Regulation Best Interest

Reg BI replaced the suitability standard for retail broker-dealer recommendations and established a federally enforced best-interest standard. The rule was adopted by the SEC in 2019 and became effective June 30, 2020. Reg BI lives alongside the FINRA suitability rule (which still governs institutional and non-retail recommendations) and the know-your-customer rule (which still governs the underlying KYC duty for all customers).

Scope: When Reg BI Applies

Reg BI applies to a broker-dealer's recommendation of any securities transaction or investment strategy (including account-type recommendations and rollovers) made to a retail customer.

A "retail customer" is a natural person, or the legal representative of a natural person, who uses the recommendation primarily for personal, family, or household purposes.

For retail customers, Reg BI is the operative best-interest standard. For non-retail (institutional) customers, the suitability rule continues to apply.

Think of it this way: Reg BI splits the customer universe into two lanes. A natural person buying for their household goes into the Reg BI lane. A pension fund or a corporate treasury goes into the suitability lane. The same product, the same firm, the same rep can have different obligations depending on which lane the customer is in.

Exam Tip: Gotchas

• Reg BI applies to recommendations of account types and rollovers, not only to specific securities transactions. A rep recommending that a customer roll a 401(k) into an IRA at the firm is making a Reg BI recommendation.
• A natural person buying through a small business entity may still be a retail customer if the recommendation is used primarily for personal, family, or household purposes. The form of the account (entity vs. individual) does not control; the use of the recommendation does.

The Four Component Obligations

Reg BI is satisfied only when all four component obligations are met. A failure of any single obligation is a Reg BI violation.

Disclosure Obligation Detail

The Disclosure Obligation requires written disclosure of:

• The firm's capacity (broker-dealer or, where applicable, dual-registered with an investment adviser)
• All material fees and costs that apply to the customer's transactions, holdings, and accounts
• The type and scope of services provided
• All material conflicts of interest associated with the recommendation
• Any material limitations on the securities or investment strategies recommended (e.g., proprietary products only, a limited menu)

Form CRS (covered in the next section) is one of the disclosure mechanisms used to satisfy parts of this obligation. Reg BI disclosure can also be satisfied through trade-confirmation disclosures, prospectus delivery, the firm's account agreement, and Form CRS in combination.

Exam Tip: Gotchas

• Disclosure does not cure a violation of the other obligations. A firm cannot disclose its way out of a poor recommendation. A Care Obligation violation persists even if the conflict was disclosed.

Care Obligation Detail

The Care Obligation has three sub-prongs:

• Understand: the firm must understand the potential risks, rewards, and costs of the recommendation. This is parallel to the reasonable-basis component of suitability.
• Best interest: the firm must have a reasonable basis to believe the recommendation is in the customer's best interest. Costs must be explicitly considered, including the cost of the recommended security relative to reasonably available alternatives.
• Series of transactions: when recommending a series of recommended transactions (or a rollover, an exchange, or a switch), the firm must have a reasonable basis to believe the series is not excessive in light of the customer's profile. This is parallel to the quantitative-suitability obligation.

Think of it this way: The Care Obligation is Reg BI's counterpart to all three layers of suitability (reasonable-basis + customer-specific + quantitative), elevated to a best-interest standard. Costs are a required factor under Reg BI; under suitability, costs are relevant only as part of the overall suitability analysis but are not a required element.

Exam Tip: Gotchas

• Reg BI requires explicit consideration of cost and lower-cost reasonable alternatives. A firm that recommends a Class C share when a Class A share with a breakpoint is reasonably available violates the Care Obligation, even if the Class C purchase would have been suitable under the suitability rule.
• Best interest is a higher standard than suitability. A recommendation can be suitable for a customer (reasonable basis to believe it fits the profile) without being in the customer's best interest (the best of the reasonably available alternatives).

Conflict of Interest Obligation Detail

The Conflict of Interest Obligation requires the firm to:

• Identify all conflicts associated with recommendations to retail customers
• Disclose them under the Disclosure Obligation, AND/OR
• Mitigate them through controls (compensation grids, supervisory review, oversight committees), AND/OR
• Eliminate them outright when required

Reg BI mandates elimination of certain conflicts:

• Sales contests tied to specific securities or types of securities within a limited time period
• Sales quotas tied to specific securities or types of securities within a limited time period
• Bonuses tied to specific securities or types of securities within a limited time period
• Non-cash compensation tied to specific securities or types of securities within a limited time period

Production-based compensation tied to overall business (gross production grids based on total commissions across all products) is permitted. The prohibition targets product-specific incentives that push reps toward particular securities at the expense of customer interests.

Exam Tip: Gotchas

• Reg BI requires firms to ELIMINATE (not just disclose) sales contests and bonuses tied to specific securities. Disclosure is not sufficient for product-specific contests; the firm must remove them entirely.
• Production-based compensation tied to total firm production is permitted. A firm can pay a rep based on overall gross commissions; the firm cannot pay an extra bonus for selling Product X over Product Y.

Compliance Obligation Detail

The Compliance Obligation is the umbrella requirement: the firm must establish, maintain, and enforce written policies and procedures (WSPs) reasonably designed to achieve compliance with Reg BI as a whole, including the other three obligations.

This obligation pairs with the FINRA supervisory-system requirement. A firm that has Disclosure, Care, and Conflict of Interest WSPs but does not periodically test, monitor, and update them can violate the Compliance Obligation independent of any other violation.

Exam Tip: Gotchas

• The Compliance Obligation is independent of the other three. A firm that satisfies Disclosure, Care, and Conflict obligations on a transaction-by-transaction basis can still violate Reg BI if its overall policies and procedures are inadequate.

Reg BI vs. Suitability Comparison

The exam tests "which standard applies?" repeatedly. The answer turns on the customer.

Think of it this way: Reg BI and the suitability rule coexist in the rulebook. Both apply to a broker-dealer, but to different customer populations. The exam tests "retail natural person = Reg BI; institutional or non-retail = suitability." Once you know the customer type, you know the standard.

Exam Tip: Gotchas

• Reg BI is HIGHER than suitability. A recommendation can pass suitability (reasonable basis to believe suitable) and fail Reg BI (not in the customer's best interest because a lower-cost alternative was reasonably available).
• Reg BI applies only at the time of recommendation, not as an ongoing duty to monitor accounts. After the recommendation is made, the firm's duty under Reg BI ends; ongoing relationship duties may arise under other rules (the supervisory system, the know-your-customer rule).