Eye On

Eye on: Compliance

November 19th, 2019 · 3 min read

This conversation with Robert Stirling, executive consultant at NRS Compliance, a strategic partner in the Chalice Advisor Exchange, underlines the importance of keeping up with compliance in a rapidly changing regulatory landscape.

What is “Reg BI,” and why is it important? Regulation Best Interest (Reg BI) raises the standard of conduct under which broker-dealers must operate. It does not impose any obligations on RIAs or their representatives.

To over-simplify, under Reg BI, a BD must make recommendations that are in the client’s best interest. But this standard fundamentally differs from the fiduciary standard of conduct applicable to RIAs, primarily in that it applies at the time recommendations are made, and not at all times. It is designed to clarify the BDs’ duties to retail clients beyond simple suitability and, in principle, to address situations in which BDs recommend products that are suitable but not necessarily in the client’s best interest. Reg BI also imposes broad disclosure obligations on BDs, including conflicts of interest and compensation practices.

Although it doesn’t apply to them directly, investment advisors and their representatives need to understand Reg BI in order to accurately communicate to retail clients the distinction between applicable standards of conduct — especially if they are dual registrants or have affiliated BDs.

What other proposals or rules should RIA owners be aware of? There are several. On Nov. 5, the SEC introduced significant revisions to the advertising and solicitation rules for the first time in decades. The proposed rule would significantly change current rules on testimonials and endorsements, provide new requirements for performance presentations, and revisit requirements for paying solicitors. The proposal is subject to a comment period and may undergo significant changes — or in fact be dropped altogether. But it’s important as a reflection of the SEC’s thinking on this vital subject.

Next up, the Department of labor is expected to re-introduce its late and unlamented fiduciary rule — this time it’s a kinder, more accessible framework that is in sync with "Reg BI" and the SEC’s recent interpretive release on the meaning of the term "fiduciary."

Already on the books but still brand-new territory is a rule requiring SEC-registered RIAs with retail clients to provide additional disclosure. By July 30, 2020, these RIAs must include a Form CRS (aka Form ADV Part 3) to, in the SEC’s wording, “inform retail investors about: (1) the types of client and customer relationships and services the firm offers; (2) the fees, costs, conflicts of interest, and required standard of conduct associated with those relationships and services; (3) whether the firm and its financial professionals currently have reportable legal or disciplinary history; and (4) how to obtain additional information about the firm."

What are the commonest misconceptions among RIA owners regarding compliance? There are so many! But the main ones are these, in no particular order:

  • Compliance and ethics are identical
  • Having a chief compliance officer means you, the CEO, are absolved from having anything to do with compliance
  • Other RIA owners you play golf with know more about compliance than your CCO
  • Compliance is just a matter of using the right verbiage on the right forms and submitting them by the deadline
  • Therefore, documents, contracts and written procedures are OK if they contain certain magic words — even if they don’t accurately reflect your firm’s business
  • SEC examiners visit your office to hear your opinions of the SEC

What’s the worst compliance misstep you’ve encountered? Again, there are many to choose from. But one comes to mind, and it illustrates that good compliance extends beyond simply meeting the bare requirements of the rules. An RIA owner hired a third-party solicitor to bring in new clients. The advisor met all of the requirements of the Cash Solicitation Rule, but did not consider additional best practices, such as requiring a review of the solicitor’s marketing efforts. One day the advisor asked the solicitor how things were going, and the solicitor replied, “I’m getting a great response to that ad.” The advisor asked, “What ad?” It turns out the solicitor had printed up a flyer saying the advisor’s performance was up 40% and mailed it to the solicitor’s contact list. That list included one of the advisor’s competitors, who forwarded it to the SEC.

Learn more about Starkweather & Shepley here.