Broker-dealers (“BDs”) should be aware that, on June 5, 2019, the SEC adopted “Regulation Best Interest” (“Reg BI”), which requires BDs and their registered representatives (“RRs”) to “act in the best interest of the retail customer,” when “making a recommendation” regarding “a securities transaction or investment strategy.”  In addition, the SEC’s new rules require BDs to deliver Form CRS relationship summaries (“Form CRS”) to retail customers.  BDs will need to be in compliance with Reg BI and Form CRS, which were accompanied by more than 1,000 pages of explanation, by June 30, 2020.   On August 7, 2019, FINRA issued Notice 19-26, which informed BDs and RRs of the need to comply, but offered no guidance on compliance.  This post summarizes some of the key aspects of Reg BI and Form CRS.

The Obligations Required by Reg BI

Reg BI does not impose a general fiduciary duty.  Rather, Reg BI requires BDs and RRs to comply with four obligations: (i) a disclosure obligation; (ii) a care obligation; (iii) a conflict of interest obligation; and (iv) a compliance obligation.  Reg BI’s obligations of care and compliance resemble obligations already set forth in FINRA Rules 2111 and 3110, respectively.   In contrast, Reg BI’s disclosure and conflict management obligations create new duties, and require BDs to update their written supervisory procedures, internal and external procedures, and certain compensation practices.

The Obligation of Care Largely Mirrors FINRA’s “Suitability” Rule

Reg BI’s obligation of care closely resembles the suitability standard of FINRA Rule 2111.  Under Reg BI, BDs and their RRs must have a reasonable basis to believe that a recommendation:  (1) would be in the best interest of at least some retail customers (Rule 2111’s reasonable basis suitability test); (2) is in the specific customer’s best interest (Rule 2111’s customer-specific suitability test); and, (3) if the recommendation involves a series of transactions, the transactions should not be excessive or place the BD’s financial interests ahead of the customer’s interests (Rule 2111’s quantitative suitability rest).

In addition, Reg BI expressly requires BDs and RRs to consider “the costs associated with the recommendation,” and to refrain from placing their own financial interests ahead of the customer.  Although Reg BI does not require a BD to recommend the lowest cost option, the SEC “elevated” cost consideration to the text of Reg BI to emphasize that the cost of a product, transaction, or account type (asset-based fees versus transaction-based fees) is “always relevant” to—though not always dispositive of—whether a recommendation is in the customer’s best interest.  Thus, to ensure compliance, BDs should train their RRs to: (1) evaluate and discuss the costs of both products and account types with retail clients at the time of a recommendation, and (2) document those discussions.  These discussions will be critical to satisfying not only the care obligation, but, as explained below, the disclosure obligation as well.  BDs also should confirm that their written supervisory policies reflect these procedures.

New Burdens Associated with the Obligation of Disclosure and Form CRS

Reg BI expressly requires BDs and RRs to make “full and fair” written disclosures at the time of any recommendation, concerning (i) the material fees and costs associated with the transaction, holdings, and accounts; (ii) the type and scope of services; (iii) any limitation on services offered; and (v) any conflict of interest.  Although account-opening documents and confirmations may contain some of these disclosures, Reg BI requires disclosures that are more detailed than those required by current law.   For example, Reg BI requires firms to disclose: (1) whether they are acting as a BD, a registered investment advisor (“RIA”), or a dual registrant; (2) the duty of care to which the firm is held, including whether the firm will make recommendations or engage in ongoing account monitoring; (3) the variance in fees associated with brokerage accounts and advisory accounts; (4) the existence of any conflicts of interest; and (5) any disciplinary and legal history.  These disclosures are largely intended to ensure that retail customers understand whether they are working with a BD, who must act in their interest, or an RIA, who must act as a fiduciary.  The disclosures are also designed to assist customers in determining whether they should choose a brokerage account, where fees are charged for transactions, or an advisory account, where fees are based on a percentage of assets.  The SEC’s explanatory comments about the disclosure obligation endorsed restrictions regarding the use of the titles “advisor” and “adviser” and stated it would “presume” that BDs who are not also registered as RIAs violate the disclosure obligation when they refer to themselves or their RRs as  “advisors” or “advisers.”

Firms will make many, but not all, of these disclosures via the new Form CRS.  The SEC has published templates of Forms CRS for BDs, RIAs, and dual registrants, which include language that firms must include in their Form CRS disclosures.  Notably, Form CRS requires firms to compare the fees associated with transaction-based brokerage accounts with the fees associated with fee-based advisory accounts.  Form CRS also requires the BD to state that it has “a legal or disciplinary history” if either the BD or any of its RRs has made disclosures concerning criminal proceedings, regulatory proceedings, judicial proceedings, or unsatisfied judgments on their Forms BD, U-4 or U-5, or if an RR has reported a customer complaint or a specified termination on a Form U-4 or Form U-5.   Finally, all firms must include “conversation starters” on Form CRS to help investors ask questions that will assist them in choosing between firms and between brokerage and advisory accounts.

BDs must submit their initial Form CRS to FINRA via the Central Registration Depository (“CRD”) no later than June 30, 2020, and must update the Form CRS within 30 days if there are any “material changes.”  BDs must begin to deliver Form CS to their retail customers once the Form CRS becomes effective, and must post the form on their websites, if they have one, in a readily accessible format.   BDs will be required to deliver the Form CRS to new customers at the earliest of: making a recommendation, opening an account, or executing a transaction.

BDs should begin preparing their Form CRS and additional disclosures early, in light of the scope of these obligations.  This will ensure the timely completion of Form CRS and any additional disclosure documents and updates to written supervisory procedures, and afford time for BDs to provide training to RRs about how to respond to customer questions concerning the Form CRS.  In addition, BDs that are not dually registered as RIAs should evaluate the risks of referring to themselves and their RRs as “advisors” or “advisers” in their communications with the public and with customers.  Finally, BDs may consider whether to support RRs in seeking expungements of inaccurate or meritless information regarding customer complaints.

The New Burdens Associated with the Conflict of Interest Obligation

Regulation BI also requires BDs to “establish, maintain, and enforce policies” designed to:  (1) identify and disclose conflicts of interest, and (2) eliminate conflicts that cannot be ameliorated by disclosure.

The SEC has opined that BDs and RRs act under a remediable conflict of interest when:  (1) selling proprietary products; (2) offering a limited range of products; and (3) offering products with substantial variations in compensation to the BD and RR.  Reg BI permits firms to remediate these conflicts with appropriate disclosures—which are in addition to the disclosures included in Form CRS.

However, the SEC has concluded that sales contests, quotas, and bonuses based on the sale of specific securities within a limited time period undermine one’s ability to make recommendations that serve the customer’s best interest, and thus, the conflicts created by such practices cannot be remediated by disclosure.  Therefore, Reg BI requires BDs to eliminate these compensation practices.  Note, however, that Reg BI does not require BDs to eliminate compensation tied to total production or asset accumulation.

In sum, BDs should review their product offerings to identify any conflicts that must be disclosed, and to develop procedures for disclosure and documentation thereof.  Further, despite the June 2020 deadline for compliance, firms should consider eliminating sales contests and quotas as soon as possible, particularly to avoid state-level regulatory action and customer-generated litigation.

The Compliance Obligation

Finally, Reg BI requires firms to establish and enforce written policies “designed to achieve compliance with” Reg BI.  The SEC adopted a flexible approach, which, like FINRA Rule 3110, allows firms to adopt procedures that reflect the firm’s scope, size, and business lines.  The SEC has suggested that a reasonable compliance program would include: “controls; remediation of non-compliance; training; and periodic review and testing.”   In addition, the SEC amended SEA Rules 17a-3 and 17a-4 to require BDs to keep records concerning recommendations and the delivery of Form CRS to customers for a period of six years.

* * *

In conclusion, though Reg BI’s obligations of care and supervision are familiar, its disclosure and conflict management obligations are largely new—and extensive.   Therefore, firms should begin the process of conforming to Reg BI, as outlined herein, post haste.

For many, the topic of workplace violence may, understandably, exclusively invoke thoughts of the types of mass shootings and other employee-on-employee violence that commands the most extensive media coverage.  Financial services employers, though, like employers in other significantly public-facing industries, must address a broader array of concerns—ranging from threating behavior by clients, to domestic abuse spilling over into the workplace.  The legal framework that has, substantially in the past decade, come into being around issues of workplace violence in some respects provides employers with important tools for addressing workplace violence, but, in other respects, can complicate employers’ efforts to maintain a safe workplace.

In a recent video webinar, Elizabeth K. McManus and Edward M. Yennock, members of Epstein Becker & Green’s Financial Industry Service Team, discussed measures that employers may take to prevent workplace violence and to address threats before they materialize into a crisis, as well as some of the challenges—both legislative and practical—that employers face in dealing with these issues.  Topics explored include, among others: creating an effective workplace violence policy, recognizing and reporting potential threats, navigating the risks and regulations associated with mental illness and domestic violence, complicating factors such as the so-called “parking lot” gun laws, and the ability of employers to obtain workplace protection orders in a number of jurisdictions.

The following is a clip from the webinar:

Our Employee Benefits and Executive Compensation practice now offers on-demand “crash courses” on diverse topics. You can access these courses on your own schedule. Keep up to date with the latest trends in benefits and compensation, or obtain an overview of an important topic addressing your programs.

In each compact, 15-minute installment, a member of our team will guide you through a topic. This on-demand series should be of interest to all employers that sponsor benefits and compensation programs.

In our newest installmentTzvia Feiertag, Member of the Firm in the Employee Benefits and Executive Compensation practice, in the Newark office, presents “HIPAA Privacy and Security Rule Compliance.”

While employers themselves are not directly regulated by the Privacy and Security Rules of the Health Insurance Portability and Accountability Act (“HIPAA”), most employers that sponsor group health plans have ongoing compliance obligations. This crash course offers a brief overview of who and what is covered by these rules, why employers should care about HIPAA compliance, and five tips to maintain compliance.

Click here to request complimentary access to the webinar recording and presentation slides.

In the financial services industry, investigations by the government or self-regulatory organizations are commonplace, and because they inevitably involve employee conduct (or misconduct), there is frequently an internal employment-related investigatory component. With potential financial liability and reputational harm ever-present, the strength of a company’s investigatory process is critical.

In a recent video webinar, John F. Fullerton III, co-leader of Epstein Becker & Green’s Financial Industry Service Team, spoke about when materials related to an internal investigation can and cannot be shared with a third party – such as a forensic accounting firm – while still maintaining the attorney-client privilege in connection with the investigation.

This Employment Law This Week® Monthly Rundown discusses the most important developments for employers in August 2019.

This episode includes:

  • Increased Employee Protections for Cannabis Users
  • First Opinion Letters Released Under New Wage and Hour Leadership
  • New Jersey and Illinois Enact Salary History Inquiry Bans
  • Deadline for New York State Anti-Harassment Training Approaches
  • Tip of the Week

See below to watch the full episode – click here for story details and video.

We invite you to view Employment Law This Week® – tracking the latest developments that could impact you and your workforce. The series features three components: Trending News, Deep Dives, and Monthly Rundowns. Follow us on LinkedInFacebookYouTubeInstagram, and Twitter and subscribe for email notifications.

Our colleague Amanda M. Gomez 

Following is an excerpt:

Additionally, employers that can demonstrate a good faith effort through proactive measures to comply with the Act may be able to mitigate liability should a claim arise. Similar to “safe harbor” provisions in equal pay laws in Massachusetts and Oregon, such proactive measures should include regular audits of compensation practices. While these measures do not create a complete defense, employers that successfully present evidence of a “thorough and comprehensive pay audit” with the “specific goal of identifying and remedying unlawful pay disparities” may avoid liquidated damages. The key word here is “remedying”; employers that conduct pay audits, but then fail to take steps to correct unlawful pay discrepancies revealed by the audit, will not reap the benefits of the “safe harbor” defense and could instead find themselves without the proverbial port in a storm.

Notably, the Act goes further than most other comparable state wage discrimination laws by mandating notification to employees of employment opportunities. Employers must make reasonable efforts to provide notice of internal opportunities for promotion on the same calendar day the opening occurs. These announcements must disclose the hourly or salary compensation, or at the very least a pay range, as well as a description of benefits and other compensation being offered. Failure to comply with these provisions could result in fines of between $500 and $10,000 per violation. …

Read the full post here.

On June 19, 2019, the New York State Senate and Assembly passed legislation that would, if signed into law, broaden the scope of last year’s ban on clauses requiring employees to arbitrate sexual harassment claims so as to prohibit such clauses with respect to all types of discrimination claims. As reported on this blog, this ban on mandatory arbitration clauses was deemed invalid, as contrary to federal law, by the June 26, 2019 decision of the U.S. District Court for the Southern District of New York in Latif v. Morgan Stanley & Co. LLC, et al. (S.D.N.Y. No. 18-11528). It is too early, however, to declare the death of New York’s ban on mandatory arbitration clauses in harassment and discrimination claims. Absent diversity of citizenship, plaintiffs’ counsel may choose to assert only state-law claims in an effort to eliminate federal court jurisdiction over an employer’s petition to compel arbitration. As motions to compel arbitration will continue to be decided by New York state courts, employers should be mindful of the relevant New York decisions when drafting arbitration agreements and dispute resolution programs.

Like federal law, New York state law generally favors the enforcement of arbitration agreements. But there are important caveats. Initially, Section 7503 of the CPLR requires courts to decide certain threshold issues before compelling arbitration, including: whether there is an agreement to arbitrate; whether the agreement has been followed; and whether the underlying claim is barred by the statute of limitations. In addition, the New York Court of Appeals has held that certain issues are so “interlaced with strong public policy considerations that they have been placed beyond the reach of an arbitrator’s discretion.” Assoc’d. Teachers v. Board of Ed., 33 N.Y.2d 229, 335 (1973); accord City of NY v. Uniformed Fire Off. Ass’n., 95 N.Y.2d 273, 281 (2000); see also Merrill Lynch Pierce Fenner & Smith v. Benjamin, 1 A.D.3d 39, 44 (1st Dep’t. 2003).

In Brady v. Williams Capital Group, LP, 14 N.Y.3d 459, 467 (2010), which involved claims of race and gender discrimination, the Court of Appeals recognized that the policy favoring arbitration must sometimes yield to “an equally strong policy requiring the invalidation of such agreements when they contain terms that could preclude a litigant from vindicating his/her statutory rights in the arbitral forum.” The Brady court observed that arbitrator fees may “preclude a litigant from effectively vindicating her federal statutory rights.” Therefore, the Court of Appeals concluded that New York courts must evaluate whether the cost of arbitration is prohibitive on a case-by-case basis and consider: (1) the litigant’s ability to pay the fees; (2) the cost differential between arbitration and court litigation; and (3) whether the costs of arbitration might deter a party from bringing claims.

Employees may try to invoke these cases to argue that, regardless of what the federal district courts have said on the matter, their discrimination claims should not be arbitrated because New York has a strong public policy—as evidenced by the recent legislation—favoring judicial resolution of discrimination claims, and/or because arbitration is purportedly an ineffective means of vindicating their right to a discrimination-free workplace. The first contention, though, is belied by the fact that New York’s statutory nullification of mandatory arbitration clauses is expressly qualified: it applies “[e]xcept where inconsistent with federal law.” As explained here, the Latif opinion expressly rejected the arbitration ban as inconsistent with federal law. Further, under the rules of statutory construction, the New York legislature is presumed to be aware of the federal cases invalidating state legislation that purports to ban arbitration agreements. Thus, it will be difficult to argue that New York has a strong public policy against arbitrating claims of employment discrimination.

In light of the Court of Appeals precedent referenced above, however, employers doing business in New York should review arbitration agreements and dispute resolution programs to ensure that they provide employees with an effective means to vindicate their statutory rights. Employers should carefully evaluate any provision that requires employees to share arbitration costs, or requires an unsuccessful employee to pay costs or attorney’s fees. Likewise, employers should review any choice-of-venue provision that might require an employee to arbitrate in a distant forum, which may increase costs. Employers should also evaluate any choice-of-law provision that subjects New York-based employees to the laws of other states. Employers may also wish to emphasize that they engage in interstate commerce, as this may support arguments that arbitration agreements should be reviewed under the Federal Arbitration Act, even in state court. Finally, employers should review any procedural rules that restrict the employee’s right to participate in the arbitrator selection process, and should evaluate whether any permitted arbitral forum offers a diverse roster of neutrals.

Furthermore, employers should consider disclosures that remind employees of the benefits of arbitration. Arbitration agreements often advise employees that discovery is limited in arbitration and that they are forfeiting their right to a jury trial, without also noting the reasons why an employee might prefer arbitration—e.g., it is generally faster than traditional litigation and provides employees with the option of resolving claims confidentially. Indeed, in Latif, the plaintiff sought unsuccessfully to keep his identity confidential. And the recent New York legislation allows nondisclosure clauses in settlement agreements if requested by the employee, recognizing that some employees may value confidentiality. Of course, given the sensitivity around nondisclosure agreements, employers need to careful when discussing the benefits of confidentiality.

In sum, the Latif decision is a welcome development for many, and provides support for enforcing arbitration agreements. Nevertheless, until New York courts review the soon-to-be-expanded ban on mandatory arbitration clauses, employers should draft arbitration agreements and dispute resolution programs with the expectation that they will be challenged in state court.

Launched more than a decade ago, the #MeToo movement made its way into the national (and international) conversation in 2017, and, by 2018, the movement had such momentum that it spurred a cornucopia of new state laws.  One of these new laws, which became effective July 11, 2018, is a New York State statute that prohibits employers from requiring employees to submit sexual harassment claims to mandatory arbitration.  This new law is codified in Section 7515 of the Civil Practice Law & Rules of the State of New York (“C.P.L.R.”), entitled “Mandatory arbitration clauses; prohibited.”  Section 7515 reflects the New York State Legislature’s (which consists of the New York State Assembly and the New York State Senate) determination that employees should be allowed to have their sexual harassment claims adjudicated in a court of law, if that is their preference.  The introductory clause of Section 7515 also indicates, however, that legislators understood that an unqualified prohibition of mandatory arbitration might not pass muster under federal law:

Prohibition. Except where inconsistent with federal law, no written contract, entered into on or after the effective date of this section shall contain a prohibited clause as defined in paragraph two of subdivision (a) of this section.  (C.P.L.R. § 7515(b)(i).)

Hence, the statute engendered substantial uncertainty among employers.  Now, almost one year after C.P.L.R. § 7515 became law, a U.S. District Court Judge, the Hon. Denise Cote of the Southern District of New York, has addressed this confusion by opining on whether New York State may outlaw privately negotiated agreements to submit all disputes, inclusive of claims for sexual harassment, to arbitration.  In Latif v. Morgan Stanley & Co. LLC, et al., No. 1:18-cv-11528 (S.D.N.Y. June 26, 2019),  Judge Cote delivered a clear message about the collision of C.P.L.R. § 7515, which operates to constrain parties’ rights to agree to arbitrate claims, and the Federal Arbitration Act (the “FAA”), which, as repeatedly reinforced by the U.S. Supreme Court in recent years, mandates substantial deference to private arbitration agreements.  Employers, especially those in the financial services industry, have reason to cheer Judge Cote’s opinion in Latif, which restores a degree of certainty about whether a mandatory arbitration clause governing an employment relationship may still be enforced—at least in some courts.

The essential facts are as follows: Mahmoud Latif (“Latif”) signed an employment agreement (the “Offer Letter”) that incorporated by reference Morgan Stanley’s mandatory arbitration program.  Read together, these documents formed the “Arbitration Agreement” between Latif and Morgan Stanley.  The Arbitration Agreement provided that any “covered claim” that arose between Latif and Morgan Stanley would be resolved by final and binding arbitration, and that “covered claims” included, among other causes of action, discrimination and harassment claims.  Nevertheless, Latif commenced an action against Morgan Stanley in federal court, asserting, among other charges, claims of sexual harassment under federal, state and municipal law.  The Morgan Stanley defendants moved to compel arbitration of the entire case, inclusive of the sexual harassment claims.  Latif opposed that motion on the basis of C.P.L.R. §7515, which, according to Latif, expressed New York State’s “general intent to protect victims of sexual harassment,” and required the Court to retain jurisdiction over the sexual harassment claims—even though those claims fell clearly within the ambit of the Arbitration Agreement.

In granting Morgan Stanley’s motion to compel arbitration, inclusive of the sexual harassment claims, Judge Cote held that C.P.L.R. §7515 could not serve as the basis to invalidate the Arbitration Agreement.  The Court’s rationale is straightforward: C.P.L.R. §7515 purports to nullify agreements to arbitrate sexual harassment claims “except where inconsistent with federal law,” and the statute is indeed inconsistent with the FAA’s “strong presumption that arbitration agreements are enforceable.”  Judge Cote therefore stayed Latif’s court action pending the outcome of arbitration proceedings.

In light of the foregoing, to maximize the likelihood of full enforcement of an arbitration agreement, inclusive of claims for sexual harassment, employers should promptly consider the prospect of removal of a New York State court action to federal court, if circumstances otherwise permit such removal.

Finally, employers also should note that, on June 19, 2019, the New York State Legislature voted to amend Section 7515 to prohibit not only the mandatory arbitration of sexual harassment claims, but also the mandatory arbitration of any allegation or claim of discrimination.  While, as of this writing, the amendment has not yet been signed into law by the executive, it appears safe to predict that states will continue, in the near future, to attempt to prohibit or constrain mandatory arbitration of discrimination/harassment claims in a way that generates apparent conflict with federal law.  The Supreme Court’s adjudication of a constitutional challenge to C.P.L.R. §7515, and/or like statutes, under the Supremacy Clause of the U.S. Constitution seems to be a likely end-game.

Our colleagues 

As we previously reported, on April 9, 2019, the New York City Council passed Int. 1445-A, which prohibits employers from pre-employment drug testing for marijuana and tetrahydrocannabinols (“THC,” the active ingredient in marijuana). On May 10, 2019, Int. 1445-A became law by operation of the New York City legislative process, which automatically made the bill law after 30 days without action by Mayor de Blasio. The law becomes effective May 10, 2020, giving New York City employers one year to prepare.

Under the law, employers, labor organizations, and employment agencies, and all of their agents, are prohibited from requiring a prospective employee to submit to a marijuana or THC drug test as a condition of employment. This conduct is now characterized as an “unlawful discriminatory practice.” There are, however, several exceptions to the law. For example, the law will not apply to employees in the following roles: safety-related positions, transport-related positions, caregivers, and certain federal contractors. Further, to the extent that a collective bargaining agreement requires drug testing, the law will not apply to such testing. Please see our Act Now Advisory for further details related to these exceptions. …

Read the full post here.

Tuesday, May 7, 2019 – Downtown Dinner Program

Wednesday, May 8, 2019 – Repeat Suburban Lunch Program

Join our colleagues Lauri Rasnick, Kevin Ryan, and Peter Steinmeyer for an interactive panel discussion which will provide insights into recent developments and expected trends in the evolving legal landscape of trade secret and non-competition law. This program will also discuss unique issues and developments in the health care and financial services industry. Our colleagues will also be joined by Thomas J. Shanahan, Associate General Counsel at Option Care.

Issues arising from employees and information moving from one employer to another continue to proliferate and provide fertile ground for litigation. Many businesses increasingly feel that their trade secrets or client relationships are under attack by competitors—and even, potentially, by their own employees. Individual workers changing jobs may try to leverage their former employer’s proprietary information or relationships to improve their new employment prospects, or may simply be seeking to pursue their livelihood.

How can you put yourself in the best position to succeed in a constantly developing legal landscape?

Whether you are an employer drafting agreements and policies or in litigation seeking to enforce or avoid them, you will want to know about recent developments and what to expect in this area.

During this program, the panel will discuss:

  • Legal trends in the enforceability of non-competes
  • New and pending state and federal legislation, including the Massachusetts Noncompetition Agreement Act
  • Recent judicial decisions regarding restrictive covenants, including an important California case concerning provisions barring solicitation of employees
  • New cases and statutes regarding protection of trade secrets
  • Continuing governmental scrutiny of “no poach” agreements and restrictions on low wage workers

To register, click here. 

ACC Chicago is an Approved Illinois CLE Provider. 1 General Credit Hour (pending) for this program. Participants seeking MCLE credit need to sign in and provide their Illinois Bar number