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Risky Business: How Departing Brokers Can Unintentionally Trip Reg. BI

As everyone in the securities industry appreciates, a registered representative’s departure from one broker-dealer firm to join another is a not uncommon event. Such departures, even when voluntary and made on good terms, can and often raise a host of issues. Just last year for instance, FINRA issued Regulatory Notice 19-10 (April 5, 2019), which can be found here.

Regulatory Notice 19-10 addressed a representative’s leaving his or her firm to join a new B-D. The Notice instructed member firms to: (1) promptly and clearly communicate to affected customers how their accounts will continue to be serviced, and (2) provide customers with timely and complete answers, if known, when the customer inquires about the departing rep. Also included in this Notice was the admonition that a customer’s questions about a departing rep be answered “without obfuscation” and that the member BD (i.e., the departed firm) provide information to customers of the departed rep in a fair, balanced and not misleading manner.

The latest guidance regarding potential obligations relating to a departing associated person originates from the staff of the U.S. Securities and Exchange Commission in the context of Regulation Best Interest (Reg. BI). 1 Last week the staff posted its latest round of FAQs regarding Reg. BI’s application to and implementation in various factual hypotheticals, which are found here.

Notably, the Staff considered whether Reg. BI applies to an associated person’s solicitation of retail clients to follow him to a new firm. The staff posed the following scenario:

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; [is my communication subject to Reg BI]?

The Staff answered:

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.

Not 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.

(Posted January 10, 2020) (emphasis added). 2

The staff’s analysis in the hypothetical above focused on a “join me” oral or written communication or solicitation from a broker a customer or client at the former firm. The key to understanding the staff’s analysis about a “call to action” triggering Reg. BI’s application was another of its Qs & As regarding whether a so-called “hire me” conversation occurring in an informal setting (e.g., on the golf course, at social gatherings, or while running errands) could nonetheless trigger application of Reg. BI. In answering that question, the staff made clear that for a communication to be subject to Reg. BI the principle consideration is whether the communication included a “recommendation,” i.e., a “call to action” about a “securities transaction or investment strategy involving securities.” 3 What matters then, as always, is the content of the communication. The staff reasoned:

Whether your [hire me] communication [made in an informal setting] is subject to Regulation Best Interest depends on whether you make a ‘recommendation,’ not on the location or setting of the communication.

Regulation Best Interest applies to a ‘recommendation of a securities transaction or investment strategy involving, securities (including account recommendations) to a retail customer.’ The Commission interprets whether a recommendation has been made to a retail customer that triggers the Regulation Best Interest obligations consistent with the precedent under the anti-fraud provisions of the federal securities laws as applied to broker-dealers, and with how the term has been applied under the rules of self-regulatory organizations. Under this existing framework, a factor to consider is whether the communication reasonably could be viewed as a ‘call to action.’ The more individually tailored the communication to a specific customer or a targeted group of customers, the greater the likelihood that the communication may be viewed as a ‘recommendation.’

If you engage in a communication with a retail customer that rises to the level of a ‘recommendation,’ whether in the context of a ‘hire me’ conversation or otherwise, the recommendation will be subject to Regulation Best Interest.

Not all communications with a prospective retail customer will rise to the level of a recommendation. For example, consider a scenario where you meet a prospective retail customer at a dinner party and say: ‘I have been working with our mutual friend, Bob, for fifteen years, helping him to invest for his kids’ college tuition and for retirement. I would love to talk with you about the types of services my firm offers, and how I could help you meet your goals. Here is my business card. Please give me a call on Monday so that we can discuss.’

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.

(Posted January 10, 2020) (emphasis added). The staff then summarized this “call to action” analysis in its answer to the about when a departing (or departed) broker’s solicitation to a retail customer activates application of Reg. BI. 4

In short, these recently posted FAQs raise important considerations relative to applications of Reg. BI for both the departing and gaining firm and the recruit new hire. The key to any of the described scenarios is whether the customer or client understood the solicitation communication to be a “call to action” about a securities transaction or investment strategy involving securities (including account recommendations) to a retail customer, which recommendation the customer “uses.” 5 Thus brokers who depart one firm for another firm with the intent to solicit clients at the new firm should be aware for the potential application of Reg. BI to such solicitations. So too, broker-dealer firms should keep in mind these same guidelines when recruiting reps, reminding the recruit of the potential consequences of his or her “join me” pitch.

Finally I cannot let pass without comment the staff’s rather curious suggestion in its hypothetical 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….” (emphasis added). No doubt some brokerage firms and Protocol members even would challenge whether such a “practice”—common or not—would breach one or more covenants and terms in an employment or independent contractor agreement between the rep and his/her existing (albeit soon to-be-former) firm, and/or result in loss of the protections the Protocol affords when its requirements and prescriptions are followed. 6


1 See Regulation Best Interest: The Broker-Dealer Standard of Conduct, SEC Rel. No. 34-86031 (June 5, 2019) (“Final Rule”). Read more here. (Reg. BI, Rel. no. 34-86031). 

2 See SEC, Frequently Asked Questions on Regulation Best Interest, (posted Jan. 10, 2020). Read more here.

3 Id.

4 Id.

5 See Reg. BI, Rel. no. 34-86031 at p. 99, fn. 202. As the SEC made clear in footnote 202

… Regulation Best Interest applies to a retail customer who receives a recommendation and uses the recommendation. Among other things, we interpret a retail customer to use a recommendation when: (1) the retail customer opens a brokerage account with the broker-dealer, regardless of whether the broker-dealer receives compensation; (2) the retail customer has an existing account with the broker-dealer and receives a recommendation from the broker-dealer, regardless of whether the broker-dealer receives or will receive compensation, directly or indirectly, as a result of that recommendation; or (3) the broker-dealer receives or will receive compensation, directly or indirectly as a result of that recommendation, even if that retail customer does not have an account at the firm.

A retail customer’s receipt and use of a recommendation is discussed further in Section II.B.3.b of the Final Release. Id. at pp. 120-22.

6 Most firms would contend such practice would further be contrary to the firm’s policies and procedures.

© 2020 Winstead PC.National Law Review, Volume X, Number 52

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About this Author

John Kincade, Winstead, Shareholder; Co-Chair, Securities Litigation & Enforcement
Shareholder

John Kincade is Co-Chair of Winstead’s Securities Litigation & Enforcement Practice Group. He practices at all levels of federal and state securities litigation, arbitration and regulatory enforcement disputes. He represents a wide range of financial services clients including brokers/dealers, investment advisers, banks, and their registered persons in complex, high stakes FINRA arbitrations, FINRA Enforcement proceedings and investigations, and SEC and State enforcement matters. He also advises privately held and publicly traded companies and their officers and directors in federal...

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