In 2019, the Securities and Exchange Commission adopted Regulation Best Interest (BI), redefining standards of professional conduct for broker-dealers and associated persons. The standard, which falls under the Securities Exchange Act of 1934, requires broker-dealers to follow the best interests of their clients when recommending securities or investment strategies that involve securities. Adhering to this standard is required for SEC compliance.
SmartAsset’s Advisor Marketing Platform can help you add new clients at your desired pace. Sign up for a free demo today.
Understanding Regulation Best Interest
Regulation Best Interest was first proposed in 2018 and formally approved by the SEC in 2019. In proposing Regulation Best Interest, the SEC aimed to hold broker-dealers to a higher standard of conduct, beyond the existing suitability rule, to ensure greater investor protections. The rule was officially implemented on June 30, 2020.
Under Reg BI, broker-dealers must consider the best interests of their clients when making investment recommendations. The standard is satisfied when these four obligations are met:
- Disclosure. Broker-dealers must provide certain disclosures to clients before making investment recommendations or at the time the recommendation is made. This disclosure must include all material facts about the investment products or services being recommended.
- Care. The care obligation requires broker-dealers to exercise reasonable diligence, care and skill when making investment recommendations.
- Conflict of interest. Broker-dealers must establish, maintain and enforce written policies and procedures to prevent conflicts of interest and address them when they occur. For example, a broker-dealer could not sponsor a contest that incentivizes employees to push the sale of a particular security.
- Compliance. The SEC also requires broker-dealers to establish policies that ensure compliance with Regulation Best Interest. They must also comply with record-making and recordkeeping requirements established under the standard.
Who Is Subject to Regulation Best Interest?
Regulation BI applies to broker-dealers, associated persons of broker-dealers and their retail customers. An associated person of a broker-dealer can refer to the following:
- Partners
- Officers
- Directors
- Branch managers
- Employees or other persons under the control of the broker-dealer
Under Reg BI, the conflict of interest and compliance obligations apply to broker-dealers alone. Disclosure and care obligations apply to broker-dealers and their associated persons.
A retail customer, meanwhile, is any person or legal representative of a natural person who receives securities or investment recommendations from a broker-dealer and uses the recommendation primarily for personal, family or household purposes. Using a recommendation means a customer has opened or will open a brokerage account with the broker-dealer, or that the broker-dealer benefits financially as a result of the recommendation, regardless of whether the customer has an account with them.
Regulation Best Interest vs. Fiduciary Standard
While broker-dealers are subject to Reg BI standards, registered investment advisors are held to a fiduciary standard instead. Under the fiduciary standard, RIAs must adhere to a duty of care and a duty of loyalty. As such, advisors must:
- Provide advice in clients’ best interest, based on their understanding of the client’s goals and objectives.
- Act with clients’ best interests in mind when executing trades or investment transactions.
- Disclose potential conflicts of interest or any relevant material facts concerning the advisor-client relationship.
Regulation Best Interest and the fiduciary standard appear similar, but there is a notable difference. The fiduciary standard duty applies to the advisor-client relationship in its entirety. Regulation BI, on the other hand, requires broker-dealers to act in the best interests of their clients only when making investment recommendations.
Ensuring Compliance With Regulation Best Interest
The SEC clearly outlines its expectations regarding compliance and what broker-dealers must do to satisfy them. Specifically, broker-dealers must create a written set of policies and procedures that ensure that Regulation Best Interest standards are always met. The SEC also recommends that broker-dealers include guidance in their compliance policies that cover:
- Controls
- Remedies for non-compliance
- Training
- Periodic review and testing
Regulation Best Interest also introduced new record-keeping requirements. Under these rules, broker-dealers must do the following:
- Maintain records of all information collected from and/or provided to retail customers to whom the broker-dealer makes investment recommendations.
- Retain records of information collected from or provided to retail customers for at least six years after their account was closed or from the date on which their information was last replaced or updated.
Additional Requirements Under Regulation BI
Regulation Best Interest requires broker-dealers to provide a relationship summary to retail customers. Form CRS is used to convey information about the following:
- Types of client and customer relationships the firm offers
- Types of services the firm offers
- Fees
- Conflicts of interest
- Required standards of conduct
- Disciplinary actions against the firm or its employees
This form should also tell customers how they obtain more information about the firm in question. The only time a registered broker-dealer will not need to file this form is if they have no retail investors to report the information to. Broker-dealers can submit these forms online through the Central Registration Depository (CRD). Broker-dealers who are also registered investment advisors would use Form ADV to submit a relationship summary through the Investment Advisor Registration Depository (IARD).
Frequently Asked Questions
Which Clients Are Impacted by Regulation Best Interest?
Clients of registered broker-dealers are impacted by Regulation Best Interest when receiving investment recommendations. Specifically, the SEC applies this standard to retail customers who use recommendations they receive from broker-dealers for personal, family or household purposes.
What Is the FINRA Suitability Rule?
FINRA’s suitability rule requires firms or associated persons to recommend securities or investment strategies that are suitable for their clients. The suitability standard does not require broker-dealers or advisors to act in the best interests of their clients when making recommendations.
What Are the Four Components of Regulation Best Interest?
The SEC specifies four obligations that must be met to satisfy Regulation Best Interest. They are a disclosure obligation, a care obligation, a conflict of interest obligation and a compliance obligation. Failing to meet any one of these obligations means that the Regulation Best Interest standard has not been met.
Bottom Line
Regulation Best Interest is intended to ensure investors are getting appropriate investment recommendations when working with broker-dealers. If you’re subject to this standard, it’s important to ensure full compliance not only for yourself but for any associated persons connected to your firm.
Tips for Growing Your Advisory Business
- Using an online lead generation service like SmartAdvisor can help you connect with investors who are ready to take the next step and work with a professional advisor. SmartAsset AMP (Advisor Marketing Platform) is our holistic marketing service financial advisors can use for client lead generation and automated marketing. Sign up for a free demo to explore how SmartAsset AMP can help you expand your practice’s marketing operation. Get started today.
- Maintaining compliance with regulatory guidelines is an essential business activity and one that may become time-consuming if you’re trying to handle it all yourself. Investing in a good compliance software program can streamline this process and ensure that you’re up to date on the latest regulations. And remember that if you’re an RIA firm, you must appoint a chief compliance officer (CCO) to oversee implementation and reporting of compliance policies.
Photo credit: ©iStock.com/PeopleImages, ©iStock.com/dolgachov, ©iStock.com/JackF