What Is Regulation Best Interest?
Regulation Best Interest (Reg BI) is a rule adopted by the U.S. Securities and Exchange Commission (SEC) that establishes a standard of conduct for broker-dealers and their associated persons when they make a recommendation to a retail customer of any securities transaction or investment strategy involving securities. Falling under the umbrella of securities regulation and financial compliance, Reg BI requires these financial professionals to act in the best interest of their retail customers at the time a recommendation is made, without placing their own financial or other interests ahead of the customer's interests. This rule was designed to enhance investor protection by requiring broker-dealers to address conflicts of interest and provide transparent disclosures.44,43
History and Origin
Prior to Regulation Best Interest, broker-dealers were primarily held to a "suitability" standard, which generally required that a recommended investment be suitable for a client based on their profile, but did not explicitly demand that it be the best available option for that client.,42 This standard, primarily enforced by the Financial Industry Regulatory Authority (FINRA), allowed for potential conflicts where a suitable, but more lucrative, product for the broker might be recommended over another equally suitable, but less profitable, one for the broker.41
The passage of the Dodd-Frank Act in 2010 included a provision that gave the SEC the authority to establish a "best interest" standard for broker-dealers, akin to the existing fiduciary duty for investment advisers.40 After extensive public comment and debate, the SEC officially adopted Regulation Best Interest on June 5, 2019, with a compliance date of June 30, 2020.,39 The rule aimed to address the long-standing investor expectation that their financial professional would act in their best interest, an expectation often not met by the previous legal standard applicable to broker-dealers.38
Key Takeaways
- Regulation Best Interest requires broker-dealers to act in a retail customer's best interest when making recommendations.37,
- It significantly enhances the previous suitability standard for broker-dealers.36,35
- The rule mandates four core obligations: disclosure, care, conflicts of interest, and compliance.34,33
- Reg BI applies to recommendations of any securities transaction or investment strategy involving securities made to retail customers.32
- It aims to reduce potential harm to retail investors from conflicts of interest.31
Interpreting Regulation Best Interest
Regulation Best Interest is interpreted through its four primary obligations, which collectively require broker-dealers to put their retail customers' interests first when making recommendations. These obligations are:
- Disclosure Obligation: Broker-dealers must provide written disclosure to retail customers about the material facts of their relationship, including the capacity in which they are acting (e.g., as a broker-dealer), fees, the scope of services, limitations, and any conflicts of interest.30,29
- Care Obligation: A broker-dealer must exercise reasonable diligence, care, and skill to understand the potential risks, rewards, and costs associated with a recommendation. They must then consider these factors in light of the retail customer's investment profile and make a recommendation that is in the customer's best interest.28
- Conflict of Interest Obligation: Firms must establish, maintain, and enforce written policies and procedures reasonably designed to identify and, at a minimum, disclose or eliminate conflicts of interest. In some cases, mitigation or even elimination of conflicts may be required if disclosure alone is insufficient.27,26
- Compliance Obligation: Broker-dealers must establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest as a whole.25,24
These obligations mean that broker-dealers must go beyond merely recommending a "suitable" product and instead recommend a product that aligns with the customer's best interest, considering factors like costs, risks, and the customer's investment profile.23
Hypothetical Example
Consider a new retail customer, Sarah, who is looking to invest for retirement and approaches a broker-dealer for guidance. According to Regulation Best Interest, the broker-dealer must understand Sarah's financial situation, investment objectives, and risk tolerance.
- Information Gathering: The broker collects information about Sarah's age, income, existing assets, liabilities, and long-term financial goals, such as retirement at age 65.
- Product Analysis: The broker identifies several mutual funds that are suitable for Sarah's retirement goals. Fund A has a high expense ratio but pays the broker a higher commission. Fund B has a lower expense ratio and a strong historical performance, but pays a lower commission.
- Best Interest Recommendation: Under Reg BI's Care Obligation, the broker must consider the costs associated with the recommendation. Even though Fund A offers a higher commission, the broker, acting in Sarah's best interest, recommends Fund B because its lower expense ratio and comparable performance are more advantageous for Sarah's long-term portfolio growth. The broker also provides Sarah with a Form CRS, summarizing their relationship and any potential conflicts.
This example illustrates how Regulation Best Interest requires the broker-dealer to prioritize the customer's financial well-being over their own compensation, a key difference from the less stringent suitability standard.
Practical Applications
Regulation Best Interest significantly impacts how financial products are recommended and sold to retail investors. Its practical applications include:
- Enhanced Due Diligence: Broker-dealers must conduct more thorough due diligence on both the recommended products and the retail customer's individual circumstances to ensure the "best interest" standard is met. This includes understanding the risks, rewards, and costs of specific securities or investment strategies.22
- Conflict Management: Firms are required to implement robust policies and procedures to identify, disclose, and, where necessary, mitigate or eliminate conflicts of interest arising from compensation structures, proprietary products, or other business practices.21
- Documentation Requirements: Broker-dealers must maintain comprehensive records demonstrating their compliance with Reg BI's obligations, including documentation of the basis for their recommendations and the disclosures provided to customers.20,19
- Training and Supervision: Firms must provide ongoing training to their associated persons to ensure they understand and adhere to the heightened standard of conduct. Supervisory systems must also be updated to monitor compliance effectively.
- Account Recommendations: Reg BI extends to recommendations of account types (e.g., brokerage versus advisory accounts), requiring the broker-dealer to recommend the account type that is in the customer's best interest.18
The Securities and Exchange Commission (SEC) and FINRA actively examine broker-dealers for compliance with Regulation Best Interest. For example, the SEC's Division of Examinations and FINRA provide guidance and issue risk alerts to help firms understand and fulfill their obligations.17,16
Limitations and Criticisms
Despite its aim to enhance investor protection, Regulation Best Interest has faced limitations and criticisms. One major concern is that the rule does not explicitly define what constitutes a client's "best interest," leading to varying interpretations and applications across firms. Some critics argue that this lack of precise definition may limit the rule's overall effectiveness and still allows for some conflicts of interest to persist, falling short of a true fiduciary standard similar to that applied to registered investment advisers.,15
Another critique centers on the rule's scope, which primarily focuses on recommendations made at a specific point in time, rather than establishing a continuous duty to monitor a customer's account performance or overall client relationships.14 This contrasts with the ongoing fiduciary duty of investment advisers.13 Concerns have also been raised that the disclosures required by Reg BI, particularly the Form CRS Relationship Summary, may not always be sufficiently clear or effective in informing investors about the nuances of their relationship with a broker-dealer. The Mercatus Center, in an academic response, suggested that the SEC withdraw the regulation until it could demonstrate through a more robust economic analysis that the rule would likely reduce the transaction costs for parties involved.12
Regulation Best Interest vs. Suitability Standard
Regulation Best Interest (Reg BI) significantly elevates the standard of care for broker-dealers beyond the traditional suitability standard previously in place.
| Feature | Suitability Standard (Prior) | Regulation Best Interest (Reg BI) |
|---|---|---|
| Primary Focus | Recommending investments that are "suitable" for the client's profile (e.g., age, risk tolerance, goals). | Recommending investments that are in the "best interest" of the client, prioritizing the client's interests over the broker-dealer's. |
| Conflicts of Interest | Required disclosure of some conflicts, but less emphasis on mitigation or elimination. | Explicitly requires policies and procedures to identify, disclose, mitigate, and, in some instances, eliminate conflicts of interest.11 |
| Cost Consideration | Less explicit requirement to consider costs in relation to other suitable options. | Explicitly requires consideration of costs and fees associated with recommendations.10 |
| Standard Level | A lower standard, allowing for a range of suitable options, even if a less profitable one for the broker might be better for the client. | An enhanced standard, closer to a fiduciary duty, requiring the broker-dealer not to place their financial interest ahead of the customer's.9 |
| Ongoing Duty | Generally no ongoing duty to monitor client accounts after a transaction, unless specified. | Generally no ongoing duty after a transaction unless ongoing portfolio management is agreed upon. |
The key distinction is that while the suitability standard allowed a broker to recommend any of several suitable products, Reg BI aims to compel the recommendation of the single best product or strategy among suitable options, free from the firm's or individual's conflicting financial interests.
FAQs
What does "acting in the best interest" mean under Reg BI?
Under Regulation Best Interest, acting in the best interest means that a broker-dealer must recommend investments and strategies that prioritize the retail customer's financial interests over their own. This includes considering factors like costs, risks, and the customer's investment profile.8
Does Regulation Best Interest apply to all financial professionals?
No, Regulation Best Interest specifically applies to broker-dealers and their associated persons when they make recommendations to retail customers. Investment advisers are already held to a separate, typically stricter, fiduciary duty under the Investment Advisers Act of 1940.7,6
What is Form CRS?
Form CRS, or the Client Relationship Summary, is a standardized, plain-language document that broker-dealers and investment advisers must provide to retail investors. It summarizes the types of services offered, fees, conflicts of interest, required standards of conduct, and disciplinary history, helping customers understand their relationship with the firm.5,4
When did Regulation Best Interest become effective?
Regulation Best Interest was adopted by the SEC on June 5, 2019, became effective on September 10, 2019, and broker-dealers were required to comply with the rule by June 30, 2020.3
How does Reg BI address conflicts of interest?
Reg BI requires broker-dealers to establish, maintain, and enforce written policies and procedures to identify and address conflicts of interest. This involves disclosing material facts about conflicts and, in some cases, mitigating or eliminating those conflicts where disclosure alone is not sufficient to satisfy the best interest standard.2,1