15.3 Regulation Best Interest

Regulation Best Interest (Reg BI)

Regulation Best Interest, adopted by the SEC in 2019 and effective June 30, 2020, establishes a standard of conduct for broker-dealers when making recommendations to retail customers.

Core Requirement

When making a recommendation to a retail customer, a broker-dealer and its associated persons must act in the best interest of the customer at the time of the recommendation, without placing their own financial or other interest ahead of the customer's interest.

Key Terms

Retail Customer: Natural person receiving services for personal, family, or household purposes

Recommendation: Suggestion to buy, sell, or hold securities, or investment strategy

Best Interest: Based on reasonable understanding of customer's investment profile

Investment Profile: Age, financial situation, objectives, risk tolerance, etc.

The Four Component Obligations

Reg BI requires broker-dealers to comply with four distinct obligations:

1. Disclosure Obligation

Requirement: Provide full and fair disclosure of material facts about the relationship and any conflicts of interest.

Must Disclose:

Capacity: Whether acting as broker-dealer, investment adviser, or both

Fees and Costs: All material fees, costs, and compensation

Conflicts of Interest: Material conflicts associated with recommendations

Scope of Services: Types of accounts and services offered

Limitations: Any limitations on recommendations (e.g., proprietary products only)

Timing: Before or at the time of the recommendation

2. Care Obligation

Requirement: Exercise reasonable diligence, care, and skill when making recommendations.

Understand the Product: Know the risks, rewards, and costs

Reasonable Basis: Belief that recommendation could be in best interest of some retail customers

Customer-Specific: Belief that recommendation is in best interest of particular customer

Consider Costs: Evaluate costs and reasonably available alternatives

Quantitative Suitability: Not recommend excessive transactions

3. Conflict of Interest Obligation

Requirement: Establish, maintain, and enforce written policies and procedures to identify and address conflicts.

Identify Conflicts: Recognize conflicts associated with recommendations

Disclose Conflicts: Full and fair disclosure to customers

Mitigate Conflicts: Reduce impact of financial incentives

Eliminate Certain Conflicts: Remove sales contests, quotas for specific products

Conflicts to Address:

Compensation Structures: Higher payouts for certain products

Proprietary Products: Incentives to recommend firm's own products

Revenue Sharing: Payments from product sponsors

Sales Contests: Prizes for selling specific products (must be eliminated)

4. Compliance Obligation

Requirement: Establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Reg BI.

Written Policies: Comprehensive compliance procedures

Training: Educate associated persons on requirements

Monitoring: Supervise recommendations and identify issues

Recordkeeping: Document compliance efforts

Updates: Revise policies as rules or business changes

Form CRS (Customer Relationship Summary)

Overview

Form CRS is a standardized disclosure document that must be provided to retail investors:

Length: Maximum 2 pages (4 pages for dual registrants)

Format: Plain English, specified headings and order

Comparison: Includes "conversation starters" to prompt discussion

Filing: Filed with SEC through CRD (BD) or IARD (IA)

Required Content

Introduction: What types of services we offer

Fees and Costs: How we are compensated and associated costs

Conflicts of Interest: What conflicts we have and how we address them

Standard of Conduct: Our obligation to you (Reg BI vs. Fiduciary)

Disciplinary History: How to research firm and financial professionals

Conversation Starters: Questions customers should ask

Delivery Requirements

New Customers: Before or at earliest of: recommendation, placing order, or opening account

Existing Customers: Within 30 days of filing

Material Changes: Within 60 days of update + communicate changes

Upon Request: Must provide promptly

Recordkeeping for Form CRS

Record: Date each Form CRS was provided to each retail investor

Retention: Minimum 6 years

Method: Electronic or paper

Reg BI vs. Fiduciary Standard

Scope: Reg BI (Broker-Dealers) - At time of recommendation; Fiduciary (Investment Advisers) - Ongoing relationship

Standard: Reg BI - Best interest; Fiduciary - Best interest + loyalty

Duty of Loyalty: Reg BI - Not explicitly required; Fiduciary - Required

Compensation: Reg BI - May have conflicts (disclosed); Fiduciary - Must avoid or fully disclose

Duty to Monitor: Reg BI - Not required; Fiduciary - Ongoing monitoring

Enforcement: Reg BI - SEC, FINRA; Fiduciary - SEC or State

On the Exam: Reg BI is a "point-in-time" standard at the recommendation, while the fiduciary duty is ongoing. Both require acting in the customer's best interest, but fiduciary includes an ongoing duty of loyalty.

2026 Enforcement Focus

The SEC has increased enforcement of Reg BI, focusing on:

Care Obligation: Are recommendations truly in customer's best interest?

Conflict Disclosure: Are all material conflicts adequately disclosed?

Policies and Procedures: Are they reasonably designed and enforced?

Documentation: Is compliance adequately documented?

Key Takeaways

1. Reg BI requires acting in retail customer's best interest at recommendation

2. Four obligations: Disclosure, Care, Conflict of Interest, Compliance

3. Must eliminate sales contests and quotas for specific products

4. Form CRS is max 2 pages (4 for dual registrants) and must be delivered before recommendation

5. Reg BI is point-in-time; fiduciary standard is ongoing