Regulation Best Interest

Reg BI is the SEC's response to the mandate of Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, directing the SEC to study the standards of conduct applicable to broker-dealers and investment advisers and to adopt rules if necessary and appropriate — and its adoption completed a decade-long regulatory debate about whether broker-dealers who provide personalised investment advice to retail customers should be subject to a full fiduciary duty equivalent to that applicable to investment advisers under the Investment Advisers Act of 1940. 

Regulation Best Interest is directly and extensively tested on the Series 7 and Series 65 examinations in the context of broker-dealer conduct standards, the four component obligations, the retail customer definition, the comparison with suitability under FINRA Rule 2111, and the distinction from the investment adviser fiduciary duty.

The General Obligation — The Foundational Standard

The general obligation of Regulation Best Interest — stated in 17 CFR 240.15l-1(a)(1) — requires that a broker-dealer or associated person, when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer, shall act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker-dealer or associated person ahead of the interest of the retail customer.

This general obligation contains two distinct and equally important components. 

The affirmative component — act in the best interest of the retail customer — requires that the broker-dealer's recommendation be oriented toward achieving the best outcome for the customer given their investment profile and circumstances. 

The negative component — without placing the financial or other interest of the broker-dealer ahead of the interest of the retail customer — specifically prohibits the recommending broker from prioritising its own compensation, product quotas, or other financial interests when selecting among reasonably available alternatives.

The SEC deliberately chose not to define the term best interest in the rule text, following the same approach used in the Investment Advisers Act's treatment of the investment adviser fiduciary duty — instead providing through the four component obligations a framework of specific behaviours that together constitute compliance with the best interest standard. 

A broker-dealer that satisfies all four component obligations simultaneously satisfies the general best interest obligation.

The Retail Customer Definition — Who Reg BI Protects

Regulation Best Interest applies only to recommendations made to retail customers — a defined term under 17 CFR 240.15l-1(b)(1) that limits the rule's scope to natural persons — individuals — or the legal representatives of such individuals who receive a recommendation primarily for personal, family, or household purposes.

The retail customer definition specifically excludes institutional investors, sophisticated counterparties, and entities — corporations, partnerships, trusts used for non-personal purposes, and other non-natural person entities do not qualify as retail customers for Reg BI purposes regardless of their size or sophistication. 

This limitation reflects the SEC's judgment that natural persons making personal investment decisions require the heightened conduct standard that Reg BI provides, while institutional market participants have sufficient sophistication, resources, and bargaining power to negotiate appropriate standards of conduct through their commercial relationships with broker-dealers.

The primarily personal, family, or household purposes qualifier further limits the retail customer definition — a natural person who uses a brokerage account exclusively for business investment purposes rather than personal investing may not be a retail customer even though they are an individual. 

In practice the vast majority of individual investors maintaining retail brokerage accounts at broker-dealers are retail customers whose recommendations are subject to Reg BI.

The Four Component Obligations — The Implementation Framework

Regulation Best Interest establishes a general best interest obligation that is satisfied through compliance with four specific component obligations — each addressing a different dimension of the broker-dealer's relationship with retail customers and its management of conflicts of interest. 

These four obligations are the most directly and extensively tested aspect of Reg BI in the securities licensing examination curriculum.

The Disclosure Obligation

The disclosure obligation — codified at 17 CFR 240.15l-1(a)(2)(i) — requires the broker-dealer, prior to or at the time of the recommendation, to provide the retail customer in writing with full and fair disclosure of all material facts relating to the scope and terms of the relationship with the retail customer and all material facts relating to conflicts of interest associated with the recommendation.

The disclosure must include that the broker-dealer is acting as a broker-dealer — not as an investment adviser — with respect to the recommendation, the material fees and costs that apply to the customer's transactions, holdings, and accounts, the type and scope of services provided including any material limitations on the securities or investment strategies that may be recommended, and all material facts relating to conflicts of interest associated with the specific recommendation being made.

The most significant practical implementation of the disclosure obligation is the Form CRS — the Customer Relationship Summary — which broker-dealers and investment advisers must deliver to retail customers before or at the time of entering a new relationship. 

Form CRS provides a standardised disclosure document in plain language describing the types of services offered, the fees and costs, any material limitations on services, legal standards of conduct, and conflicts of interest — enabling retail customers to compare broker-dealer and investment adviser relationships and understand the applicable conduct standard before making a choice.

The Care Obligation

The care obligation — codified at 17 CFR 240.15l-1(a)(2)(ii) — requires the broker-dealer to exercise reasonable diligence, care, and skill in making the recommendation — specifically by understanding the potential risks, rewards, and costs associated with the recommendation and having a reasonable basis to believe that the recommendation is in the best interest of at least some retail customers — the reasonable basis determination — and is in the best interest of the specific retail customer based on that customer's investment profile — the customer-specific determination — and does not place the financial or other interest of the broker-dealer ahead of the interest of the retail customer.

The care obligation is the component most directly related to the prior FINRA Rule 2111 suitability framework — it requires the broker-dealer to understand what it is recommending and to match the recommendation to the customer's specific circumstances. 

However the care obligation goes beyond the suitability framework in one critically important respect — it requires the broker-dealer to consider the costs and reasonably available alternatives before making a recommendation. 

Under the prior suitability standard a broker who recommended a higher-cost product when an equally suitable lower-cost alternative was available did not necessarily violate the suitability rule — both products were suitable. 

Under the care obligation the broker must consider whether the higher-cost product is in the customer's best interest when a lower-cost alternative providing equivalent or superior outcomes is available — the cost differential must be justified by a specific benefit to the customer.

The Conflict of Interest Obligation

The conflict of interest obligation — codified at 17 CFR 240.15l-1(a)(2)(iii) — requires the broker-dealer entity — not the individual associated person — to establish, maintain, and enforce written policies and procedures reasonably designed to identify and fully and fairly disclose all material conflicts of interest associated with the firm's recommendations, identify and mitigate any conflicts of interest that create an incentive to place the firm's interest ahead of the customer's interest, identify and disclose or eliminate any material limitations on the securities or strategies the firm recommends, and identify and eliminate sales contests, sales quotas, bonuses, and non-cash compensation tied to the sale of specific securities or types of securities within a limited time period.

The specific prohibition on sales contests tied to specific securities is one of the most practically significant provisions of the conflict of interest obligation — it directly prohibits the types of incentive programmes that historically created the most severe conflicts between broker financial interests and customer best interests. 

A broker-dealer may not incentivise its registered representatives to sell a specific security or product during a specific contest period through prizes, travel, or other non-cash awards because such incentives create powerful financial pressure to recommend the contest security regardless of whether it is the best available alternative for each specific customer.

The Compliance Obligation

The compliance obligation — codified at 17 CFR 240.15l-1(a)(2)(iv) — requires the broker-dealer entity to establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with all of Regulation Best Interest. 

The compliance obligation is the supervisory infrastructure component of Reg BI — requiring the firm to have systems, controls, and procedures that make compliance with the other three obligations operationally achievable and verifiable.

The compliance obligation is distinct from the conflict of interest obligation in its scope — while the conflict of interest obligation addresses the specific problem of managing conflicts through policies and procedures, the compliance obligation addresses the broader need for a firm-wide supervisory framework that detects, prevents, and remediates violations of any Reg BI component. 

A firm that has excellent disclosure and care practices at the individual representative level but lacks adequate supervisory review to detect violations has likely failed the compliance obligation even if most individual recommendations comply with the other obligations.

Regulation Best Interest Versus FINRA Rule 2111 Suitability — The Critical Comparison

The comparison between Regulation Best Interest and the FINRA Rule 2111 suitability standard is the most directly and consistently tested regulatory conduct standard comparison on the Series 65 examination — requiring candidates to articulate precisely how the two standards differ and why the SEC considered Reg BI an upgrade from the prior suitability framework.

Under FINRA Rule 2111 suitability the broker-dealer must have a reasonable basis to believe that a recommended transaction or investment strategy is suitable for the customer based on the customer's investment profile — including age, financial situation, investment objectives, risk tolerance, time horizon, and other relevant factors. 

The suitability standard does not require that the recommendation be the best available option — only that it be suitable for the customer. 

If two products are equally suitable for a customer, the broker-dealer may recommend whichever produces the higher commission without violating suitability — the financial interest of the broker is not constrained by the suitability framework as long as the recommendation itself is suitable.

Under Regulation Best Interest the broker-dealer must act in the customer's best interest without placing its own financial interest ahead of the customer's. 

This language specifically addresses the gap that suitability left open — a broker recommending a higher-cost fund when an equally or more suitable lower-cost fund is available must justify that recommendation in terms of the customer's best interest. The fact that both funds are suitable is not sufficient — the broker must affirmatively consider whether the higher-cost choice serves the customer better or whether the cost difference is simply increasing the broker's compensation at the customer's expense.

FINRA Rule 2111 does not apply to recommendations subject to Regulation Best Interest — the two standards are mutually exclusive for retail customer recommendations by broker-dealers effective June 30, 2020. The reasonable-basis and quantitative suitability obligations of Rule 2111 continue to apply to non-retail recommendations and to the firm-level analysis of whether strategies are suitable for any investors at all.

Regulation Best Interest Versus the Investment Adviser Fiduciary Duty

The SEC explicitly stated in the adopting release for Reg BI that the best interest standard is not identical to the fiduciary duty applicable to investment advisers under the Investment Advisers Act of 1940 — a distinction that remains one of the most actively debated questions in securities regulation.

The investment adviser fiduciary duty under Advisers Act Sections 206(1) and 206(2) — interpreted in the SEC's 2019 fiduciary interpretation Release IA-5248 — is a continuous duty that applies throughout the entire advisory relationship, requiring the adviser to act in the client's best interest in all aspects of the relationship including making recommendations, managing portfolios, selecting service providers, and managing conflicts. 

The fiduciary duty applies to every aspect of the advisory relationship — not only to specific recommendation events.

Regulation Best Interest applies at the moment of a recommendation — it is a transaction-specific standard rather than a relationship-wide ongoing duty. 

The broker-dealer's Reg BI obligations are triggered by a specific recommendation and are discharged at the time of that recommendation — there is no ongoing Reg BI monitoring obligation between recommendations of the type that the investment adviser's continuous fiduciary duty requires.

This distinction is important for the Series 65 examination because investment advisers must satisfy their fiduciary duty continuously throughout the client relationship — including when they are not making specific recommendations — while broker-dealers must satisfy Reg BI at the time of each specific recommendation. 

The broker-dealer's obligations between recommendations — absent a specific recommendation — are not governed by Reg BI but rather by the general conduct standards applicable to all broker-dealers.

Examination Relevance and Key Takeaways

Regulation Best Interest is tested on the Series 7 and Series 65 examinations in the context of broker-dealer conduct standards, the four component obligations, the retail customer definition, the comparison with FINRA Rule 2111 suitability, and the distinction from the investment adviser fiduciary duty.

The key points to retain are these.

Regulation Best Interest — codified at 17 CFR 240.15l-1 — was adopted by the SEC on June 5, 2019 and became effective June 30, 2020. 

It requires broker-dealers and associated persons when making recommendations to retail customers to act in the best interest of the retail customer without placing the broker-dealer's financial or other interest ahead of the customer's interest. 

A retail customer is a natural person or their legal representative who receives a recommendation primarily for personal, family, or household purposes — institutional investors and non-natural persons are not retail customers. 

FINRA Rule 2111 does not apply to recommendations subject to Regulation Best Interest — the two standards are mutually exclusive for retail customer recommendations.

The four component obligations are the disclosure obligation — full and fair written disclosure of material facts about the relationship and conflicts of interest before or at the time of the recommendation including through Form CRS; the care obligation — exercise reasonable diligence, care, and skill, understand risks, rewards, and costs of the recommendation, have a reasonable basis to believe it is in the best interest of retail customers generally and the specific customer based on their investment profile, and consider costs and reasonably available alternatives; the conflict of interest obligation — applicable to the broker-dealer entity only, requiring written policies to identify, disclose, and mitigate conflicts and to eliminate sales contests tied to specific securities; and the compliance obligation — written policies and procedures reasonably designed to achieve compliance with all of Reg BI firm-wide.

The critical distinction from FINRA Rule 2111 suitability is that suitability requires only that a recommendation be suitable — it does not prohibit recommending a higher-cost suitable alternative over a lower-cost equally suitable one. 

Reg BI requires the broker to act in the customer's best interest without placing its own financial interest ahead of the customer's — specifically requiring consideration of costs and reasonably available alternatives. 

The critical distinction from the investment adviser fiduciary duty under the Investment Advisers Act of 1940 is that Reg BI is a transaction-specific standard triggered by a recommendation, while the investment adviser fiduciary duty is a continuous relationship-wide obligation applying throughout the entire advisory relationship even between specific recommendations.