Reg. BI – “Full and Fair” Disclosure (or, Reading the Adopting Release So You Don’t Have To)
Regulation Best Interest requires broker-dealers to provide their retail customers “full and fair” written disclosure of all material facts relating to (1) the scope and terms of the B-D customer relationship and (2) any conflicts of interest associated with each securities recommendation. It didn’t start that way. When the SEC first proposed the rule, it said B-Ds would have to “reasonably disclose” all material facts on those two topics. But people fought it out in the comments, as they say, and the stronger “full and fair” formulation emerged.
Anyway, what does “full and fair” disclosure mean? Put another way, what is the difference between “full and fair” disclosure and “reasonably disclosing” material facts? First, the SEC doesn’t think the two standards are “significantly different”. Adopting Release at 211. The Commission also points out that the “full and fair” formulation didn’t come from nowhere. It pops up in other securities disclosure obligations, including municipal securities (MSRB Rule G-42), Reg. FD, and ’33 Act reporting. Id. at 212 n.469.
The SEC doesn’t think “full and fair” disclosure is too stringent! No, sir! While it will be “generally similar” to the disclosure obligation applicable to investment advisers under the Advisers Act, it’s not as broad. Id. at 212. For example, Form ADV requires disclosure of the adviser’s principal owner and certain financial industry activities and affiliations, which aren’t explicitly required under the Disclosure Obligation. Id. at 213. Form ADV and the fiduciary duty also go to disclosure of the entire relationship while the Disclosure Obligation is tailored to the recommendation and also given at relevant points in time. Id. at 213-14.
But again, if “full and fair” is not a fiduciary standard, what is it? The Adopting Release breaks it down by topic.
Form and Manner
This is a big one. It might be tempting for some B-Ds to focus on the “full” part, ignore “fair”, and bury retail customers in a flood of disclosures that are impossible to process in any real way. The SEC is hoping that doesn’t happen and designed its “approach to avoid having retail customers receive overwhelming amounts of information.” Id. at 214.
Regardless, the Commission doesn’t specify exactly how written disclosures have to be made. Id. at 218. It decided not to mandate a specific form. Id. at 219. Instead, the “disclosure should be concise, clear and understandable to promote effective communication between a broker-dealer and a retail customer.” Id. at 218. You can do it electronically if you want! Id. at 218. But the SEC says it wants to leave you with flexibility to accommodate your business practices. Id. at 227-28.
In Writing
Disclosures under Reg. BI do have to be in writing. If you’re giving recommendations over the phone, the SEC will have you know that you can send written disclosures before the call or while you’re talking by email, mister. Proposing Release at 117 n.213. You can give oral disclosures – they may be necessary on the fly – but you have to document that in writing if you do. Adopting Release at 227-28. As a best practice, you can follow up by sending the written disclosure following up on the oral disclosure you just made. Id. at 230. And that while it’s not explicitly required by Reg. BI, that writing “should” be in plain English. That is, it should include “the use of short sentences and active voice, and avoidance of legal jargon, highly technical business terms, or multiple negatives.” Id. at 230-31 & n.513.
How do you deliver the disclosures?
You can do it electronically if the delivery is consistent with the Commission’s guidance on electronic delivery of documents. That basically means three things: (1) you have to tell the customer the information is available electronically; (2) the access has to be comparable to paper form and excessively burdensome; and (3) you have to be able to show delivery. Getting informed consent from customers can be helpful in demonstrating delivery. Id. at 231.
Can other documents do the work?
You might have some other documents – like a product prospectus, relationship guide, account agreement, or fee schedule – lying around the house already. Id. at 223. As part of Reg. BI, you’re also having to complete Form CRS to describe the relationship between you and your retail customer. Can you use one of these existing documents to fulfill your Disclosure Obligation?
Naturally, the answer depends on the particular facts and circumstances. You have to think about your actual recommendations and consider whether your standardized documents sufficiently identify the material facts about a potential conflict of interest. Id. at 224-25. So take the documents you have, and go as far as you can with them, but you remain responsible for disclosing all material facts regardless. Id. at 225.