

Chris: What specific conflicts of interest should firms focus on when attempting to comply with that obligation?

Mitch: Reg BI does not explicitly define material conflicts of interest. In contrast to the DOL rule, Reg BI allows firms to sell proprietary products, including initial public offerings, and continue to receive payments from third parties for shelf space – as long as they disclose conflicts of interest. For example, in instances where a registered representative holds a limited license (e.g., only to sell mutual funds), but the firm offers a full suite of products, the representative may need to disclose this to their customers. However, the final rule makes clear that there are certain conflicts of interest that cannot be cured through disclosure, specifically prohibiting certain types of sales contests and quotas within defined parameters (e.g., for specific security types in short time periods).

Chris: Where would you recommend that firms focus their energies relative to this aspect?

Mitch: Our team at CRC recommends that firms review their range of products and services they offer along with their payout grid in order to identify potential conflicts and determine whether they will need to be mitigated, eliminated, or disclosed. The final rule also instructs firms to develop a penalty system for any representatives that do not adequately manage or disclose their conflicts of interest. Firms will need to establish, maintain, and enforce written policies and procedures reasonably designed to:

• Identify and at a minimum disclose (in accordance with the Disclosure Obligation) or eliminate all conflicts of interest associated with the recommendation
• Identify and mitigate conflicts of interest that create an incentive for a broker-dealer’s financial professionals to place either their interests or the broker-dealer’s interest ahead of the retail customer’s interest
• Identify and disclose any material limitations on offerings (e.g., proprietary or other limited range of products) and any conflicts associated with the limitations, and prevent the limitations and associated conflicts from causing the broker-dealer or its financial professionals to place their interests ahead of the retail customer’s interests
• Eliminate 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

SEC expectations and compliance

Chris: Can you map out the SEC’s expectation for compliance procedures relative to the rule?

Mitch: Reg BI requires firms to develop policies and procedures in order to demonstrate that they have met the best interest standard – including documenting all written and oral disclosures to clients. The SEC has made changes to Rules 17a-3 and 17a-4, which require broker-dealers to maintain records of all information collected and provided to retail customers pursuant to Reg BI for six years, including the identity of each natural person who is an associated person of the broker-dealer responsible for the customer accounts. Firms that fail to maintain adequate policies and procedures may face enforcement actions from the SEC and FINRA for compliance failures.

Chris: How should firms seek to comply?

Mitch: CRC advises firms to review and enhance their policies and procedures that address: Product and Pricing; Operations; Technology; and Communications. Additionally, firms should put in place processes to capture and retain disclosures, provide training on the new requirements and ensure that there is a supervisory structure to oversee compliance.

Is Reg BI different for Investment Advisors?

Chris: Are there any specific issues that investment advisers should consider? Are they impacted differently than broker-dealers?

Mitch: While investment advisers have an existing fiduciary obligation, the SEC’s investment adviser interpretation of Reg BI makes these obligations explicit:

• Provide advice in the best interest of the client
• A duty of loyalty
• Best execution for client transactions
• Disclosure of conflicts of interest

Because the final rule did not include enhancements contained in the proposal, investment advisor are not likely to require significant analysis or operational changes as those for broker-dealers, e.g. – licensing and continuing education requirements, provision of account statements to clients and similar financial responsibility requirements.

Exemptions

Chris: How would a broker-dealer qualify for an exemption under the rule?

Mitch: To qualify for an exemption from the Advisers Act (“the Act”), broker-dealers must satisfy 2 conditions: they must not receive any special compensation (i.e., only commissions and not asset-based fees, and must provide only “solely incidental” advice.

Chris: How should firms identify whether advice provided to retail clients is incidental?

Mitch: Determining whether advice provided to retail clients is “solely incidental” will be determined by 2 criteria: level of investment discretion and account monitoring. Unlimited investment discretion is not solely incidental advice and the broker-dealer would be subject to the Act. If investment discretion is limited in time, scope, or some other way the advice provided may be deemed solely incidental. In addition, continuous, previously agreed-upon account monitoring would likely not be considered solely incidental, while periodic account monitoring or voluntary account monitoring likely would be.

The SEC also clarified the solely incidental exception under the Advisers Act: broker-dealers do not have a fiduciary duty to a retail investor unless that broker-dealer is exercising unlimited investment discretion with respect to the account, or the broker-dealer has agreed to continuous monitoring of the account.

State regulations

Chris: What about state regulators? How do they factor into this rule?

Mitch: After the DOL rule was vacated, a number of states began to introduce their own fiduciary or best interest standards. These rules vary across states – some states like Nevada, are contemplating a private right of action and a largely ongoing obligation. Others states like New York would only apply a best interest standard to the sale of life insurance annuities. These differences will make it operationally challenging for firms to adhere to each state’s specific requirements.

Chris: Has the SEC commented on this issue?

Mitch: Currently, the SEC declined to provide any opinion on whether its rules would preempt state standards and left the question to “future judicial proceedings.”

The industry can likely expect litigation on this issue as states continue to move forward with their rulemakings and attempt to retain control over standards in their jurisdictions. Meanwhile, the DOL has stated that it will issue an updated version of its fiduciary rule later this year. While there have not been any explicit assurances, it is likely that the concepts and requirements from the DOL will align with Reg BI.

Client behavior

Chris: Finally, do you have any insight into concerns that firms have regarding broker-dealers’ responsibilities under this rule, particularly with respect to client behavior?

Mitch: It is important to remember that Reg BI does not render a BD or IA responsible for a client’s behavior or choices, provided that all above mentioned criteria are satisfied. Reg BI does not extend beyond a particular recommendation or generally require a broker-dealer to have a continuous duty to a retail customer or impose a duty to monitor. The rule also doesn’t require the broker-dealer to refuse to accept a customer’s order that is contrary to the broker-dealer’s recommendation or apply to self-directed or otherwise unsolicited transactions by a retail customer, whether or not the customer also receives separate recommendations from the broker-dealer.

Chris: Thank you for taking the time to answer our questions and provide insight on some of the key components of Reg BI.

Mitch: My pleasure, as always. The CRC team is readily available to discuss relevant regulatory issues with our clients and colleagues in the industry, and we make it our top priority to keep our thumb on the pulse of the ever-evolving regulatory landscape so that we can provide accurate, up-to-date advice.

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