Regulation Best Interest – Reg BI
Financial Advisers Must Act in the Best Interest of the Customer
The Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) have implemented significant changes to the standard of conduct that governs interactions between brokerage firms and their customers with the introduction of Regulation Best Interest, or “Reg BI,” which took effect on June 30. This regulation is an addition to the Securities Exchange Act of 1934, and it sets forth a “best interest” standard of conduct for broker-dealers and associated persons when recommending any securities transaction or investment strategy, including account types, to retail customers.
Reg BI builds upon and enhances the principles previously outlined in FINRA’s Suitability Rule (Rule 2111). This rule mandates that broker-dealers and their associated persons must have a reasonable basis to believe that a recommended transaction or investment strategy is suitable for the customer, based on diligent gathering of information about the customer’s investment profile. The rule specifies three main suitability obligations: reasonable-basis suitability, customer-specific suitability, and quantitative suitability.
Under Reg BI, broker-dealers are now required to place the financial or other interests of their customers ahead of their own and adhere to four core obligations: Care, Disclosure, Conflict of Interest, and Compliance. These obligations compel brokers to act with due diligence, fully disclose all relevant information, manage and disclose any potential conflicts of interest, and maintain and enforce policies designed to ensure compliance with the regulation.
For brokerage firms and their clients, navigating these changes can be complex and necessitates the involvement of a knowledgeable securities law firm. Such a firm can provide crucial guidance on compliance with Reg BI, ensuring that broker-dealers align their operations with the new standards. Securities law firms play a vital role in advising clients on how to adjust their policies and practices to meet the requirements of Reg BI, offering training for brokers, and developing comprehensive compliance programs.
Additionally, for investors and clients, a securities law firm can serve as an essential resource, offering advice on the implications of Reg BI and assisting in the evaluation of the suitability of investment recommendations made under this new standard. These legal experts ensure that the rights of investors are protected under the evolving regulatory landscape, fostering trust and integrity in the broker-client relationship.
Care Obligation
The care obligation requires that the BD, or an associated person of the BD, in making the recommendation, exercises reasonable diligence, care and skill to:
- Understand the potential risks, rewards and costs associated with the recommendation, and have a reasonable basis to believe the recommendation could be in the best interest of at least some retail customers;
- Have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer based on that retail customer’s investment profile and the potential risks, rewards and costs associated with the recommendation and does not place the financial or other interest of the BD or such natural person ahead of the interest of the retail customer; and
- Have a reasonable basis to believe that a series of recommended transactions, even if in the retail customer’s best interest when viewed in isolation, is not excessive and is in the retail customer’s best interest when taken together in light of the retail customer’s investment profile and does not place the financial or other interest of the BD or such natural person making the series of recommendations ahead of the interest of the retail customer.
Disclosure Obligation
The disclosure obligation requires a BD or associated person, prior to or at the time of the recommendation, to provide the retail customer, in writing, full and fair disclosure of:
- All material facts relating to the scope and terms of the relationship with the retail customer, including:
- That the BD or associated person is acting as a BD or an associated person with respect to the recommendation;
- The material fees and costs that apply to the retail customer’s transactions, holdings, and accounts; and
- The type and scope of services provided to the retail customer, including any material limitations on the securities or investment strategies involving securities that may be recommended to the retail customer; and
- All material facts relating to conflicts of interest that are associated with the recommendation.
Conflict of Interest Obligation
To satisfy the conflict of interest obligation, the BD must establish, maintain and enforce written policies and procedures reasonably designed to:
- Identify and, at a minimum, disclose, in accordance with the disclosure obligation, or eliminate, all conflicts of interest associated with such recommendations;
- Identify and mitigate any conflicts of interest associated with such recommendations that create an incentive for an associated person of a BD to place the interest of the BD or such natural person ahead of the interest of the retail customer;
- Identify and disclose any material limitations placed on the securities or investment strategies involving securities that may be recommended to a retail customer and any conflicts of interest associated with such limitations, in accordance with the disclosure obligation;
- Prevent such limitations and associated conflicts of interest from causing the BD or an associated person of the BD to make recommendations that place the interest of the BD or such associated person ahead of the interest of the retail customer; and
- Identify and eliminate any sales contests, sales quotas, bonuses and non-cash compensation that are based on the sales of specific securities or of specific types of securities within a limited period of time.
Compliance Obligation
In a new part of the general obligation, and in addition to the procedures required by the conflict of interest obligation, a BD must also establish, maintain and enforce written policies and procedures designed to achieve compliance with Regulation BI as a whole. These procedures must not only address conflicts of interest, but also compliance with the disclosure and care obligations. The SEC believes that, while creating an affirmative obligation with respect to Regulation BI as a whole, the compliance obligation provides sufficient flexibility to establish compliance procedures across a broad range of business models. A reasonably designed compliance program generally would also include controls, remediation of noncompliance, training, and periodic review and testing.