Vincent Micciche, CRCP, GFS, L5 - Revised September 2020
This guide was designed to assist an independent registered representative (registered rep) in identifying key elements of Regulation BI that affect you in your capacity as a registered rep. Each element addresses a specific obligation you have when making recommendations to your clients.
In addition to complying with Regulation BI, an advisor can use this guidance as a roadmap to demonstrate procedural prudence and substantiation of recommendations. I recommend It be used in conjunction with a decision-making framework like the Global Financial Steward (GFS) process. For your convenience, I have attached the GFS Template as Addendum A to this document.
The following contains guidance and opinions that I have provided, as Chief Compliance Officer, to my firm and others. Note that all firms have different policies and procedures and you should consult with your firm regarding its specific policies, procedures and requirements regarding Regulation BI.
1 – Recommending Types of Accounts (see GFS Steps 1 and 2)
In addition to substantiating the recommendation you make when proposing a financial solution to your customer, you must have a reasonable basis to believe the type of account you recommend is in the customer’s best interest.
When considering such choices as Brokerage, Advisory, Qualified or Non-Qualified, you should minimally consider the following:
- Fees and expenses of the account over time
- Alignment of products and services with the customers goals
- Alignment with the customer’s investment profile
- Withdrawal penalties
- Protection from creditors or judgments
2 – Monitoring (see GFS Step 5)
Reg BI does not impose a duty to monitor. If you agree to monitor, you are required to disclose the terms, scope and frequency of such services in a written agreement with the customer.
You may voluntarily review your customer’s accounts. This would not constitute account monitoring within the meaning of Reg BI and would not create an implied agreement.
Consistent with Best Practices and the GFS template we do voluntarily monitor our customer accounts as a matter of procedural prudence.
Document your meetings and correspondences in your CRM
3 – Considering Elements of Care, Skill and Costs (see GFS Steps 1 and 2)
Reg BI expands on the basic Suitability rule of FINRA (2111) which requires knowing your customer and knowing the product you are recommending.
Care, Skills and Costs are new elements that must be considered when making a recommendation. Care and Skill were implicitly required before but are now explicit which means you must be prudent and diligent in dealing with customers and you must have the requisite expertise and knowledge of the product you are recommending.
Cost is the new meaningful element that must be considered. Your analysis must consider the following:
- Initial cost of purchase
- Deferred Sales Charges
- Ongoing fees (all in)
This does not mean you always have to recommend the cheapest solution. Rather, you must have a reasonable basis for believing the recommendation is in the client’s best interest. Be sure to address costs and fees in your written substantiation
This is particularly important when recommending Funds or Annuities with different share classes or different compensation schedules.
You must consider the total expenses of acquiring and holding an investment or the intended holding period. There are useful tools available to assist you in this analysis including the FINRA Fund Analyzer which can be found at https://www.finra.org/investors/tools-and-calculators/fund-analyzer-additional-information
There are also helpful resources for the investor there as well. Share the link with your customer when recommending Mutual Funds.
Document your decision-making process and the resources you shared with your customer in your CRM
4 – Guarding Against Excessive Trading (see GFS Step 2)
Reg BI requires you to guard against excessive trading. This pertains to everything, not just trading individual securities. Replacements, Exchanges and in-and-out trading of Mutual Funds may be considered excessive trading.
While “churning” was always considered violative, it pertained only to accounts that were controlled by the Rep. This new element specifically says it applies to series of recommended transactions “Irrespective of whether the BD exercises actual or de facto control over the customer’s account.”
Be vigilant with this one. It may consider the recommendation of strategy of acquiring laddered annuities a violation.
Document your substantiation in your CRM
5 – Considering Reasonable Alternatives (see GFS Steps 1 and 2)
The Care Obligation in Reg BI requires a representative to consider reasonably available alternatives offered by the firm when determining whether you have a reasonable basis for your recommendation.
This is particularly important when you have access to a large portfolio of products and services. It does not mean that you must consider every possible alternative. Nor does it mean you have to recommend the “best” alternative.
For example, you like to sell Indexed Annuities to your clients and the normal rationale you provide is that IA’s are for safe money. They are, but you need to go further and look at other conservative options as well like Structured Variable Annuities, conservative fixed income Mutual Funds and other instruments that protect against loss of principle. Equally important, you should consider what portion of the customers total assets should be allocated to any given product. You should look at several different Indexed Annuities.
The best way to fulfil this obligation is to apply a prudent process that supports your decision making. Sound familiar?
This aspect of the Reg will probably impact “specialists” more than others as they tend to focus on a narrow product area. If you are one of those, you will need to do a good job of explaining the alternatives you considered and the method you applied to evaluate the pros and cons of each.
Regulators rely on high tech surveillance to determine who they will examine. Selling a “one size fits all” model will draw attention.
Document your decision-making process and the specific alternatives you considered when making your recommendation in your CRM
6 – Regarding Complex Products (see GFS Step 2)
Years ago, products were much simpler and straight forward. Today, they are becoming much more complex and readily available. It is very easy for an investor to get involved in products they may not understand or become exposed to risk they cannot fully appreciate.
Acting in a customer’s best interest not only includes making good recommendations, it also means that you have applied your expertise by explaining the recommendation in a way the customer can understand.
Many instruments have restricted liquidity or utilize leverage. Others have unusual risks associated with them that may be difficult to understand. It is essential that a customer understand those risks and complexities and it is your job to ensure their understanding.
There are many tools available to assist you in explaining complex products including prospectuses, approved sale literature, Investor Bulletins from Regulators and your firms Acknowledgement Forms. You should use as many as necessary to ensure the customer understands the risk.
Bottom line – Do not recommend a complex product unless you have expert knowledge in it and are able to educate your customer.
Keep in mind most firms limit customer allocations to alternatives to 15% of total investable assets.
Provide a detailed explanation of how you concluded that a Complex Product was in the customer’s best interest when compared to other options available. Document your substantiation in your CRM
7 – Full and Fair Written Disclosure (see GFS Steps 3)
One of the most significant obligations imposed by the Reg is disclosure of all material facts. Some of this obligation will be fulfilled by written disclosures being prepared by the firm for distribution to customers. However, there will be disclosures that are specific to situations that will need to be prepared by you at the time of making a recommendation.
Material facts include but are not limited to the following:
- The capacity in which you are acting. (Registered Rep of your B/D or IAR of your Registered Investment Advisor)
- Fees, costs and expenses that pertain to the transaction, strategy or account you are recommending and how they are applied.
- Scope of services and whether the account will be monitored. If so, you also need to disclose how and the frequency.Requirements, if any, for a customer to open or maintain an account such as minimum balances.
- Material Limitations on the securities or strategy you are recommending. There are potentially several and you need to think this through. Are you product-limited by your level of licensing (series 6 only)? Are there firm policies that limited participation in margin, options, alternatives, IPOs etc. or limitations or products available? Are you not able to access the advisory side of the firm because you are not a 65?
- Basis for your recommendation. This may be fairly general at times like “need for guaranteed income” or “college education funding”. More likely, there will be factors that are unique to the recommendation especially when there is a change in strategy or replacement of an existing investment. It is extremely important that you state the facts that demonstrate the economic benefit to a customer.
- Risks associated with your recommendation. Although standardized disclosures will cover most of this, you will need to explain, in plain language, the risks that are specific to the customer in a manner they understand. A good example is margin. Although the margin agreement discloses all the risks in fine print, the customer need to understand real the real-life possibility that they can lose more than they invested.
Disclosures must be made in writing. The oral disclosures you make must be memorialized in acknowledgement forms that are provided by the institutions and your firm. It is imperative that you use the “other” section on such forms as needed.
A best practice would include sending a follow up correspondence to the customer summarizing your discussion.
As always, use your CRM to memorialize all the above.
8 – Disclosing and Managing Conflicts of Interest (see GFS Steps 3)
Broker/Dealers are obliged to disclose material conflicts of interest that can affect their ability to make recommendations in a customer’s best interest. Most, if not all, of this duty will be discharged through the firm’s Customer Relationship Summary (CRS).
As an independent producer, you have access to a very large universe of products and many variations within a product genre. As a best practice, you need to discuss that with your customers in plain language and evidence that discussion and disclosure.
This is particularly important in the area of annuities as there maybe “bonuses” associated with a product where a substantially similar one does not. Differences in compensation are a material conflict and must be disclosed.
In some insurance products, you can choose how you will be compensated – either up front, continuously, or a combination of both. Your choice may affect the long-term cost to a customer. Accordingly, this is a material conflict and must be disclosed.
When seeking a “fixed income” strategy for a portion of the customer’s portfolio, you have an enormous range of choices. They vary in compensation, liquidity, complexity and risk. In fact, your compensation here can range from as little as a fraction of a percent on high grade bonds to commissions in excess of 7% and more on alternatives.
The best way to address this is to have a general conversation about the full universe of product solutions available to you as a starting point when meeting with a customer. You can refine that conversation as the determination of appropriate solutions becomes clearer.
Another classic conflict of interest is limitations that you may have because of licensing. The differences between series 6 products, series 7 products and Advisory solutions are significant.
Acting in a customer’s best interest requires an objective and competent analysis of their needs that is not influenced by your capacity to fulfill their needs.
Integrity is a hallmark of an elite advisor and a character trait of a true steward. There may be times that your analysis points to a solution you cannot fulfill. Don’t compromise and don’t get caught up in the adage – “When you’re a hammer, everything looks like a nail”. If the best solution for customer is something you do not or cannot provide. You must say so.
This is not an exhaustive list. Rather, it is a sampling of common scenarios you may encounter. Apply your knowledge and common sense when discussing conflicts. It’s better to err on the side of too much as opposed to too little.
In the narrative you provide to your supervisor, ALWAYS make note of the conversation surrounding potential conflicts of interest and record it in the note field for that customer in Your CRM.
9 – Use of the terms Adviser and Advisor are restricted
One of the objectives of Regulation BI is to differentiate B/D’s from RIA’s as opposed to harmonizing the regulation that applies to both. This has resulted in more relaxed regulation for B/D’s than was originally expected. It also clarified the duties of RIA’s.
As a result, B/D’s are not allowed to use the terms Adviser or Adviser unless the firm is dually registered as an RIA.
Registered Representatives are not allowed to use the terms Adviser or Advisor in any manner UNLESS they are an Independent Advisory Representative (IAR) of the firm which means they have a Series 65.
If you do not have a series 65 and are exempted by a state in which you conduct business, your firm may allow you to use those terms if you only conduct business in that state. If you are registered in any other jurisdiction which requires a Series 65, you are prohibited from using those terms.
Unless you qualify, as explained above, you must discontinue the use of terms Adviser or Advisor in all websites, emails, letterheads, business cards, brochures, social media, advertisements or communications of any sort.
If you have any questions regarding the applicability of this prohibition to you. You should contact your supervisor for further guidance. If this prohibition applies to you, you need to discontinue use of non-compliant materials and make appropriate changes to your social media presence.
10 – Oral Disclosures are Acceptable and Advised
Most of what a client learns from you comes from oral explanations, discussions and answering questions they have. It is perfectly okay to orally expand on the written disclosures we are required to provide when we make recommendations provided, they are accurate and do not contradict the written disclosures.
Plain language is always better than complicated legalese. Being instructive displays knowledge and competence. Being a good listener instills trust.
The duty of acting in a customer’s best interest is inextricably tied to avoiding self-interest. The enthusiasm we have in recommending a particular investment must be balanced by a discussion of the disadvantages and risks of that investment.
Allow your discussion to be guided by your client’s questions. Proceed only when you are convinced of the client’s understanding of the benefits, risks and nature of the investment you are recommending.
You need to memorialize the oral discussions you have in two ways:
- Promptly follow up your meeting with an email that summarizes your discussion.
- Promptly enter a summary of your meeting and the topics discussed in your CRM.
11 – Addressing Conflicts of Interest (See GFS Step 5)
A conflict of interest is a fact or condition that might incline a B/D or registered representative to make a recommendation that is not neutral and disinterested. Securities brokerage, by its nature, is very susceptible to conflicts of interest. Whether consciously or not, we are being influenced by many factors as we are providing advice and making recommendations to customers.
Regulation BI specifically requires that the firm and its registered reps to address conflicts by mitigating or eliminating them. It also imposes a duty on us to continually monitor for conflicts.
GFS Step 5 Dimension 2 – “Scrutinize for Conflicts and Self-Dealing”
The duty imposed by the Reg aligns nicely with the call for action in this dimension. Our decision-making process regarding the actions we take after identifying a conflict are informed by our assessment of the magnitude and potential effect of a conflict.
Conflicts of interest are not subjective – they exist, or they don’t.
The firm addresses this duty by applying a procedurally prudent method of identifying conflicts and scrutinizing our policies to ensure that we make reasonable efforts to eliminate or mitigate a conflict. Furthermore, we must disclose and explain our processes to our customers.
Your duty as a registered rep is similar.
• You need to scrutinize potential conflicts through examination of your practice model, your limitations and information and guidance provided by the firm.
• Once a conflict is identified you need to take appropriate action to eliminate or mitigate it.
• You need to disclose it to your customer and engage a discussion about it and its potential effect.
• You need to substantiate your recommendation which must be supported by a prudent process (GFS).
The following list of questions is not exhaustive and should be considered by all representatives affected by Reg BI.
• Do I have access to variety of products that are substantially similar solutions that provide significantly different levels of compensation?
• Am I limited in what I can recommend by the licenses I hold?
• Am I limited in what I can recommend by the company appointments I have?
• Am I limited in what I can recommend by my knowledge and expertise?
• Can I receive more favorable treatment from one institution as opposed to another for recommending their product? (Trips, Meetings, Dinners, Bonuses, etc.)
• Can I receive more compensation for recommending one strategy over another? (Insurance vs Brokerage vs Fee based)
• Does the type of account I recommend effect my compensation?
• Do my operating expenses influence my decision to provide or with a particular service?
To fulfil your obligations regarding this section you must document your discussion of all relevant factors regarding potential conflicts and your customers acknowledgment of understanding and acceptance.
This must be done with every recommendation/transaction you make.
Use your CRM to Document and Memorialize your interactions with customers.
12 – Conversation Starters
The design concept of the Customer Relationship Summary (CRS) is to embed questions throughout the document either in the form of section titles or conversation starters. The format and design will vary from firm to firm.
I think we have all thought, at one time or another, “I’m not sure I know all the right questions to ask”. This often happens when we are purchasing an item to perform a task. For example, you are looking to buy lawn tractor. Without the requisite mechanical knowledge of engines, suspensions, transmissions, duty cycles, etc., it is unlikely that you will ask all the right questions when making your decision. Indeed, you are relying on the sales professional to make sure he or she is covering all the bases. Similarly, the CRS is designed to ensure that the important points are being covered and the right questions are being asked and answered.
The benefit to your customer is right out of the GFS playbook. There is a prudent process in place to support their decision making.
You will find the following questions incorporated in the document. The ones that are section titles will be answered by the document itself. The remainder are called Conversations Starters. You are required under Reg BI to raise these questions and discuss the answers with prospective customers when opening a new account. You are required to do the same when meeting with existing customers after the effective date of June 30, 2020.
- Given my financial situation, why should I choose an advisory account? Why should I choose a brokerage account?
- Do the math for me. How much would I expect to pay per year for an advisory account? How much for a typical brokerage account? What would make those fees more or less? What services will I receive for those fees?
- What additional costs should I expect in connection with my account?
- Tell me how you and your firm make money in connection with my account. Do you or your firm receive any payments from anyone besides me in connection with my investments?
- What are the most common conflicts of interest in your advisory and brokerage accounts? Explain how you will address those conflicts when providing services to my account.
- How will you choose investments to recommend for my account?
- How often will you monitor my account’s performance and offer investment advice?
- Do you or your firm have a disciplinary history? For what type of conduct?
- What is your relevant experience, including your licenses, education, and other qualifications? Please explain what the abbreviations in your licenses are and what they mean.
- Who is the primary contact person for my account, and is he or she a representative of an investment adviser or a broker‐dealer? What can you tell me about his or her legal obligations to me? If I have concerns about how this person is treating me, who can I talk to?
The CRS is a very effective checklist that can ensure that brokers are being thorough and diligent in their disclosure of material information. Used properly, it will help avoid material omissions.
You are required to record and archive the time and place the CRS was provided to the customer. Use your CRM.
Addendum A - The GFS Template