Most of the regulations
Regulation Best Interest (Reg BI)
Reg BI was designed to help protect retail customers with their relationships with broker-dealers and investment advisers, requiring additional disclosures, limiting certain activities, and different interpretations of previous rules and regulations. Also created was the Form CRS, a new customer relationship summary form.
The simple idea is that if a customer seeks a recommendation from a broker-dealer, or advice from an investment advisor, they are entitled to a recommendation or advice that is in their best interest as a customer. The firm must strive to put the client’s best interest ahead of its own. This is an increase above simple suitability requirements.
Reg BI only applies to retail customers. For simplicity, a retail customer is a natural person or their non-professional legal representative who will receive a recommendation of a transaction with securities or an investment strategy involving securities from a broker-dealer, and uses that recommendation for personal, household, or family reasons and purposes.
Form CRS is a new relationship disclosure document that broker-dealers and investment advisors must provide for retail customers. Form CRS must be provided no later than account opening, placing an order, or receiving a new recommendation. Unlike many other disclosure documents, this one has a page limit of 2, so it is concise. The CRS must discuss the services offered along with;
- The fees, costs, potential conflicts of interest, and a standard of conduct associated with those relationships and services
- Whether the firm or its financial professionals currently have legal or disciplinary history reports
- How to obtain certain information, like copies of documents and related materials, from and about the firm.
Broker-dealers file form CRS with the Central Record Depository (CRD), while investment advisors would file with the Investment Adviser Registration Depository (IARD) as the part 3 of form ADV.
Brokerage firms, as part of the general obligation, must fulfill the following 4 specific obligations to satisfy Reg BI;
- Disclosure - The firm must provide certain required disclosures regarding any recommendations made and the relationship between the firm and that customer before or at the time the recommendation was made.
- Care - The firm must exercise reasonable diligence, care, and skill in making recommendations.
- Conflicts of interest - The firm must establish, maintain, and enforce written procedures and policies that will reasonably address actual conflicts of interest, and alert to potential conflicts of interest for them to be disclosed. Not all potential conflicts of interest are bad, but bad ones must be prevented, and the “not actually bad but could look bad”, must be disclosed.
- Compliance - the firm must establish, maintain, and enforce written procedures and policies that are reasonably designed to achieve compliance with the rules of Reg BI.
Regulation M
Designed to prevent market manipulation during securities offerings by prohibiting issuers, underwriters, and selling shareholders from artificially influencing the price of the offered securities. To prevent manipulation by the issuer or others, when the issuer is selling these securities in the primary market. Broker-dealers acting as syndicate/selling group members may have their market activities restricted just prior to the issuance, to help prevent manipulation. How long the restricted period lasts depends on the public float and average daily trading volume of the security. Securities that are actively traded generally won’t have much, if any, restricted period, and syndicate/selling group members can trade once the securities are released. Securities that are thinly traded are a much bigger concern, as those have much more manipulation potential, and would therefore have longer restricted periods. The specific lengths aren’t needed. The issuer and its selling shareholders are prohibited from buying share of their company’s stock in the secondary market while their company is in the process of an issuance.
Stabilization
Stabilizing bids look like market manipulation. There is a very good reason why they look like market manipulation; they are. The difference of course, is that stabilization is a legal form of market manipulation. Stabilization is used to prevent a stock price from falling below the IPO of a firm commitment offering. It can never be used to be used to raise the price. That is a little pedantic, “prevent the decline” vs “raising the price”, because if the price went up, that sure would prevent it going down, but they are very different in this industry. The lead manager, on behalf of the syndicate, may enter a single disclosed stabilizing bid, at or below the public offering price. It must be disclosed as a stabilizing bid. This is the only legal form of market manipulation the SEC allows.
Regulation S-P
The regulations around safeguarding the private information of their customers and clients is designed to protect non-public information, along with any list derived from non-public information. Publicly available information is not protected by this regulation.
Institutions, to follow Reg S-P must establish privacy policies in regard to what information they collect and keep about their clients, who has access, and how they protect it, and notify their customers about them. Additionally, the customers must have an easy way to opt-out of the annual notifications and the sharing of their non-public personal information with third parties. Sometimes broker-dealers work with other companies to provide services or products to the client. That might require sharing certain non-public personal information. The client can opt out of that, so their information won’t be shared, and it must be easy; no triplicate mailed to 3 different addresses. It has to be like a button, or a simple letter/email.
Firms must provide each customer with the privacy notice initially and annually. Consumers must get the privacy notification before the firm can disclose any non-public information to unaffiliated third parties. If the firm does not intend to disclose any of that information, no disclosure is then required.
Regulation SHO
Reg SHO deals with short sales. Reg SHO applies to equity securities and any other security that is convertible into an equity security (convertible bonds and similar). Previously, there was a practice called “uncovered short selling” or “naked shorting”, where the first part of shorting stock, borrowing the stock, was not actually completed. There can be lots of problems caused by this, so in the early 2000s, we got Reg SHO.
Location requirement
One of the ways to think about Reg SHO, would be to add a W; so it becomes SHOW. Prior to effecting a short sale transaction, the broker-dealer must know the location of the securities. They have to locate the securities, so the customer actually has something to borrow. The broker or dealer will have met these requirements if they have;
- Borrowed the security, or entered into a bona-fide arrangement to borrow the security, or
- They have reasonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due, and
- They must document their compliance
There are many firms in the industry whose whole business model is to have securities for customers to borrow and short. They publish lists which can help make location requirements easier to meet. The SEC also accepts these, and the firm’s own internal easy-to-borrow list, which they have researched, and believes it can easily borrow securities on that list to be delivered by the delivery date.
Under Reg SHO, fail-to-deliver position at a clearing firm in a threshold security for thirteen consecutive days, the participant at the clearing firm shall immediately close out the fail-to-deliver position by purchasing securities of like kind and quantity.
Marking orders
Broker-dealers must mark order tickets as long or short. Order tickets have both buy or sell listed, along with long or short. Remember, a long buy opens a long position, a long sale closes a long position and a short sell opens a short position, while a short buy closes a short position. This requirement to mark order tickets goes for the sale of all equity securities on any exchange or in the OTC markets.
A person is considered long if they purchased the security. They would also be considered long if they entered into a binding contract to purchase the security but it hasn’t been delivered yet, or if the customer holds some derivatives contract to purchase the security and hasn’t received notification the position will be settled in physical certificates.
For a sale order to be marked “a long sale”, if the seller is deemed to own the security being sold, and either that the security to be delivered in the physical possession or control of the broker or dealer, or it is reasonably expected that the security will be in their physical possession no later than settlement.
For the sale order to be marked “a short sale”, if the seller doesn’t own the security being sold (delivering borrowed shares), or owns the security but doesn’t reasonably expect it will be in the possession or control of the broker or dealer before the settlement.